Schumpeter Tamada, Ph.D.

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On May 23, 2017, tamadaatkawansei commented on 1. Evaluate the Argument of the “Capitalist’s Dilemma” Article :

Schumpeter’s Comments on “Capitalist’s Dilemma.”

The relationship between the types of innovation and the job increase should be carefully verified. Ratio still does matter in the micro-level capitalists. I propose four suggestions to avoid Capitalist’s Dilemma.  1) Separate managers and capitalists completely. 2) Managers become capitalists. 3) Increase the number of “silent capitalists.” 4) Enlighten the capitalists.

1. On the assumption that the market-creating innovation create a lot of jobs but the performance-improving innovations create fewer jobs

Even the performance-improving (sustaining) innovations may create a lot of jobs. 

For example, Toyota is now making Lexus. To do so, Toyota or their suppliers need to hire craftsmen to equip hand-stitched leather seats, lacquer finished wood panels on their Lexus cars. Rolls-Royce needs to hire metal polishing craftsmen to finish the radiator-grills of their cars to upgrade their cars. 

Swiss watchmakers hire more people by upgrading their watches from quartz-driven Swatch, which is made by robots mostly, to hand-made mechanical watches. (Since this example might not fit the definition of performance-improving innovation, but they are surly going upward in the watch market.)

I think the question whether an innovator hires a craftsman or a robot, is answered not by the type of innovation (market-creating, efficiency, or performance-improving) they are going to pursue, but by the relative productivity between the craftsman and the robot, which is calculated by the comparison between the wage and the interest (=cost on capital goods, like robots). Since the interest rate is historically low in these days, we can hire more robots very cheaply.

From the macroeconomic viewpoint, even market-creating innovations may decrease jobs. For example, eBay, categorized as a new market disruption in your book “Innovators’ Solution,” surely created a new market for person-to-person auctions.

But, a father purchased a used toy for his son by using eBay, will not go to the nearby Toys”R”Us to purchase a new toy. Since the income is limited for every people in the short run, most market-creating innovations would reduce the demand for the goods and service supplied by incumbent firms, and therefore decrease jobs working in the incumbent firms.

2. Ratio does matter.

You insist that the capital is cheap and not scarce anymore. From macroeconomic viewpoint, you may be right.

But as the micro-level capitalist, say your grandmother investing her scarce pension, the return on capital does matter. So, the question is how to maximize long-term return on investment despite the big asymmetry of information between the capitalists and the innovators.

3. Suggestions to avoid Capitalist’s Dilemma 

The main cause for Capitalist’s Dilemma is the difference between the capitalists and the innovators in the confidence in the profitability of the future innovation of different types. This is old and new phenomena. In the 19th Century, there was a conflicting view on the future of electric lighting between the innovator, Thomas A. Edison, and the capitalist, J. P. Morgan. Edison saw a clear future vision on electric light bulb and insisted in investing in the new factory and making lightbulbs in mass production. On the other hand, the capitalist, J. P. Morgan refused to invest more capital until the current investment is payed off by the income. Edison became furious and put his own money into the factory.

To reduce the Capitalist’s Dilemma, I propose following four solutions.

1) Separate managers and capitalists completely

This approach is already conducted by Google, issuing special stocks. The shareholders having these special stocks have the right to get dividends but they are not allowed to intervene into the management decisions. By issuing special stocks, Google got a perfect freedom to innovate. 

2) Managers become capitalists

Why does the future vision of innovation by the capitalists and the innovators differ? Because they have different bodies. If we could make innovators be capitalist as well, this would solve the Capitalist’s Dilemma.

“A joint-stock company” was a novel idea to collect scarce capital and put it into a new venture. But in these days, the side effect “capitalists’ myopia” is prevailing. 

Modern innovative managers can also be capitalists by management buy outs (MBOs) and put the capital into the market-creating innovations. 

In Japan there are many long-living companies surviving through harsh economic waves for more than 100 years. 90% of them are NOT joint-stock public company. The oldest company in Japan, which in fact is the world’s oldest, is Kongo-gumi, a construction company founded in 6th Century, lasting more than 1200 years. Most of the century-living companies are family-owned or unlisted, owned by a few “visible” capitalists’ hand. The capitalist-manager’s interest is not to make the company grow rapidly but to make it survive for many centuries as a family heritage.

Therefore, making a joint-stock public company into unlisted or privately owned, managers will be able to pour the entire capital into the market-crating, disruptive and long-term innovation.

3) Increase the number of “silent capitalists” 

As is clearly written in the best-selling book “A Random Walk Down Wall Street” by Burton G. Malkiel, just buying the whole stock listed in a certain market according to each company’s market capitalization, you can beat most of active fund managers or, in our words, professional capitalists, who evaluate the firms’ future value, speculate the best timing to buy or sell stocks and trade frequently. 

In 2014, one-third of the capital held by individuals and professionals (in the U.S. I assume) is invested in passive index funds.

In Japan, Government Pension Investment Fund invests 35% of its134 trillion-yen ($1.2 trillion) asset into the world’s stock market, and more than 80% of its stock market investment, which is about 37 trillion yen ($ 0.3trillion) is poured into passive index funds. 

Having these silent capitalists as their shareholder, managers would feel less tension toward myopic, short-term, efficiency or upgrading innovation.

4) Enlighten the capitalists

WR Herbrecht, a venture capital in San Francisco, is not using RONA, ROCE, IRR, for their investment decision. Instead, they invest in disruptive firms using their pattern recognition capability. Their performance is superb.

If more and more capitalists learn Prof. Christensen’s theory on innovation, and begin investing their capital more wisely, then market creating innovation would be fostered and flourish.

Hoping this little article help you somehow,

Schumpeter Tamada, Ph.D.
Professor, Institute of Business and Accounting, Kwansei Gakuin University