The U.S. is currently going through the fifth and largest merger and acquisition wave in its history. The first great merger wave followed the depression of the late 19th century. In an effort to secure economies of scale and maintain market share in their growing markets, firms began to merge.
The second wave followed World War I and shifted the merger mix from horizontal to vertical integration. Firms were no longer able to engulf competitors; instead they purchased companies that operated at different stages of the production process. The third wave (late 1960s) was motivated by the desire for diversification through conglomeration. The fourth wave, in the 1980s, restructured and dismantled those conglomerates and led to increased corporate focus and productivity that spurred growth in the nineties. In the 1990s, the fifth wave of corporate consolidations is characterized by consolidation of market share and acquisition of new technologies.
From a regional perspective, California seems to be losing ownership of its telecommunications companies and banks in this latest wave of consolidations. First, Pacific Telesis was purchased by SBC Corp in 1997. Last year, Bell Atlantic announced its intended purchase of GTE. Now, AirTouch has been acquired by Vodafone.
A little more than a decade ago, California held a global competitive advantage as an emerging financial center for the Pacific Basin economies. Los Angeles, and later San Francisco, evolved quickly as the center of financial service providers. From 1976 to 1986, depository institutions in Los Angeles went through rapid transformation with explosive growth. Output expanded 325% and employment increased 54%, outpacing the nation as a whole.
Financial institutions and services based on emerging financial innovations and technologies were largely resident within the state. California's changing landscape (high rate of in-migration and rapid small business formations) benefited tremendously from the locally owned expanding financial sector. For example, while total employment in Los Angeles increased 30% from 1976 to 1986, depository institution employment grew by 55%.
Rapid expansion in capitalization and employment in the finance sector during the 1980s make a compelling argument for its importance to small and mid-sized businesses. Employment in savings and loans and credit union industries increased 321% and 578% from 1976 to 1986, respectively. They catered to small and mid-sized enterprises and nurtured their growth. More flexible and agile local lending institutions developed relationship lending that penetrated small technology growth and/or ethnic-owned businesses far better than larger banking institutions. Business formation and job creation were among the highest in the country.
Over the past decade, the combination of financial regulation, industry consolidation, and demise of locally owned thrifts and banks conspired to reduce California's and Los Angeles' potential global leadership in finance that had evolved since the days of A. P. Giannini. The state and metropolitan area suffered far greater job losses than the U.S. average. Depository institutions lost 31% of their job base from 1986 to 1996, far above the nation's 12% decline, from efficiency gains in industrial organization and operations.
The obvious question is whether the state can continue to thrive without a solid, competitive, localized financial base. The remarkable recovery in the Los Angeles area depends extensively on the small-business growth of the past few years. High tech start-ups and service-oriented entrepreneurial firms require diverse local sources of financing. Whereas supply factors in the labor market (education, skills, migration) affect job creation and retention, demand factors (business formation and growth) are determined more by aggregate economic activity, which is highly influenced by this change in industrial structure and organization of the financial services industry. In short, there is considerable unrealized potential economic growth that could be negatively affected by this loss of financial comparative advantage.
Glenn Yago is Director of Capital Studies at the Milken Institute.