Tag Archives: Milton Friedman

Applying Public Interest Capitalism to the health insurance industry

Former health care executive Wendell Potter has been calling attention to how health insurance companies increase shareholder value at the expense of their customers and the broader public interest.  Potter left an executive post at CIGNA to become a senior fellow at the Center for Media and Democracy.  His descriptions of how insurance firms short-change their customers and cynically manipulate the political process to serve there masters on Wall Street are a powerful indictment of the shareholder value maximization ideology.  Potter’s interview with Bill Moyers, below, is well worth watching.

Wendell Potter interview with Bill Moyers from YouTube

From a Public Interest Capitalism perspective, one of the most interesting characteristics of the interview is that neither Moyers nor Potter ever questions the ideology of shareholder value maximization–Milton Friedman’s doctrine that a company exists only to make as much money as possible for its shareholders.  So we have only two choices: healthcare managed by greedy corporations who will (metaphorically) throw their customers under the bus to boost profits, or healthcare managed by the government.  Although I have nothing against healthcare managed by the government, my research on Public Interest Capitalism suggests another possibility: restructuring capitalism so that corporations seek to balance private profits and the public interest.

The idea of such enlightened corporate management may seem far-fetched, and it is far-fetched when economic institutions create overwhelming incentives for management to increase shareholder value regardless at any social cost.  But these incentives can be changed.  We could start by prohibiting compensation linked to share price (stock options and stock grants) in publicly traded companies.  Capping executive compensation at a multiple of the compensation of the lowest-paid employee–perhaps forty times–would probably help, too, by limiting the ability of senior executives to profit personally from abusive tactics.  Then limit dividends and voting rights to shareholders who have owned shares for at least five years, thereby reducing the influence of activist investors and hedge funds while protecting the legitimate interests of long-term shareholders.  Requiring that insurance companies disclose, in a standard and easy-to-understand format, performance metrics related to patient satisfaction, recision rates, and so forth would help the public identify abusive firms.

In light of our shareholder-oriented corporate governance institutions, it’s easy to understand why health insurance companies behave the way they do.  Institutions determine whether we can cooperate productively, or whether we slip into wasteful and socially injurious redistributive conflicts, as in the case of the American health insurance industry.  But just because we have developed pathological institutions doesn’t mean that managers necessarily want to behave this way–Potter obviously did not–or that we have to stand idly by as these institutions wreak havoc on our healthcare system and our government.  As Nobel-prize-winning economist Douglass North points out in his book Institutions, Institutional Change, and Economic Performance, institutions are “humanly devised constraints that shape human interaction”.  Humans devised them, and humans can change them.

Japan and market fundamentalism: Hatoyama versus Tabuchi

Yukio Hatoyama, slated to be the next prime minister of Japan, has an op-ed piece in the New York Times criticizing the excesses of globalization and American free-market fundamentalism.  His comments on both topics are right on target. To begin with, Hatoyama calls for an

end to unrestrained market fundamentalism and financial capitalism, that are void of morals or moderation, in order to protect the finances and livelihoods of our citizens

He is right to do so.  During the past few decades, the behavior of many American companies and the teachings of influential American economists have certainly been “void of morals or moderation”.  If this seems extreme, read about health insurance companies and nursing homes operated by private equity companies.  And recall that Milton Friedman published a well-known article in the New York Times Magazine titled “The Social Responsibility of Business is to Increase its Profits”.

With respect to globalization, Hatoyama says:

globalism has progressed without any regard for non-economic values, or for environmental issues or problems of resource restriction.

If we look back on the changes in Japanese society since the end of the Cold War, I believe it is no exaggeration to say that the global economy has damaged traditional economic activities and destroyed local communities.

Under the principle of fraternity, we would not implement policies that leave areas relating to human lives and safety — such as agriculture, the environment and medicine — to the mercy of globalism.

Hatoyama might be interested to read my good friend David Grewal’s book Network Power, which provides carefully reasoned support for these positions.

The New York Times has also published a response to Hatoyama’s article, in the form of an article by Hiroko Tabuchi.  The article is generally critical in tone.  Tabuchi writes that:

many economists here [Japan] say Japan may need more American-style deregulation and market-led growth, not less, to invigorate its stagnant economy.

Of course, that’s hardly surprising: there are few maladies for which mainstream economists do not prescribe “deregulation and market-led growth”.  The article is framed to support this position, making it read more like an opinion piece than like a journal article.  Tabuchi goes on to say:

Japan may be famous for its ruthlessly efficient, competitive manufacturing industries — like Toyota’s just-in-time production, in which parts are delivered just before assembly to keep inventory low. But its domestic service sector, which makes up 70 percent of the economy, is an overregulated, inefficient mess, businessmen and economists say.

Tabuchi is parroting a fairly standard, biased description of the Japanese economy.  She gives no statistics to support the extreme claim that the “domestic service sector … is an overregulated, inefficient mess”.  Indeed, casual observation suggests that she is dead wrong.  Health care is arguably the most important service industry of them all, and Japan’s health care system certainly is not an inefficient mess, though the government plays a major role.  Here are the statistics, from PBS Frontline: Japan spends 8% of GDP on healthcare, versus 15.3% for the U.S.; Japan’s life expectancy is 82 years, versus 77 for the U.S., and Japan’s infant mortality rate is 2.8, versus 6.8 for the U.S.

How about finance, another important service industry?  Japan’s financial industry certainly is not as innovative as America’s, but financial innovation probably does not have much social value anyway.  Certainly Japanese finance did not bring the world to the bring of economic collapse.  Though I do not have the data on hand, I am reasonably certain the Japanese financial sector does not account for 40% of corporate profits.

My personal experiences with the Japanese railway, retail, restaurant, air travel, health care, professional services, and hotel industries contrast sharply with Tabuchi’s characterization of the domestic service sector.  Indeed, Tabuchi’s only evidence for Japan’s service sector being an “overregulated, inefficient mess” is that a new airline has had difficulty getting a license for international flights, and that Japanese businesses employ more people than necessary.  These are both spurious.

The airline industry has very high fixed costs and low marginal costs, so free competition will drive prices below average cost, reducing profits to the point where firms cannot service the debt taken on to finance fixed investments.  The result, as we know here in the U.S., is one bankruptcy after another, often together with layoffs and broken promises to employees.  Small wonder that Japanese airlines have better service.  That a prospective entrant could not get a license may well be evidence of appropriate regulation and dynamic efficiency, though careful analysis would be necessary to say so with any confidence.

As for Japanese businesses employing more people than necessary, this does not necessarily indicate overregulation or inefficiency.  Indeed, as Tabuchi points out:

Japan’s jobless rate is at a record high of 5.7 percent, and it could be as high as 12 percent if not for a government subsidy program that encourages companies to keep surplus workers

So firms should fire their excess employees and leave them feeling betrayed and worthless, and without income?  That certainly would not contribute to economic growth or the general welfare.  Why not keep people employed, where at least they have income, some sense of purpose and belonging, and maybe even a chance of being useful?

Carrying the absurdity a bit further, Tabuchi continues:

Now, with a rapidly aging population and almost no immigration, Japan must increase its productivity, economists say.

Of course, if 12% of the labor force might as well be unemployed, there can be no shortage of labor.  If growth picks up, surplus labor will flow to the sectors that are willing to pay a premium for it (and the government will probably cut employment subsidies).

Perhaps Tabuchi should consider performing her own analysis rather than relying on what “economists say”.  They often get it wrong anyway.

From hired hands to higher aims?

Over the last several decades, maximizing shareholder value has become widely accepted as the duty and legitimate purpose of business managers.  Many scholars propounded this ideology, and probably none more forcefully than Milton Friedman.  In a well-known article in the New York Times Magazine in 1970, he argued that “The Social Responsibility of Business is to Increase its Profits“.  In his book From Higher Aims to Hired Hands, Harvard Business School professor Rakesh Khurana describes how this view replaced a conception of the business manager as a steward of the public interest responsible for skillfully balancing the interests of corporate stakeholders to sustain the enterprise and create value for society.  William Lazonick and Mary O’Sullivan provide a complementary perspective.

Unfortunately, while maximizing shareholder value squares nicely with neoclassical economic theory, it can cause serious problems in practice.  In my research project on Public Interest Capitalism, we link shareholder value maximization to inequity, short-termism and underinvestment, and deterioration of social capital.  In a nutshell, there are three fundamental problems with relying on shareholder value maximization as the criterion for corporate management.  First, market incentives (hence profit) may correlate only slightly or even negatively with social welfare (on this point, see David Grewal’s book Network Power).  Second, markets can impede innovation (Mary O’Sullivan provides the details in Contests for Corporate Control).  Third, by reducing the purpose of the company to generating as much profit as possible for a diffuse external constituency, shareholder value maximization decrease the identification of employees to organizational goals, thereby hindering learning and efficient operation.  For a different but complementary perspective, see Simons, Mintzberg and Basu’s “Memo to: CEOs“.

Fortunately, it appears that the shareholder value maximization movement may have run its course–albeit after bringing the global economy to the brink of collapse.  A group of MBA students at Harvard Business School, concerned about business ethics and inspired by Rakesh’s work, have started MBA Oath, a movement to professionalize management.  The New York Times has the story: “A Promise to Be Ethical in an Era of Immorality“.  This is a very encouraging development.