Join our community of smart investors

The angry brigade

Way back when, in his avuncular style and in his annual letter to the shareholders of Berkshire Hathaway (US:BRK.B), Warren Buffett told the one about the fly-fishing novice, wide-eyed at the artificial flies – the Jock Scotts, Crazy Charlies and Woolly Buggers – for sale in the fishing-tackle shop. “Do fish really go for these?” he asked. “How should I know,” came the salesman’s reply. “I’ve never sold to a fish.”

The response has some resonance with the contest to be the next leader of the Conservative party and therefore the UK’s next prime minister. The point is the contestants haven’t been selling to the UK’s electorate but to a special sub-species within them. This rare species comprises the paid-up members of the Conservative party, who number only about one in every 250 of the UK’s enfranchised population.

And the presumption is that they rise to a special bait; a feed laced with both low taxation and high levels of public spending, just the sort of treat to dazzle the elderly, affluent male fish who predominate among Conservative party members. Yet in a sense that sort of sales pitch – it could hardly be labelled a political manifesto – would appeal to almost anyone. Who doesn’t want the benefit of public spending without having to pay for it?

And therein lies the difficulty. It is one thing to conduct a popularity contest – effectively what’s happening in the race to replace Boris Johnson – but it’s quite another to frame sensible policies to an electorate whose sense of entitlement has been stoked and passed on even to the third generation as a result of 75 years of peace and prosperity. This, if you like, is the contradiction within democracy. The sociologists and political scientists say political bosses must be honest with voters, must engage them in an intelligent dialogue. That is the only way to keep their trust, and trust is the vital intangible that separates democracy from autocracy. Fine in theory; but perhaps never yet achieved in practice. In the west since the 1950s it has always been easier for governments to bribe enough of the electorate while the Danegeld fund was sufficiently full and double up on the promises when the fund got dangerously empty, as it may be now.

This is why the guys and gals who aspire to be the UK’s next unelected prime minister – as I write, the contest is down to its final three – have promised everything you could possibly ever imagine (I exaggerate). No matter that the ratio of both public-sector spending and public-sector debt to national output (GDP) are at their highest levels in the past 40 years or so (see chart); ‘spend to grow’ is the required sound bite in this campaign and damn the possible consequences.

The exception here is poor old Rishi Sunak. He can’t say what his entitled audience expects to hear. The price of taking on the high office from which he recently resigned is that he is condemned to fiscal continence, a burden that does not afflict the other candidates who can – and have – promised the incontinent version.

As such, Sunak may well fall foul of game theory’s ice-cream vendors’ problem. This intellectual exercise, much loved by the more cerebral marketing people who run political campaigns, dictates where on the beach the metaphorical ice-cream seller should stand in order to maximise sales. If there are just two sellers – for which, in this context, obviously read ‘political candidates’ – then beside each other in the midpoint of the beach is the place to be. The same applies even if there are three vendors. It is only when a fourth comes along that it can pay to take up a lonely spot towards one end of the beach.

Sunak’s difficulty is that by the time the leadership contest goes to Conservative party members the number of candidates must have been whittled down to two and his solitary spot won’t attract enough customers (sorry, party votes). Assuming he is still in the race, he risks being overwhelmed by whichever candidate occupies the centre ground; although in this context it is obviously ironic that the centre ground is where the fiscally extreme policies lie. Still, that’s what you get with populist politics. When people get angry, extremes become normal.

As if to stimulate further anger – and with special relevance for investors – along comes research from the US this week showing that, in companies where institutional investors gather in numbers, jobs and wages are squeezed purely so shareholders’ returns can be enhanced.

The paper, Shareholder Power and the Decline of Labour*, digs deep into returns from quoted US manufacturing companies for the period 1982-2015. Drawing on a sample of 533,000 data points, it shows that “increases in shareholder power, measured by ownership of large and concentrated institutional shareholders, are reliably associated with reductions in companies’ employment and wages”. Putting that into numbers, a 10 percentage point increase in large shareholder ownership correlates with a 2.1 per cent to 2.5 per cent cut in a company’s employee numbers and payroll costs. Worse, the cuts to jobs and wages, on average, add nothing to companies’ productivity, “suggesting that shareholder power mainly re-allocates rents away from workers”. And perhaps to confirm the darkest suspicions, this trend is most marked where activist investors are on the scene. In other words, the contest between shareholders and employees is a zero-sum game, which employees have been losing.

It may be telling that the data for the research stops at 2015 since when the theory of the company – its aims and how it achieves them – has not exactly been re-written but is being revised. Once maximising shareholders’ returns was the goal – period. Now the aims are wider, fuzzier and – perhaps – less mercenary.

Not that the angry classes who shape so much of public opinion and the fate of politicians have necessarily noticed. Rage, anger and entitlement will continue playing a big role driving investment returns through the 2020s, as they have done for the past 10 years or so.

 

bearbull@ft.com

*By Antonio Falato, Federal Reserve Board; Hyunseob Kim, Federal Reserve Bank of Chicago and Till von Wachter, University of California, Los Angeles