Capitalism 3.0: Chapter 4 (About the EoE)
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Capitalism 3.0: Chapter 4
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The Limits of Privatization
The corporation is an externalizing machine, in the same way that a shark is a killing machine. There isn't any question of malevolence or of will. The enterprise has within it, as the shark has within it, those characteristics that enable it to do that for which it is designed.
—Robert Monks,1998
It’s tempting to believe that private owners, by pursuing their own self-interest, can preserve shared inheritances. No one likes being told what to do, and words like statism conjure fears of bureaucracy at best and tyranny at worst. By contrast, privatism connotes freedom.
In this chapter, we look at Garrett Hardin’s second alternative for saving the commons: privatism, or privatization. I argue that private corporations, operating in unconstrained markets, can allocate resources efficiently but can’t preserve them. The latter task requires setting aside some supplies for future generations—something neither markets nor corporations, when left to their own devices, will do. The reason lies in the algorithms and starting conditions of our current operating system.
The Algorithms of Capitalism 2.0
If you’ve ever used a computer spreadsheet, you know what an algorithm is. Each cell in the spreadsheet contains a set of instructions: take data from other cells, manipulate the data according to a formula, and display the result. The instructions within each cell are algorithms.
If you think of the economy as a huge spreadsheet, with each cell representing a producer, consumer, or property owner, you can see that the behavior of the whole is driven by the algorithms in the cells. Our current operating system is dominated by three algorithms and one starting condition. The algorithms are: (1) maximize return to capital, (2) distribute property income on a per-share basis, and (3) the price of nature equals zero. The starting condition is that the top 5 percent of the people own more property shares than the remaining 95 percent.
The first algorithm is what drives corporations. It tells them to sell as much as they can, pay as little as possible for labor, resources, and waste disposal, and make shareholders happy every quarter. It focuses the minds of managers every day. If they work in marketing, they wake up thinking about how to sell more; if there’s no demand for their product, they must create some. If they work in finance, they worry about margins and leverage. If they’re in labor relations, they bargain hard, replace long-term employees with temps, and shift jobs to places where wages are lower. All the while, the CEO feeds sweet numbers to Wall Street.
The second and third algorithms then mesh with the first. It’s the combination of these algorithms that causes the wheels of capitalism to devour nature and widen inequality among humans. At the same time, nothing in the algorithms requires or encourages corporations, either individually or collectively, to preserve anything.
This doesn’t mean people inside corporations don’t think about protecting nature, raising their workers’ pay, or giving something back to society. Often, they do. It does mean their room for actually doing such things is too narrow to make a difference. Nor does it mean that, from time to time, some brave mavericks don’t briefly flout the corporate algorithm. They do that, too. What I’m saying is that, in the great majority of cases, the corporate algorithm and its brethren are obeyed. For all practical purposes, the publicly traded corporation is a slave to its algorithm.
Socially Responsible Corporations
To survive over time, every organization needs to take in more money than it spends. (The only possible exception may be the U.S. government.) This means that even nonprofit organizations must, in a sense, make a profit. But making a profit isn’t the same as maximizing profit. In the first instance, profit is a means to an end; in the latter, it’s the purpose that trumps all others. Millions of organizations earn enough money to stay alive, yet pursue goals other than profit. Is it possible for publicly traded corporations to be like that? Can they have multiple bottom lines? Can they, in other words, rise above their profit-maximizing algorithm?
There are several ways this might be possible: enlightened managers might choose a higher goal than profit, shareholders might insist on it, and government might require it. Let’s consider each possibility.
Enlightened Managers
Managers are human beings; they don’t care just about money, they also care about the larger world. The problem is, they’re trapped in a cold-hearted system. Managers are paid to do one thing, and to do it well. At best, they can be public-spirited as long as they don’t harm the bottom line. This gives them some range to operate—for example, if using recycled paper adds minimally to their costs without reducing quality, they might use it. But if it adds substantially to their costs, they won’t—or more accurately, can’t—sacrifice profit for the sake of a few trees. What matters at the end of the day isn’t the managers’ personal values, but the difference in price between recycled paper and paper made from newly felled trees.
There are other reasons not to rely upon the voluntary benevolence of corporate executives. As The Economist has written, “The great virtue of the single bottom line is that it holds managers to account for something. The triple bottom line does not. It is not so much a license to operate as a license to obfuscate.”
As a businessperson, I find this argument compelling. Every large organization, to be managed well, needs a mission. That mission should be as clear as possible. It’s hard enough to manage to one bottom line; it’s more than thrice as hard to manage to three. How do managers know, much less quantify, the external consequences of what they do? And even if they know, what do they do when goals conflict? Does profit trump nature or vice versa? If managers are accountable to shareholders for profit-based performance, to whom are they accountable for commons-based performance?
Hypothetical answers to such questions can no doubt be drafted, but what would happen in the real world, I suspect, is what The Economist surmises: profit maximization would dominate, accompanied by obfuscation about other goals. Corporate communications departments would try to maximize the appearance of social responsibility for the lowest actual cost. We’d see beautiful ads and reports, but little change in core behavior.
It’s important to remember that the profit-maximizing algorithm is enforced not just by laws, but by a variety of carrots and sticks. For example, CEO compensation is typically based on a list of goals established by the board. These often include nonfinancial goals, but the goal that carries the most weight, and is least amenable to obfuscation, is profit. Further, the CEO and other top managers usually receive stock options. Since stock prices are driven by reported quarterly earnings, managers who own stock or stock options strive to maximize these.
When carrots fail to motivate, sticks come into play—and they can be brutal. An “underperforming” corporation will be devalued by the stock market. This makes it susceptible to takeover. A classic example is the Pacific Lumber Company of California, the largest private owner of old-growth redwood trees in the world. Prior to 1985, Pacific Lumber was a family-run business that took a long-term perspective. When it logged, it left up to half the trees standing, creating natural canopies and keeping much of the soil stable. It was also generous to its workers, renting them housing at below-market rates and refraining from layoffs during downturns.
Sadly, however, Pacific Lumber’s responsible behavior made it easy prey for a takeover. Its concern for nature and its employees diminished its profits and hence its share price. Because of its cutting practices, it held tremendous stands of virgin redwoods that could be liquidated quickly. In addition, its pension plan was over funded. Spotting all this, corporate raider Charles Hurwitz offered to buy the company in 1985 through a holding company called Maxxam. At first the directors refused, but when Hurwitz threatened to sue them for violating their fiduciary duty to shareholders, the directors succumbed.
Hurwitz financed his purchase with junk bonds, the interest on which was more than the historical profits of the company. To service this debt, he terminated the workers’ pension plan and began harvesting trees at twice the previous rate. Such were the fruits of the previous managers’ enlightened practices.
It is possible for a company to pursue multiple bottom lines if it’s closely held by a group of like-minded shareholders—that was the case at my former company, Working Assets. But once a corporation goes public—that is, sells stock to strangers—the die is pretty much cast. Strangers want a stock that will rise when they plunk down their money, and profit is the sure path to doing that. It’s just a matter of time, then, until the profit-maximizing algorithm kicks in.
I’ve spent a good part of my life talking with people who wish publicly traded companies could be socially responsible—not just cosmetically, but sufficiently to make a difference. They contend that corporations were once dedicated to public purposes, escaped their bounds, and can be put back in. They recall a time when companies were rooted in their communities, hired workers for life, and contributed to local charities. The trouble is, those days are irreversibly gone. Today, owners live nowhere near workers, labor and nature are costs to be minimized, and it’s hard to see what might displace profit as the organizing principle for publicly traded corporations.
Managers are ultimately responsible to shareholders, so if shareholders demanded social responsibility, perhaps managers would pay attention. That’s the thinking behind socially responsible investing. Could this tactic tame corporations?
Partisans of this approach employ two techniques: screened investment (putting money in “good” companies and withholding it from “bad” ones) and shareholder activism. Screened investment funds have made considerable progress since I co-founded Working Assets Money Fund in 1983; they’ve grown from virtually nothing to over $2 trillion in assets, or approximately 10 percent of professionally managed money in the United States. These funds vet the corporations whose securities they buy, not just for financial performance but for social and ecological behavior as well. Their vetting process typically excludes firms that sell tobacco or alcohol, violate environmental regulations, discriminate against minorities, treat workers badly, or manufacture weapons. In theory, if enough people invested this way, they could lure corporations into behaving better than they otherwise might.
In reality, though, it hasn’t worked like that, and doesn’t seem likely to. One reason is that socially screened investment funds (with a few exceptions) aren’t willing to accept a lower rate of financial return. “Doing well by doing good” is their mantra, and they strive to beat, or at least equal, the returns of funds that are not socially screened. When they succeed (and often they do), this “proves” that social responsibility makes good business sense. On the other hand, it means the funds can demand of companies only “good” behavior that enhances the bottom line. In this sense they’re in the same narrow boat as managers who want to do good but can’t if it hurts their profits.
A deeper reason for the funds’ lack of impact may be found in this contradiction: as the funds get bigger, their screens necessarily get looser. If you have a few million dollars to invest, you can be picky about your nonfinancial criteria. If you have billions, you’ll run out of places to put your money if you’re too persnickety. Thus, as Paul Hawken has noted, over 90 percent of Fortune 500 companies now appear in portfolios that call themselves socially responsible, and the managers of those portfolios rarely bite the hands that feed them. Success, in this way, is its own undoing.
The second technique—shareholder activism—has also picked up steam in recent years. In this approach, concerned shareholders meet with top managers and urge them to change the company’s ways. If the managers resist, the shareholders file resolutions that, if approved at an annual shareholder meeting, would change corporate policy. In 2003, over three hundred resolutions were submitted on issues ranging from CEO compensation to labor and environmental practices. None passed, because managers, through proxies, control the great majority of shares, although in some cases the resultant publicity did lead to changes.
A grander vision of shareholder activism involves the employee pension funds that, collectively, own over half the shares of many U.S. companies. In this vision, American workers, through their retirement funds, would require publicly traded corporations to place workers, communities, and nature on a par with short-term profit. In reality, pension funds have come to play a larger role in capital markets, but ironically, it’s usually as the swing votes when raiders seek to take over underperforming corporations. In these situations, the pension funds often vote with raiders to enhance stock-holder value.
Recently, pension funds have also pushed for improvements in corporate governance. But pension fund trustees are hardly sans culottes in pinstripes. They’re tightly bound by their fiduciary responsibility to retirees, and must seek the highest rates of return or face reprisal from the U.S. Labor Department, which oversees them.
It would be a luscious irony if capital markets could become a check on runaway capitalism. But capital markets suffer from the same disease as corporations themselves—an incurable devotion to maximizing profit. This isn’t to say that efforts to improve corporate responsibility are a waste of time; such efforts raise consciousness and are incrementally helpful. And they’re certainly a form of right livelihood. But do they carry within them a systemic solution to the defects of capitalism? This I deeply doubt.
==Notes “. . . a license to obfuscate.”: Clive Cook, “The Good Company,” The Economist, Jan. 20, 2005.Hurwitz: Ned Daly, “Ravaging the Redwoods: Charles Hurwitz, Michael Milken, and the Costs of Greed (Capitalism 3.0: Chapter 4) ,” Multinational Monitor, Sept. 1994. See also David Harris, The Last Stand: The War Between Wall Street and Main Street Over California’s Ancient Redwoods (San Francisco: Sierra Club Books, 1997). * Working Assets: Report on Socially Responsible Investing Trends in the United States (Washington, D.C.: Social Investment Forum, 2005). * Fortune 500 companies socially responsible? Paul Hawken, “Is Your Money Where Your Heart Is? The Truth About SRI Mutual Funds,” Common Ground, Oct. 2004, p. 14. * shareholder file resolutions: Report on Socially Responsible Investing Trends. * origins of free market environmentalism: Ronald Coase, “ The Problem of Social Cost,” Journal of Law and Economics, Oct. 1960, pp. 1–44. * polluters trespassing on common property: Kennedy, Crimes Against Nature, p. 190.
