MANY observers find it difficult to reconcile to the logic behind the unabated rise of the KSE-100 stock index. To the optimists, each one of these worried commentators looks like the proverbial doubting Thomas who refuses to see the brighter side of any picture, more so the improving economic landscape. Going by official claims of growth and poverty reduction, there is good reason to believe that, perhaps, this is the case.
KSE-100 is not the only stock index that has been rising over the past two and a half years though, compared to stock indices anywhere else in the world its rise has been bewildering. Stock indices in several developing and developed countries exhibited the same pattern and for much longer. This was unmistakably visible from the sustained rise of stock indices in South and South East Asia – regions that experienced a severely de-capacitating economic down turn in the late 1990s.
According to the Economist magazine, over the past three years corporate profits in the US have risen by 60 per cent and last year the sector recorded the highest after-tax profit in the past 75 years. According to research conducted by Union Bank of Switzerland, last year, as a proportion of GDP, corporate profits in G-7 countries rose to their highest level in the past 25 years. Interestingly enough, rise in corporate profits far exceeded GDP growth in these countries.
A remarkable phenomenon that accompanied these trends in corporate profits was the slowing down of economies, especially in the G-10 group, with the result that in all these countries (and some of the developing countries as well) increase in corporate profits surpassed GDP growth by a wide margin. This is no ordinary coincidence. It marks the creation of a serious economic distortion; viewed in that perspective, high corporate profitability loses much of its lustre because it is accompanied by growing poverty and unemployment.
Rising economic inequalities bring into focus the distortions that need the focused attention of policy-makers. Although optimists have come out with an array of explanations about the amazing rise of corporate profitability (focused cost-cutting, economies afforded by information technology, automation of production processes, and out-sourcing to markets with cheaper labour viz. China and India) the fact is that declining labour wages account for the bulk of the rise in corporate profitability.
That this is the truth is undeniable. The pervasive government-sanctioned employee layoffs and fast spreading culture of switching over to automation helped the phenomenal rise in corporate profits. Alongside this development, both skilled and unskilled unemployment kept rising steadily while government functionaries kept proclaiming that the rising stock indices in fact represented economic growth.
In France 10 per cent of the workforce is unemployed and Germany is faced the highest rate of unemployment since 1945. Situation is nearly as bad in the rest of Europe, US and Japan. Were Pakistan’s Federal Bureau of Statistics to report unmitigated truth, unemployment in Pakistan too would be near its peak since 1950s. World Bank reports on Pakistan’s rising poverty level (33 per cent of the population) and falling per capita consumption (down by 0.2 per cent) in the country’s vast rural sector betray part of the bitter truth.
By lending their blessings to the sky-rocketing stock exchange indices governments seem to overlook the fact that many of the reported corporate profits may eventually turn out to be false claims as was the case with hundreds of companies in 2001. With profit as the prime driving force behind corporate sector activity, managers are more likely to overstate it for advancing their career prospects, even if temporarily because many of them give precedence to living lavishly today rather than worry about tomorrow. Even if the corporate results reflect the truth, given India and China’s expanding problems in sustaining their growth, many of these fancy results may not be repeated.
New business strategies that encourage the manufacture of cheap and low quality goods expanded markets though, in the process, consumers ended up paying far more compared to the intrinsic value of the goods they bought. Clever advertisers joined hands with the corporate sector in duping the consumers into buying these “cheap” goods as fair value for their money. But the most disturbing factor has been lack the of criticism of these trends in the press, which now appears more keen on publishing expensive advertisements rather than telling the bitter truth. Recently, when I took my two-year old laser printer to a computer repairs shop the shopkeeper told me it was a very old model whose spares were no longer produced by the manufacturer. “You see”, he said “now they have switched over to a new strategy. Printers now cost as little as Rs. 3,200 but their ink cartridges cost as high as Rs. 2,800. It is far more convenient to junk the printer rather than have it repaired”. Besides uncovering the true profiles of corporate business strategies, the comment also reveals corporate concern about environmental pollution that rises from heaps of junk (short-lived goods) that they are manufacturing.
A major factor in expanding the market for these cheap goods has been the over exuberant role of financial institutions that frantically promote consumer finance with all its attendant risks rooted in the fragile repayment capacity of the consumers who live with the perpetual fear of job insecurity and of the ever-present possibility of a significant rise in interest rates and prices of essential items. Take, for instance, the impact of rapidly rising fuel prices on limited income earners who recently leased over-priced vehicles. While auto manufacturers have booked their profits on the sale of vehicles, the consumer finance bubble can burst any moment.
Passing on the entire cost and all market risks to consumers wholly unequipped to manage them, is another popular business strategy. In Pakistan, a classic example of passing on the costs and market risks almost entirely to the consumers is provided by the petroleum sector whose profits keep rising while oil prices touch their historical peaks. Corporate executive don’t seem to realize that they owe it to the consumers to protect them from international market price shocks through hedge arrangements and strategic buying of raw materials.
What the profit-hungry corporations also don’t realize is that rising unemployment and falling real purchasing power of the still employed will ultimately lead to an unmanageable recession globally. In that scenario, all business strategies of every conceivable design and ingenuity will fail to deliver. The drive to sustain increase in corporate profits well above GDP growth rates never made economic sense. It won’t make sense in the future as well.
But blaming the corporate sector alone for these developing distortions would be unfair. The State has a far greater responsibility of observing these trends and arresting them in their tracks. This is not to suggest the State should stifle the private sector. What the State needs to adopt are policies that maintain a balance between corporate aspirations and the demands of common good.
On the contrary, in the recent past the State encouraged unrealistic drops in interest rates which, on the one hand, drastically lowered the borrowing costs of the corporate sector and on the other forced savers to accept returns on savings that were often well below the real rates of inflation. This manifested scant realization of the longer term impact this development would have on the incentive for saving. Not many seem to have learned from the bitter experiences of the debt-ridden US economy where saving is now an almost forgotten value.
Yet, in many countries the State remains oblivious to these trends. It is compounding its offense by lowering tax burden on the corporate sector. While the State must remove distortions in its taxation regime that encourage some sectors at the expense of others, it must not allow some players in the corporate sector to walk away with obviously questionable profits. It can do so by rationally taxing the enterprises that remain overly profitable for sustained periods because that is a sure sign of a distortion in the taxation regime.
This loss of focus has permitted corporations to get away with many benefits that they do not deserve on the basis of their business practices and their sense of social responsibility. It would be a serious oversight, no matter how well-intentioned, if the corporate sector is not made to realize its larger responsibilities to the society as a whole. Market de-regulation – a well conceived mechanism otherwise – should not be allowed to be debased by the selfish few.
It is allowing serious economic distortions to develop and the cost nations will pay for rectifying them. Pakistan has paid the price of government incompetence on a number of occasions the heaviest being the one paid in 1971. It was the creation of similar distortions (remember the 22 families?) that led to that disaster. One only hopes that we are not moving headlong towards anything even remotely resembling that tragedy.
