The right sort of takeover boom
Tuesday 17 October 1995
Oversimplifying somewhat, this boom has two main distinguishing features: it is concentrated into a small number of specific areas, in particular financial services and the former nationalised public utilities, and the rationale is unusually skewed towards cost-cutting. You do not, on the whole, get chief executives in the UK proclaiming that they are bidding for this or that firm because it is a wonderful way to expand into a new and exciting market. Instead the stress is on the savings that might come from rationalisation. Unsurprisingly, financial services and public utilities are the areas where the perceived savings are greatest.
So the merger boom is not a late-1980s burst of euphoria; rather a mid- 1990s cold shower. And of course this is reflected in the different tone of the economic recovery. Tell people that last year saw the highest growth since 1988 and they are unimpressed. It doesn't feel like that. The sense of insecurity is far too great.
All this might seem straightforward. It is quite reasonable to argue that a different sort of economic recovery should require a different sort of corporate response. What is less obvious is the way in which the corporate response makes possible a different set of economic policies.
In a nutshell, a series of takeovers where the rationale is to grind down costs - and inevitably employment - both demands and makes possible an expansionist economic policy, whereas a takeover boom built on an overly confident perception of the prospects for growth demands a restrictive set of policies. The only way in which the people who lose their jobs in the large companies will find employment is by there being sufficient growth in smaller firms. That can only happen under conditions of decent growth.
On the other hand, a world where companies are grinding down costs instead of passing them on in higher prices is an economy that can sustain cheap money without that money immediately feeding through the economy, creating higher inflation. Monetary policy, by the way, must be used to encourage growth. In the text-books they still suggest governments can stimulate growth by running an easy fiscal policy. But the danger of a perverse reaction in the bond markets is too great.
A number of countries that allowed their fiscal deficits to rise sharply during the last economic cycle, in particular Canada, Sweden and Italy, saw a correspondingly sharp rise in the risk premium demanded by the bond markets. If long rates go up, they invariably drag short rates up behind. Result: any stimulus through an easy fiscal policy was offset by higher interest rates.
So this is the takeover boom that is not only wholly consistent with cheap money, it actually requires cheap money. Put another way, the micro- economic process of industrial restructuring needs cheap money both to finance it and to shelter its victims from the harsh consequences. If this argument is right, there are a number of practical consequences. The first and in a way most interesting to the financial markets is that this takeover boom can continue for a long while.
A second is that the more mergers that take place and the more relentless the extraction of consequential cost savings, the more the authorities can take risks with inflation. That does not mean they can go wild, nor does it mean they should expand their fiscal deficits. But it does mean there is a micro-economic or structural reason for seeking to hold down interest rates, as well as any macro-economic reasons.
A third is that the more the Government of the day seeks to slow the process, as a future Labour government might, the less it can rely on this to hold down inflationary forces. For it is not just post-merger restructuring that helps cut costs; fear-of-takeover restructuring is just as effective.
Economists are not good at spotting the way in which micro and macro policies interact. Remember how the failure to see how financial deregulation and easy money would feed on each other exacerbated the 1987/88 boom. But that was a negative interaction bound to end in tears. The present process is positive. Or rather it is positive provided it is sustained by the authorities.
So what will happen next? There is a natural cycle to the mergers in both financial services and the public utilities. At some stage in the next year, perhaps 18 months, the job will be done. On past experience, however, long before those two particular seams are mined, the markets will be seeking other areas where a reorganisation of the corporate world promises similar cost savings. So the takeover boom can run for rather longer than that.
What might choke it off? One candidate would be a sharp rise in interest rates, probably associated with a sharp fall in share prices. Another would be a less liberal attitude to mergers. But provided the authorities appreciate that the more rapid the structural change in the company sector the greater the economy's capacity for growth, the less likely they are to call a halt. Expect this particular show to run a while yet.
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