Peter Drucker Takes The Long View The original management guru shares his vision of the future with FORTUNE's Brent Schlender.
By Brent Schlender; Peter Drucker Reporter Associate Lixandra Urresta

(FORTUNE Magazine) – We all know who Peter Drucker is. He's the original management guru and also, without a doubt, the most prescient business-trend spotter of our time. In the early 1950s he was among the first to discern how thoroughly computer technology would transform business. It was he who, way back in 1961, first called attention to the impending rise of Japan as an economic power, a transformation he helped chart. We can also thank him for coining the concepts of "privatization" and "knowledge workers" and "management by objectives," among others.

And, of course, he is known as the man who first recognized that management itself is a discipline worthy of deep and formal study, one that, as he puts it, "feeds off economics, psychology, mathematics, political theory, history, and philosophy." For more than 50 years he has helped FORTUNE 500 companies, governments, charities, churches, universities, small businesses--even a professional baseball team--take management challenges seriously. Along the way he has written 31 books (two of them novels) that compose a library on the art of management. At age 88 he continues to lecture at the management school that bears his name at Claremont Graduate University.

Facing an oeuvre as broad as that, all a journalist can do to prepare for a four-hour "chat" with Drucker at his home in Claremont, Calif., is to bring an open mind and plenty of tapes and batteries. As you can see in the pages that follow, Drucker doesn't disappoint.

Throughout the discussion, a transcending irony emerges that is, at first, difficult to explain. Right off the bat, Drucker professes never to make predictions, and apparently for a good reason. But then he proceeds to point out trend after trend, all of which could yield serious and specific future consequences for people in almost any line of business.

After a while, however, another pattern reveals itself. Drucker derives most of his observations about the future from his deep and nuanced understanding of history. He has certainly witnessed a lot firsthand in his 88 years--the fall of the Austro-Hungarian Empire, which helped precipitate World War I; the Great Crash of 1929; the horrors of World War II; the waste of resources during the Cold War; the evolution of the multinational corporation; the rise and stagnation of Japan as an industrial power; and now the apparent collapse of many of the Asian Tiger economies. So even though Drucker may be reluctant to make outright predictions, he can't help but try to remind us that our future will be bright only if we remember those lessons of the past that are all too easy to forget, and then apply them to matters at hand.

You've said that you never make predictions. Why?

I don't make predictions because I got the first big break of my career making one that turned out to be horribly wrong. This was August 1929, and I wrote what was the first econometric paper on the New York Stock Exchange. I wasn't quite 20 years old, living in Frankfurt as a trainee at the European headquarters of a Wall Street brokerage. I started with an absolutely obvious axiom regarding demand showing that with the all-new stockholders in the American economy--the Aunt Sallys who came into the market in the 1920s--they simply couldn't sell. Using impeccable mathematics I reached the inescapable conclusion that the stock market could only go one way, and that was up. This article appeared on Oct. 15, 1929, in a prestigious continental European economic journal published by the Frankfurter Zeitung. I was smothered with praise and got my first job on the strength of the article. Of course, we all know what happened a few days later.

This was my last prediction.

So you don't make predictions. What is your prognostication, then, for the stock market in the near term?

I never comment about the stock market anymore, but I will tell you that I pulled [my own investments] out of it completely last January.

Can Japan reverse its economic malaise?

If I sound like an old economist, it's because I am. Keynes pointed out that there's such a thing as confidence. But he made confidence dependent on the interest rate. There is no evidence of that. High interest rates damage confidence, but low interest rates don't necessarily produce it. If the confidence is lacking, people don't convert the additional money into purchasing power. They hold it. That's what's happening in Japan. The savings rate is going up.

The Japanese have a strong reason to drag their feet on financial deregulation. Deregulation invariably forces up interest rates, and savings are still the dynamo of the Japanese economy, especially when it comes to exports. So the Japanese are torn, and by no means stupidly, between the desire to maintain their low interest rate, their minimum deregulation, and minimal consumption, vs. the need to rev up the economy--which means increased consumption. Their behavior is by no means irrational.

We in America believe this is just a bureaucracy holding on. That is so to some extent, but Japan's bureaucracy has been successful twice against all Western advice. We gave them the same advice--deregulate dramatically--when they wanted to move the farm population to the cities in the late 1950s, and when they transformed the mom-and-pop stores into big retail outlets. They replied, "No, we put social cohesion above rapid economic growth," and in both instances they got both. I doubt they can pull it off again. If East Asia recovers fast, yes. But if East Asia doesn't recover fast, it will be hard.

Japanese bureaucrats have a very successful history, but they depend too much on it. I don't think the present power group can really handle the things that really threaten Japan: the demographics, with 1.5 births for each woman of reproductive age, which would reduce the population from 135 million people today to 50 million by the end of the next century, and the shift from manufacturing to something else. The economy is no longer dominated by manufacturing, but the mentality of the country totally is.

Even the tremendous accomplishment of the past 15 years--a shift from an economy that is totally dependent on exports to the West to one with a better balance that includes domestic consumption and exports to Asia--is a problem. They have now become more dependent on the Pacific Rim and the Asian mainland than they ever were on the West.

So what steps can the U.S. take to help Japan?

In Japan now, the question is, How do you get rid of the bureaucracy that has outlived its usefulness? That needs a catastrophe. But the prescription that "if only Japan would become more like America, it would have no problems" is just wrong. If we are telling the Japanese that they should become more like the U.S., well, yes, the financial system in Japan is inadequate even to Japan's needs. The interest rates are low, and the costs are very high. It should be the other way around, as it is here.

I told you that when my father quit the ministry of economics in Austria he became the chairman of a big bank. He was put into that position by the government. The bank was the first of the old pre-World War I banks to crumble. They put him in, this was in 1923, to liquidate it. My school was kitty-corner across from it, so after school I usually went over to his office to work on my homework in a little broom closet and then went home with him on the streetcar. Even a bank chairman in those days had no automobile. That commercial bank was the most backward Austrian bank. My father was put there to liquidate it because it could not be modernized.

Every time I go to a Japanese bank, I see in my mind's eye that commercial bank of 1923. The Japanese have protected their banks much too long.

But for total political, systemic change, the American attitude that the U.S. should be the model for Japan is wrong. Europe should be the model. The U.S. is the model for technology and for management education. But when it comes to political and social structure, the U.S. is no model.

What similarities do you see between Japan and Europe?

The idea Americans have that Japan's society and economy are unique and different from the rest of the world is a mistake. We in the U.S. are the exception. Japan is absolutely continental European in its basic practices. That's the key to understanding why Japan's political and bureaucratic institutions are so inflexible, and why they are moving so slowly in deregulating their financial system and markets.

A great weakness of [the U.S.] is that the people who know Japan are specialists who don't know Europe. And the people who know Europe are specialists who don't know Japan. So our Japan specialists don't realize the Japanese are basically a very conservative and very traditional European country in their governmental policy and structure. European history can explain a lot of things about Japan today.

The French have learned that the government does not have to own business outright to control it--as long as the CEO is a former high-level government bureaucrat, they still have full control! The Japanese exert that same control over industry, partly by having bureaucrats "descend from heaven" into positions at key companies. The other way to ensure continuity is that everybody in key positions is a graduate of the top universities. In elite Japan, your classmates are closer to you than family.

It's a club. Every graduate of one of the prestige universities of France has in his bottom drawer a secret book that shows every other graduate. I once described this to a Japanese, and he shook his head and said: "That just shows you how backward those Europeans are. We don't need a book. We know." And they do. The first thing a Japanese businessman or bureaucrat says when he introduces someone is what school he comes from.

This did not originate in Japan. In France, unless you come from one of three, maybe four, universities, you'll never get anyplace in government. England works the same way--past the middle-level bureaucrats, the government ministries are dominated by Oxbridge graduates. The fact of the matter is that Japan is simply and quite deliberately modeled after France, Germany, and England. And it's no wonder: The man who first built the Japanese civil service in 1873 spent two years in France.

Elite bureaucracies like these can survive economic depression, scandals, wars, and almost anything. In the late 19th century, France was run by a military bureaucracy. Along came the Dreyfus affair in 1896, and you would have thought that would have killed off any bureaucracy. But the military bureaucracy barely blinked. It was not destroyed until World War II. Then it was replaced by a civilian bureaucracy. The German system survived the total degradation under Hitler and still exists, not because these people are very powerful, but because they have the popular base in these countries. Japan works the same way.

We think Japan is the exception. No--we in the U.S. are the exception. Japan and Europe are the rule.

Let's get to a different subject--what do you think about the government's pursuit of Microsoft?

Look, I am not afraid of monopoly. In 1906 a German economist named Liebman published a book that is still the book on cartels, in which he showed that every monopoly in history, unless it was a government monopoly, never lasted more than ten or 15 years.

In 1979 I made myself absolutely impossible by publishing an article in the Wall Street Journal in which I said the petroleum cartel--OPEC--is dead. I predicted that the price of oil would not go up any further, and I got more brickbats for that than I ever got in my life. It wasn't because I was smart; it was because I had read Liebman. I said that between 1980 and 2000 petroleum prices would not go above $20 a barrel, except in case of war. So far I've been right, and adjusting for inflation it is now about its lowest price in history. I wasn't bright; I just remembered what I had read.

Incidentally, historically the best thing that can happen to a monopolist is being broken up. Rockefeller's Standard Oil was saved by antitrust. He was totally committed to kerosene. He didn't believe in the automobile or gasoline. At the one oil company that wanted to go into gasoline--Standard Oil of Indiana--he fired the manager. If the Supreme Court hadn't split up the Standard Oil Co., it would have stayed with kerosene and would now be about the size and importance of Occidental Oil.

If AT&T had been allowed to keep Western Union and pour all its resources into that company, can you imagine? And so on.

So I'm not worried about Microsoft's monopoly. Sure it's a monopoly, but... Three of my grandchildren are in computers, and they all maintain that the PC is yesterday anyhow, and that the Internet is the thing. I don't understand a word they are saying, but that's irrelevant. Certainly it is most unlikely that Microsoft, if it behaves like a monopoly--and it does at present--can maintain itself very long. Ten years perhaps. I'm not worried about it.

Let's get away from the news for a minute. What's the strongest thing about American corporate management these days?

Where American management has done really sensationally is in the medium-sized companies, which also is where the growth in the economy is. "Medium-sized" is a very imprecise term, but these companies have grown in the world economy far better and faster than the big ones have grown. And they attract able young people. All of last year's MBAs at Claremont got jobs, and many of them are being grotesquely overpaid, for which I congratulate them. Practically all of them will start working for big companies.

I check in on my old students, and here's what tends to happen: After three years they know a little bit about themselves. Then they go to work for another big company. Four years later they go to work for a medium-sized company. Why? In part they went to GE to get job security. But after three years they realize there ain't no job security at GE. They're still young--age 27 or 29 or whatever--and still not very high up. But they work with a joint-venture partner that is much smaller, and they realize that if they worked for the partner, they could be the ones going to China to fix a production problem.

These are the ablest people in the organization, and when they make that move they improve the management of the medium-sized companies.

The management at big companies, however, is very uneven.

What do you think is terrible about management at FORTUNE 500 companies?

The worst trend in management is those enormous millions paid to people at the top when they lay off 12,000 people. You have no idea how contemptuous upper-midlevel managers are of those people. They are the ones who do all the work, the ones who tell the people they are fired. These execs don't mind their bosses' getting millions, but just not for dismantling things. There's no bitterness about Michael Eisner, because his success doesn't come out of anybody's hide.

That bitterness is a very high price to pay. I once read a book about Marco Polo in which he asked Genghis Khan what he expects of his officers. And he said, "Of an officer I expect that he takes care of the men before he takes care of himself. Of a general I expect that he takes care of the horse before he takes care of the men." Polo asked why, and he said: "An officer leads by doing; a general leads by example." CEOs should lead by example. But they violate that principle with their exorbitant compensation for eliminating employees. That's a terrible trend.

Another trend that I dislike is not just in American business but in American politics too. Everyone is too prone to keep their mouths open. There's too much talking, too much publicity, too much hype, too much spinning.

Do you know who hired the first public relations man in this country? It was Alfred Sloan, who hired a financial editor to keep GM out of FORTUNE. FORTUNE was a muckraker in its early days, and Paul Garrett was hired to keep GM out of FORTUNE, and he succeeded for ten years. Many years later I once asked Mr. Sloan why he did that. And he said: "I find it embarrassing to have to explain to a journalist things I don't understand myself." That was a very typical Sloan comment. The old man had such a sense of humor.

It's become an incredibly noisy society. Look, I'm biased and very old-fashioned. I was brought up by the maxim that a gentleman only gets into the papers when he is born, when he marries, and when he dies. If he gets into the papers more than that, he is no gentleman. I violated that rule very early, but never mind.

I came to this country as the American writer for a group of British papers in the mid-1930s. Everybody knew in Washington that Franklin Roosevelt had been a womanizer. Yet this was never published. In the early '60s I was a member of a statutory advisory committee to the Secretary of Defense, and I spent a few days each month in Washington, and everybody knew about Mr. Kennedy's activities. Myself being something of a prude, I was a little shocked. Still, it was not only not published; nobody paid much attention. What you have today is completely different, and that applies to American business too. The world has become a very noisy world.

A related problem is that management is becoming ever more fashion-conscious. Managers implement strategies like downsizing and reengineering just because they seem the thing to do. Managers are fashion-conscious because, in reality, 90% of running an organization is routine. Teenagers are fashion-conscious because most of what goes on at school is boring. The same goes for managers.

Perhaps the worst example of this is the emphasis on teams. It takes years to build a successful team, but companies are rushing into it and expecting instant results. In most cases, teams don't even work. Teams are difficult to manage. Who is boss? The team leader or the engineering boss who assigns the project to the team? It's never a good idea to create a conflict of interest and loyalties. Teams are the right strategy only for a very small number of situations.

What's your take on today's stock-option culture?

Stock options play on the same old irrational expectations that drive a Mexican immigrant to buy a lottery ticket. You know you're unlikely to win, but what's the risk? Stock options make the most sense in industries where the probability is that a business won't succeed. A startup doesn't want to be so loaded down with the financial burdens of paying large cash salaries. They also appeal to young people who are willing to knock themselves out and work long hours but don't need a lot of cash flow. What's different about Silicon Valley lately is that the survival rate of companies has been better than usual--instead of six out of ten companies failing, only four out of ten have been failing.

As for stock options for top management of large companies, you have to remember that one reason they look so attractive is that we've had an extraordinary stock market for the past ten years. Over a 50-year period, you shouldn't expect such consistent gains. So while I'm not a believer in stock options as a form of compensation, it sometimes makes sense for performance-related compensation to be paid in the form of options, since they put no pressure on cash flow.

You know, the one thing I remember from my days as a securities analyst is that the figure to watch is cash flow. You can only fake cash flow if you are willing to risk going to jail. Earnings are a less accurate indicator. It takes very little to change an earnings picture completely.

That brings us to another concern of mine--the quality of earnings we're seeing. For many companies, the stock market has been so attractive that they are beginning to rely too much on earnings from trading to shore up profits. If you are counting on trading for earnings, as many financial institutions are doing now, you'll lose your shirt. It never fails. When a trader does well for six months, he starts to get clever, and then disaster strikes.

The stock market also doesn't really understand the role of innovation. In most manufacturing companies, 95% of all profits come from products that are three or more years old. Even at 3M, where only 25% of the products are more than three years old, this is true. But innovation always has the power to change everything. The unexpected always happens.

Here's a prediction. Automakers world-wide keep adding production capacity, and I don't know why. We must have two times the capacity that the world really needs, and in the next 15 years we are bound to have a radical change in automotive technology, most likely in the engine. When that happens, most of the world's automakers will come a cropper.

What do you think about all the efforts CEOs make to manage their businesses to satisfy the stock market?

Let's ask the question: Would it be a good idea if management for five years would not manage for the stock market?

On the one hand, it's high time management managed for performance. Have you heard of James Harrington? In the late 17th century Harrington rephrased Aristotelian law, stating that a change in property ownership always results in a change in power. We've had a change in property with the emergence of institutional investors. That is a change in power. It was high time. So the pressure on performance is going to continue, thank God.

But we have not thought through what performance means. Performance is far more than just the stock price, which is a very short-term measure. We need time for management to think through what performance really means.

Yes, we need to think through what performance is; we need both short-term and long-term measures. But management hasn't accepted this yet. That's because they're under short-term pressure from investors, who themselves are under pressure from their own management, who are looking for short-term results.

Whether we will be out from the pressure of securities analysts, I don't know. I used to be a securities analyst, and so I can speak with freedom: There's one thing securities analysts will never understand, and that's business, because they believe that money is real. Securities analysts believe that companies make money. Companies make shoes. No securities analyst can really understand that. Yes, your stock price is exceedingly important because it controls the cost of your most expensive resource--capital. And so the stock price is very meaningful, and there is no profit unless you earn the cost of capital. Alfred Marshall said that in 1896, Peter Drucker said that in 1954 and in 1973, and now EVA (economic value added) has systematized this idea, thank God. But you still have to have a balance between where you stand on the stock market, and also between innovation and profitability.

Management is a balancing act between the short term and the long term, between different objectives at different times. You have to have performance concepts and measures that enable you to do different things at different times. And the present stock market and the constant pressure to make next quarter's numbers are a severe impediment to achieving that balance.

What about the merger mania that seems to have gripped American business?

In the information technology industry, you have a merger wave that is typical of a rapidly emerging industry. Outside of the IT industry, the present merger wave is simply defensive. The industries that merge are industries that are shrinking. The best example right now is the institutional banking industry. The market is grotesquely overcrowded. How many are there? A dozen major Americans, and half a dozen major Europeans who are pretty good, and there isn't that much business to go around. When I was a securities analyst, I was always told to watch the overhead. If the overhead starts growing faster than sales and revenues for any length of time, watch out. The overhead in the corporate bankers, in the institutional financial services, has grown at least twice as fast as revenues lately. That means you make for the nearest exit.

It's a defensive industry. So they all are buying retail operations. But so far it hasn't been proved that institutional banking can coexist with retail. They represent totally different mindsets. None of the classical composers wrote a decent operetta. And the one attempt Johann Strauss made to write a grand opera was an abysmal failure. Merrill Lynch is doing a magnificent job with its two arms, but the others have yet to show they can do it.

The pharmaceuticals industry is merging because the growth is in areas they don't understand. So they buy minority participations in genetics, in medical electronics, in microbiology. The irony is that the pharmacologists don't understand a word of what the geneticists are talking about. That's why one smart pharmaceuticals company won't take more than a 29% position in a genetics company, because they know they would run it into the ground. They understand the science, but they don't know the way the smaller company works.

The merger wave in daily papers and in publishing is probably a mistake. There's no doubt that the Internet means something for publishing; what it means, we don't quite know yet. Where it has had immediate impact is in an area that nobody anticipated, which is book distribution, and so Barnes & Noble and moved into a vacuum. I'm not sure that those huge, very expensive book publishers like Simon & Schuster or Doubleday make sense anymore.

Even though you've now given us a bunch of predictions, we know there's only one area where you actually like making predictions. So why don't we talk about some demographic trends?

Demographics are the single most important factor that nobody pays attention to, and when they do pay attention, they miss the point. Everybody talks about the aging population in developed countries, which is the less important fact, because we know what to do about it. All you have to do is to raise the retirement age to 79, which is what it will be by 2010. How do I get that number? If you go by what corresponds to age 65 when Social Security began in 1936, the proper retirement age now is 79, given current life expectancy.

Unlike our great-grandparents, old people are in much better physical and mental shape. That's not only because of medical advances but also because of the changes in the jobs they held. Don't forget, prior to 1929, the number of people who did not do manual work was almost zilch. And the people who did manual work--farmers, factory workers, domestic servants--did backbreaking work. They were old by the time they were 40. Remember the children's stories about the grandmother who sits in the corner and reads to the kiddies? Do you know how old she was? Thirty-nine years old. She had no teeth, and she could only eat gruel. She was a bent old woman and everybody hoped she wouldn't live very long because nobody wanted to support her. Today the leading occupational hazard for most people is hemorrhoids. I'll tell you a secret. The proportion of the labor force with hemorrhoids each year is almost exactly equal to the number of people who were killed by falling hot iron in steel mills in 1910.

So retired knowledge workers with marketable skills are going back to work--but not full-time, not to an office, not to commuting. Working part-time beats sitting at home and moaning or playing bridge all day. The bottom line is that if you go forward to 2010, when baby-boomers will be retiring, increasingly fewer will be blue-collar workers. So most will be able to work well into their 70s.

However, as I said, the great event is not that so many more people are getting older. The great demographic event is that in the developed countries the number and proportion of younger people is rapidly shrinking. We've already talked about Japan. In Italy now there are about 60 million people, and at current rates at the end of the next century there will be only 20 million Italians. Southern Europe is committing collective suicide with a birth rate of less than one child per woman of reproductive age, vs. a figure of 2.2 or 2.15 here. The U.S. is the only developed economy to have enough young people, and that's only because immigrants still have large families.

Those shrinking numbers of younger people will have to both drive their economies and help support much larger numbers of older people. It's a vicious circle that will only get worse unless people keep working at a much older age. There is a direct correlation between the burden of supporting the older people and the drop in the birth rate: When the younger generation can't cut back on supporting the old, they have to cut down on the other side of the dependency spectrum, namely children, and they do.

The other consequence of having fewer young people is political. Old people are notoriously greedy and selfish. You have no idea of how overpaid the older people are today. People who retire at 65 with a kind of halfway decent salary have a company pension as well as Social Security, and so does his or her spouse. If they work a little on the side, they may well be doing a good deal better than when they were still employed. Add to this Medicare, and never have older people been so prosperous.

When you consider that in all developed countries the people over 55 have more political power, simply because they vote so much more than the younger people, well, you see that to take anything away from us is going to be very, very brutal. We are going to fight and scream and implore the heavens, and make you younger people pay dearly.