How to Save Capitalism

On August 19th last year, America’s business leaders made the most astonishing about-turn. The chief executives of 181 of the country’s biggest corporations - ranging from Apple to Ford to Amazon - declared that they should no longer put the pursuit of profit above all else, and that from henceforth they would commit to lead their companies - not only for the benefit of shareholders but all stakeholders. Making money remained important, they declared, but they have an obligation to make the world a better place, protect the environment against the so-called climate emergency and promote diversity and inclusion in a new principle which “outlines a modern standard for corporate responsibility.”

When trying to explain the reasoning behind this extraordinary change of direction, Jamie Dimon, chairman of this Business Roundtable and CEO of JP Morgan, America’s biggest bank, said: “The American dream is alive, but fraying. Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term.” He went on: “These modernised principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans.”

Marc Benioff, chairman and founder of Salesforce, went further. He said: “Capitalism, as we know, it is dead. We’re going to see a new kind of capitalism – and it won’t be the Milton Friedman capitalism, that is just about making money. The new capitalism is that businesses are here to serve their shareholders, but also their stakeholders – employees, customers, public schools, homeless and the planet.”

Corporate titans have to start virtual signalling to ensure their own survival. After all, they are the ones who are the most responsible for having messed up capitalism.

Alex Gorsky, chairman and CEO of Johnson & Johnson and chair of the Roundtable’s corporate governance committee, said the new statement, “affirms the essential role corporations can play in improving our society when CEOs are truly committed to meeting the needs of all stakeholders.” While Darren Walker, president of the Ford Foundation, added: “This is tremendous news because it is more critical than ever that businesses in the 21st century are focused on generating long-term value for all stakeholders and addressing the challenges we face, which will result in shared prosperity and sustainability for both business and society.”

In one fell swoop, these corporate titans were giving up on the philosophy of Friedman and his free-market disciples, a philosophy which has reigned supreme in the US and the Anglo-Saxon world over the last few decades. It was Professor Friedman who declared that “the social responsibility of business is to increase its profits.”

But no more. America’s bosses are now ‘woke’.

What has woken them?

First, there was the rise of populism which led to the election of President Trump, fuelled by the despair felt by many American voters who have not enjoyed any wage growth - adjusted for inflation - since 1980. The US middle classes are shrinking while the poorer are stagnating. The wealth gap is at similar levels to that of the late 1930s. Two-thirds of the bottom 60 per cent of the population have no savings. It’s estimated that nearly a fifth of children live in poverty. Add to this the fact that America’s public-education system is among the worst in the developed world and you have a recipe for disquiet.

Second, Wall Street has taken fright. These Roundtable bosses sense the discontent about the way things are - from both right and left - and they are acting out of pure self-interest. They want to save their bacon, bacon that they have made, ironically, by following Friedman’s pursuit of profit to excess. They are scared because they see Elizabeth Warren making solid ground in the Democrat race - threatening sky-high wealth taxes, the break-up of the giant tech companies like Facebook and Amazon - supported by many Republicans - and new curbs on the financial industry as part of her platform for “economic patriotism.”

Warren, a bankruptcy law expert who made her name during the financial crash, wants a new “21st Century Glass-Steagall Act” which “rebuilds the wall between commercial banks and investment banks as well as tough compensation rules that punish bankers for failed risky investments.” The private equity boys will also be punished. She doesn’t mince her words: “The truth is that Washington has it backwards. For a long time now, Wall Street’s success hasn’t helped the broader economy – it’s come at the expense of the rest of the economy. Wall Street is looting the economy and Washington is helping them do it.” No wonder CEOs are sitting up and starting to twitch, and that Democrat donors have either stopped giving money or switched to supporting Trump.

The third reason is more subtle - corporate titans have to start virtue signalling to ensure their own survival. After all, they are the ones who are the most responsible for having messed up capitalism. They hijacked capitalism for their own ends, and they are now paying the price. It is risible to listen to bankers like Dimon talk about the need for less inequality and a more sustainable culture when he was paid a cool $31 million last year. He is, no doubt, a brilliant banker. He is also a billionaire - thanks to the share options, salary and bonus packages he has enjoyed since he joined the bank in 2004.

Misha Friedman / Getty Images

And here’s the rub. Dimon is the manager of JP Morgan’s business. He is not an entrepreneur, and has never risked his own capital. What businessmen like Dimon - and so many others running companies in the US and the UK have done - is not do what Friedman said and put shareholders first but prioritise management instead. They have been helped by an entire industry devoted to complex share options and benchmarked salaries.

This is why so many top US CEOs have earned eye-watering fortunes from their companies over the last 50 years - even when they have underperformed or, indeed, gone bust. We have also seen this phenomenon first hand in the UK over the last few decades. It was a culture imported to the City from the US via Wall Street after the Big Bang. The pay virus has now infected every other sector of industry.

Take a look at the egregious bonus packages that executives like Jeff Fairbairn, the chief executive of house-builder, Persimmon, and his management cronies, have earned because of their outrageously complex share schemes. Or at Thomas Cook, where a series of hopeless bosses managed to squirrel away many millions of pounds each while they ran the company into the ground and piled up massive debts. Shareholder primacy requires responsible shareholders too. Unfortunately, institutional investors have not been up to the task.

But why have shareholders been so loath to protest and vote against these pay packages? Is it because those same fund managers are also earning excessive pay packages, and so measure themselves against their corporate peers? Despite public outrage, the rate of pay for US and British CEOs has reached astonishingly high levels: the average pay for a FTSE 100 chief executive is now around £4m a year compared to around £100,000 in the 1980s. Some shareholder pressure groups have had a go at protesting but only for pay packages to be approved.

One of the UK’s leading businessmen - someone who took out a mortgage to fund his first venture - and who has chaired several British FTSE 100 companies, claims capitalism has been hijacked by the management class. “Over the last few decades it has become possible to become seriously rich without taking any financial risk,” he tells me. “These managers didn’t have skin in the game. They didn’t create the business and their rewards very often are not tied to performance but luck. Luck in the sense that if you start your tenure at the bottom of the cycle and exit at the top you hit the jackpot.”

The former chairman of a British bank had this to say: “I have seen businesses where the shareholders took all the risk and eventually all the losses whilst traders, investment bankers and investment managers walked away with huge sums of money.”

As Ray Dalio, the founder of Bridgewater Associates, one of the world’s biggest hedge funds and a self-made billionaire, concludes: “The problem is that capitalists typically don’t know how to divide the pie well and socialists typically don’t know how to bake it.” In fact, Dalio thinks the distribution of society’s spoils is now so unequal in the US the government should declare a national emergency. As he wrote recently: “Capitalism is evolving in a way that is not working well for the majority of Americans because it’s producing self-reinforcing spirals: up for the haves and down for the have-nots.”

Dalio has formulated a five point plan to remedy the situation which includes bringing together government institutions to create a new fiscal and monetary policy.

Saving capitalism from capitalists is not a new phenomenon. In 1958, two American political philosophers, Louis O. Kelso - who became fascinated by politics after studying the Great Depression - and Mortimer J. Adler wrote The Capitalist Manifesto which argued that capitalism had not failed because it was inherently bad, but because of the unequal distribution of income.

As Kelso put it, the rich kept getting richer because they owned the capital, while the workers struggled because they derived income only from their labour. Government attempts at redistribution of wealth would always fail, he argued, because workers have no access to capital. He advocated leveraged buyouts and employee share ownership to spread the spoils to the many.

There is no question that capitalism needs reforming, if not a complete shake-up from inside out and, specifically, from top to bottom. But is this trend towards a “stakeholder capitalism” the way to go?

One modern crusader against crony capitalism is Professor Luigi Zingales, professor of finance at the University of Chicago, who argues for more competition, an end to subsidies and lobbying, freer markets and less privilege for the few.

His two books, Saving Capitalism from the Capitalists and A Capitalism For The People: Recapturing the Lost Genius of American Prosperity, are blistering critiques of how big business together with corrupt politicians and lobbyists are corroding American democracy.

With his first-hand experience of Italian cronyism, Zingales is better placed than most to argue that the US must curb the power of big corporations - and monopolies like Big Tech - if the country is to prosper and democracy to survive.

America has done it before, he says. In the late 19th century there was a similar movement against big business which led, eventually, to many of President Theodore Roosevelt’s reforms – ranging from anti-trust to accounting transparency, anti-fraud and a less-concentrated financial system.

Zingales concludes: “That’s what we need today; structural reforms that break the elites. Today our anti-trust laws cannot do anything against these types of monopolies.”

There is surprising agreement between free-market champions on the right and among left-wing commentators - on both sides of the Atlantic- that curbing financial fire-power and breaking up monopolies is the way forward.

Democrat activist, Matt Stoller, also argues in his new book, Goliath: The 100-Year War Between Monopoly and Democracy, that it is this concentration of wealth which has led to the return of authoritarianism and populism in American political life for the first time in eighty years. Stoller, who worked for Bernie Sanders on the Senate budget committee, is clear that tech giants such as Amazon, Google and Facebook are the new robber baron monopolies. Like Senator Warren, he argues that concentrated economic power threatens democracy.

For Stoller, antitrust policy is a vehicle for “preserving democracy within the commercial sphere, by keeping markets open”. As the former associate Supreme Court justice Louis Brandeis, wrote in the 1930s: “We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can’t have both.” Nothing much has changed.

The reality is that corporations are owned by their shareholders so, of course, technically, shareholders must be put first. But this does not mean - and has never meant - that other stakeholders should not be treated equally and fairly.

If only corporate bosses had read The Theory of Moral Sentiments, by the father of economics, Adam Smith, first published in 1759.

In the opening paragraph, Smith wrote: “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.”

As experience has shown time and time again, the best companies are those that treat all of their communities well - ranging from employee-owned businesses such as the John Lewis Partnership in the UK and, according to Glassdoor, the In-N-Out burger chain in the US. Treating everyone with kindness is surely the essence of “good business” and, as Smith said, should be implicit.

Indeed, some critics of stakeholder capitalism argue that corporate bosses would pay themselves even more if they could control the purpose and role of their companies whereas if the purpose is to serve shareholders, theoretically, executives have to deliver for them. If they don’t, they are out, albeit with golden goodbyes.

While this should be what happens, we have seen that shareholders have been loath to wield power over their corporate managers and to say, enough is enough.

There’s a real danger that if shareholders do not start flexing their muscles, governments may be tempted to do it for them - either by imposing wealth taxes or, as in the case of Warren, threatening to take away pay if executives are found to be at fault.

Most of those same business leaders who redefined the Roundtable manifesto in Washington last summer were in Switzerland earlier this year for the World Economic Forum at Davos.

This year was the 50th annual meeting, so there was even more champagne popping than usual for what has become the wokest of woke fests. And guests got their big moment: the meeting between a real-life prince and a green Nordic goddess, a brief chat between Prince Charles and Greta Thunberg on how they would save the planet.

All the glitterati in business were there for the Windsor-Thunberg pledge: JP Morgan’s Jamie Dimon, BlackRock’s Larry Fink, who has recently launched a new greener policy for investing, Facebook chief operating officer, Sheryl Sandberg and Uber’s Dara Khosrowshah to name a few of the tycoons.

As well as the bubbly and the networking, they were ostensibly there to discuss the event’s main topic: Stakeholders for a Cohesive and Sustainable World. This was the theme chosen by Klaus Schwab, the WEF’s chairman, whose Davos manifesto is for a “better kind of capitalism,” one which follows the stakeholder model. Indeed, one of Schwab’s ambitions is to help corporations define new methods for updating their key performance indicators to account for the shift in stated goals. He recommends a new “shared value creation” measure that should include “environmental, social, and governance” goals as a complement to standard financial metrics.

There is no question that capitalism needs reforming, if not a complete shake-up from inside out and, specifically, from top to bottom. But is this trend towards a “stakeholder capitalism” the way to go? And what does defining stakeholder capitalism even mean in practice? Should it be about banning the use of plastic cups? Is it how “diverse” they can make their executive boards? Is it about closing tax loopholes? Or cutting the pay of CEOs? Or is the debate too wrapped in with gesture politics than genuine action? Most of the guests arrived by private jet from around the globe. Yet while they were in Davos, they were offered snow grips so they could walk around instead of the usual chauffeur driven cars to save on energy. Even President Trump was spotted wearing snow grips. What is the world coming to?