& #8220;There Will Be No Capital Formation & #8221;

Chandrakant Sampat

Chairman, capitalideasonline.com

What worries you the most?

Capital markets operate ias part of the economy. They reward durability and the ability to generate more than the cost of capital. But now mutations have started occurring. These can be disastrous for capital markets, society and the entire human species.

The question really is, will the Darwinian concept hold - that natural selection weeds out mutation and preserves what is favourable, or are we moving towards the Gouldian concept of "punctuated equilibrium" where the old ends abruptly, and something entirely new replaces the old.

I would like to share with you some thoughts from what Bill Joy, the chief scientific officer of Sun Microsystems, wrote in Wired magazine way back in April 2000. He argued that it is no exaggeration to say that we are on the cusp of the further perfection of extreme evil. And evil whose possibility spreads well beyond weapons of mass destruction bequeathed to nation states, to a surprising and terrible empowerment of extreme individuals.

Because of the recent rapid and radical progress in molecular electronics - where individual atoms and molecules replace lithographically drawn transistors and related nanoscale technologies, we should be able to meet or exceed Moore's law rate of progress for another 30 years. By 2030, we are likely to be able to build machines that are, in quantity a million times as powerful as the personal computers of today.

Genetic engineering may soon provide treatments, if not outright cures, for most diseases; and nanotechnoloogy and nanomedicine can address yet more ills. Yet, with each of these technologies, a sequence of small individually sensible advances leads to an accumulation of great power, and concomitantly, great danger.

What does this mean for business and capital markets?

For businesses, the concern is that they will become obsolete very fast. Put differently, the rate of Schumpeter's waves are accelerating and the waves are becoming shorter. Normally, at the end of each wave capital shifts to the new big thing. This movement to the new creates a bubble. The US is spending on GNR (genetic, nano and robotics) $1.3 billion, Japan almost the same and Europe $700 million.

Rapid innovation and the speed of technological progression is a big threat for existing businesses. Products would be manufactured by assemblers at a cost no greater than that of wood. In future, space flights may be more accessible than transoceanic travel today.

Josef.A Schumpeter's theory of creative destruction will gain more relevance in future. To keep pace in the fast changing world, companies will have to destroy themselves in order to be in business. As Schumpeter said, competition can come from new commodity, new technology, a new source of supply and a new type of organisation.

Competition which makes a decisive cost or quality advantage and which strikes not at the margin of profits and the output of existing firms but their lives, will obviously be destructive. Schumpeter's process of creative destruction is even more rampant today. Can the stock markets finance the rapidly decreasing competitive advantage periods that this implies? And what happens to society which is subject to such periodic upheavals?

All you are saying is that companies will have a shorter life-span in future. But as long as companies are doing business, capital markets will remain. Isn't it?

The essence of this whole thing is that there will be no capital formation. Let's take an example. Today companies depreciate computers at an accelerated rate of 30 per cent. In future, they may have to depreciate their entire business in three years, or lesser time, because their business itself, or the way their business is conducted, may have become obsolete.

According to Peter Drucker, profit is nothing but the cost of staying in business. So companies will have to generate adequate cash flows that will ensure they can completely recreate themselves to stay in tune with the pace of change. By implication this means there will be very low or no capital formation if you look at businesses in perpetuity.

Even then won't newer companies attract attention in capital markets? In that sense, markets will still pose investment opportunities...

Capital markets cannot exist if there is no capital formation. I am not saying that there won't be opportunities at all. There might be. Greed will make sure that capital flows in search of businesses that promise to make money, but what will happen to old businesses? You will lose much more in the old businesses you are invested in.

A small amount of money can move swiftly to new businesses. But what will happen to all the pension funds, mutual funds assets and all the insurance companies which have huge sums deployed in equities? They may not be able to move their assets to new growth areas that easily. Also, what about the banks and financial institutions which may have lent to these businesses?

Take the example of The Unit Trust India. The institution could not move its assets to the technology sector as it could not see the transformation. And by the time they saw the merits and shifted part of the assets to tech stocks, the market was ripe for a crash. Going forward, these cycles will get shorter. Stock booms will be short-lived, or merely blips. By the time you understand the potential and decide to invest, the opportunity may vanish. The $25 trillion market capitalisation that the global market boasts of today is under threat.

Won't companies in sectors such as single-use consumer goods be relatively insulated? What could possibly change for them?

Well, one never knows. I reiterate that we are in a state of flux. Technology can alter anything and everything. As I said, the products that are manufactured could change drastically and some may simply lose their relevance. The possibilities are immense.

For a business to qualify as a good investment it should generate positive cash flows and exhibit durability. If these two criteria are satisfied, you can consider it as a good investment opportunity. But technology poses a threat on both these counts.

What do you think is a logical solution to this problem?

I don't know. But all I can say is, we have to slow down a bit. Here, I have to refer to what Carl Sagan wrote in the book Cosmos. According to him, if the mutation is too high, we lose the inheritance of four billion years of painstaking evolution.

If it is too low, new varieties will not be available to adapt to some future change in the environment. The evolution of life requires a more or less precise balance between mutation and selection. He says that when the balance is achieved, remarkable adaptations occur.

What is your prognosis for the capital markets? Do you mean they won't survive?

It will not be inappropriate to say that capital markets will cease to exist in the current form in a few years from now. As Peter Drucker has said, capital markets haven't really innovated in the past 50 years and it is high time they reinvented themselves.