ROCE stands for Return On Capital Employed. It underpins
economic growth and is the most important equation of our times.
All accounting students learn how
to calculate and use this equation within the details of corporate finance but
we are all familiar with the concept. ROCE is stated as follows:
ROCE = Returns
Investment
It calculates the ratio between an investment and the amount
of increase the investment earns. It is better known as a percentage rate of return. For example a company investing $10 million
in a new product and making $2 million profit a year enjoys a 20% ROCE. If PR
can afford to invest £10 in a savings account, he might make 20 pence in a
year; a 2% ROCE.
If more people are to enjoy getting returns out of
investments, then our economy needs to grow. This is the theory that motivates
pretty well all business people and political leaders in the West and in the
East. This makes ROCE an important equation – it represents our increasing
prosperity and source of additional wealth.
On February 24th. 2013, Britain’s creditworthiness was
reduced from AAA to AA1 by Moody’s rating agency. This is the first time in history that Britain
has had a less-than-perfect rating. This happened because of uncertainty regarding returns that would be obtained from investments; about if the ROCE would work. This kind of assessment worries many people but there is much more to the ROCE and our prosperity than finance alone can accommodate.
After all, Charles Ponzi understood the financial ROCE
equation all too well. Charles was an Italian who emigrated to the USA. He
became very successful running the "Securities Exchange Company" in
Boston. His success was based on the extraordinary ROCE offer he made to
clients: make a 50% profit within 45 days or 100% profit within 90 days. Like
all good ideas, Charles’ idea was simple. His clients would buy International Reply
Coupons (IRCs) from other countries and then redeem them in the USA for postage
stamps. This was then made possible because post World War I inflation meant
that IRCs could be bought cheap in Italy and sold for a profit in the USA. This
is a form of arbitrage, or profiting by buying an asset at a lower price in
one market and immediately selling it in a market where the price is higher –
it is not illegal. Charles earned $20 million in a few months ($222 million in
current values).
Like all investors, Charles had to rely upon the survival of
his market; the willingness of investors to believe
in the scheme and keep it afloat with further investments. Without belief in
the continuity of a market, no business has a future. However - just as in 2008
– some people began to doubt if Charles’s scheme had enough underlying assets.
Just as in the financial crash of 2008, Charles's market collapsed because the
investors lost faith in the ability of his scheme to keep on generating
returns. As banks still do, Charles relied on the money obtained from new
investors to pay existing investors. In Charles's plan the underlying assets were
weak. When investors found out that Charles’ did not have enough IRCs
for the plan to work, they stopped investing - the "Securities
Exchange Company" collapsed costing investors £20 million and ruining
six banks. The Ponzi scheme failed in the 1920’s (and again in the financial collapse of 2008). The financial
ROCE collapsed.
Consequently PR joins the many other voices and asks if the
financial ROCE and economic growth are reliable ways to secure our prosperity?
In Germany in 2012, the number of people who saw growth as important was down
14% on the 2010 figure and eight out of ten Germans wanted a new economic order
(Jacobs 2012).
But what is the alternative to ROCE and the economic growth system?
Steady State Economic (SSE) is one such system but as PR discussed in a post
with the title Populating the Steady State Economy (SSE),
we ultimately need a more than economic answer.
Presumably neither is “no growth” a solution since there are
things that even ardent critics of economic growth would like to have “growing”:
desirables such as clean energy infrastructure, community gardens, green
buildings, free time, happiness, creativity and a more equitable distribution
of wealth. Many of these desirable need investments so the ROCE may indeed have
a place in any alternative economic system.
However the ROCE and the growth economy are so well embedded
in our society that there are necessarily many questions to be considered. The
FAQs at Postgrowth.org raise many of these:
It seems that accepting and using the ROCE equation is not
as straightforward as you might at first believe. It is a core belief that
supports our complicated, problematic societies and whilst it does measure the financial wealth we
need, it is at the source of many questions now being asked.
But in addition to all these concerns, the ROCE equation still has to shoulder much more. The future of humanity depends upon finding a new form of
ROCE, a way to link investments and the returns they generate – one that
entails neither misplaced Ponzi beliefs
in finance markets nor the oversimplifications of the financial numbers now in
use.
 |
| Times Square Enlightenment |
Reference
Jacobs, S. (2012). Germany's 'post-growth' movement. The
Guardian Newspaper, Wednesday 19 September .
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