Shareholders are stakeholders too

Inevitably, as humans, we lapse into animating or even anthropomorphising physical phenomenon. We endow systems and structures with some kind of personality or inherent purpose or morality.

We do it with climate. And we do it with markets. And capitalism.

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Pic: Economist Adam Smith's "invisible hand" theory

These things just are but it’s humans who give them meaning and some sense of “being”. Yet markets and climate and myriad other phenomenon are systems, they are amoral, neither good or bad. They happen no matter what.

"Ironically, one of the best ways we can influence climate change is via markets and capitalism.”

But just because climate is complex and natural, that doesn’t mean what humans do doesn’t matter - as climate change has demonstrated all too catastrophically. Humans have and can take actions to alter the climate.

So too markets. Even in the most centrally-controlled economies markets exist - black or otherwise - often to exchange favour and power. And even in the most open, “free” markets, regulation and rules and covert prices exist which shift outcomes – only in economic textbooks are markets unfettered with full price transparency.

Influencing outcomes

Ironically, one of the best ways we can influence climate change is via markets and capitalism. Markets are driven by prices and so it’s important costs and benefits are priced as clearly as possible if those markets are to deliver sustainable outcomes.

As ANZ Chief Economist Richard Yetsenga notes, for meaningful action on climate change “the price of carbon-intensive consumption must rise or availability fall relative to low-carbon consumption. This could be through a price signal such as interest rates, product prices or an exclusionary policy which overtly limits some types of consumption”.

This hasn’t been the case with climate as the costs of global warming have not been factored into prices while policies too often fail to recognise the long-term benefits of sustainable solutions. A climate which reduces natural disasters and limits the forced movement of populations is a better economic outcome.

Globally, one of the simplest and most effective market mechanisms has been a price on carbon.

Financial regulators have no doubt. According to Christine Lagarde, the president of the European Central Bank (ECB), “an orderly transition to carbon neutral entails greater costs in the near term, but these are far outweighed over the longer term by lower physical risks and higher output”.

“It is a no-brainer option. We need to take action. Even a disorderly transition, where policies are enacted in a haphazard way or before green technologies are fully mature, is still less costly than sitting down and watching and there being no transition at all. The long-run benefits from acting early on climate are clear.”

Addressing distortions

But beyond climate, distorted pricing is the root cause of the current crisis in capitalism. Economic rents which are pernicious - and typically favour the rich and powerful - have not been properly taxed. Policy is too often driven by vested interests - not the best social outcomes.

Addressing these distortions to better recognise costs is behind the latest reformation process known as “stakeholder capitalism”. This is hardly new thinking because distortions in market economies are hardly a new phenomenon.

The father of modern economics, Adam Smith, argued the “invisible hand” behind markets enriched the whole of society, not exclusive individuals or individual groups – such as shareholders. While each agent acted in their own self-interest, transparent markets and rational pricing of costs and benefits directed capital and human action towards long term sustainability.

It was only in the 1970s with Milton Friedman’s argument around the moral obligation of corporations to maximise profits for one category of stakeholders – shareholders - that the broader perspective was lost. Friedman was not wrong but his acolytes failed to recognise if shareholders are to benefit in the long term customers must be fairly treated, employees must be properly valued – if for no other reason that good ones will leave if they’re not – and societies must grow wealthier in aggregate not inequality.

Whether it’s called stakeholder capitalism or triple bottom line or corporate social responsibility, the essence is the same: everyone, including shareholders, has more opportunity to prosper in sustainable, equitable societies. And healthy capitalism will promote that with appropriate price signals.

Inequality rising

Unfortunately, after the global financial crisis, decades of global warming and now the pandemic, markets are becoming more distorted and wealth inequality is rising. This is not just morally wrong but unsustainable economically.

Research from McKinsey & Co found 87 per cent of people who were asked about the role of companies declared they should create value for multiple interests, not just make profits. Ignoring this is a manifesto for social unrest. Every company requires a social licence to operate.

Meanwhile, flipped the other way, the intricate nature of a corporation’s deep enmeshment in society is clear. McKinsey’s Michael Birshan says “value flows from corporations to households through eight different pathways”.

“If you take a dollar of revenue that the average corporation generates, 25 cents of that flows through as labour income: wages, salaries, and other benefits to employees. Seven cents of that dollar goes to capital income, meaning dividends, share buybacks, and interest payments to debtholders. Six cents goes to investment - earnings that are retained to be invested in new productive assets - and four cents to production and corporate taxes.

“The remaining 58 cents goes to supplier payments, which then result in labour income, capital income, investment, and tax pathways for those supplier companies.”

Diverging links

Other research from McKinsey found across 10 countries that account for about 60 per cent of global gross domestic product (GDP) – including Australia - the historic link between the growth of net worth and the growth of GDP no longer holds.

“While economic growth has been tepid over the past two decades in advanced economies, balance sheets and net worth that have long tracked it have tripled in size,” McKinsey found. “This divergence emerged as asset prices rose - but not as a result of 21st-century trends like the growing digitisation of the economy.”

Wealth disparity is growing at a macro level and those for whom the pandemic and climate change have been most damaging are suffering the most. Benefits are accruing to those with existing capital while labour is being under-priced.

“Asset values are now nearly 50 percent higher than the long-run average relative to income,” McKinsey says. “And for every $1 in net new investment over the past 20 years, overall liabilities have grown by almost $4, of which about $2 is debt.”

The wealthy are benefitting from what economists call “negative externalities” – damaging collateral effects -  which are lowering GDP but being paid for by the less wealthy.

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Proper capitalism

Essentially stakeholder capitalism is simply proper capitalism – resources used are paid for at a true price, rents are taxed appropriately, negative externalities and paid for in full and offset against profits.

More companies – and critically more investors – are recognising this with their attention to environmental, social and governance (ESG) principles and in articulating a “purpose”.

One of the corporate leaders on this front, former Unilever boss Paul Polman, has written a book, Net Positive: How Courageous Companies Thrive by Giving More Than They Take, calling on business leaders not just to do less harm but more good - by focusing on their stakeholders’ long-term interests and taking responsibility for their impact on the wider world.

Markets will work no matter what, there are always prices – they may just not be the ones we think they are. But capitalism will work in all our favours if prices are set to encourage the best outcome for society whether that is to properly value labour or limit the damage of climate change.

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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