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A Roadmap For Reshaping Capitalism

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In July 1–2, 2019, in Adam Smith’s home in Edinburgh Scotland, an international group of multidisciplinary thinkers and doers met in response to “a call to arms” to discuss “reshaping capitalism and the global order.” The conference was the first major event to be held in Adam Smith’s home since the passing of the founder of capitalism in 1790. It drew together leading scholars and practitioners who care deeply about the balanced, long-term performance of the economic system and the survival and advancement of liberal democracies. Here are some points that stood out in the wide-ranging discussion.

Steve Denning

In his opening statement, Professor David Teece said:

Today high rates of innovation are threatened by weaknesses at all levels of society, in families, in communities, in education and in the corporation itself. The problems are amplified by the way capital markets put pressure on the managers of business firms for short-term financial performance. This guts the capacity of business firms to innovate…. The causes of short-termism run far deeper than the time horizon of managers. Issues of corporate governance and securities regulation are implicated. These self-inflicted wounds are reparable.”

The Power Of Markets

There was widespread agreement that market-based solutions are almost always preferable to centralized planning. Smith’s dictum on the subject in The Theory of Moral Sentiments was repeatedly cited:

The planner “seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider … that, in the great chess-board of human society, every single piece has a principle of motion of its own.”

At the same time, there was a growing recognition that markets enjoy no presumption of optimality. In this respect, economists’ continuing talk of “perfect competition” is particularly misleading. In each case, the question is: "What is this specific market for? How is it actually working?"

Professor William Lazonick reminded the conference that academic models of “perfect competition” are not only fictions. They are often the opposite of perfection: where they tend to exclude innovation and generate sweatshops, they are economically and socially detrimental.

In this respect, the monopolistic behavior and invasions of privacy by the global tech giants must be evaluated and where appropriate regulated, including markets created by the private firms themselves, where they involve self-dealing or unfair competition.

The Role Of The Public Sector

There was relatively little discussion of capitalism vs socialism. Niall Ferguson, Senior Fellow, Hoover Institution, argued that the distinction between socialism and capitalism has become a false dichotomy. It might be better not to use the term, “capitalism,” as it tends to validate the notion of socialism as ‘the government ownership of the means of production,’ which no country or serious economist supports today. What really matters is whether you have the rule of law and real economic freedom--or not.

Many speakers expressed concern at growing income and wealth inequality. Yet Weijian Shan, Group Chairman and CEO, PAG Asia Capital, suggested that inequality per se isn’t the issue. Fifty years ago, China had perfect equality: everyone was poor, which wasn’t good. What matters is equitable growth. In a world where everyone’s income is increasing, people may not care if the CEO of Amazon gets $10 billion richer, but they do mind if their incomes have been stagnant for many decades. In this matter, broad-based economic growth is central.

In terms of rectifying inequality through taxation, Niall Ferguson noted that different countries have widely differing degrees of income redistribution through taxation ranging from Chile (practically none) to Finland (very high). However increasing taxation of the rich won’t resolve the underlying cause of growing inequality, namely, unequal access to the gains from economic growth.

There was widespread recognition that the actions being taken to deal with climate change are inadequate. Yet there were few viable suggestions as to how to make a difference. Divisive politics, driven by growing income and wealth inequality, makes this issue particularly difficult to solve.

It was noted that the asymmetric impact of climate change has yet to be understood and digested, let alone dealt with. For instance, on present trends, the entire nation of Bangladesh will be under water. Where will a population of some 200 million go? The challenges of such massive migrations are difficult to imagine, let alone resolve.

Participants noted that overall, the public sector has not adapted to these challenges as rapidly as the economic environment itself is changing, particularly the transitions that are occurring in the digital economy and climate change. Legislators who sometimes barely understand the dynamics of the digital economy are poorly placed to regulate it. Systematic efforts must be made to upgrade the understanding and skills of the public sector.

Maximizing Shareholder Value

Perhaps the most striking news from the conference was the emerging consensus that maximizing shareholder value is a thoroughly bad idea. If no remedial action is taken, the economic, social and political consequences are likely to be dire. We know, Professor Jay Barney said in the closing session, how to fix this set of problems. The question is, do we have the political will?

While participants recognized that generating long-term shareholder value is obviously vital, they also noted the noxious consequences of the pervasive goal of public corporations in maximizing shareholder value as reflected in the current stock price, which include excessive attention to short-term outputs, value extraction over value creation, pervasive self-dealing by executives, mistreatment of employees, growing income and wealth inequality, and the self-defeating nature of the very objective itself. In effect, the goal of maximizing shareholder value has ended up destroying shareholder value, as Professor William Lazonick explained here.

The Primacy Of The Customer

Conference participants agreed that firms need to deal with the claims of all stakeholders, not just those of shareholders. In evaluating the claims of different stakeholders, several speakers stressed the primacy of the customer. Lady Lynn Forester de Rothschild suggested as a model the Credo of Johnson & Johnson, articulated in 1943, in which customers i.e. those who use the products, are first; the employees second, the community third, and finally stockholders.

Reference was made to Peter Drucker’s dictum that “There is only one valid purpose of a firm: to create a customer”. In Management (1954) and later books, Drucker set aside the goals of making money for the firm or pursuing some preachy purpose with a capital "P". He advocated an unambiguous focus on customers as the primary goal and devoted several chapters in each book to explaining why. Making money, he said, is the result of the delivering value to customers, not the goal of the firm in its operations.

The primacy of the customer was also recognized as a key principle of Agile management which underlies the success of the largest and fastest-growing firms on the planet: Amazon, Apple, Facebook, Google, and Microsoft.

Different participants talked about these issues in different ways. Some spoke in terms of firms’ dynamic capabilities to respond to the shifting needs of customers as central to success in the digital era. Professor John Kay explained why evolutionary rationality is more important than axiomatic rationality in an unpredictable fast-changing marketplace.

Steve Denning

Whatever the terminology deployed, there was a widespread recognition that the bureaucratic management practices that characterized the giant firms of the 20th Century are unable to keep pace with the accelerating 21st Century marketplace. Change is no longer just an option: it’s the key to survival as well as thrival.

The Theory of Moral Sentiments Vs. The Wealth of Nations

Customer capitalism may help resolve the tension between Adam Smith’s two books, The Theory of Moral Sentiments and The Wealth of Nations. In the former book, published in 1759, Smith said that all human beings are in principle capable of “sympathy” for other human beings. But by the time Smith wrote The Wealth of Nations in 1776, he seemed to have lost that faith in respect of businessmen. He noted many times in The Wealth of Nations that the businessmen of his day were pursuing their “own interest” and appeared indifferent to considerations of morality or society.

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

Smith considered that regulations or appeals to businessmen’s morality would be ineffective to control such tendencies. Where effective markets were in play, society was nevertheless rescued by “the invisible hand” of the marketplace:

The real and effectual discipline which is exercised over a workman, is not that of his corporation, but that of his customers. It is the fear of losing their employment which restrains his frauds and corrects his negligence.”

Smith tended to think of serving customers as involving a sacrifice of the businessman’s “own interest”. As Professor David Teece said:

Prior generations generally assumed that self-sacrifice was called for and it even made sense. … Now serving others is sometimes considered a sucker’s game, even though it truly isn’t.”

If serving customers was ever a sucker’s game, it isn’t any longer. In the 21st Century, a basic shift in power in the marketplace from the producer to the customer has led to firms making more money by serving the interests of customers. In effect, there is now alignment between making money and “sympathy” for other human beings, i.e. customers. Now businesses have a financial incentive to intuit, understand and meet customers’ needs—needs that customers may not even know they have. (For example, no customer was asking Steve Jobs to put a thousand songs in their pocket.) Today, businessmen can serve customers without sacrifice—they can make more money by having genuine “sympathy” for the human beings who are their customers.

Treating Employees Right

Over the last several decades, the focus on maximizing shareholder value has led to firms treating employees as disposable elements. “The second task of management,” Drucker had said (that is, after creating customers), “is to make work productive and the worker achieving.” Yet in pursuit of shareholder value, the dignity of work and the worker have suffered grave setbacks. People doing work were treated as “human resources” i.e. things to be mined. Towards the end of the century, work and workers were often no more than collateral damage in the rush to maximize shareholder value. As Professor Lazonick noted, gains in productivity were skimmed off the top for shareholders, including the firms' executives.

William Lazonick

Professor John Kay explained the importance of teams in today’s knowledge economy, particularly when it comes to innovation. Teams are groups of people who produce more than the sum of their parts. He explained why teams are key to mastering evolutionary rationality in an unpredictable fast-changing marketplace. Real teams create meaning and lead to more productive and creative work.

Enhanced Private Sector Governance

The discussion suggested that the main actions to be taken to reshape capitalism are in the area of private sector governance, with the support of the public sector.

The problem of self-dealing by executives must be resolved. As Professor Emeritus Arie Lewin explained:

When we allow firms to buy back their stock and that counts as part of their bonus at the end of the year, it’s not managing the business or investing in the business: the criticism is that this is self-dealing. There is something that got corrupted in the way that we reward top executives. Even more so, if you add to that the idea that average executives in a Fortune 1000 company benefiting above normal, simply because the firm buys back its stock.”

The Role Of Business Schools and Economics Faculties

Speakers at the conference—mainly economics and business school professors—spent more time analyzing problems and formulating questions than in offering solutions or suggesting answers to the daunting array of issues. Indeed, some speakers suggested that this apparent lack of answers reflected the possibility that the agenda of research and teaching currently underway in business schools and economic faculties is not commensurate with the extent of the challenges.

It was noted that the growing popularity of “socialism” among the younger generation is accompanied by little understanding as to what is meant by the term. It was suggested that academia could do more to disseminate the instructive but dispiriting history in the 20th Century of government efforts to own or control the productive parts of the economy.

The First Panmure House Declaration

As the conference came to a close, its sponsors issued the First Panmure House Declaration, which was signed, without discussion, by over 80 conference participants.

The first declaration of Panmure House urges international leaders to base their policies and decision-making on a set of common principles, as espoused and formulated by Adam Smith, which cherish the required values of an ethically-based liberal democratic system, a moral commitment to the well-being of our communities, and affirm responsibility to protect economic, social and political freedoms, and resources, wisely avoid unintentional consequences, follow the rule of law, favor markets and prices as guides to resource allocation and a long term view of private and public investment to support inclusive economic growth and prosperity for all."

—Panmure House, Edinburgh, Scotland, 2nd July 2019

The declaration gives limited treatment to the problems as discussed at the conference and restates faith in what has been called “the Washington consensus”, i.e. the principles of neo-liberalism that have characterized Western democracies for the last seven decades.

Developing A Road Map For The Future

In forthcoming work towards getting an actionable road map, it will be important to:

  • Disseminate knowledge about the shortfalls in performance of the neo-liberal consensus.
  • Suggest practical ways to make the economy more productive, more equitable, more humane, and more meaningful.
  • Encourage the evaluation of markets, rather than lending support to the dogma that all markets are good, let alone “perfect”.
  • Encourage more interchange between different streams of academia and practitioners.

Overall, the road map must be willing to go beyond declarations of the conventional wisdom, to confront hard truths about problems we face and to point to practical steps to resolve them. As Martin Wolf recently argued: “Liberalism will endure but must be renewed: It is a work in progress, not a utopian project.”

At this time of celebration of Adam Smith's thinking, it is sobering to realize that if a book like The Wealth of Nations were to be submitted for publication to the economics profession today, it would be instantly rejected for its lack of mathematics, its embedding of transactions and markets in their social context, its obsession with the ethical dimension, and its repeated references to beauty. The very things that have made the book so influential and so persuasive over several centuries are elements that the economics profession has tended to set aside. We have extracted the prose of Smith’s thinking but left behind the poetry. If we are to put in place arrangements that will last for another couple of centuries, we will need to restore and celebrate the poetry and beauty of shared prosperity.

And read also:

Reshaping Capitalism

How To Solve The Problem Of Wealth Inequality

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