A recent discussion with Thomas Biesheuvel of Bloomberg Business brought up the economic question of wars and catastrophes stimulating economy. Will the recent major bankruptcy boost us?
If only the strongest survive, that’s a good thing for the future of our industry... isn't it?
The dinosaurs were the strongest creatures alive at the time… why didn’t they make it, and what does that have to do with diamonds?
Why doesn’t profit need to be our first priority?
The Broken Window Fallacy
A man's child breaks a window in his home, forcing the man to repair the damage.
Initially, it seems that the boy has greatly contributed to the economy because by repairing the damage, his father will need to hire a glazier, a contractor and pay for both labor and product. The hired professionals will then have more money to spend, money will change hands and the economy will flourish.
The assumption that breaking windows (representing wars, crises and catastrophes) stimulates the economy was exposed as a fallacy by famed French political economist Frederic Bastiat. One of his brilliant essays, "That Which is Seen and That Which is Unseen," explains his theory that economic considerations must take into account the full picture. In essence, objective economic analysis must include not only what appears to be real, but also secondary influences and those around them that are affected by economical resolutions. This includes not only immediate consequences such as benefits, profits or alliances but also the long term effects and the widespread impact.
Additionally, states Bastiat, a good economist must take into consideration the economic effect not only on one link of the chain (like diamond mines and sightholders) but also to the rest of the chain (like the polished market.) If analysis fails to include the entire picture, a decision’s effect may provide temporary advantage but cause disastrous consequences in the long term, or in other links in the chain.
So, why is breaking a window a false contribution to the economy?
Well, the answer lies within the question. By breaking the window pane, the child reduced his father's capital income since he now has to spend money on repurchasing instead of buying new things such as a new suit, shoes or other luxury items. While it’s true that he might have benefited the glazier and the contractor, he discriminated against the tailor, the salesclerk, the designer, well… you get the idea.
Maintenance doesn't stimulate production. In short, Bastiat claims that destruction - and its costs - recycles the economy rather than moving it forward.
When I interviewed with Thomas Biesheuvel recently (for Bloomberg Business) he respectfully challenged my economic logic by asking me if the current challenging industry climate might simply refresh the industry and re-grow it organically. This assumption is false, and in fact, causes even significant companies to declare bankruptcy. Unemployment ensues, as well as a lengthy chain of economic “earthquakes.” In turn, industrial reconstruction forces the industry to spend more. Time and effort is invested rebuilding, and ultimately these crises simply recycles economy, which is absolutely not the same thing as stimulation.
Migration of brainpoweris a common phenomenon among researchers, health care experts and scientists who suffer from the absence of effective conditions and development in their home countries and therefore migrate to other locations which offer more opportunity.
When a large industry, such as the diamond industry, endures destructive “earthquakes” every few years that threaten stable income, talented, educated minds migrate to safer industries where they will have a more reliable ground for development. Although powerful, wealthy companies may survive the catastrophe, creative young minds will no longer be there to lead the foreground.
The theory of biological evolution suggests that the giant dinosaurs, strong and powerful, standing at the top of the food pyramid, did not survive because they were unable to adapt. Changes in environmental conditions required creative thinking and solutions; strength alone was insufficient for ultimate survival – it was only a temporary advantage. Once creativity was required, they became extinct. This brain drain trend which is forcing out our young creatives will ultimately be our demise as an industry.
When Your Customers Earn Good Profit, It’s Good for Your Business
"A business that makes nothing but money is a poor business.”
- Henry Ford
Ford Motor Company, a major international car manufacturer, flourished for the majority of the 20th century manufacturing long, wide, grandiose cars. The oil crisis in the 1980’s, however, coupled with the growing Japanese auto industry brought Ford into crisis. In 1983, the company initiated a recovery program which aligned with Ford's original vision: People, Products, Profit, in that order.
"Ford's determination that people and products are before profits created magic," said Donald Petersen, former CEO at Ford. The company immediately eliminated huge, inefficient vans and jeeps, got rid of a series of unprofitable brands, cut models, streamlined processes. In short, they adapted. It turns out that successful companies set their own purposes beyond profit. Profit alone is a narrow vision for the short term.
According to my sources, the collective feeling was that Phillipe Mellier’s Presidents’ Meeting speech can be summed up like this: he couldn't care less. De Beers is earning impressive profits, and that’s enough.
Well, the devastating impact of carelessness is already beginning to show. Huge companies are collapsing and bankruptcies are piling up. There is substantial unemployment among brokers, widespread layoffs, factory closures and abandonment of office spaces in favor of sitting free of charge in the trade halls. Granted, the polished market prices play a role here as does the absence of advertising and support within the market.