Business To Save Capitalism?

On October 19, 2011, in economic theory, by Jon Lewis

Capitalism at Risk: Rethinking the Role of Business. Joseph L. Bower, Herman B. Leonard, and Lynn S. Paine. Harvard Business Review Press 2011, pp.254, $29.95 The message of the ongoing Occupy Wall Street protests remains unclear. Nevertheless, it is safe to say that some of the most virulent Occupy Wall Street (OWS) protesters are questioning [...]

Capitalism at Risk: Rethinking the Role of Business. Joseph L. Bower, Herman B. Leonard, and Lynn S. Paine. Harvard Business Review Press 2011, pp.254, $29.95

The message of the ongoing Occupy Wall Street protests remains unclear. Nevertheless, it is safe to say that some of the most virulent Occupy Wall Street (OWS) protesters are questioning the very underpinnings of the American capitalist system. While it is easy to mock the most outrageous elements among the self-described occupiers, those who underestimate this burgeoning movement do so at their peril. Even Republican Majority Leader Eric Cantor backtracked from his original criticism of OWS as a “mob” and has rightly acknowledged that too many Americans are indeed facing an uncertain economic future.

Although the authors conceptualized and wrote Capitalism at Risk prior the advent of the inchoate OWS protest movement, they begin with the premise that capitalism is imperiled and subsequently argue that business itself must take the lead in maintaining the viability of the global capitalist system. In their recent co-authored book, Bower, Leonard, and Paine, all three of whom are professors at Harvard Business School, set forth what they described to be a “radical proposition.” It is their belief that business needs to adapt. “The capitalist system,” write the authors, “has generated enormous wealth in recent decades, but if the system continues to operate more or less as it has been operating, then it is vulnerable to breaking down in serious ways.” Unlike other scholars who would prefer to see governments taking the initiative in ameliorating the excesses of capitalism, while simultaneously preserving its undeniable benefits, the authors want business itself to take the lead in this regard.

Conceptualized as a project to commemorate the centennial of Harvard Business School, Capitalism at Risk is the resultant product of a series of off-the-record meetings, as well as some on-the-record interviews, which the authors conducted with forty-six prominent Harvard MBA program graduates in Asia, Europe, Latin America, and the United States. Although the work would have benefited from a more clearly delineated timeline, detailing exactly when the authors met with the forums’ participants, it would appear that the discussions were conducted prior to the financial meltdown of late 2008. As part of their discussions and interviews with the aforementioned business leaders, the authors presented them with a World Bank Study. This document, also drafted prior to the financial crisis, projected how the global economic system might appear in the year 2030. The authors then asked the participants to reflect upon the report.

Building on these discussions, Bower, Leonard, and Paine identify what they consider ten disruptive forces, both internal and external, to the success and viability of the free-market system: the financial system; the state of trade; inequality and populism; migration; environmental degradation; failure of the rule of law; public health and education; state capitalism’s rise, radical movements, terrorism, and war; and evolution and pandemics. They then add their own argument regarding the inadequacies of existing institutions to cope with the ten disruptors. In light of the spread of the OWS movement to Europe, it is notable that the authors found that the business executives they spoke with expressed deep concern with capitalism’s current tendency to produce gross inequality and how this could give rise to populist, anti-free market political movements.

In phraseology sure to endear themselves to sociologists and to frustrate those readers who would prefer less academic jargon, the authors conceptualize market capitalism as embedded in an ecosystem. “But if market capitalism is viewed in relation to the larger sociological system in which it is embedded, many, if not all, of the concerns voiced by our executives appear to be interrelated and to lie at the interface between the market system and the larger system that supports and legitimizes it.” In other words, businesses do not operate in a vacuum; rather, they function within a broader context and have to be responsive to both internal negative consequences of capitalism as well as to exogenous factors.

In the second half of Capitalism at Risk, the authors make the case for what they term the “business as leader” approach, arguing that “business can and must play a central role in sustaining the market system and improving its performance for society.” They build the case for innovative business models and institutional activism. As an example of an innovative business model, they point to China Mobile’s success in bringing rural Chinese into the market system and also making a profit. In the final chapter, “Rethinking the Role of Business,” the authors argue that, in light of government’s inability to provide necessary public goods, firms will have to find a way to do so, while simultaneously finding a way to be profitable.

Although Capitalism at Risk contains many important insights, its central argument, that business needs to change, is perhaps not so radical after all. Successful corporate executives need to be cognizant of the political worlds in which they work, and successful global businesses have repeatedly adapted to differing geopolitical circumstances. Generally well presented, at times the book’s prose seems uneven; this is perhaps due to the fact that there were three authors. The book’s greatest weakness, however, is that the business executives’ concerns discussed in Capitalism at Risk were expressed prior to the massive bailouts of the financial sector, the sovereign debt crisis in Greece, and the rise of both the Tea Party and the OWS movement. This, it must be stressed, is hardly the authors’ fault. Nevertheless, one wonders what the resultant product would have been had the authors’ conducted the forums in 2009 and 2010.

In conclusion, Capitalism at Risk provides a framework for business executives who are concerned about the state of global capitalism and would like to adapt their firm’s business structures to address new socio-political challenges. The authors are clearly passionate about advancing their argument and should be commended for addressing very serious issues and providing possible solutions. Although some executives may reject the authors’ arguments, it would be far better for business to change on its own, rather than be overtaken by anti-capitalist political forces prone to excess and sloganeering.

Jon Lewis (c) 2011

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The Perils of Short-Term Thinking

On October 10, 2011, in executive compensation, moral hazard, by Jon Lewis

Saving Capitalism From Short-Termism: How To Build Long-Term Value and Take Back Our Financial Future. Alfred Rappaport. McGraw-Hill 2011, pp.235, $30.00 Capitalism and the viability of the free market system are in crisis, perhaps to a degree not seen since the Great Depression. Protesters in New York City and other major American cities are rallying [...]

Saving Capitalism From Short-Termism: How To Build Long-Term Value and Take Back Our Financial Future. Alfred Rappaport. McGraw-Hill 2011, pp.235, $30.00

Capitalism and the viability of the free market system are in crisis, perhaps to a degree not seen since the Great Depression. Protesters in New York City and other major American cities are rallying against what they perceive to be corporate greed and malfeasance, Senate Democrats are pushing for a millionaire’s tax, and public support for free trade is on the decline. With unemployment at 9.1% and the very real possibility that the United States will soon be entering a second recession within a matter of three years, it is imperative that policymakers reflect upon what went wrong in 2008 so as to better comprehend how we have managed to get into such a mess in the first place.

In Saving Capitalism From Short-Termism, Alfred Rappaport (Northwestern University) argues that the business culture’s emphasis on short-term results rather than long-term value creation has had a deleterious impact on the American economy. “Short-termism, the obsession with short-term results irrespective of the long-term implications, was a prime factor in the recent global financial crisis.” He warns the reader that failure to address short-termism will harm economic vitality, individuals’ sense of financial security, and the free market system’s dominance. When corporate executives focus singlehandedly on meeting quarterly earnings expectations rather than on creating long-term value for the corporation, trouble ensues. The author contends that, in an era in which professional managers are entrusted with other peoples’ money, there are inevitably conflicts of interest between the managerial class and the shareholders and beneficiaries whose interests they are expected to serve. “More broadly what is in the best interests of corporate and investment managers, or at least is perceived to be in their best interests, may not serve the collective interests of the economy—a sobering lesson that the global financial meltdown delivered forcefully.”

As to what he perceives to be the main problem, Rappaport points to the practice of rewarding managers for “short-term performance rather than longer-term value creation.” Those with a background in finance will appreciate Rappaport’s discussion of why earnings are of limited usefulness when gauging a company’s value. His writing can be pithy, such as when he analogizes short-termism to a disease, with the obsession over earnings being the carrier of said disease.

A particular strength of Saving Capitalism From Short-Termism is Rappaport’s ability to make his work relevant to those interested in better understanding what contributed to the financial crisis of 2008. He first distinguishes between failures in the public and private sectors and posits that, “an essential cause of the epic collapse was a collection of perverse, short-term financial incentives.” He does not subscribe to the notion that getting rid of government bailouts would have reduced managerial risk taking. “The evidence,” he argues, “suggests that overconfidence, groupthink, and short-term performance incentives dictate the level of managerial risk taking and that eliminating bailouts would not meaningfully affect that risk-taking behavior.” Even if one accepts the veracity of this statement, it remains the case that a sizeable amount of the public views bank bailouts in a negative light, and that, in politics, perception may matter even more than reality.

While Rappaport may be too dismissive of the moral hazard perils of public sector bailouts, he is more persuasive in arguing that all of the private sector culprits, ranging from homebuyers, appraisers, and lenders to credit rating agencies, corporate boards of directors, Wall Street investment banks, and institutional investors reacted to incentives that promoted short-termism. “Each private-sector culprit,” writes Rappaport, “responded to incentives that offered outsized short-term rewards that overwhelmed the long-term risks.” It should be noted that he does not let the public sector, notably Congress and the Federal Reserve, off the hook. He points out that that they magnified the harmful impact of the private sector incentives, singling out the Community Reinvestment Act of 1977, political pressure on Fannie Mae and Freddie Mac, the easing of credit standards, lax regulation in the financial services sector, and low interest rates.

Given the author’s argument that deeply flawed incentives induced private sector actors to engage in behavior that was deleterious to the financial system and the economy in the aggregate, it is not surprising that he would argue for changing the incentive structures that predominate in today’s business culture. In the second half of the book, Rappaport proposes a series of changes that he believes would reduce the current overemphasis on short-termism. These include, but are not limited to, redesigning new compensation programs that reward employees for long-term value creation; changing corporate policies and behavior; overhauling corporate financial reporting, with an emphasis on the corporate performance statement; and replacing asset-based fee structures for investment managers with performance fees. Those without a business or legal background will likely not find this discussion particularly accessible. Readers with an interest in corporate governance will, by way of contrast, find much of Rappaport’s discussion to be worthy of serious consideration.

In conclusion, in Saving Capitalism From Short-Termism, Rappaport provides a comprehensive and straightforward argument why the contemporary business culture’s narrow focus on short-termism is both misguided and detrimental to the economic health of this country. Many of Rappaport’s observations are on point. It may, unfortunately, take an even greater financial crisis than the one that occurred in 2008 to foster the changes that he believes are necessary to creating long-term value.

Jon Lewis (c) 2011

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Keynes and Hayek

On October 4, 2011, in economic theory, by Jon Lewis

Keynes Hayek: The Clash That Defined Modern Economics. Nicholas Wapshott. W.W. Norton & Company 2011, pp.382, $28.95 With high rates of unemployment and even higher rates of underemployment plaguing the United States, there are many calls for President Obama and the Congress to do something to alleviate the situation. Although President Obama has not made [...]

Keynes Hayek: The Clash That Defined Modern Economics. Nicholas Wapshott. W.W. Norton & Company 2011, pp.382, $28.95

With high rates of unemployment and even higher rates of underemployment plaguing the United States, there are many calls for President Obama and the Congress to do something to alleviate the situation. Although President Obama has not made much headway in promoting his jobs bill, there is an emerging bipartisan consensus in Washington that reducing corporate income taxes could induce much-needed economic growth. Underlying the debates between liberals and conservatives is a philosophical disagreement as to how much, and indeed whether, the federal government should intervene to counter unemployment and to foster job creation.

Ideas are shaped by historical context. They can also take on a life of their own, freed from those who formulated them, and subsequently impact the course of history in surprising ways. Such is one of the premises underpinning Nicholas Wapshott’s ambitious new study of the parallel lives of and debates between John Maynard Keynes, who advocated government intervention in the economy, and F.A. Hayek, best known for championing the free market. Keynes, who was British, and Hayek, who was from Vienna and is associated with the laissez-faire Austrian School of economics, were two of the twentieth-century’s preeminent political economists. While Keynes was more concerned with the perils of mass unemployment and advocated government spending to counter recessions, Hayek was primarily concerned with what he perceived to be the deleterious effects that inflation had on a society and cautioned against governments intervening in the free market.

In Keynes Hayek, Wapshott, a journalist formerly affiliated with London Times and the New York Sun (full disclosure: I wrote a couple of opinion columns for, and received compensation from, the latter newspaper several years ago), defines his recent work as an attempt to answer the question of who was right, Keynes or Hayek, and to demonstrate that the academic disagreements between the two men continue to define the liberal-conservative political divide to this very day.

The author traces both the intellectual and personal dispute between the eponymous economic giants. We learn that both men’s ideas were shaped by the mass inflation that engulfed the vanquished powers of Central Europe after the First World War. Hayek, whose family personally experienced mass inflation in interwar Vienna, developed a strong bias against governments adopting inflationary measures to fix an allegedly broken economy.

Whereas Keynes argued that government should act in order to improve people’s lives, Hayek believed in the futility of government intervention. Wapshott contrasts the optimist Keynes with the pessimist Hayek, who we are told suffered from clinical depression. “Keynes believed that man had been placed in charge of his own destiny, while Hayek, with some reluctance, believed that man was destined to live by the natural laws of economics as he was obliged to live by all other natural laws.” If one accepts Wapshott’s characterization of Hayek’s pessimism, this begs the question of whether one can be an optimistic Hayekian, believing in the limitation of man to create his own destiny and yet believing that the future is necessarily going to be better than the past.

The author’s greatest contribution to furthering our understanding of the Keynes-Hayek dispute is his discussion of how most presidents, even Republicans who employed Hayekian rhetoric, have implemented Keynesian measures. “For many Keynesians,” writes Wapshott, “Reaganomics was little more than a thimblerig, a political gimmick that, behind the macho Hayekian rhetoric about slashing the size of government, set off a public spending spree on defense that boosted aggregate demand and economic growth.” George W. Bush, after the 9/11 attacks, acted as if he were working right out of the Keynesian playbook with “massive federal spending” which included, among other things, “pork barrel projects, such as the building of fire stations in Maine, that had nothing to do with keeping America safe.” This massive spending splurge would, of course, be criticized by the Tea Party who argued that Bush’s and the Congressional Republicans’ irresponsible spending led to the sovereign debt crisis with which the United States must now contend.

Although rich in detail, highly informative, and generally well written, Keynes Hayek suffers from two notable weaknesses. First, the author could have done more to define and to explain some of the economic and financial concepts that he discusses throughout the book. A lay reader without a background in economics or monetary policy could easily find the earlier chapters rough going. While the work has a selected bibliography at the end, it would have benefited from a glossary that would have made it easier for those with only a rudimentary knowledge of economics to better appreciate the nuances of the debate between Keynes and Hayek. The other major weakness in the work pertains to Wapshott’s seemingly capricious utilization of descriptive terminology. Alan Greenspan is an “ultra-conservative”; the Cato Institute is “conservative”; and Hayek was “never a conservative, but had become a libertarian, but he did not propose a state of anarchy.” Adam Wolfson is at first referred to as a “neoconservative thinker”; just several pages later, he is a “conservative political scientist.” Whether these are accurate descriptions are up to the reader to decide.

So, when all is said and done, who has won the debate: Keynes or Hayek? Wapshott leans toward Keynes, referring to Milton Friedman. “Although Keynesianism has been declared dead a number of times since the mid-1970s, Friedman’s acknowledgment in 1966 that ‘in one sense, we are all Keynesians now; in another, nobody is any longer a Keynesian; is a more accurate, if teasingly ambiguous, assessment of the state of economics in the early twenty-first century.” Yet, at the same time, Wapshott acknowledges that the Tea Party’s adoption of the Hayekian message advocating for small government has made American politics increasingly Hayekian. The battle, it would seem, rages on. Whether the Tea Party will be a lasting force is American politics remains yet to be determined.

In conclusion, Keynes Hayek is an exploration of how two men and their very distinct ideas about the role of government impacted twentieth-century economics and politics. While a useful addition to modern economic history, this work will be appreciated more by those already familiar with the Keynes-Hayek dispute than those who are coming to the subject for the first time.

Jon Lewis (c) 2011

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