We’ve reformed free-market capitalism before, so why not now?

Kirkaldy-born father of economics Adam Smith argued that the best way for a nation to generate wealth was to trust in the invisible hand of the free market and the role of enlightened self-interest, keeping government intervention to a minimum. His ideas still form the basis of our global economic system, but many layers of thought have been added to them since.

During the neo-liberal policy revolution of the 1970s, triggered by the abrupt end of the post-war economic expansion, Milton Friedman argued that the sole purpose of business is to maximise profits for its shareholders. The idea caught on and for decades neo-liberal capitalism contributed to wealth creation and economic growth worldwide, but it also put vast sums of money into the hands of the very few.

“The pursuit of returns to companies’ owners at the expense of other stakeholders has undoubtedly led to greater profits, generating enormous wealth for investors and the executives whose rewards have been increasingly tied to shareholder returns. But it has come at a cost to employees, customers and the environment; incentivised boards to pay less tax; diverted cash to earnings-flattering share buybacks rather than investment; and — among those outside the privileged club of equity owners — eroded the trust on which companies ultimately depend.”
Financial Times

A revolution in thought

We don’t need to overthrow capitalism, but we do need a new rule book. A policy revolution (like in the 1970s) that will benefit the majority of people and the planet by changing international measures of success and by debunking the myth that the assumptions of neo-liberal capitalism are divine economic laws we must adhere to now until eternity.

For example, there is the argument that the wealthy should be taxed less so that they can pump more wealth back into the economy (trickle-down economics), or the idea that CEOs should be paid several times more than employees because of their value-creation. These assumptions, though true to an extent in boom times, become increasingly absurd in the recovery from an economic downturn.

There hasn’t been much trickle down for the people who lost their homes due to subprime mortgage lending in the 2007–2008 crisis.

When house prices collapsed in 2008, the value of middle-class households’ portfolios dropped substantially, while the quick rebound in stock markets boosted wealth at the top. Due to their heavy investment in equities, the top 10% wealthiest households were the main beneficiary from the stock market boom while being at the same time relatively less affected by the drop in residential real estate prices. The consequence of substantial wealth losses at the bottom and in the middle of the distribution coupled with wealth gains at the top produced the largest spike in wealth inequality in postwar American history. And without housing prices keeping Americans’ wealth growing, the rising inequality that had been happening in income for decades was suddenly much more noticeable.
Harvard Business Review

Imagine if the bailouts handed out to Wall Street had been used to pay off sub-prime mortgages instead? Where would those families be now? Would we be in a better or worse position to face the prospect of a post-pandemic recession, or even depression?

A new era

It was revealed in January this year that top FTSE bosses now earn their workers’ average salary in the first three days of the year. Those bosses haven’t been furloughed, but a passing glance at today’s economy will tell you that their value-creation is meaningless without a healthy workforce.

A century ago, Joseph Schumpeter predicted that capitalism would be destroyed by the very intellectual class that benefits so much from it. This doesn’t necessarily entail departing from being a consumer society, or even from the free market, but exploring other versions of capitalism.

So is introducing a new form of capitalism for the next half century a way in which we could meet the demands of a more sustainable consumer society, while investing in the resilience and agility required for responding to complex global crises, from pandemics to climate migration?

We have lived through other forms of capitalism before — including post-war Keynesian economics, which advocated government intervention in terms of fiscal policy and expenditure to provide higher levels of employment than would ordinarily be available if markets really were left to provide jobs based solely on supply and demand — and it is the 1970’s Friedman interpretation of capitalism that has been diminishing for some time, due to its ineffectuality in providing for the people hit hardest during not one but now two global economic crises in the space of a decade.

I’d like to think that the COVID 19 pandemic has catalysed the first tentative steps towards a new era of economics: an era in which economic output will be measured beyond Gross Domestic Product, so that both the private and public sectors could be made more accountable for their societal and environmental impacts; an era that some (many of them women) leaders of small nations have been calling for publicly for some time.

The ideals of Adam Smith, David Hume and the Scottish enlightenment, which paved the way for modern capitalism, were that governance and commerce should be forces for greater liberty, progress, tolerance and fraternity. Therefore it is more than plausible that a new 21st century brand of capitalism could give business a higher purpose without leaving profit-making or free-markets behind.

Restoring trust for transformation

The few politicians who are arguing for radical economic change are, however, mainly viewed as anti-establishment figures, so there is indeed space for business leaders to take up the cause of a new kind of capitalism, just as there is space for the majority of those in elected power to be more courageous and long-termist in their convictions.

The post-war system of international institutions is at a historic low in terms of trust and effectiveness and populism is on the rise across Western democracies, leaving geopolitical power vacuums in their wake.

“We are at a critical juncture. According to last year’s Edelman Trust Barometer, 64% of people globally expect CEOs to lead on social change rather than waiting for government intervention. And a significant 84% expect CEOs to influence policy debates on social issues. Overall, trust in business (52%) remains higher than global trust in government (43%).” 

As a result of this ebb in international leadership, we’re seeing cities, small nations and small businesses take a leading role in trialing new economic models to see if they can work financially and politically: from universal basic income experiments in Finland; to the provision of free public transport in Luxembourg; to doughnut economics in Amsterdam.

No one is asking for a rehash of post-war government intervention. We need to look at what’s worked in the past and then experiment both in the public and private sector with entirely new economic assumptions, but don’t take it from me, take if from four economists who think a departure from treating less than century-old economic norms as gospel is long overdue.

The pursuit of profit for purpose

“By 2020, millennials will make up 40% of all consumers. Profit with purpose is set to become the new norm. The CEOs of the future will want their companies to be recognised as forces for good.” 

Of course, seeking profit in and of itself isn’t a bad thing. In fact it’s necessary for self-sustaining companies to provide jobs, products and services, it’s just that we should question whether profits can only be made by keeping wages low and encouraging over-consumption. Those are precisely the questions that a growing movement of entrepreneurs have asked since the last recession and they’ve discovered that trying to work to a new set of rules when everyone else is clinging to the old ones can be an epic undertaking.

Companies working to “profit for purpose” business models, like Amiqus, face challenges in finding patient capital; in finding investors that aren’t looking for a quick exit; in investing their limited resources heavily in their people and customer experience; in turning down opportunities for growth that don’t meet their values and, sometimes as a result, in taking longer, years longer, to reach break-even.

Even in the most economically progressive countries, the idea that we could move towards majority “ethical capitalist” or “responsible capitalist” business models remains a niche intellectual discussion and it is true that the minority of CEOs taking risks to set new precedents haven’t yet been fully tested by a global economic downturn.

If there were another great recession, profit for purpose companies would have to make cuts like any other business, but the difference, one would hope, would be in the what, how and why.

Hope exists

It may very well be possible to keep our consumer economy and tackle poverty and climate change, but only if we strip much of the power of the corporate lobbies interested in maintaining status quo or even populist politics, while at the same time convincing big business that a departure in the norms that have served multi-million dollar CEO bonuses is also in their interests.

Key to success may be further research into whether “doing the right thing” in business actually leads to greater overall resilience and more profit over time.

We’ve already seen B-Corps and ethical big businesses reach national scale and even enter new markets. Companies like Patagonia, Ella’s Kitchen and The Body Shop have all set exciting precedents for the future of ethical capitalism.

Some of the world’s largest corporates have also seen changes in leadership lead to different priorities that are certainly moving in the right direction (Microsoft/Novartis/Unilever), but, so far, much of the progress has been informal, behind the scenes or led by small business. Outside of regulated matters, like consumer safety, businesses largely volunteer to hold themselves accountable and the danger is that as everyone jumps onto the purpose band-wagon, it will just become another meaningless, fashionable CSR exercise of box ticking, assigning tax-deductible budgets and attending annual conferences, rather than a sincere movement to reform capitalism.

“There is a growing acceptance among business leaders of the need to broaden the pursuit of shareholder value to one that is based on inclusivity, sustainability and purpose. This newspaper has welcomed the direction. Some attempts to confront the problem, however, have been only skin deep. Adding the label “purpose” on to existing corporate models will not be enough. Companies and policymakers should not be afraid to explore whether the change should start at the foundations of the business world, and whether new corporate structures are needed to take capitalism in this new direction.” 
Financial Times

Leadership and mission blindness

In any size of business, sincere top-down leadership is vital in preventing purpose washing, which could further damage trust in both the private and public sectors. It all comes down to how you treat people, particularly behind closed doors, but even mission-led companies still struggle to attract a diverse workforce at all levels of management.

There are real problems of scale for purpose-led businesses and it’s not easy to control a whole supply chain, even when you’ve committed to do so, when the rest of the world isn’t adhering to the same rules. There is also the danger of mission blindness. If a global company ultimately believes it is doing inherent good (Facebook), that’s a justification for just about anything and leaders will lack a sufficient level of self-reflection to encourage innovation where it matters most, for the public interest.

“The current technology and venture capital structure is broken. It rewards quantity over quality, consumption over creation, quick exits over sustainable growth, and shareholder profit over shared prosperity. It chases after “unicorn” companies bent on “disruption” rather than supporting businesses that repair, cultivate, and connect.” 

As more and more businesses take up a higher mission, it’s important to ask “Who is all this purposeful work really benefiting?”, so that business leaders don’t become mission blind.

Are biodegradable nappies and all the other “purposeful” products out there just something to make the middle class feel better about their consumption, while, as Greta puts it, the planet is “on fire”?

It’s true that, if you don’t work for a fancy tech start up, it’s probably going to be a while before purpose-led business models have a big impact on your life, but the precedents they set are already making a difference to public expectations around packaging, carbon footprint, chemical usage, working conditions and more.

What’s needed as we begin to experience the long-term economic consequences of a global pandemic are credible ways to measure impact and to prevent business and political leaders from using purpose as a smokescreen for questionable or even unethical practices in the recovery.

Normal is what we choose it to be

There are some basic principles of monetary economics that will never change. There will always be inequalities and we do need for-profit companies for economic growth, but the idea that free-market capitalism should only ever serve to create profit and dividends is in no way a natural law of economics. Something I’m sure Adam Smith would agree with.

What we’re faced with now is a need to make big and sometimes painful changes to what’s been normal for over half a century, because normal is what we choose it to be.

Sure, it isn’t normal to have a universal basic income and no, there haven’t been enough long-term experiments to show conclusively that we’ve even figured out the right parameters for a future universal basic income, but that doesn’t mean that it flies in the face of capitalism to find out whether UBI might decrease, increase or have a minimal effect on health and poverty.

Reason tells us that it is too early to say either way and that, by experimenting now, we might actually learn something that helps us in the future.

There are ways to make us all happier, healthier and more prosperous, while tackling global crises, but it’s going to take a seismic shift in what we’re collectively willing to try; with government intervention, private investment in experimental business models and consumer demand all with a role to play.

A recent YouGov poll showed eight out of ten people now want the government to prioritise the health and wellbeing of citizens over economic growth. Why settle for a system that’s had its time, when it’s the perfect time to change the system?

Author: Laura Westring leads Public Affairs at Amiqus