In the industrial age, the GDP growth in the Western world had been funded by constantly increasing debt levels. Governments, companies and families were able to take on more loans through sofisticated financial instruments. Countries year after year funded deficits with newly issued obligations. As long as the debt in percentage of GDP remained constant, more debt was not considered an issue in the high growth Western economies of the last decades.
Not only governments used debt insruments to fuel growth of the economy. We all took on mortgages, personal loans and car leases. The impact of this loan explosion was twofold. It made us asset rich (inflated though ..) and it boosted the economy through higher spending. While we became richer in terms of assets, the dark side became apparent after the 2008 credit crunch. Many families that bought into the real estate market found that their assets no longer were ‘in the money’ as the value of their properties declined below the mortgage obligations. Incurring debt changes the nature of (legal) ownership into economic ownership of options.
Also companies gradually introduced debt funding as a key instrument to value creation. Whereas 50 years ago loans were occasionally used to fund capital expenditure or working capital, the leveraged buy out market was until 2008, driven by financial leverage capacity of up to 10x EBITDA. The consequent high company valuations created the perception of a bright future and wealth. Again resulting in higher spending and fueling the economy. Yet, similar to the mortgage market, the option (on value creation) became part of the nature of equity ownership. The claim of the equity holders is limitted to value creation (or loss) as the claims of the debt holders come first (interests and repayments). According to the Miller & Modigliani theory, financial leverage creates value as it lowers the cost of capital. Not unlimmitted though. The credit crunch illustrated clearly that the pay off of to much leverage is an increased risk profile and credit default risk…
Debt and oil fueled the industrial economy. It created wellfare and GDP growth. It made many of us wealthy. However, the flipside of the debt fueled economy is the following: legal ownership is not the same as economic ownership and these two types of ownership diverted more and more. Too much debt makes us vulnerable to risk. It is obvious that more debt is not an option. This is even more true as continuous innovation & industry disruption result in shorter Product Life Cycles’s with a shorter forecast horizon and increased risk.
So what is next? How to develop a new democratized and mindful economy? Open Incubation is building upon social & open innovation and distributed entrepreneurship. In this blog I will explore the concept op Open Incubation, provide cases and develop a framework.