Recently CNBC held a round table with various business leaders to discuss the state of the economy in the US and the world. The concern was that markets are unfair, leaving certain segments behind. This issue is especially of interest in light of the growing attention to ESG (environment social governance) and the pressures on markets and society from recent events associated with a pandemic and renewed focus on injustices of racism. Their discussion identified a number of things wrong with the way our economy works and the complexity of solutions.
There seems to be a narrative advancing with significant political implications that capitalism is not only not working, but it's just a bad system. Some strong advocates of this view go as far as saying capitalism in a sense is a corrupt economic system. They would say the structure itself works against a fair society. They point to the Friedman Doctrine's emphasis solely on shareholders as an inherent tendency of capitalism to be biased to the wealthy (that's the social part of ESG) and be a threat to the environment over time (that's the E). This movement advocates for a whole different system as the solution.
I have looked at business and economics from several different perspectives and come to the conclusion that capitalism is not a corrupt system by design, but capitalism has been corrupted. There are two fundamental ways the natural design of capitalism has been altered, which is the meaning of corrupt.
Let me start by briefly describing the natural model of capitalism (see below). Then I will point out 2 ways I believe capitalism has been corrupted.
At the center or heart of capitalism is the capitalist. Without capitalists there is no capitalism. This is the entity that risks financial capital in order to accomplish a mission and get a financial return on the investment. Both are essential to the economy. It's the capitalist who decides the mission and how to allocate resources to "successfully" accomplish the mission. The capitalist, also called shareholder, desires to produce an expected profit both for continuance and financial gain (called return on capital). Profit belongs to the capitalists to do as they choose. The capitalist's choice on how to use profit is essential for capitalism to work well. That's why they are called in academic circles, the residual claimant.
Capitalists form companies and engage agents to execute the capitalist's wishes when the job is too big for capitalists to do it all. These agents are called executives. They support the capitalist's endeavors as long as both parties view the exchange between them is fair. In capitalism the fair exchange between two parties is ultimately what makes the system work. In order for the exchange to be fair, both parties must maintain a freedom to choose to participate. Fair exchange is fundamental to human motivation.
Executives who run the company governed by the capitalist hire workers, employees and contractors who execute the plans of the executives. Again, both should be able to freely choose the other and the relationship remains as long as the exchange between the two parties is considered fair by each.
Other entities that are affected by actions of agents are called stakeholders. These include customers, suppliers, the communities in which the agents operate and the physical world that provides natural resources the capitalists needs across time. Again, fair exchange must exist between the capitalist's agents and a stakeholder or the relationship between the two will be broken. Each must choose to participate in the exchange in order for the exchange to be viewed as fair. Nature will even rebel if not treated fairly. All nature seeks equilibrium.
The role of government in a capitalistic system is to maintain the freedom of the market. A free market cannot exist where there is coercion or collusion on the part of any participant. The role of government is ONLY to keep markets free, the choices of market participants make it fair.
So, how has capitalism been corrupted? The two areas of corruption include the reversal of the roles of capitalists and agents and the improper role of government.
First, too often the agents have moved to the center and taken over the place as the heart or driver of markets. This is evidenced by the ESG efforts, which are led by a "CEO Round Table." CEO's and other top executives have hijacked the role of capitalists in deciding the mission and how resources should be allocated. This has evolved over the past 50 years as capitalists have become less personally engaged and abdicated their role to the agents. Institutions, such as pension plans and mutual funds, own much of the stock and they are interested mainly in financial returns, often short term. Trading has grown so that much of the capitalist's focus is only financial and very short term. With the exception of capitalist and CEO being the same person(s), strategies are primarily financial and short term.
If capitalists saw mission in broader ways, they would see that investing in stakeholders could grow the overall capacity for economic growth. In a bigger economy the capitalist's share of the market would provide greater returns from a bigger pie. Capitalists would benefit from investing in worker capabilities, education, health, access to credit, and a fair justice system. This is a much larger perspective for capitalists than just ethics and morality. This focus would be a significant return through economic growth. Why isn't ESG led by an "Investor Round Table"?
Second, the government has taken on the role of deciding how a market should be fair. This is the seeds of socialism because this role of government removes choice from the market participants. This change over the past 50 years may be a result of society realizing capitalists have not invested in stakeholders properly, or it simply may be a power grab by politicians. Probably some of both. Regardless of cause, governments corrupt capitalism when it decides that it must determine what's fair in the exchanges between capitalists and its stakeholders rather than freedom of choice of each party to determine what is fair.
These two factors of corruption did not occur overnight and will not be fixed overnight. My problem is that these two factors are not even showing up in the narrative on economic growth. Everyone wants growth, but agents of capitalists and government bureaucrats seem to want power and personal gain more. These two areas are at the heart of problems people think exist with capitalism.
Is the capitalism inherently corrupt?
Is it really the capitalists that are greedy (versus agents and politicians) or are capitalists just asleep?
That's what I ponder when people question capitalism as the best economic system for growth ....
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