Tag Archives: public interest capitalism

Michael Pettis on the Euro Crisis

Michael Pettis provides an excellent analysis of the crisis in the Euro zone. The historical parallels to the French indemnity of 1871-73 are fascinating and counterintuitive. The crisis is driven by macroeconomic forces:

Germany exported capital because by repressing wage growth, Berlin ensured the high profits and low consumption that forced up its national savings rates. Instead of employing these savings to invest in raising the productivity of German workers (in fact domestic investment actually declined) it offered them either to fund German consumption at high real interest rates (and there were few takers), or through German and Spanish banks this capital was offered to other European households for consumption or to other European businesses for investment. The offers were taken up in different ways by different countries. In countries where the offered interest rates were very low or negative, the loans were more widely taken up than in countries where real interest rates were much higher. To ascribe this difference to cultural preferences rather than to market dynamics doesn’t make much sense.

Cui bono:

The “losers” in this system have been German and Spanish workers, until now, and German and Spanish middle class savers and taxpayers in the future as European banks are directly or indirectly bailed out. The winners have been banks, owners of assets, and business owners, mainly in Germany, whose profits were much higher during the last decade than they could possibly have been otherwise

Plus ça change…

In fact, the current European crisis is boringly similar to nearly every currency and sovereign debt crisis in modern history, in that it pits the interests of workers and small producers against the interests of bankers. The former want higher wages and rapid economic growth. The latter want to protect the value of the currency and the sanctity of debt.

Self-interest vs. Greed and the Limitations of the Invisible Hand

This is why we need Public Interest Capitalism:

Markets can only function well if there is an appropriate legal framework to restrict the behavior of market participants; however, the legal framework is inevitably inadequate. A “greedy” market participant that seeks to gain at the expense of others can usually findsome way to do so.

http://www.academia.edu/1434169/Self-interest_vs._Greed_and_the_Limitations_of_the_Invisible_Hand

Inaugural issue of DJB Quarterly

In connection with my research on Public Interest Capitalism, I’ve decided to write a monthly newsletter covering global economic trends.  The first issue focuses on US trends including the ongoing economic recovery, the decline of labor unions, state and local government budget deficits and spending cuts, tax avoidance by large corporations, and financial sector profits.  I also discuss Michael Porter’s recent article on creating shared value.  The newsletter is available for download here.  This work is supported by the Abegglen Scholarship Fund.  To subscribe, please email me.

UPDATE: My friends in Japan suggested that I add my perspective on the Tohoku disaster.  Here’s an updated version with a discussion of the disaster from a Public Interest Capitalism perspective.

Roger Bootle on Greed

From Bootle’s recent book The Trouble with Markets, excerpted in a Telegraph article entitled “Greed isn’t good – it’s dangerous“:

Society cannot live by greed alone. Even if it can cope perfectly well if some of its members are motivated in this way, it needs millions of people to be motivated by duty, responsibility, and a sense of public purpose. These are feelings that the triumph of unbridled greed in the financial markets threatens to overwhelm. The market was made for man, not man for the market.

Exactly.  We need to get the financial sector under control and restore the balance between private and public interest in corporate management.

Reading Aoki & Jackson

I’m at the Tokyo Foundation office in Toranomon, Tokyo reading this article by Masahiko Aoki and Gregory Jackson entitled “Understanding an emergent diversity of corporate governance and organizational architecture: an essentiality-based analysis”.  Aoki and Jackson propose that the view (currently ascendent in financial economics) of the firm as the private property of the shareholders can be understood as a special case of a more general game-theoretical model of corporate governance.  Moreover, when employees and managers can create value by exerting control over the production process, circumscribing the control rights of shareholders may be desirable.  Aoki and Jackson argue:

An enforceable legal framework for worker participation may be a necessary prerequisite to focus managers and workers on the potential positive-sum gains of cooperation by constraining the potential for short-term gains from non-cooperation that may exist under liberal and purely contractual regimes

As Mary O’Sullivan argues in her book Contests for Corporate Control, insider (manager and employee) control is essential to innovation.  Thus, in a world where competitive advantage increasingly derives from dynamic capabilities, learning, and innovation, it seems reasonable to expect that forms of corporate governance that limit the control rights of shareholders will exhibit better performance.

This work is thus broadly consistent with my research on Public Interest Capitalism, which advocates redesigning capitalist institutions (“rules of the game”) in order to encourage more equitable, sustainable, and innovative economic activity.  Along these lines, I favor a rule requiring employee approval in the case of hostile takeovers, since the possibility of a hostile takeover impedes the creation of implicit contracts between managers and employees, among other stakeholders.

The article also includes an interesting empirical analysis of the institutional clusters emerging in the Japanese economy.

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.

Another critique of market fundamentalism–by the chairman of a major bank

In my research on Public Interest Capitalism, I argue that markets and self interest do not necessarily serve the public interest.  This research draws on theoretical work by the respected economist Douglass North, who argues that institutions (i.e., values, social norms, and regulations) determine whether economic actors engage in wasteful redistributive activities, or productive value-creating activities.  When resources are squandered on redistributive activities, societies decline.  Recently, similar concerns have been echoed by Yukio Hatoyama, Japan’s prime minister to be.  Today, the Telegraph reports on a remarkable speech by Stephen Green, the chairman of HSBC.  The following are quotes from his speech, as reported by the Telegraph.

At their worst, financial markets can be engines of destructive excess. In recent years, banks have chased short-term profits by introducing complex products of no real use to humanity.

capitalism generally, and banking specifically, needs to reaffirm its commitment to contributing to social and economic development

There is no question that the markets – in the form of investors and traders – have often put pressure on boards to pursue short-term strategies and profits.

The results of that pressure are now plain to see in the broken businesses and weakened economies around the world. This was the basic failure of corporate governance.

Legislation is not and can not be sufficient without a culture of values in our industry

If this crisis leads to a genuine reassessment of the role of business and banking in market economies, it may come to rank as one of the great turning points in history of the modern world.

These points closely parallel the arguments that my colleagues and I make in our research on Public Interest Capitalism, so it’s encouraging to see these views articulated by a senior bank executive.  North would surely applaud Green, too, for recognizing that values are an essential complement to legislation (see also my discussion of Why Greed is Bad).  Finally, I think that Green could be right about the potential historical significance of reassessing the role of business in society: if businesses seek to profit through contributing to the general welfare, instead of seeking to profit at its expense, we may enjoy more equitable, sustainable, satisfying, and rapid economic growth.

I doubt that Green or any of his close associates will stumble across this blog, but I invite anyone at HSBC to contact me to discuss Public Interest Capitalism.