Creative Destruction
Columbia Management
By Robert McConnaughey
June 13, 2012
“ . . .mutation — if I may use that biological term — that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism . . . Every piece of business strategy acquires its true significance only against the backdrop of that process . . . It cannot be understood irrespective of it or, in fact, on the hypothesis that there is a perennial lull.” - Joseph A. Schumpeter, “Capitalism, Socialism and Democracy” (Harper, 1975)
Creative Destruction is always at play in competitive markets of all kinds. Given the metamorphic pressures caused by today’s over-levered and structurally low- growth global economy, the forces of Creative Destruction are perhaps far greater than normal. Low overall growth and historically high profit margins create a particularly potent environment in which corporations compete for their share of a potential profit pool. Revenue growth is increasingly hard to come by and cost-reduction opportunities may have been stretched to their outer limits. So growth strategies will increasingly be driven by the quest for market share gains which inevitably come at the expense of others. The same logic holds for the economies of nations. When there is less growth to go around, high unemployment, and interest costs/ future entitlement liabilities weigh heavily on options, the forces of international competition ratchet up, with significant consequences to be considered.
The markets have focused largely of the “Destruction” side of the ledger and reasonably so. Profit growth will definitely be challenging in this environment. Examining the challenges of Creative Destruction as it relates to the health of nations is a slightly different task. It is easier to advocate for the fertile ground of growth that comes from allowing “Destruction” among companies than it is for nations. The human costs of policy options ranging from severe austerity to a money-printing driven inflation and devaluation of currencies are not to be taken lightly. The ethics of these options weighs on decision makers, but we must also consider the political calculations of elected officials. Rarely do candidates get elected of prescriptions of pain. Human nature is such that deferral of consequences and selectively illogical optimism allows for “can-kicking” to usually win out over “medicine taking.” In today’s world, most proposed solutions to excessive leverage involve collectivizing risks away from troubled pockets to be shared with broader societies.
That was the nature of the Troubled Asset Relief Program (TARP) rescues in the U.S. as well as most actions taken and contemplated in the European Union (EU). The failure of certain constituents is delayed by spreading those costs over a broader base. A sound strategy if the dilution across the broader base is modest enough such that the new collective entity is not fatally infected with the disease of the rescued entity. This is my concern with the situation in the EU.
With increasing weakness in larger nations, Germany is simply not large enough to carry the weight of the weaker players given the lack of possible unity on fiscal issues and appropriately competitive cost structures. Even with German support, the competiveness of southern Europe is not improved under the common currency even with some of the capital holes “band-aided” over. It may well take allowing selective “Destruction” and revaluation to get to an actual cure for what ails the weaker players in Europe. Scary though that may be, it might ultimately put Europe on a more sustainable future versus continued “extend and pretend” tactics.
Disclosure
The views expressed are as of 6/11/12, may change as market or other conditions change, and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts are accurate.
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