Sam Keller's TEC Blog

Thursday, August 1, 2013

Stop the war on Capitalism

As a follower of current events, politics, government policy and the economy, I have concluded that there is a war on capitalism in America.  While the Administration talks of job creation, the tax code, business regulations and the desire to redistribute wealth tell a different story.

In a recent article from the Harvard Business School titled "A Manager's Moral Obligation to Preserve Capitalism" published in the July 29, 2013 edition of Working Knowledge, authors Rebecca M. Henderson and Karthik Ramanna make several interesting points as they argue that company managers have a moral obligation to preserve capitalism.

From Professor Ramanna we learn that "capitalism earns its legitimacy through the idea that the pursuit of self-interest explicitly delivers on certain moral goods for society. Individuals could criticize that moral framework—a Marxist, for instance, might argue that capitalism ignores issues of fairness in outcomes—but they can't say that it doesn't exist."

It is this idea of  "fairness in outcomes" that the current Administration espouses.  Those who oppose this idea believe that the way to equalize outcomes to to improve the low end of the economic ladder not bring down the top.

As the article states, "Capitalism's moral logic was perhaps most famously articulated by free market champion Milton Friedman when he said that 'the social responsibility of business…is to increase its profits.' That sentiment puts faith in the market to distribute wealth in the freest, fairest and most efficient way possible—indeed, Friedman went further to say that any attempt to curb the free market was harmful to the good of society."

And by the way, to distribute wealth, wealth must first be created.  Without private sector profit, there is no wealth to distribute.  It takes private sector business people to create wealth through capitalism.  As Margaret put it so well, "The problem with socialism is that you eventually run out of other peoples' money".

In a new working paper, "Managers and Market Capitalism", co-written by Henderson and Ramanna, they agree with Friedman's moral framework—but only when certain conditions are met. In their view, capitalism has two powerful things going for it. First, it has been shown to be incredibly effective in leading to economic growth. Ramanna observes, "If you look around the world, capitalism has lifted hundreds of millions of people out of poverty where previously deployed systems did not."

Second, capitalism tends to be self-correcting. When the free market does fail, the market itself steps in to correct the problem. For example, where a certain company dominates a market to create a near monopoly, entrepreneurs can find competitive advantages to create new opportunities. "Markets make markets work," says Ramanna. "That is the good news about capitalism."

But that doesn't mean markets always work to self-correct structural problems. As Adam Smith first identified in The Wealth of Nations (first published in 1776), free markets require certain conditions in order to function—among them, well-defined property rights, enforceable contracts, non-collusion between parties, and knowledge that puts everyone on a level playing field. And while some of these conditions are self-fulfilling in markets, some are not.

So some public or government intervention is viewed as necessary—and that intervention manifests itself as institutions that operate not through a competitive market process, but through a democratic political process.

Once the market is open to politics, then that market can be corrupted. Some have referred to this new problem as "crony capitalism".   Ramanna asks "if the knowledge is so esoteric that it only resides in a few individuals and those individuals engage in a political process that structures institutions that underlie capitalism, what are (their) obligations?"

The traditional free-market answer to that question is that their obligation is to increase profits for your shareholders, period. But what if that means, for example, undermining accounting standards in order to achieve short-term gains (remember Enron)?

Henderson and Ramanna argue that managers have another interest, not just to serve as agents for their shareholders, but also to serve as agents for the system as a whole. It is not in the long-term interest of a society that deploys capitalism to allow its corporate managers to set up systems that distort the market—potentially leading to corporate scandals or an economic crash—and the undermining of capitalism itself.

 Rather, in these political processes where self-interest can undermine the integrity of capitalism, a manager's moral obligation is put aside his or her own self-interest in order to preserve the interests of the system as a whole.

Of course, that's not an easy sell to someone in a highly competitive market trained to exploit every advantage. This is where norm-setting becomes important, the authors say. Ramanna points to norms that have shifted in the history of capitalism that were not necessarily in a company's self-interest. "We have been able to shift the moral boundary of self-interested corporate behavior when it comes to employing child labor and indentured labor," he says. "Part of this norm-shifting was done by carefully laying out the evidence and then building a strong logical case for what is consistent with the ethical imperatives that legitimize capitalism."

CEOs are usually not immoral people. So the next step in that goal, says Ramanna, is to determine what institutions might be necessary to shift the ethical consensus. He and Henderson have begun to look at increased disclosure on corporate accountability—particularly as it relates to lobbying—as one possible way to fill the information gap. Further, some industry groups have begun to push a concept called "ethical lobbying," in which they take on only clients that agree to broaden their focus to consider systemic interests beyond self-interest, a trend that Ramanna and Henderson think has potential to help change the prevailing mindset.

"Ethical norms don't shift in an instant; these are the kinds of shifts that take place over a generation," says Ramanna. "But if enough CEOs and lobbyists get together and say there is something not quite right about what we are doing, then we may be able to start changing norms."

This seems a far better way to approach the issue of achieving a narrowing of economic disparity  instead of more Government intervention and regulation.  I have observed that when such intervention and regulation don't have the desired results (an all to frequent occurrence), and too often create unintended consequences, the answer is more intervention and regulation, exacerbating the problem. The result - the current Administration's war on capitalism.

For the full text of the article click here