Merger mania isn’t good news
Martin Sorrell, the boss of WPP, one of the biggest advertising agencies in the world, gave an interesting interview to the Guardian at the end of August. Sorrel warned that, with all the uncertainty in the world (Syria/Iraq, Russia/Ukraine, the Eurozone stagnation and so on) firms are unwilling to take risks and invest. Instead they are looking to mergers and acquisitions (takeovers to you and me) to grow their businesses.
Although many business people like to cultivate a buccaneering image, most businesses are cautious and risk averse. As health service guru and businessman Roy Lilley, says in an excellent recent blog, “the business of business is the avoidance of risk” . And the bigger the pile of money they’re sitting on, the more cautious they tend to be.
Although a lot of executives seemed to get a thrill out of mergers and takeovers, they are a timid, risk averse strategy for growing a business. It’s less risky to take over an existing firm, especially a successful one, with its existing brands and assets, than risk splurging treasure on the hard work of developing new products or cracking a new market.
This is probably one of the reasons why the global economy, especially in Europe and America, is struggling to get out of second gear, even six years after the great crash. Individual firms may grow through mergers and takeovers, by grabbing a bigger share of the pie, but the size of pie doesn’t grow at all.
In fact, rather the reverse. It’s rare for a merged firm to produce more or employ more people than the firms did when they were separate entities. Product lines shrink, plants close, people get laid off, there is usually a retrenchment to the home country of the dominant partner. And many takeovers are really about taking out a competitor or stripping assets.
Shareholders may do well, at least in the short term, as takeover activity tends to swell share prices. Workers usually suffer, whatever promises are made at the time; many lose their jobs or see their wages and conditions cut. Overall, mergers and takeovers tend to mean lower output, lower investment and fewer jobs.
(We saw this starkly in both the stock market bubble of the 1980s and the dot-com bubble around the turn of the century. On both occasions, frenetic takeover activity drove stock prices through the roof but in comparison economic performance, in terms of output, jobs and incomes, was underwhelming to say the least.)
Takeovers may be right for the firm or firms concerned, but bad for the economy as a whole, especially when everyone’s at it. This is another example of the conflict between individual behaviour and collective outcomes which haunts economics. As long ago as the 1930s, Keynes wrote about the “paradox of thrift”: while it was sensible for individual families to save during hard times, if everyone cut their spending, the times would get harder still. We should all be saving a lot more, but if we all saved, say, another 10% of our income, the economy would collapse like a house of cards.
Once you start seeing these conflicts, it’s hard to stop: it’s obviously sensible for young people to “get a foot on the ladder” and buy their first home as soon as they can. But the more of them do so, the more unaffordable houses become. It’s obviously right for you to take your bright kid out that mediocre local school, but the more people follow suit, the worse the school gets.
The remarkable thing about these vicious circles, with which we’re all familiar, is that mainstream economics ignores them completely. Instead, it asserts that individuals rationally pursuing their own interests will ALWAYS produce the optimum result. There is no such thing as a “collective” interest – just the sum of lots of individual decisions. After all, adding up lots of individual good decisions must produce a good result, right?
The godfather of market economics, Adam Smith, seemed to support this simplistic idea when he wrote in The Wealth of Nations that “what is prudence in the conduct of every private family can scarce be folly in that of a great Kingdom”. It’s also the thinking behind Mrs Thatcher’s famous claim that “there is no such thing as society. There are individual men and women, and there are families.”
It should be easy to see that this can only be true if each individual decision has no effect on anyone else – impossible in any environment in which human beings live together, let alone a highly connected and mutually dependent society like ours.
This idea of isolated individuals going about their business with no impact on each other is one of the central fantasies of what James Meek, in his recent Guardian essay on privatisation, calls the “market belief system”. Market fanatics have to believe it because without it, the whole neo-classical edifice of free market economics crumbles like wet cardboard.
This is really a version of the prisoners dilemma or the fallacy of composition – where what is true of the parts is assumed to be true of the whole. At the theoretical level, this disconnect between microeconmics (the study of the behaviour of people and firms) and macroeconomics (the study of the economies of countries or regions) has never been resolved. But that’s a tale for another day.