The Business Roundtable last week produced a 400-page publication claiming that its members should no longer look first to profitability but should follow the interests of stakeholders as a whole, including employees and the environment. This is pabulum we are used to from the titans of Big Business, who are no longer truly capitalist in our distorted low-interest-rate economy. The problem is, that by downplaying the central tenet of capitalism, they may, like the acolytes of central planning, produce hugely sub-optimal economic results.
Adam Smith put best the central truth of capitalism, several times in both “The Wealth of Nations” and “The Theory of Moral Sentiments,” to be an “invisible hand” of the market promoting optimal results. For example: “Every individual… neither intends to promote the public interest, nor knows how much he is promoting it… he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”
Adam Smith’s “invisible hand” of the market is immensely powerful, operating wherever it is permitted to operate. Even in situations where the market forms only a small part of the overall supply/demand picture, it operates to reduce costs, match prices and expand its coverage as far as circumstances allow. Thus, for example the short-term health plans whose expansion was authorized by President Trump last year, being cheaper than plans bought over the Obamacare exchanges, have expanded their usage far more than was expected. Similarly, the new permission to buy a limited range of drugs from foreign suppliers has reduced drug prices overall, as even a limited free market exerts a salutary effect on neighboring products.
You can see the effects of the free market outside healthcare also. In education, charter schools typically improve the education of children in poor areas, as the local public schools are forced to eliminate unionized sloth and match the offerings of their new competitors. Conversely, authorized private sector monopolies, such as local cable TV systems, have seen their prices increase far more rapidly than other services while their service quality has deteriorated – to the extent that new offerings such as satellite TV and streaming services have eaten at their market share even though with cable already laid they should be far more competitive than oustsiders.
The market only optimizes economic outcomes, however, if participants are economically motivated. You see this from economic outcomes in places where the primary motivation of producers, consumers and governments is non-economic. For example, much of the Middle East is held back by participants placing religious affiliation above the market mechanism. Similarly, many African countries are divided by tribal loyalties, which prevent markets from optimizing within them. Similar considerations must lead us to believe that elevating non-economic considerations above profit maximization will prevent the market mechanism from performing its proper optimization function, leading to outcomes that may be highly suboptimal.
To compete effectively in a modern economy, a corporation must satisfy many of the non-economic criteria that the Business Roundtable elevates above shareholders. Product quality and safety are essentials if it is to remain in business. Employees must be treated decently, or the corporation will not be able to attract good people who serve the customer well.
Environmental considerations must be taken into account, for three reasons: the law requires it, there is often a huge reputational cost from environmental bad behavior, and long-term return maximization requires the company to avoid short-termist exploitation of all kinds. There is reputational and political risk to alienating communities in which the company operates; it also brings long-term costs in that local disgruntlement may make the company’s adaptation to new circumstances unnecessarily difficult.
Every non-market constraint that companies impose upon themselves, or that is imposed upon them, makes their part of the economy less optimal, not only for shareholders but for everybody doing business with them.
For example, President Trump is currently in a battle with the automobile companies, who have happily accepted California’s draconian fuel economy standards, ignoring the looser standards available under Trump’s administration in the other 49 states. From the American automobile buyer’s view, as well as that of the automobile companies’ shareholders, Trump is absolutely right; the unnecessarily harsh standards imposed by the Sacramento soft-brains add about $3,000 to the price of each car, as well as making the cars less safe and worse-performing. When the costs of government are added up, that $3,000 per automobile, entirely without electoral mandate outside California, must be added to them; deviations from pure market principles are frighteningly expensive.
Another government interference with the market that makes its results suboptimal is the Basel system of risk weightings for bank assets. Under that system, devised under the auspices of the the Bank for International Settlements, owned by the world’s governments, government debt of OECD countries is given a zero risk-weighting for capital allocation purposes, while mortgage debts are given a reduced capital weighting compared with ordinary loans.
The result has been that governments, even over-borrowed ones like Italy and Japan, are able to borrow altogether too easily, since their paper requires no capital allocation. Conversely small businesses, lending to which should be one of the two principal businesses of commercial banks (the other being providing a safe, modestly lucrative home for depositors’ money) get very little of the banks’ lending capacity. The cost to the global economy of this vast misallocation of resources has been astronomical, both in overspending governments and in small businesses starved of capital. New competitors in the venture capital industry have emerged for business finance, but they are very expensive, and themselves have several cognitive weaknesses such as an absurd over-reverence for the tech sector.
As discussed in this column, the greatest loss of economic value from ignoring market realities has come from government interest rate policies of the past 24 years, and most particularly since 2008. These have set the real risk-free return on capital below zero for over a decade in most rich countries. Capitalism cannot be expected to work properly without a positive return on capital, and it accordingly hasn’t worked properly for the last decade. The result has been a bidding up of asset prices to insane levels, a debt market that has come to ignore risk completely (so that in Europe there are “junk” bond issues being done at sub-zero nominal interest rates) and a productivity growth malaise in rich countries that has academics bemoaning the end of the Industrial Revolution.
Today there are vast enterprises like Uber (NYSE:UBER), with a capitalization of $60 billion, that lose $1 billion a quarter and achieve even that level of return only by taking advantage of the inability of “gig” economy workers to account properly for the depreciation on their vehicles. Uber is a product of a capital market that has its central price, the long-term risk-free rate of interest, set by dozy self-serving governments rather than by the supply and demand for a money limited in amount either by a well-run central bank or by a Gold Standard.
It is very unlikely that the Business Roundtable’s 400-page tome will do as much damage as the Fed and its sister central banks; for one thing nobody takes that body particularly seriously. It is an agglomeration of very large companies, and very large companies, even at the best of times, are not especially capitalist institutions, as Adam Smith observed 240 years ago. In the past decade, the Business Roundtable companies have been especially profitable, but as Smith gloomily observed “Profitability is always highest, in the countries which are going fastest to ruin.”
It is a sobering thought. Meanwhile the Business Roundtable has joined the Fed, the Basel bank regulators, and the automobile fuel economy standards setters, in attempting to run a capitalist system without allowing the market free rein. Essentially, they are attempting to amputate the market’s Invisible Hand, and no good will come of it.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)