THE HIGH-RISK SOCIETY
Now key to economic survival: Coping with uncertainty
For most Americans, economic security no longer exists. In an adaptation from his forthcoming book, The High-Risk Society, Economics Editor Michael J. Mandel explains how individuals and corporations must cope with an economy in which both risks and rewards are escalating:
To listen to Presidential candidates Bill Clinton and Bob Dole, you would think the U.S. economy is either in great shape, or fraught with danger.
The problem is, they're both right. Unemployment is low, real wages are near an all-time high, and corporations are earning record profits after years of stagnation. But business executives are running scared from intense competition at home and abroad, and workers still justifiably fear layoffs. The latest numbers show that 12% of college-educated male workers lost their jobs between 1993 and 1995, a higher rate than in the 1980s or even the early 1990s. Since the beginning of October, thousands of job cuts have been announced at companies including Aetna Inc. and TWR.
Americans are living with a combination of growth and uncertainty that they've never seen before. The most vibrant areas of the economy--such as high tech, small business, and global trade--are precisely those with the most turmoil. The software industry is growing at a 10% annual rate--yet technological change can wipe out a software company overnight. Small business has created nearly all the net new jobs since 1991, reports Cognetics, an economics firm based in Cambridge, Mass.,--but owning a small business or working for one is a risky way of life. Exports are growing three times as fast as the overall economy--yet cracking a foreign market is an expensive and uncertain venture.
Welcome to the high-risk society. It's not the society our parents grew up with, stable and secure. Instead, this economy is becoming much more like the financial markets. Consider: Ordinary investors in the financial markets would love safety--but they are driven to higher-risk investments such as stocks, which offer better long-run returns.
MORE PAIN. Now, this same risk-return trade-off pervades the whole economy. Individuals and companies would like to run from uncertainty. But they cannot. In the 1990s and beyond, many of the best routes to success require even greater risk: taking a job in a high-tech industry, accumulating big debts to get a graduate degree, putting retirement money into stocks to get higher returns. Companies are forced to attempt radical reengineering and work reform to stay competitive, or pursue cutting-edge technological innovations that have a good chance of failing (table, page 94).
The shift to a high-risk society has been accelerated by the past 20 years of government action. Free trade, deregulation, and open immigration, supported by Republican and Democratic Administrations, yield faster growth and higher living standards but add to economic uncertainty.
Pain and prosperity now go together. That's not comforting news, especially for those people who don't have the education or skills to compete in the high-risk society--though this group is slowly shrinking as some two-thirds of high school graduates go to college.
But the government cannot protect Americans from this insecurity. In an economy where the forces of growth are also the forces of uncertainty, that would be like protecting a tree from the sun. Instead, Americans need new ways to manage risk, just as investors can diversify their portfolios.
For much of the postwar period, it was not necessary to choose between growth and security. In the 1950s and 1960s, companies such as General Motors Corp. could make high profits year after year. Blue-collar workers could aspire to a unionized job offering both decent wages and security. A generation of white-collar workers could come out out of college and expect to make their career with a big company.
In Wall Street parlance, such markets and jobs offered high returns with little risk. The equivalent would be an investment with a guaranteed 15% annual yield. Such high-return, low-risk opportunities exist only fleetingly in financial markets.
Instead, high-risk securities tend to have higher returns, while lower-risk investments have lower returns. Savings accounts are safe but pay only 3% a year, no more than inflation. But the stock market--which can fall 25% in a week--averages about a 7% return over inflation. "You can't expect to get a greater return without having to pay for it," says Stephen Ross, a Yale University economist.
NEW RIVALS. The risk-return trade-off in financial markets is driven by two key forces: intense competition and widespread availability of information. This combination means that an investment strategy that produces high returns with little risk will quickly attract new investors who hope to cash in on the success. The result: Returns drop, and risks rise.
Now, competition and information drive the real economy as well. Open markets force workers and companies to contend with more foreign rivals. Technology creates new alternatives, as efficient database programs replace managers who once filed reports. Deregulation removes limits on competition in telecommunications and other industries.
The fury of competition is fueled by a torrent of information. Knowledge about profit opportunities diffuses much faster throughout the global economy than ever before. Alert companies know what rivals are doing, not just across the street but around the world. Any worthwhile feature in a new car or software program is rapidly matched by competitors.
The analogy between the financial markets and the real economy is not perfect. Money can be switched between stocks in moments. By contrast, it may take years to renovate a factory or learn a new skill. But businesses and workers react far faster than in the past.
This creates a sort of schizophrenia. Sure, workers and businesses prefer security to uncertainty. But most of the best opportunities in today's economy come from taking chances.
Consider the career choices for new graduates. The high-tech sector--computers, software, communications--is hot. It's growing, wages are rising much faster than elsewhere, and the industry offers a chance to become rich young.
But today, growth does not buy security. As employers, high-tech businesses cannot offer stability. A startup or small company may create thousands of jobs, and then become obsolete or lose out to competitors.
Nothing epitomizes the risk-return trade-off more than Netscape Communications Corp. The Internet company still leads the browser market, but it's facing brutal competition from Microsoft Corp. Five years from now, Netscape could be an economic giant, or it could fade away.
BIG DEBTS. Getting more education offers limited protection from uncertainty. As an investment, a college degree still earns an 11% return--but it's more akin to putting money into stocks than buying a meal ticket. Many college graduates borrow heavily and face higher odds of layoffs than 10 years ago. Getting an advanced degree just ups the ante. Holders of law, business, medicine, and other graduate degrees earn much more than mere college graduates but often leave school with large debts. This exposes them to big risks if the demand for MBAs or doctors should sag.
With exports booming, workers can play in the high-risk society by looking for a company in the global market. A factory producing for export pays 12% more on average than a nonexporter, say economists Andrew B. Bernard of Massachusetts Institute of Technology and J. Bradford Jensen of the Census Bureau. One example: The global strength of U.S. semiconductor companies helped boost wages for semiconductor workers by almost 30% since 1990.
But looking for a hot exporter is a gamble as well. Jobs in semiconductors and software are booming. But employment in a related industry, computer manufacturing, has dropped by one-third since 1988 because key components such as diskdrives and laptop screens are made overseas.
The pressure to make high-risk, high-return choices hardly abates as workers get older. According to a recent survey by the Employee Benefit Research Institute and the American Savings Education Council, only 26% of nonretired Americans believe Social Security will be an important source of retirement income. Instead, experts tell them to invest their retirement money in stocks and other high-yield, risky assets.
Corporate America does not escape the pressure to take risks. Many companies tried "reengineering"--rethinking their processes from scratch. When reengineering works, it can cut costs and boost productivity and profits. But more than two-thirds of reengineering attempts fail, estimates Eric Clemons, a Wharton School professor. "The payoff for being right is enormous," says Clemons. "But it's very high-risk to throw out your expertise."
Other management strategies are also high-risk, high-return gambles. Take work reform, which gives workers more flexibility and greater participation in decisions. Businesses using the best work practices can boost sales per employee by as much as $100,000. But to get such benefits, companies must take the dangerous leap of trying several different workplace reforms at once, including a new pay system and added training. "Incremental changes don't have much of an effect," says Thomas Kochan, an MIT labor expert.
HURDLES. Any company that reaches for high profits in global markets faces more uncertainties. Currency gyrations are felt in the bottom line of companies, such as the ones that invested in Mexico and were hit hard by the sharp decline in the peso in late 1994 and 1995. Moreover, the bets with the biggest potential payoffs--emerging markets such as Russia, China, and India--expose companies to political and economic turmoil.
Being a technological leader also means taking risks. For example, the coming generation of low Earth-orbit satellites will, if successful, connect subscribers to a global information network. But pioneers such as Motorola Inc. and Orbital Sciences Corp. face major technological, financial, and competitive hurdles. To name one: Sending signals to the right spot on the globe requires that the new satellites become massive computers in the sky. "It's really never been done before," says David W. Thompson, CEO of Orbital Sciences.
For the most part, government is encouraging, not fighting, the uncertainty. Policymakers have stressed growth at the expense of security. Take the push for deregulation. Airline deregulation lowered average fares, while creating more uncertainty for travelers and airlines. Telecom deregulation will likely yield a similar mix of lower prices and more confusion.
Free trade, too, is a high-stakes, high-return policy. Producers gain from access to fast-growing foreign markets, while consumers can buy lower-price imports. At the same time, however, foreign competition leaves a trail of devastated industries and workers.
The coming battle over Social Security also raises risk-and-reward issues. Social Security succeeded in reducing economic insecurity for older Americans. Now, support is building for a partial privatization of Social Security, which would let workers invest some of their contributions in stocks. The gain would be higher expected retirement income--but at the cost of more exposure to the volatility of the financial markets.
Can anything be done to make Americans feel more secure? The damage done by economic uncertainty is real. But the clock cannot be turned back to the economy of the 1950s and 1960s. Instead, new institutions are needed to cushion the risks, while letting Americans take advantage of the growth.
LONG FIGHT. The government is slowly moving in the right direction. A bill signed this summer, for example, helps workers who are laid off or who change employers retain their health insurance and retirement benefits.
But more can be done. Any future tax reform proposal should permit people to average their incomes for tax purposes across good years and bad. This would protect against uncertainty by giving big tax refunds to workers who lose their jobs or see their incomes suddenly drop.
In the long run, the U.S. will have to develop ways for Americans to buy insurance against economic uncertainty, just as they buy fire insurance for their homes. This is not as far-fetched as it sounds. Financial markets already offer investors the chance to buy complicated futures and options on interest and exchange rates. The same expertise, with some assistance from the government, can create insurance policies that provide some protection for workers, say, concerned that their industry will be overrun by foreign competition.
Adjusting to the high-risk society will not be easy. Americans need security, but they need growth as well.
From The High-Risk Society: Peril and Promise in the New Economy by Michael J. Mandel. (C) 1996 Michael J. Mandel. Published by Times Business BooksBy Michael J. MandelReturn to top