“Developing Countries and Public Interest Capitalism”

Developing Countries and Public Interest Capitalism
Looking beyond Return on Equity for Successful and Sustainable Businesses
                                             -By George Hara and Manish Uprety F.R.A.S.
                                   
The twenty-first century is being hailed as Asia’s Century with the balance of World GDP significantly shifting towards the continent. While in 1950 it was less than 5% of World GDP, the Asian share  now accounts for about a third of it, and is forecast to be over half of it by 2050. With increasing economic output comes geo-political weight and a greater responsibility for the governments to secure the betterment of its citizens.
Capitalism it is argued is a social system in which the government is exclusively devoted to the protection of individual rights, including property rights — one in which there exists absolutely no government intervention in the economy.
However, causing a widening wealth disparity, the American and British style of Capitalism that has long been considered as the global standard may be reaching a dead end. Therefore to overcome the challenge the writers of the article advocate Public Interest Capitalism (PIC). While George Hara conceptualised the notion of PIC, Manish Uprety is interested to explore the relevance and application of PIC in the context of developing economies.
Public Interest Capitalism is a corporate philosophy where in the long run a company sustains fair distribution to all the members who contribute to the company, including its employees, suppliers, customers, community, and shareholders. The fair distribution based on public interest capitalism reduces the increasing disparity and enables a more robust middle class.
Shareholder Capitalism and limitations of ROE and IRR
The concept of Capitalism increasingly prevalent in the globalized world today is based on the idea that the company is owned by stockholders. The style of management prevalent in the US with excess focus on shareholder interests and return on equity (ROE) may one day lead many socially beneficial companies to failure. In a company governed solely by stockholders’ interests, stockholders want the highest possible return in the short term. If this kind of Capitalism prevails, the results will be catastrophic.
Internal rate of return (IRR) is a popular measurement used by investors. Because IRR is designed for higher returns when a particular amount of cash is returned to the investor in a shorter term, the measurement tends to cater towards speculators rather than investors. If this measurement is applied to gauge the performance of whole industries that make up the real economy, lengthy research and development that lower the IRR have no place. In other words, IRR cannot be used to measure the profitability of industries such as manufacturing.
The drawback of this mindset is that it leads the investors towards speculation rather than investment. To the speculative investors, industries such as manufacturing and retail distribution are not efficient since they require substantial R&D or the holding of inventory: their IRRs are too low. Stockholders also tend not to agree with long-term projects, which naturally makes the management more short-term oriented.
If speculators become a major stockholder, they try to make the company’s business that supports the real economy turn into a fund-like, finance-based business. These problematic speculators expect the management not to focus on R&D but on M&A. They demand that retained earnings be distributed as dividends or through stock buybacks – all to maximize short-term returns for shareholders.
Speculation is a zero-sum game that creates winners and losers – where wealth becomes concentrated into a small group of individuals and the remaining majority loses everything. Imagine that a hundred people bet $100 each in a game of rock-paper-scissors. One person wins the $10,000 pot, and the other ninety-nine people lose. The sum of the money involved is always $10,000, and no new value is created during the speculative game.
Shareholder capitalism, along with market fundamentalism, eventually leads to speculative financial capitalism. Speculation always creates a bubble economy, which of course is a major cause of instability in the financial markets throughout the world.
Public Interest Capitalism- A Sustainable Option
Hence a company should be considered as a public institution and should not be construed solely belonging to its stockholders. The profit must be distributed to all of the company’s stakeholders (called “Shachu” in Japanese) including its employees, customers, suppliers, local communities, and even the planet. While a stockholder who supports the company’s growth by holding one’s shares for the long-term could be considered as one of the true owners of the company, the goal of many investment funds is simply to artificially boost the stock price for immediate gains. These funds should not be considered foremost when deciding how to run a company.
Though there is always a demand for lowering corporate taxes, there is not much evidence to show that it leads to higher wages or more business investments. Instead, most of the profit is allocated to stockholders as dividends or through stock buyback programs with the intention of increasing share price.
When a company uses its funds to maximize shareholder returns rather than to invest for growth, long-term prospects of the company decline, and therefore long-term stockholders may suffer a loss. The employees are also discouraged to spend money since their raises always seem very limited compared to shareholder return. As a result, employment stalls, and the income gap widens. The disparities become a cause of conflict that makes economies implode and the world more unstable.
Under the Public Interest Capitalism, a company is considered as a public institution, and therefore its purpose is to contribute towards the society through its business. In order to achieve this, the company must:
1. Allocate its profit to all of its stakeholders or “Shachu” that support the company, not just to its stockholders;
2. Strive for sustainable growth; and
3. Continually adapt and challenge itself to improve existing products and services offerings and venture into new growth businesses.
Because the shareholder-centric model of Capitalism (“Shareholder-centric Capitalism”) demands that management teams maximize share prices in the short run, long-term R&D projects become less prioritized and pushed aside. In particular, ambitious R&D projects that have the potential to create new core businesses and even an entirely new industry are no exception.
This necessitates medium- and long-term risk taking and investment in order to create and maintain stable economic growth in the developed countries of the 21st century, the development of new businesses and future key industries based on Public Interest Capitalism is crucial.
The idea of Public Interest Capitalism plays an important role not only in advanced countries but also in underdeveloped countries, because it encourages economic independence. In 2030, the population of advanced nations will only account for 12% of the whole world’s population but the remaining 88% will live in the developing world, primarily in Asia, Africa and Latin America. Companies in advanced countries need to establish strong ties with underdeveloped countries in order to survive. However, shareholder-centric management and capitalism will only cause tension in the process making Public Interest Capitalism a viable and sustainable option.
ROC (Return on Company) Index- A Holistic Index
Instead of having a propensity to value a company through its ROE (Return of Equity), the Public Interest Capitalism’s research division at the Alliance Forum Foundation has come up with “ROC” (Return On Company), a new index that measures the value of the company from a holistic perspective of its stakeholders. The ROC (Return on Company) evaluates the sum of all the returns to the entire Shachu.
The company that distributes its profit to the entire Shachu will eventually bring a higher return to stockholders. A higher ROC tends to correlate with a higher future ROE, which implies that ROC is a long-term version of ROE.
ROC is an area of growing interest for the industry and academics. There is an inherent need to develop a new investment theory by linking ROC with stock prices. The positive correlation between the two would even motivate the speculators to invest in companies with sustainability and a fair profit distribution to Shachu, which would then spur the stock prices even further. The mainstreaming and establishing of ROC as a benchmark would lead to investors buying stocks or bonds of companies that act as “public institutions.”PIC’s relevance for the Developing Economies

“Public Interest” refers to economic and general well- being of ourselves, our children and the future generation. A “company” should be a public institution that contributes to the society through its business. There are three pieces of management philosophy according to public interest capitalism: (1) fair distribution of the company’s profit, (2) long-term sustainability of the company and (3) entrepreneurship to create and improve the business.
The characterising features of developing countries are low per capita real income, high population growth rate/size, high rates of unemployment, dependence on primary sector and export of primary commodities. As countries move on the development trajectory, their economies gradually become isomorphic in terms of its constituents. For example, Japan, India and Sri Lanka though on various levels of development have the service sector contributing over 60 % in their respective economies. In the due course, growing economies face similar kind of challenges and need to set their priorities and focus areas. Cross-sector integration of technologies in IoT (Internet of Things), telecommunications, artificial intelligence, food, materials, and chemicals with healthcare is an important evolving area. A process including the careful collection and selection of information about new technologies both domestically and internationally, along with goal setting and speedy decision as well as creativity is crucial to bridge various divides. It demands an innovative regulatory policy.
Under the Public Interest Capitalism paradigm, governments have to play a major role in solving these challenges by building a robust ecosystem to realize technology and policy innovation in the priority areas. While projects should be led by the private sector, vision and goal setting by national leaders is essential.

Soon it shall be two decades when the philosophy of Public Interest Paradigm was first pitched to shift the focus away from the excessive shareholder capitalism. Since then public interest capitalism has not only been adopted by leading management teams but has become the basis of policy changes to defy short-termism. With the West also beginning to notice the damaging effects shareholder capitalism has on the health of many companies that are engines of the economy and industry, the tide is finally turning in favour of public interest capitalism. It is quite prudent for the developing economies to take a page out of the book of public interest capitalism and use the very learning to build responsible companies contributing toward a healthy society and sustainable economy.

 

* George Hara is a Cabinet Advisor to the Japanese Prime Minister Shinzo Abe. He is a leading venture capitalist who is the Group Chairman of DEFTA Partners and Chairman of the Board of the Alliance Forum Foundation.  In 2019 George Hara was included in the list of Top Ten Japanese Leader since 1945 World War II.

 

Manish Uprety F.R.A.S. is an ex-diplomat from India.

 

 
** This article is an edited version of the original published in the May-June 2019 print edition of OSL Magazine, Sri Lanka. ISSN 2630-7359

 

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