Way back in 2011, there was an article in The New Republic, a profile of Timothy "Eddie Haskell" Geithner, that has stuck in my mind.
It was not because it showed how he was basically a brown-noser who achieved success by sucking up, though it did. Rather it was because of the only time that Geithner showed any enthusiasm about anything beyond his own career:
Though Geithner had begun the transition from wartime to peacetime secretary successfully, I also wondered how well he would complete it. It had occurred to me that the same qualities that made him so effective in a crisis—his ability to craft solutions under enormous constraints—were less well suited to some of the tasks that followed, when a treasury secretary might have to reimagine the world rather than accept its limits as given. I asked Geithner if he had a grand vision for the postcrisis landscape—for, say, a less bloated financial sector with a smaller role in the economy—and a map for how to get there. Could he be a figure like George Marshall, who helped win the World War and then remade Europe so that it couldn’t happen again?
Geithner hunched his shoulders, pressed his knees together, and lifted his heels up off the ground—an almost childlike expression of glee. “We’re going, like, existential,” he said. He told me he subscribes to the view that the world is on the cusp of a major “financial deepening”: As developing economies in the most populous countries mature, they will demand more and increasingly sophisticated financial services, the same way they demand cars for their growing middle classes and information technology for their corporations. If that’s true, then we should want U.S. banks positioned to compete abroad.
“I don’t have any enthusiasm for ... trying to shrink the relative importance of the financial system in our economy as a test of reform, because we have to think about the fact that we operate in the broader world,” he said. “It’s the same thing for Microsoft or anything else. We want U.S. firms to benefit from that.” He continued: “Now financial firms are different because of the risk, but you can contain that through regulation.” This was the purpose of the recent financial reform, he said. In effect, Geithner was arguing that we should be as comfortable linking the fate of our economy to Wall Street as to automakers or Silicon Valley.
So, why am I bringing up this disturbing behavior now, 12 years later, because, once again we have a real world example of just how wrong this world view is, and this is important because many of the most powerful people in our society continue to follow this ruinious line of reasoning.
One need only look at the impact of financialization on Cisco Systems, where the formerly dominant internet hardware supplier is now an also-ran:
Once the global leader in telecommunication systems and the Internet, over the past two decades, the United States has fallen behind global competitors, including China, in mobile-communication infrastructure—specifically 5G and Internet of Things (IoT). This national failure, with the socioeconomic and geopolitical tensions that it creates, is not due to a lack of US government investment in the knowledge required for the mobility revolution. Nor is it because of a dearth of domestic demand for the equipment, devices, and applications that can make use of this infrastructure. Rather, the problem is the dereliction of key US-based business corporations to take the lead in making the investments in organizational learning required to generate cutting-edge communication-infrastructure products.
No company in the United States exemplifies this deficiency more than Cisco Systems, the business corporation founded in Silicon Valley in 1984 that had explosive growth in the 1990s to become the foremost global enterprise-networking equipment vendor in the Internet revolution. In our Institute for New Economic Thinking Working Paper, “The Pursuit of Shareholder Value: Cisco’s Transformation from Innovation to Financialization”, we provide an in-depth analysis of the corporate resource-allocation decisions that have underpinned Cisco’s organizational failure.
Since 2001, Cisco’s top management has chosen to allocate corporate cash to open-market share repurchases—aka stock buybacks—for the purpose of giving manipulative boosts to the company’s stock price rather than make the investments in organizational learning required to become a world leader in communication-infrastructure equipment for the era of 5G and IoT. From October 2001 through October 2022, Cisco spent $152.3 billion—95 percent of its net income over the period—on stock buybacks for the purpose of propping up its stock price. These funds wasted in pursuit of “maximizing shareholder value” were on top of the $55.5 billion that Cisco paid out to shareholders in dividends, representing an additional 35 percent of net income. Besides absorbing all its profits over the 21 years, Cisco took on debt and dipped into the corporate treasury to fund these two types of distributions to shareholders.
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Within its own organization, Cisco was an exemplar in the integration of its personnel to serve the rapidly changing requirements of enterprise networking, thus limiting employee turnover in the hypermobile labor market for which Silicon Valley is known. To gain control over rapidly emerging enterprise-networking innovations, Chambers continued a practice begun under Morgridge of growth-through-acquisition. From fiscal 1994 through fiscal 2001 (years ending in the last week of July), Cisco made 71 acquisitions, gaining a reputation for its system of integrating the incoming employees into its organizational-learning processes.
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After listing on NASDAQ in its initial public offering in February 1990, Cisco’s shares became integral to Cisco’s growth. In the process of expanding from $70 million in revenues and 254 employees in 1990 to $22.3 billion in revenues and 38,000 employees in 2001, Cisco relied heavily on its stock as both a combination and compensation currency. The purchase price of Cisco’s 71 acquisitions from 1994 to 2001 totaled $34.2 billion, of which 98% was paid in Cisco shares. Especially in the last years of the 1990s to the end of fiscal 2000 (ending July 29), in doing acquisitions Cisco had the financing advantage of its soaring stock price. As for the compensation function, virtually all of Cisco’s employees were included in a broad-based stock-option program. With stock-market speculation becoming the key driver of Cisco’s stock price in the last years of the Internet boom, the estimated average realized gains per worldwide employee (not including the five highest-paid Cisco executives) from exercising stock options was $193,500 across 18,000 employees in 1999, $291,000 across 27,500 employees in 2000, and $105,900 across 36,000 employees in 2001.
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In the decade 2002-2011, Cisco spent $71.6 billion repurchasing its own stock, equal to 126 percent of net income, while paying its first dividends in 2011. In 2012-2021, Cisco’s buybacks totaled $72.5 billion, 81 percent of net income, along with $47.0 billion paid out as dividends, another 53 percent of net income. In 2022, Cisco’s distributions to shareholders were 117 percent of the company’s all-time high net income of $11.8 billion, with $6.2 billion in dividends and $7.7 billion in buybacks.
As we document in detail in our INET working paper, over the past two decades, Cisco’s “financial commitment” has been to boost its stock yields, not to invest in its innovative capabilities. As the company ramped up buybacks from $1.9 billion in 2002 to $10.2 billion in 2005, it largely abandoned its previous investments in optical-networking equipment, including its manufacturing plant in Salem, New Hampshire. Instead of moving toward a direct-sales model, which would be required to compete in the infrastructure-equipment segment, Cisco increased its reliance on VARs, which accounted for more than 80% of the company’s revenues by 2008.
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Despite financialization, Cisco has grown over the last two decades because of the greatly expanded demand for enterprise-networking equipment. In 2022, Cisco had 2.3 times the revenues and 2.2 times the employees it had in 2001. In terms of employees in the United States, the increase was 1.5 times, up from 27,000 in 2002 to 39,900 in 2022. The company has been a job creator.
Yet, the dominance of financialization over innovation within Cisco Systems over the past two decades has had a negative impact on its capacity to develop the capabilities needed to compete as a systems integrator in the infrastructure-equipment segment of ICT. As a result, as is widely recognized, the United States has fallen behind China and the European Union as a locus of innovation in 5G and IoT. Particularly in the case of China, the home base for world leader Huawei Technologies, it is all too easy and convenient to blame unfair competition for the innovation deficit of the United States.
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As early as 2006, Cisco removed optical networking from its group of “advanced technologies.” The company’s vice president and chief development officer at the time explained that this was because “optical is more of an access technology, where the market is not going to grow as aggressively as it had in the past.” Meanwhile, in 2009, the rising China-based company, Huawei, became the world leader in optical networking, which it integrated with wireless and Internet capabilities, succeeding in global competition, where Cisco failed. Despite numerous acquisitions in the area, Cisco’s focus on a radical ‘‘all-IP’’ solution combined with its lack of radio base stations and ‘‘account control’’ left it without the capability of becoming a systems integrator that could displace the incumbents and counter the growing competitive strength of Huawei.
More broadly, the impact of growing financialization in the sector has left the United States without the capability to innovate in the development of a communication-infrastructure network. While failing to recognize the role of financialization within the sectoral dynamics, US policymakers have chosen to respond to the US loss of competitiveness with aggressive protectionist measures against Chinese competitors and by attempting to introduce a new standard that will favor US, Japanese and Korean competitors without systems-integration capabilities.
The path here is rather straightforward. The company moves from investing in technology and knowledge to various schemes to pump up its stock price.
So, instead of new plants and equipment and technology, you get mergers and acquisitions and stock buybacks.
It's great for the executives, whose stock options soar as a result, but eventually you have a company where no knows how to build, or more importantly improve, their products, and so you have Huawei and its ilk taking over the market.
It's called eating your seed corn, and it is simply unsustainable.
H/T Naked Capitalism.
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