A New Kind of Capitalism - SpeakingofDemocracy.com

“Capitalists have done a remarkably poor job of safeguarding the future of capitalism.” (source)

Capitalism can mean dramatically different things to different people. To a Wall Street executive it means being able to accumulate unimaginable wealth. To big business it may be a competitive game that must be won at all costs, even at the expense to the public interest. To a small businessman with a great idea, it might mean being able to turn his passion into an occupation, and enjoy the freedom of self-employment. To many, it is a system that has increased the standards of living for millions. To its victims, capitalism is a monster whose greed leaves many behind, and even commits great crimes against vulnerable citizens. Which view is correct? All of them.

If by “capitalism” we mean creating markets that meet the needs of the public, allowing the best ideas and products to succeed through demand, then this is a highly democratic system that should be encouraged. If capitalism means “greed is good,” and we should look out for our own self-interest at all costs than this is a very anti-social, destructive philosophy that must be tempered.

According to Mother Jones Magazine, “Just before the market crashed, one Wall Street manager wrote to another, ‘Let’s hope we are all wealthy and retired by the time this house of cards falters.'” This is one small example of how the greedy version of capitalism can lead to untold suffering (market crash, lost retirements, unemployment, etc.).

Over the past two years, as the dust of the Great Recession began to settle, a host of business leaders and prominent economic leaders have started to imagine a new kind of capitalism; one that is responsible, broadly-enjoyed, and sustainable. Below, we have included excerpts from these leaders, including Bill Gates, Michael Porter, Elizabeth Warren, James Galbraith, Joseph Stiglitz, Fareed Zakaria, and others.

There are common themes in their writings, including the need to regulate corporations, balance the interests of the public and private profit, and the need to have a strong social purpose that goes beyond the profit motive.

Keep reading.

Columbia University Professor and recipient of the 2001 Nobel Prize in Economics, Joseph E. Stiglitz, wrote in Harper’s Magazine:

Clever people will invariably circumvent regulations and accounting standards; they will seize opportunities to prey upon the poor and the ill-informed, to proﬁt by selling the notion of the free lunch.

The downturn is likely to be so severe partly because we have succumbed to the opinion that markets work best by themselves, unfetteredby government regulations.

…we need to improve the incentives that drive those in the ﬁnance industry, so that their interests align with those of the society and economy they are meant to serve.

Too many bankers and other lenders have been focused on trying to beat the system by getting around accounting and banking regulations…they had every incentive to gamble and connive.

Unless we reform incentives, the ﬁnancial sector will only try to circumvent whatever new regulations are put in place. We will simply have a short respite before the next crisis.

The present stock-option payment structure encourages CEOs to take actions that bloat the short-term reported proﬁts of the ﬁrm, thereby inﬂating the share price, and everyone (except the executives in the know) eventually loses as a result. Their pay must be based on long-term performance, and they should share the losses, not just the gains.

Adam Smith argued that in serving their own interests individuals were led “as if by an invisiblehand” to serve the interests of society as a whole. But once again we see that only with the right rewards can these interests actually be joined. (source)

James K. Galbraith:

The problem is not how to save capitalismbut how to save the unique and successfulmixed economy built in the United States overthe eighty-ﬁve years since the New Deal. Oursystem is not capitalism. Our economy has alarge public sector, which at its best was com-petently concerned with research, defense, ﬁ-nancial stability, environmental safety, socialsecurity, and large measures of education,health care, and housing. Today, after thirtyyears of attack on government, all these func-tions are damaged and in peril.

The rot comes from predators posing as con-servatives and mouthing the rhetoric of “freemarkets.” They are not actually interested infree markets. Their goal is to use the govern-ment to build monopolies, to control re-sources, to block regulation, to crush unions,to divert as much as possible from taxpayersinto private pockets. They have a reckless atti-tude toward war-making and they put the ﬁ-nancial system in peril by failing to enforcestandards of ethics and transparency. As a re-sult, they imperil the country’s credit in theworld. True conservatives recognize this,which is why they defected from Bush andMcCain long ago.

Our postwar system was built on technolog-ical leadership, ﬁnancial stability, and collec-tive security. The world gave us credit andused our currency. Why? Because we gave itback the public goods of peace and economicprogress. We were the bulwark during theCold War. Our system wasn’t imperial: wespoke instead of community, of freedom, ofcommon purposes and common values, andthe world took us seriously because we hadpaid our dues.

The next successful system should be builton that model—that is, on the basis of regu-lated finance, collective security, and, aboveall, a national purpose. Since energy and cli-mate change will dominate the global agendafor the next generation and perhaps even thefollowing, dealing with these issues must be-come our generation’s purpose too. AlthoughAmerica is the world’s great energy wastrel,among developed countries we are the bestpositioned to change, to reduce our own fos-sil-fuel use and help the world do likewise.We have the science, the technology, the en-gineering, and the educational capacity totake the lead.

What we do not have is the capacity to ﬁgure ward this goal, and for using our government to advance that strategy. We have no capacity to plan, and that is what we need now.

…Thegovernment needs a way to imagine the futurethat is not dominated by lobbies or even byCongress so long as Congress is dominated by lobbies. (source)

Well-known business strategy theorist from Harvard Business School, Michael Porter, recently published an article in Harvard Business Review called, “How to Fix Capitalism.” Here are highlights from that article:

“The legitimacy of business has fallen to levels not seen in recent history…A big part of the problem lies with companies themselves, which remain trapped in an outdated approach to value creation that has emerged over the past few decades…They continue to view value creation narrowly, optimizing short-term financial performance in a bubble while missing the most important customer needs and ignoring the broader influences that determine their longer-term success. How else could companies overlook the well-being of their customers, the depletion of natural resources vital to their businesses, the viability of key suppliers, or the economic distress of the communities in which they produce and sell? How else could companies think that simply shifting activities to locations with ever lower wages was a sustainable “solution” to competitive challenges? Government and civil society have often exacerbated the problem by attempting to address social weaknesses at the expense of business. The presumed trade-offs between economic efficiency and social progress have been institutionalized in decades of policy choices. Companies must take the lead in bringing business and society back together. The recognition is there among sophisticated business and thought leaders, and promising elements of a new model are emerging…The solution lies in the principle of shared value, which involves creating economic value in a way that also creates value for society by addressing its needs and challenges. Businesses must reconnect company success with social progress.

A growing number of companies known for their hard-nosed approach to business—such as GE, Google, IBM, Intel, Johnson & Johnson, Nestlé, Unilever, and Wal-Mart—have already embarked on important efforts to create shared value by reconceiving the intersection between society and corporate performance.

…Capitalism is an unparalleled vehicle for meeting human needs, improving efficiency, creating jobs, and building wealth. But a narrow conception of capitalism has prevented business from harnessing its full potential to meet society’s broader challenges…The moment for a new conception of capitalism is now; society’s needs are large and growing, while customers, employees, and a new generation of young people are asking business to step up. The purpose of the corporation must be redefined as creating shared value, not just profit per se.

Business and society have been pitted against each other for too long. That is in part because economists have legitimized the idea that to provide societal benefits, companies must temper their economic success.

…Solving social problems has been ceded to governments and to NGOs. Corporate responsibility programs—a reaction to external pressure—have emerged largely to improve firms’ reputations and are treated as a necessary expense. Anything more is seen by many as an irresponsible use of shareholders’ money.

The concept of shared value blurs the line between for-profit and nonprofit organizations.

A business needs a successful community, not only to create demand for its products but also to provide critical public assets and a supportive environment. A community needs successful businesses to provide jobs and wealth creation opportunities for its citizens. This interdependence means that public policies that undermine the productivity and competitiveness of businesses are self-defeating…

For a company, the starting point for creating this kind of shared value is to identify all the societal needs, benefits, and harms that are or could be embodied in the firm’s products…An ongoing exploration of societal needs will lead companies to discover new opportunities for differentiation and repositioning in traditional markets, and to recognize the potential of new markets they previously overlooked…

…The focus on holding down wage levels, reducing benefits, and offshoring is beginning to give way to an awareness of the positive effects that a living wage, safety, wellness, training, and opportunities for advancement for employees have on productivity…By helping employees stop smoking (a two-thirds reduction in the past 15 years) and implementing numerous other wellness programs, the company has saved $250 million on health care costs, a return of $2.71 for every dollar spent on wellness from 2002 to 2008…If labor unions focused more on shared value, too, these kinds of employee approaches would spread even faster.

Until now, many companies have thought that being global meant moving production to locations with the lowest labor costs and designing their supply chains to achieve the most immediate impact on expenses. In reality, the strongest international competitors will often be those that can establish deeper roots in important communities.

Not all profit is equal—an idea that has been lost in the narrow, short-term focus of financial markets and in much management thinking. Profits involving a social purpose represent a higher form of capitalism—one that will enable society to advance more rapidly while allowing companies to grow even more. The result is a positive cycle of company and community prosperity, which leads to profits that endure.

Shared value is defining a whole new set of best practices that all companies must embrace. It will also become an integral part of strategy. The essence of strategy is choosing a unique positioning and a distinctive value chain to deliver on it.

Shared value holds the key to unlocking the next wave of business innovation and growth. It will also reconnect company success and community success in ways that have been lost in an age of narrow management approaches, short-term thinking, and deepening divides among society’s institutions.

…The right kind of government regulation can encourage companies to pursue shared value; the wrong kind works against it and even makes trade-offs between economic and social goals inevitable. Regulation is necessary for well-functioning markets, something that became abundantly clear during the recent financial crisis. However, the ways in which regulations are designed and implemented determine whether they benefit society or work against it…regulation will be needed to limit the pursuit of exploitative, unfair, or deceptive practices in which companies benefit at the expense of society.

Shared value focuses companies on the right kind of profits—profits that create societal benefits rather than diminish them.

We need a more sophisticated form of capitalism, one imbued with a social purpose. But that purpose should arise not out of charity but out of a deeper understanding of competition and economic value creation. This next evolution in the capitalist model recognizes new and better ways to develop products, serve markets, and build productive enterprises…It is not philanthropy but self-interested behavior to create economic value by creating societal value…Survival of the fittest would still prevail, but market competition would benefit society in ways we have lost.

…Not all societal problems can be solved through shared value solutions. But shared value offers corporations the opportunity to utilize their skills, resources, and management capability to lead social progress in ways that even the best-intentioned governmental and social sector organizations can rarely match. In the process, businesses can earn the respect of society again. (source)

Author and journalist, Fareed Zakaria (recently became the Editor for Time Magazine), wrote a featured article in Newsweek entitled, “Greed is Good (To a Point).” Here are some excerpts:

There is still a long road ahead. There will be many more bankruptcies. Banks will have to slowly earn their way out of their problems or die. Consumers will save more before they start spending again. Mountains of debt will have to be reduced. American capitalism is being rebalanced, re-regulated and thus restored. In doing so it will have to face up to long-neglected problems, if this is to lead to a true recovery, not just a brief reprieve.

The simple truth is that with all its flaws, capitalism remains the most productive economic engine we have yet invented. Like Churchill’s line about democracy, it is the worst of all economic systems, except for the others.

Capitalism means growth, but also instability…What we are experiencing is not a crisis of capitalism. It is a crisis of finance, of democracy, of globalization and ultimately of ethics.

“Capitalism messed up,” the British tycoon Martin Sorrell wrote recently, “or, to be more precise, capitalists did.” Actually, that’s not true. Finance screwed up, or to be more precise, financiers did.

Many of the regulatory reforms that people in government are talking about now seem sensible and smart. Banks that are too large to fail should also be too large be leveraged at 30 to 1. The incentives for executives within banks are skewed toward reckless risk-taking with other people’s money. (“Heads they win, tails they break even,” is how Barney Frank describes the current setup.) Derivatives need to be better controlled. To call banks casinos, as is often done, is actually unfair to casinos, which are required to hold certain levels of capital because they must be able to cash in a customer’s chips.

…we should proceed cautiously on massive new regulations. Many rules put in place in the 1930s still look smart; the problem is that over the past 15 years they were dismantled, or conscious decisions were made not to update them. Keep in mind that the one advanced industrial country where the banking system has weathered the storm superbly is Canada, which just kept the old rules in place, requiring banks to hold higher amounts of capital to offset their liabilities and to maintain lower levels of leverage. A few simple safeguards, and the whole system survived a massive storm.

Since Ronald Reagan’s presidency, Americans have consumed more than we produced and have made up the difference by borrowing. This is true of individuals but, far more dangerously, of governments at every level. Government debt in America, especially when entitlements and state pension commitments are included, is terrifying. And yet no one has tried seriously to close the gap, which can be done only by (1) raising taxes or (2) cutting expenditures. Any sensible proposal will have to feature both prominently.

Most of what happened over the past decade across the world was legal. Bankers did what they were allowed to do under the law. Politicians did what they thought the system asked of them. Bureaucrats were not exchanging cash for favors. But very few people acted responsibly, honorably or nobly (the very word sounds odd today). This might sound like a small point, but it is not. No system—capitalism, socialism, whatever—can work without a sense of ethics and values at its core. No matter what reforms we put in place, without common sense, judgment and an ethical standard, they will prove inadequate.

The failure of self-regulation over the past 20 years—in investment banking, accounting, rating agencies—has led inevitably to the rise of greater government regulation. This marks an important change in the Anglo-American world, away from informal rules often enforced by private actors toward the more formal bureaucratic system common in continental Europe. Perhaps the state should not set the pay of the private sector. But surely CEOs should exercise some judgment about their own compensation, and tie it far more closely to the long-term health of the company. It will still be possible to get very rich—Warren Buffett, after all, draws a salary of only $100,000.

There’s a need for greater self-regulation not simply on Wall Street but also on Pennsylvania Avenue. We get exercised about the immorality of politicians when they’re caught in sex scandals. Meanwhile they triple the national debt, enrich their lobbyist friends and write tax loopholes for specific corporations—all perfectly legal—and we regard this as normal. The revolving door between Washington government offices and lobbying firms is so lucrative and so established that anyone pointing out that it is—at base—institutionalized corruption is seen as baying at the moon.

We are in the midst of a vast crisis, and there is enough blame to go around and many fixes to make, from the international system to national governments to private firms. But at heart, there needs to be a deeper fix within all of us, a simple gut check. If it doesn’t feel right, we shouldn’t be doing it. That’s not going to restore growth or mend globalization or save capitalism, but it might be a small start to sanity. (source)

Bill Gates on “How to Fix Capitalism”

They have great needs, but they can’t express those needs in ways that matter to markets. So they are stuck in poverty, suffer from preventable diseases and never have a chance to make the most of their lives…we need a more creative capitalism: an attempt to stretch the reach of market forces so that more companies can benefit from doing work that makes more people better off. We need new ways to bring far more people into the system—capitalism—that has done so much good in the world…Creative capitalism isn’t some big new economic theory. And it isn’t a knock on capitalism itself. It is a way to answer a vital question: How can we most effectively spread the benefits of capitalism and the huge improvements in quality of life it can provide to people who have been left out?…Many people assume, wrongly, that a company exists simply to make money. While this is an important result of a company’s existence, we have to go deeper and find the real reasons for our being…People get together and exist as…a company so that they are able to accomplish something collectively that they could not accomplish separately–they make a contribution to society.” (source)

Capitalism for the Long Term

McKinsey global managing director Dominic Barton issued an urgent call to business leaders in an article from the March 2011 Harvard Business Review titled “Capitalism for the long term.” In this article he says,

“For business leaders…the most consequential outcome of the [financial] crisis is the challenge to capitalism itself. That challenge did not just arise in the wake of the Great Recession. Recall that trust in business hit historically low levels more than a decade ago. But the crisis and the surge in public antagonism it unleashed have exacerbated the friction between business and society. On top of anxiety about persistent problems such as rising income inequality, we now confront understandable anger over high unemployment, spiraling budget deficits, and a host of other issues. Governments feel pressure to reach ever deeper inside businesses to exert control and prevent another system-shattering event.”

“[Business leaders:] rewire the way you govern, manage, and lead corporations to restore the public’s trust in a capitalist system jeopardized by the financial crisis and ongoing social anxiety. The choice is between reforming a system that has been the greatest engine of prosperity ever devised or allowing it to be revamped by political measures and the pressures of an angry public…the social contract between the capitalist system and the citizenry may truly rupture, with unpredictable but severely damaging results.”

“…much of what went awry before and after the crisis stemmed from failures of governance, decision making, and leadership within companies. These are failures we can and should address ourselves.”

Barton described three areas of reform: First, business must jettison its short-term orientation in favor of a longer-term focus. Executives must also infuse organizations with the perspective that serving all major stakeholders is not at odds with maximizing corporate value. Finally, companies must bolster the power of boards to cure the ills stemming from dispersed and disengaged ownership. (Source)

Barry C. Lynn, author and senior fellow at the New America Foundation, wrote a piece in Harper’s on “Abolishing Stock Options” as a cure for capitalism:

There is one easy way to get the managers o four corporations to focus more on making next-generation products and less on piling up cashfor themselves and the fund managers they serve. And that is to eliminate, or at the veryleast to alter radically, the stock options that since the early 1990s have become such a huge part of executive pay packages. Back then, options were promoted as a way to bring the self-interest of managers more in line with that of shareholders. This is exactly the problem. The old antagonism between “professional” managers inside the ﬁrm and the masters of capital outside it helped ensure a balance between acts of creation and acts of destruction.

In America, the modern manager emerged during the late nineteenth century in tandem with the limited-liability corporation. As these private governments grew bigger, so too did fears that a largely self-selecting corporate elite would abuse their authority, economically and politically. The New Dealers’ aggressive use of the IRS, antitrust law, and other state powers seemed to solve this problem, and by the 1950s managers were wont to present themselves as“corporate stewards” whose job was to serve“stockholders, employees, customers, and the public at large.” These managers knew their companies intimately: in 1950 nearly 40 percent of CEOs had forty or more years of experience with their ﬁrms. And they had an incentive to ensure the long-term health of the activities entrusted to their care, because thebest way to keep the plush ofﬁce and perks wasto invest in the people and ideas necessary for the company to grow. This balance was upset by two actions. The Reagan Administration’s overthrow of an-titrust law in 1981 freed investors and man-agers to create larger firms less regulated byhorizontal competition and hence less com-pelled to reﬁne their products and systems…short-term stock-price ﬂuctuations completed the transformation of the CEO from tri-bune of the industrial arts to Shareholder #1.

Elizabeth Warren and Amelia Warren Tyagi, Harper’s

When a baby stroller or an eyeliner is discovered to be dan-gerous, it is removed from the shelves. Yet ﬁ-nancial products go unmonitored for basic safety. When shopping in the complex and constantly evolving financial market, where actual costs and unfavorable terms are regularly concealed, consumers are on their own.

It is time we created the equivalent of a Consumer Product Safety Commission for ﬁnancial products, an agency whose purpose would be to protect home buyers and investors from the ﬁnance industry’s most dangerous offerings.

…credit card contracts that have expanded from one page to more than thirty, and payday loans that charge annual percentage ratesof over 900 percent. The world of physical products has become safer, while the world of ﬁnancial products has become far more dangerous. That’s a problem that can be ﬁxed. (source)

Further Reading:

Capitalism for the Long Term

Reforming Capitalism Article from McKinsey Quarterly

The Capitalist Manifesto, by Fareed Zakaria

How to Save Capitalism