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New economics to deal with the biggest global issue –  Part 1

by Nwaodu Lawrence Chukwuemeka

December 31, 2017 | 12:45 am
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There are two extremes in the debate over capitalism’s role in our present climate change problem. On the one hand, some people see climate change as the outcome of a consumerist market system run rampant. In the end, the result will be a call to replace capitalism with a new system that will correct our present ills with regulations to curb market excesses.

 

On the other hand, some people have faith in a free market to yield the needed solutions to our social problems. In the more extreme case, some see climate policy as a covert way for bigger government to interfere in the market and diminish citizens’ personal freedom.

 

Between these two extremes, the public debate takes on its usual binary, black-and-white, conflict-oriented, unproductive and basically incorrect form. Such a debate feeds into a growing distrust many have for capitalism.

 

A 2013 survey found that only 54% of Americans had a positive view of the term, and in many ways both the Occupy and Tea Party movements share similar distrust in the macro-institutions of our society to serve everyone fairly; one focuses its ire at government, the other at big business, and both distrust what they see as a cozy relationship between the two.

 

This polar framing also feeds into culture wars that are taking place in our country. Studies have shown that conservative-leaning people are more likely to be skeptical of climate change, due in part to a belief that this would necessitate controls on industry and commerce, a future they do not want. Indeed, research has shown a strong correlation between support for free-market ideology and rejection of climate science. Conversely, liberal-leaning people are more likely to believe in climate change because, in part, solutions are consistent with resentment toward commerce and industry and the damage they cause to society.

 

This binary framing masks the real questions we face, both what we need to do and how we are going to get there. Yet there are serious conversations within management education, research and practice about the next steps in the evolution of capitalism. The goal is to develop a more sophisticated notion of the role of the corporation within society. These discussions are being driven not only by climate change, but concerns raised by the financial crisis, growing income inequality and other serious social issues.

 

The market’s rough edges

 

Capitalism is a set of institutions for structuring our commerce and interaction. It is not, as some think, some sort of natural state that exists free from government intrusion. It is designed by human beings in the service of human beings and it can evolve to the needs of human beings. As Yuval Levin points out in National Affairs, even Adam Smith argued that “the rules of the market are not self-legislating or naturally obvious. On the contrary, Smith argued, the market is a public institution that requires rules imposed upon it by legislators who understand its workings and its benefits.”

 

And, it is worth noting, capitalism has been quite successful. Over the past century, the world’s population increased by a factor of four, the world economy increased by a factor of 14 and global per capita income tripled. In that time, average life expectancy increased by almost two-thirds due in large part to advances in medicine, shelter, food production and other amenities provided by the market economy.

 

Capitalism is, in fact, quite malleable to meet the needs of society as they emerge. Over time, regulation has evolved to address emergent issues such as monopoly power, collusion, price-fixing and a host of other impediments to the needs of society. Today, one of those needs is responding to climate change.

 

The question is not whether capitalism works or doesn’t work. The question is how it can and will evolve to address the new challenges we face as a society. Or, as Anand Giridharandad pointed out at the Aspen Action Forum, “Capitalism’s rough edges must be sanded and its surplus fruit shared, but the underlying system must never be questioned.”

 

These rough edges need be considered with the theories we use to understand and teach the market. In addition, we need to reconsider the metrics we use to measure its outcomes, and the ways in which the market has deviated from its intended form.

 

Homo economicus?

 

To begin, there are growing questions around the underlying theories and models used to understand, explain and set policies for the market. Two that have received significant attention are neoclassical economics and principal-agent theory. Both theories form the foundation of management education and practice and are built on extreme and rather dismal simplifications of human beings as largely untrustworthy and driven by avarice, greed and selfishness.

 

As regards neoclassical economics, Eric Beinhocker and Nick Hanauer explain:

 

Behavioral economists have accumulated a mountain of evidence showing that real humans don’t behave as a rational homo economicus would. Experimental economists have raised awkward questions about the very existence of utility: and that is problematic because it has long been the device economists use to show that markets maximize social welfare. Empirical economists have identified anomalies suggesting that financial markets aren’t always efficient.

 

As regards principal-agent theory, Lynn Stout goes so far to say that the model is quite simply “wrong.” The Cornell professor of business and law argues that its central premise – that those running the company (agents) will shirk or even steal from the owner (principal) since they do the work and the owner gets the profits – does not capture “the reality of modern public corporations with thousands of shareholders, scores of executives and a dozen or more directors.”

 

The most pernicious outcome of these models is the idea that the purpose of the corporation is to “make money for its shareholders.” This is a rather recent idea that began to take hold within business only in the 1970s and 1980s and has now become a taken-for-granted assumption.

 

If I asked any business school student (and perhaps any American) to complete the sentence, “the purpose of the corporation is to…” they would parrot “make money for the shareholder.” But that is not what a company does, and most executives would tell you so. Companies transform ideas and innovation into products and services that serve the needs of some segment of the market. In the words of Paul Pollman, CEO of Unilever, “business is here to serve society. “, Profit is the metric for how well they do that.

 

The problem with the pernicious notion that a corporation’s sole purpose is to serve shareholders is that it leads to many other undesirable outcomes. For example, it leads to an increased focus on quarterly earnings and short-term share price swings; it limits the latitude of strategic thinking by decreasing focus on long-term investment and strategic planning; and it rewards only the type of shareholder who, in the words of Lynn Stout, is “shortsighted, opportunistic, willing to impose external costs, and indifferent to ethics and others’ welfare.”

 

We would be continuing this discourse in the next article. For further details call on me for in-depth discussions, busness advisory services and training – send a message via WhatsApp or SMS.

 

-Nwaodu Lawrence Chukwuemeka (Ideas Exchange Consulting).

 nwaodu.lawrence@hotmail.co.uk   (07066375847).


by Nwaodu Lawrence Chukwuemeka

December 31, 2017 | 12:45 am
  |     |     |   Start Conversation

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