A Blind Faith in Capitalism is Being Rocked

Today, capitalism is under attack for the first time since the fall of communism. Three reasons are mainly, and coincidentally, responsible. First, bear markets rule in the three main stock exchanges of the world. Whenever a lot of people lose a lot of money, they blame business. Second, a wave of scandals has hit the United States, affecting some of its best-known companies – Enron, Tyco, WorldCom. Scandals and bear markets are connected: Dubious accounting practices that are submerged in a tide of prosperity are ruthlessly exposed when the tide recedes.

Finally, the anti-globalists have been gaining strength. Following Seattle in 1999, the anti-globalist movement has become increasingly articulate, well-organized and well-connected. Their main charge is that globalization has robbed states of the power to shape the economic future. This power, they say, has passed to the multinational companies. Big business roams the world in search of profits, subject to no governmental control. True enough, there are international organizations, like the IMF, the World Bank and the WTO, laying down rules of conduct. But these rules, it is alleged, are drawn up in the interests of the multinational corporations.

The current attacks on business raise two serious issues concerning the ethics of modern capitalism that need to be distinguished, though they are often lumped together. The first concerns corporate governance and is chiefly to do with the prevalence of accounting practices that enable companies to cook their books.

The second is about businesses’ social responsibility – how far corporations should pursue objectives other than maximizing profits. The first is about honesty,
the second about the social role of business.

As Peter Martin wrote recently in the Financial Times, there has been a loss of consensus on the purposes of accounting. In the past, “it was a tool for the board to assess the performance of managers, and for investors to assess the company with its peers.” Today, it is increasingly used as an instrument of “earnings management” – presenting earnings in such a way as to manage share prices – and to redistribute profits silently from shareholders to senior managers.

Some of the accounting practices that enabled these things to happen were legal, others were fraudulent. Reforms aim at strengthening corporate governance by ensuring, among other things, the independence of board members and company auditors. However, this set of problems concerning business ethics, while capable of unleashing savage denunciations of corporate greed, must be distinguished from the line of attack that aims to hold business “socially accountable.” Here, it is the pursuit of profit as such, not how profits are divided between different owners, that is the offense.

Of course, those who say that a firm should seek to maximize its profits believe it should do so honestly and legally. Managers should not steal the property of their shareholders. It is for government to put a limit to net profit through the tax system. It is also for government to protect the general interest of society as determined through the voting system.

However, there is a long tradition in economics, going back to Adam Smith, that argues that in pursuing its own interest, a firm also serves the general interest of society. As Adam Smith put it in The Wealth of Nations: “[The entrepreneur] neither intends to promote the public interest, nor knows how much he is promoting it… [but] is led by an invisible hand to promote an end which was no part of his intention … . I have never known much good done by those who affected to trade for the public good.”

The invisible hand is the most powerful metaphor in economics. But Smith recognized that the coincidence of public and private interest depended on a number of conditions, the chief of which was the absence of monopoly. The doctrine of corporate social responsibility challenges this tradition head-on. A big company exists to promote not just the interests of its owners but all those who might be affected by its decisions – its employees, its customers, its contractors, the community in which it is located, the environment. It should seek to protect and enlarge human rights, to raise standards of health and safety and to work for equal opportunities, the reduction of poverty and inequality and various other good causes. In the jargon, it should try and maximize the welfare of a large number of stakeholders – the reverse of the task set it by Adam Smith.

A key point is that financial accounting should be replaced by social accounting. For example, Shell International calculates the net value that its companies add to the world in terms of sustainable development, the environment and social progress, which has led one critic, David Henderson, to remark that Shell’s project is to “maximize the firm’s net contribution to the welfare of the world.”

If the well-being of society rather than profitability is to be the main concern of business, what is the role of profits? Some proponents of socially responsible business argue that the extra tasks that social responsibility imposes on a firm will improve a business’s long-term profitability – for example, by giving it a better reputation. Others seem to believe that profits should be a residual – what is left over for the owners after they have fulfilled their social tasks.

The main economic objection to the doctrine, in either of its forms, is that anything that raises the cost of doing business is likely to slow down the creation of wealth. This might not matter much for rich countries, but it could be disastrous for poorer states. Corporate social responsibility also confuses the roles of business and politics. It suggests that business can (and should) take over functions of government. But why should unaccountable groups claim responsibility for social decision-making. Those involved in business are often good at making money, but there is little evidence that they are good at running countries.

One can understand the appeal of corporate social responsibility, especially in a country like Russia, where for years under then-President Boris Yeltsin, the oligarchs, in effect, stole national property. It now pays for them to set themselves up as great humanitarians whose mission statements rival the Sermon on the Mount in their benevolence. But we should remember the fable of Little Red Riding Hood and the Big Bad Wolf.

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