Evolution of Corporations

However, before we even get to the question about outsourcing and free-trade, we need to understand the drivers of the same. And the trail begins with the basic question – what is a corporation?

Corporations, a legally defined term that enables group of individuals (capitalists) to pool their risk capital and organize for economic benefit (usually with limited personal liability – a great legal innovation), are the foundation of any modern capitalistic economy/society. Capitalism is the engine for growth over the past 300 years and has utterly transformed not only economies but also society at large – political, cultural, leisure, etc.

Besides lifting billions of people out of poverty, (today, a regular middle class person in the western world lives in greater luxury than medieval kings/monarchs), it has enabled the political freedom that we take for granted, as it has freed the power from land-ownership (which is limited and controlled by force) to ideas and risk-taking, that is open to anybody.
However, Corporations itself has morphed into their current form in three separate phases/evolution.

The first phase/evolution of corporations was in form of trading companies. Given the high risk and high capital requirements for international trading in the 17th century, capitalists pooled their risk capital to finance trade and share the profits. In this phase, corporations were essentially a vehicle to pool and distribute risk. Risk and equity was shared by everybody involved – the capitalists, the ship owner, the merchants, the captain and the crew. While capital got the lion’s share of the rewards, the rewards were nonetheless distributed to all parties and the corporation did no other function expect to enforce these rules.

The second phase/evolution of corporations was in form of organizing to produce/deliver products/services. As the agrarian economy transformed into industrial society in the 18th century while advances in naval technology and naval warfare reduced the risk of trading/piracy, risk capital was required to produce and deliver the goods and services. This led to the longest and greatest long-term economic boom ever, creating the middle class that would not only work for these corporations but also be the consumers for the goods and services. Corporations became the dominant form of organizing economic activity and had profound impact on all facets of life in the society.

The third phase/evolution of corporations is only now emerging. Corporations, especially the Fortune 500 firms, are now organizing ideas rather than actual delivery of product/services that these ideas produce. This is the essence of the Knowledge society/economy.

The new model is quite profound in the terms of how a corporation is managed/run and what kind of people/talent it attracts. The skills valued in the second model is now increasingly drawing lower value and productivity, with consequent declining wages or outsourcing of the same. This is not simply a cost-reduction driven move to increase profits – the market is increasingly rewarding the ability to innovate instead of simply deliver a product. The difference between the fortunes of Apple and Motorola is an excellent case in point

And US economy is leading this transformation. However, transition is painful - Broken down by income groups, the top income groups are facing unemployment rates less than 5% (full employment) while the bottom 2 groups are facing employment rates in excess of 25% (Depression era rates).

Outsourcing: Beneficial or Harmful to US?

So lets tackle what is a very controversial topic.

Many barrels of ink has been spilled on both side of the debate, although admittedly more on the cons side in the past few months. Amongst the top few reasons for opposing, restraining or even rolling-back Outsourcing and Global trade is the mercantilist trade/currency policies followed by the largest trading partner (China), collapse of the middle class in America due to outsourcing of service jobs to India / manufacturing jobs to China and un-sustainable trade deficits.

These issues/challenges highlighted are valid and true. There is no denying the fact that China is following a mercantilist trade and currency policy that depresses its currency by 40% (estimated by most respected economists), thereby not only exacerbating trade deficit with US but also ‘stealing’ export income of other countries. During the go-go growth years, people complained but accepted this as everybody was growing. Now that we are saddled with slow-to-nonexistent growth for the next few years (if not the decade), this is rapidly becoming a worldwide diplomatic issues with potentially ugly consequences.

Further, the great recession has exposed the decimation of the middle class in America. Easy money and loose credit camouflaged the reality of declining real wages and increasing disparity in wealth over the past decade, which has now come spectacularly undone. Loss of manufacturing and service jobs, for long the mainstay of the middle class in US, is creating economic havoc in an economy that depends on consumer spending and political system that encourages everybody to have the American Dream of ever-rising prosperity with each generation. The fall-out of this will be extremely consequential and potentially nasty

Unsustainable trade deficits, primarily a function of the first 2 factors, introduces another challenge to the policy makers. Ever increasing trade deficits, supported by ever increasing re-investments by trade surplus countries, creates easy money outside the control of feds and distorts credit pricing in the economy. This was the primary fuel of the enormous credit bubble that led to the current great recession and certainly needs to be tamed/controlled going forward.