How capitalism can heal itself

The election of Joe Biden in the United States may restore normality to US governance but it will not alone address the crisis of inequality, wage and wealth disparity which was a factor – however perversely – in Donald Trump’s rise.

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ANZ Chief Economist Richard Yetsenga has argued addressing those underlying, corrosive factors is not just a matter of policy or even reform, it requires a more fundamental rethink of capitalist norms.

"Something is fundamentally wrong with the way we assess economic performance and social progress.” – Stiglitz et al

Trump may have exploited the symptoms of this malaise in the distribution of capitalism’s benefits but on the Democratic side, as embodied by Bernie Sanders and Alexandria Ocasio-Cortez, there are genuine questions being asked about the practice of capitalism.

This is not a new phenomenon. Former World Bank president and Nobel Memorial prize winner Joe Stiglitz has studied the pernicious elements of capitalism and the impact on equality for decades.

Most recently Stiglitz and others have questioned how wellbeing is actually measured – and gross domestic product (GDP) is not a great metric.

His book, Measuring What Counts; the Global Movement for Well-Being, gained prominence in 2019 with Stiglitz and his coauthors arguing the interrelated crises of environmental degradation and human suffering graphically illustrate the flaws in economic measurement. “Something is fundamentally wrong with the way we assess economic performance and social progress,” they concluded.

The French economist Thomas Piketty has argued along similar lines, most notably in the work which brought him fame in 2013, Capitalism in the 21st Century.

GDP as a measure of the common good has a structural flaw: it measures economic activity but does not discriminate about that activity nor account for the impact on the “stock” of wealth. So a natural disaster may destroy myriad lives and property but be good for GDP because the rebuild adds to growth.

More broadly, polluting industries may contribute to GDP but not be charged for the negative externalities of the damage they cause the environment and people. And company profits may grow – but at the expense of worker welfare and wealth disparity.

All of these factors have long term costs and will ultimately impact growth but are not discounted in a GDP calculation.

Global balance sheet

While the economics profession and sociologists have long recognised these corrosive elements, alternatives to traditional measures have proved problematic. But work is being done.

One fascinating proposal, by Henry Paulson, the former US Treasury Secretary and Goldman Sachs alumnus, is to add the environment to the global “balance sheet”.

“One important step would be to create a new asset class comprised of things such as productive soils, crop pollination and watersheds,” he wrote in the Financial Times. “This might sound far-fetched … but valuing nature as we do traditional goods and services will create incentives to avoid biodiversity destruction, manage climate change and preserve lives and livelihoods. Harnessing the power of markets can protect our environment and prevent its rapid destruction.”

He notes the productive capacity of nature is being undermined: “Take, for example, the ‘service’ provided by pollinators — essential to grow fruits, nuts and vegetables — that are dying in record numbers. A total loss of these species could lead to a drop in annual agricultural output of more than $US200 billion.”

Another, unmeasured, asset in our society is ethics – underpinning trust, integrity and confidence. The Trump era has had costs yet to be appreciated but the impact of the Global Financial Crisis (GFC) and, in Australia, the Royal Commission into financial services, extend far beyond the hundreds of billions of direct conduct fines issued around the world.

The Ethics Centre in collaboration Deloitte Access Economics has just released a report which found an increase in ethical behaviour could raise Australians’ average income by $A1,800 a year, lifting GDP by $A45 billion a year. An increase in a company’s performance based on ethical perceptions can increase return on assets by about 7 per cent.

Benefits would accrue to workers too: “there is evidence people would enjoy higher wages consistent with an improvement in labour and business productivity. A 10 per cent increase in measures of ethical behaviour is associated with an increase of 2.7 - 6.6 per cent in individual wages – and a 2.7 per cent increase in wages would amount to an estimated $A23 billion increase in aggregate wages across the economy.”

The report’s lead author and Deloitte Access Economics partner John O’Mahony noted no one would “seriously argue that pursuing higher levels of ethical behaviour and focus was a bad thing, but articulating the benefits of stronger ethics is more challenging”.

Stakeholder capitalism

So-called “stakeholder capitalism” is currently the progressive way of thinking about how to address the flaws in the current system – which, let us be clear, is a failure of policy and regulation not of markets. Markets are amoral – they respond to supply and demand and price signals.

Too much policy and regulation, whether intentionally or not, is rigged – so price signals support vested interests and rent seekers rather than the common good.

Both the World Economic Forum and the American Business Roundtable have embraced versions of stakeholder capitalism. At a macro level, if this can deliver on its promise, such a new way of looking at capitalism should be a start to addressing income and wealth disparity.

At an enterprise level, the funders of capitalism – equity and debt providers – are increasingly looking at ESG (environmental, social and governance) measures as, at least, a proxy for how well run an enterprise is and how aware it is of the external factors that will impact earnings sustainability, such as conduct fines or a social licence to operate.

(As such measures are adopted, there will undoubtedly be some initially perverse outcomes which should dissipate over time. For example, as investors rush for more sustainable companies their price will rise while near-pariahs will become cheaper – and potentially good value on the risk-reward spectrum. Much as speculative investors have made money on North Korean bonds over the years.)

At an enterprise level, there have been a range of proposals to build stakeholder capitalism into company accounts.

For example Sonja Haut, Head of Strategic Measurement and Materiality at Novartis, envisaged a future where a “new breed” of capitalism is enabled thanks to “a new way of assessing the performance of companies based on a valuation of their overall impact – a change in which policymakers and standard-setters have played a crucial role”.

In her vision, “the new way of assessing business performance is based on standardised, comprehensive and simple impact-valuation metrics. These enhance the usual financial statements with other dimensions like society, human rights and the environment, leading to a ‘total impact’ rating that is used by management and investors alike”.

Real impact

The Harvard Business Review has just published an article taking this further: “To date, there has been no way for companies to account for their benefits and costs to society and the environment. We have been working to change that,” authors Ronald Cohen and George Serafeim write in How to Measure a Company’s Real Impact.

In July they published the cost of the environmental impact of 1,800 companies by the Impact-Weighted Accounts Initiative (IWAI) at Harvard Business School. Next year, the IWAI will publish the cost of product and employment impacts too, providing, they say, a complete picture of the impact companies create.

That, of course, is a Utopian vision of the evolution of corporate capitalism but, given the rapid evolution of initiatives like ESG and the growing recognition of those left behind by the capitalism of the last half century, it is not far-fetched.

The alternative to rethinking how the global economy rewards productive risk and taxes the detrimental is the kind of social unrest and desperate resort to despots we are increasingly seeing around the world.

Andrew Cornell is Managing Editor of bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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