On any given day, you can expect news of major corporate mergers. Last week, we had decisions from FedEx to buy the Dutch delivery company TNT for $4.8 billion and from Royal Dutch Shell to acquire the BG Group, a British natural gas company, for $70 billion. Mergers and acquisitions have become a staple of modern capitalism. In 2014, worldwide M&A totaled $3.5 trillion, up 47 percent from the year before, reports Thomson Reuters.
Now, there are many motives for mergers: to minimize competition; to reduce costs by eliminating overlapping operations; to acquire a hot product or technology (which can be peddled on existing sales platforms); to enter new geographic markets; or to get bigger. Some M&A deals make sound business sense; others suggest managerial empire-building.
But a larger issue transcends individual deals. The popularity of M&A actually involves economic weakness. Unable to expand internally — by creating products or entering new markets — companies rely on M&A for growth. However, what works for the firm may work less well for society. Although buying another company may enhance the acquiring firm’s innovation, it doesn’t add much to society’s. And society’s capacity to innovate is crucial. It generates the wealth needed to raise incomes and dampen social conflicts.
This is important. In the wake of the “Great Recession,” economists have reduced forecasts of future economic growth. Even before the financial crisis, an aging society was expected to lower growth. Relatively speaking, there will be more retirees and fewer workers. But the recent reductions in forecast growth imply a dimmer outlook for innovation, as measured by labor productivity (output per hour worked). Weaker productivity growth in turn means weaker wage and income growth.
Unfortunately, productivity’s performance since the Great Recession has been abysmal. From 2009 to 2014, it has averaged a meager 0.9 percent annually, according to the Bureau of Labor Statistics. That’s less than half the average growth of 2 percent since the late 1940s and one-third of the 3 percent rate of the first two decades after World War II. These differences have huge implications for wages and incomes. At 3 percent, incomes double in about 25 years; at 2 percent, about 35 years; at 1 percent, around 70 years.
It’s tempting to blame the productivity slowdown on the Great Recession, reflecting depressed business investment and long-term unemployment. But research by economist John Fernald of the San Francisco Fed finds that the slowdown started before the slump.
In truth, productivity has long baffled economists. The reason is that productivity, a seemingly wonky concept, really reflects a society’s basic character. It is affected by almost everything, including but not limited to worker skills, management, technology, government policies and regulations, work ethic, schools, public attitudes toward risk-taking and wealth. With so much in play, mistakes are easy.
But whatever the sources of productivity, they operate primarily through the private sector. If companies are hidebound, productivity will suffer. Here’s where popular perceptions may clash with discomforting (but invisible) realities. In our mind’s eye, the economy is swarming with entrepreneurs. Competition is intense. Old-line firms adapt, or die. Just the opposite may be happening: Evidence suggests that entrepreneurship is in decline and that U.S. firms are becoming older, more entrenched and less dynamic.
In several studies, economists Robert Litan and Ian Hathaway of the Brookings Institution found that start-ups (firms less than a year old) had fallen from 15 percent of all businesses in 1978 to 8 percent in 2011. Meanwhile, older firms (16 years or more) had jumped from 23 percent of businesses in 1992 to 34 percent in 2011. Their share of jobs was even higher, almost three-quarters of all workers.
What emerges is a portrait of business that, though strikingly at odds with conventional wisdom, is consistent with poor productivity growth. American capitalism is middle-aged. Older firms, conditioned by success, are more rigid. They’re invested, financially and psychologically, in existing markets and production patterns. They can adapt and innovate, but it’s hard. The M&A surge is one way older firms strive to overcome internal stagnation.
What’s worrisome is not the success of the middle-aged businesses; it’s the weakness of young firms and the apparent erosion of entrepreneurship. As other research has shown, start-ups ultimately account for a disproportionately high share of new job creation and innovation. The vigor of these new firms is essential for the economy to revitalize itself.
We don’t know what explains their slide, though the sheer mass of government regulations is one candidate. Older firms have the lawyers and administrators to cope with the red-tape deluge; many small new firms drown. But that’s just a conjecture illuminating the larger question. If the economy discriminates against young firms, we will all be paying the price for many years.
Read more from Robert Samuelson’s archive.