Friday, 11 February 2011

Does it matter who owns the Scottish economy?

Guest Blog: John Foster, Emeritus Professor of Economics, University of the West of Scotland

The past decade has seen a remarkably rapid shift in the ownership of Scotland’s economy.[i] 

Just ten years ago firms described as ‘based in Scotland’ in Scottish government statistics dominated manufacturing.  Taking the top manufacturing firms employing over 250 people, these ‘Scottish based companies’ contributed 60 per cent of the combined turnover.  By 2005 this share had shrunk to 40 per cent.  By 2010 it was down to a little over 30 per cent.  And it is these larger firms which have access to export markets and contribute the great bulk of Scotland’s research and development. 

Figure 1 Manufacturing firms employing more than 250 workers
Percentage of turnover contributed by Scottish based firms
Scottish Government Corporate Statistics 2010 Table 2

Taking a broader look at all the bigger Scottish registered companies, in services as well as manufacturing, it is clear that there has been a major shift in ownership and control over the past decade.  In 2004 the Royal Bank of Scotland’s ‘Wealth Creation in Scotland’ examined the value added contributed by the top 100 Scottish registered firms and concluded they provided 56 per cent of the Scottish total.   A closer examination of the share ownership of these companies revealed that most were in fact either subsidiaries of non-Scottish companies or largely controlled by investment banks and fund managers from outside Scotland. 

Figure 2 Top 100 biggest Scottish registered companies
Percentage of value added contributed by firms owned by
Scottish families/Scottish trusts, UK and
external institutions, UK holding companies, diversified
UK financial institutions, external holding companies

Less than 5 per cent of value added was contributed by firms entirely owned from within Scotland, either by trusts, local authorities or families.  Almost 50 per cent of the total ‘value added’ was from firms dominated by major British and US fund managers, 10 per cent came from subsidiaries of British companies, 18 per cent from subsidiaries of overseas companies and 15 per cent from companies dominated by UK financial institutions. 

By 2010 even this level of external control had moved forward a further stage. 

The Scottish registered companies which previously had dominant shareholdings from outside Scotland had almost all become subsidiaries of either UK or overseas companies – and the small share of value added from ‘Scottish owned’ firms had shrunk even further. 

Part of the explanation is provided by the takeover of the two banking giants, the Royal Bank and the Bank of Scotland.  But it is only part.   There is also a long list of companies which over these six years had been subject to external takeover – ‘sold on’ to external purchasers usually at the instigation of the big institutional investors looking for a quick turn-around on their investment. 

The scale of the change is further confirmed by a longer term comparison using the method developed in the 1970s by John Scott looking at changes in ownership over a much longer time period from the beginning of the century.  This involved taking the 62 biggest Scottish registered non-financial companies.  Comparing John Scott’s biggest companies for 1974 and the biggest for 2004 a major shift is indicated – with many more companies being externally-owned subsidiaries in 2004.  Looking at these same companies in 2010, the number of subsidiaries had again grown by nine.  There had also been a big fall, from 18 to 6, in the number of firms with two or more shareholders controlling between 10 and 50 per cent – which were usually either family-owned firms or firms dominated by  large external shareholders.  Furthermore, five of the 2004 subsidiary companies, those controlled by external holding companies, had ceased trading.

Table 1 The 62 non-financial Scottish registered firms with highest turnover

Wholly-owned subsidiary
29 (and 5 of the 26 dissolved)
Exclusive majority: one interest owns over 50%
Shared majority: more than one interest with over 50% combined
Exclusive minority: one interest owns between 10% and 50%
Shared minority: more than one interest owning between 10% and 50%
Limited minority: more than one interest owning between 5 and 50%

These rapid changes fit into a wider pattern at international level.  The banking crisis and world recession has produced a major consolidation of production in the hands of the biggest companies.  The market capitalisation of the biggest 500 firms globally increased by 50 per cent in one year between May 2009 and May 2010 to $23,000 billion.[ii]  While this increase may be partly attributing to improved share values and inflation, it is at least in part the result of mergers, bankruptcies of weaker firms and the acquisition of increased market share.  The reported strategy of large firms in industrial countries has been the purchase of rivals to consolidate markets rather than investment in new plant where demand remained stagnant.

Does it matter ?

How far, then, does it matter that, as part of this wider process, the ownership of Scotland’s economy is rapidly moving under the control of giant companies based outside Scotland?

The main argument in favour of external ownership is that it gives smaller economies access to capital, research and development, industrial knowledge and skills that would otherwise not be available.  As in China, this can be used to secure technology transfer and the creation of a skilled labour force that can facilitate indigenous industrial growth.

Does this match Scotland’s current situation ?

The answer here would seem to be No.

First, strong state intervention and support is necessary to secure technology transfer and the development of indigenous firms with the competitive strength to trade internationally. This has certainly been the case in China.  In Scotland it has not. In the 1950s and 60s a large number of branch plans, mainly from the US, were established with state subsidy and encouragement.  But there was only limited state support for related indigenous development and the incoming plants had only very limited supply links with the local economy. Most were closed during the economic crises of the 1970s and 80s leaving little behind them.  A second generation of branch plants in electronics was established in the 1980s and 90s, again largely US-owned, using Scotland as an export platform into Europe, and importing most of the component parts of their computers and mobile phones.  Almost half of this capacity was closed after the bust of 2001.  Hence, unless lessons are learnt from this process, particularly that any spinoff from external investment requires very strong public policy and direct intervention in production, it would seem unlikely that external capital would bring long term developmental benefits to the Scottish economy. 

Second, the current shift to external ownership is not principally about bringing in new investment and knowledge.  It is primarily about changing the control of what already exists. 

In manufacturing this leads to the loss of head office functions and often research and development as well.  It can also lead to fast and unpredictable closure.  Once markets and brands have been secured, external owners will tend to close overseas capacity in face if market contraction and consolidate production wherever costs are lowest.  Such closures usually have highly detrimental effects for the wider economy. Large indigenous Scottish manufacturing companies tends to have dense local supply networks.  They are also the companies with the power to export. Smaller firms, those with less than 250 employees, are reliant on them.

Moreover, most current acquisitions are not in manufacturing but in services. Many of the biggest have been of privatised utilities.  These utility companies often enjoy continuing subsidies from government and a semi-monopolistic position with regard to consumers – as in energy, transport and communications.   Here the rationale for external takeover is simply to consolidate market share and gain access to steady revenue streams in a sector where the level of profitability is consistently higher than that in manufacturing.  Very little is brought to Scotland in terms of technology and research and development.  Much is lost in terms of income that could otherwise be invested locally.

As well the direct impact on the economy, there is also a more indirect effect: on the formation of economic policy.  External acquisition and control, either directly or through the effective control of companies by major external investors, changes the way in which economic influence is exercised at the level of government.

Earlier in the twentieth century, when Scotland was a leading world producer in shipbuilding and heavy engineering, dominant firms used their influence over governments in a fairly coherent way to secure public investment in the productive infrastructure.  The development of hydro-electric power in the 1930s would be one example.  Another would be the Clyde Valley Plan of the 1940s – even though that was within a far more public sector oriented environment.

Managements dominated by institutional investors seeking short-term ‘shareholder value’ do not act in the same way.  A particularly blatant example was provided by the Royal Banks ‘Wealth Creation in Scotland’ report itself - which exercised a powerful influence over the Scottish Executive and the 2004 edition of its economic policy document ‘Smart, Successful Scotland’.

Wealth Creation in Scotland adopted a strongly neo-liberal and anti-public sector position.  It argued that Scotland had grown its own ‘global companies’ through the privatisation of transport, energy and communications and needed to extend privatisation further to education, health and water.  Privatisation created a steady income stream for private capital which in turn enabled the levering in of further capital from the banking sector - which could then be used for external acquisitions.  The report argued that over the past fifteen years this process had facilitated the creation of global companies for Scotland, companies which by 2004 had 80 per cent of their investment outside Scotland.

In retrospect it was a quite crazy way of developing Scotland’s own productive economy.  It effectively called for state subsidies for bankers to make profits from investing Scotland’s scarce and precious resources outside the country – in companies that very quickly became vulnerable to external takeover themselves.  Much of the recent switch in ownership resulted directly from such policies.

 Yet the neo-liberal policy nexus created by the intermediaries representing these firms, the investment bankers and lawyers that represent them, managed to exclude other perspectives, particularly those which would have involved more public sector intervention.  Indeed, the public sector got the blame for the poor state of the economy and ‘squeezing out private enterprise’.

Unfortunately, despite the debacle of 2008, these arguments remain – precisely because the corporate grip of their proponents has become stronger.  Conversely, the actual need for public sector intervention also becomes ever more apparent. There seems no other way restoring the productive economy than sustained public sector intervention. Simply looking at the powerful productive synergies at regional level which have made Germany the present-day leader in technology and high value exports, it is clear that the public sector has always played a central role and continues to do so.  A pattern of industrial ownership, in which the local government controlled Landesbanks hold long-term stakes, has anchored companies to regional economies and permitted the long-term development of supply and research inks with other companies.  This has been complemented by major companies and utilities in which the state held a major stake.  The same applies, with local variations, to France.  By contrast, the ‘Anglo-Saxon model’ of short-term shareholder value ownership by increasingly large and piratical investment funds directly militates against comprehensive regional planning.[iii]

Despite all the claims, there is no conclusive evidence that the private sector innovates or increases productivity faster than the public sector – if anything the contrary.[iv]  Key breakthroughs in technology over the past generation, such as the RB211 Rolls Royce engine or the INMOS computer chips, were developed under public ownership. The combined resources of Scotland’s privatised utilities and its still unprivatised health and education sectors, all of which draw on public income, could potentially provide markets and the reservoir of knowledge necessary for the redevelopment of the productive economy and the establishment of new areas of manufacturing excellence. 

Otherwise, the outlook is bleak.  The next five years will see much tougher global competition – and in Scotland even more takeovers and closures.[v]

[i] This article builds on the research originally conducted in 2004-5 by Sandy Baird, Richard Leonard and John Foster and published in the Fraser of Allander Quarterly November 2004 and Scottish Affairs, Winter 2006-7
[ii] Financial Times Survey of Top 500 Global Companies, 28 May 2010
[iii] A special issue of Economy and Society (November 2009, Vo.38/4), introduced by C. Lane and G Wood, reviews the debates following the research published by Peter Hall and David Soskice, Varieties of Capitalism (Oxford 2001) and Bruno Amable, The Diversity of Modern Capitalism, Oxford 2003.
[iv] Malcolm Sawyer and Kathy O’Donnell, A Future for Public Ownership, 1999 attempts industry to industry comparisons and finds publicly-owned companies have a marginally better rate of productivity increase.
[v] Daniel Shaefer’s feature in the Financial Times 19 January 2011 makes clear the intensity of competition now developing in high value engineering between German and Chinese producers.
This blog is a condensed version of a public lecture, ‘Does Ownership Matter in the Scottish Economy?’ delivered by Professor Foster at Glasgow Caledonian University  on 2 February 2011

1 comment:

  1. eToro is the #1 forex broker for newbie and advanced traders.