On Capitalism

Can American Capitalism Survive?

Steven Pearlstein on why greed is not good, opportunity is not equal, and fairness won’t make us poor. A review.

St. Martin’s Press, 2018.

D. Saint Germain

Can American Capitalism Survive?

It's a big think question, and many people are discussing it these days – and what it might look like if it doesn't. Pulitzer Prize Winner Steven Pearlstein's new book Can American Capitalism Survive, is written with this question in mind, noting "in less than a generation, what was once considered the optimal system for organizing economic activity is now widely viewed, at home and abroad, as having betrayed its ideals and its purpose and forfeited its moral legitimacy."

Greed is good, we heard in the 1980s, and culturally we adopted it as a mantra. But is it? Pearlstein reminds us that the much-quoted Adam Smith bit about how if everyone pursues their own best self-interest, it produces more wealth for everyone is not all Smith had to say. Smith also believed we are restrained by "moral sentiments" in which we cared about the well-being of others; that by restraining our greed and ambition to earn the respect of others also led to our own self-respect.

What level of greed is too much? Pearlstein suggests there are two kinds of harmful greed, a personal greed and a social one. Personal greed becomes a problem when the hunger for more becomes compulsive and presents us from appreciating are we do have; the social greed is a selfishness "so extreme that the harm it causes others outweighs the benefits to ourselves... it is a greed that requires a brutish indifference to the plight of others and offers a pretext for illegal or ruthless behavior."

Cooperation is a part of our genetic legacy, he argues; humans progressed out of the jungle through group affiliation and cooperative effort; we're social animals that depend on each other to meet our needs. But within that legacy is competition amongst the group as well; "and for that reason, an economic system that is based on the presumption that people will, or should, act only on the basis of selfishness is no more likely to succeed than one based on the utopian presumption that people will, or should, act only based on altruism. Both are based on a false understanding of human nature," he argues.

The form of social greed we see now can largely pinned to the idea that corporations should exist only to maximize profits, he argues, an idea with no basis in history or law. He traces the rise of this idea from an essay by Milton Friedman in 1970, arguing that before the 70s there was a "managerial capitalism" that dominated the country, whereby CEOs felt more responsible to their customers, communities and workers and were more inclined to spread corporate profits between all those stakeholders.  However, the structural changes of deregulation, technological change, and globalization cut into the corporate profits earned during the "golden era" of American corporations in the 50s and 60s, and with slimmer profit margins it became harder to please all stakeholders.

The 70s were a lost decade for shareholders, where due to inflation many investors lost money on their investments. An influential academic paper in the Journal of Financial Economics in 1976 asserted that the only way to get CEOs to prioritize shareholder returns would be to tie their compensation to the market performance of the company. You can see where we're going from here. As he notes, this paper is one of the most cited academic works of all time.

The "lost decade" turned into 80s shareholder activism, Pearlstein argues, with hostile takeovers tossing out CEOs and management teams deemed not producing enough returns. The threat of hostile takeovers had a "profound effect" across the boardrooms of America, where the best defense against one was a high stock price. "Almost overnight," he writes, "executives and directors tossed aside their more complacent and paternalistic management style, and with it a host of old inhibitions against laying off workers, cutting wages and benefits, closing plants and taking on debt" – thus turning the former system of managerial capitalism into shareholder capitalism.

The other important issue around too much greed in a society is the one of trust; a well-functioning capitalist society must have trust as a basis for market interactions. The government has a role in creating legal restraints and property rights, but external restraints only work to a certain degree – as Pearlstein writes, "there could never be enough laws and regulations--or courts and jailers to enforce them--to ensure that people don't lie, cheat and steal in their economic interactions. That level of cooperative behavior is possible only if there is a foundation of mutual trust reinforced by a moral code that is broadly accepted and socially enforced."

Without trust, he continues, market exchanges become much more expensive because of the cost of enforcements that would be needed to prevent cheating and stealing. He shares the example from the work of James Coleman, who discusses the diamond trade amongst Orthodox Jews in New York City, in which participants deliver bags of diamonds to each other worth hundreds of thousands of dollars with no "formal mechanisms" to ensure against theft or switching out of diamonds for crystals. The trade can operate this way because of the strong interrelationships between traders in terms of shared synagogues, neighborhoods, and intermarriages that create a high level of trust. Without these strong ties they'd need much higher levels of insurance, guards, and other safety mechanisms, which would in turn make their trade much less profitable. Coleman argued that "social capital," a term for the institutions, networks and values which nurture trust and cooperation in a market-based economy, are as important as other forms of capital — and in fact could contribute significantly to economic output. The opposite is also true, as Pearlstein writes, "greedy societies in which corruption is rife and people can't do business on a handshake tend to be poor."

From greed Pearlstein moves on to the labor market, and the wages of work. Reminding us that the moral argument for allowing the market to set the price for our labor rests on the ideas that our compensation reflects our contribution to the economic system, an equality in the chance to succeed in that system, and that allowing the market to set the price makes us all better off, he reminds us of how fantastically income inequality has grown in the United States, and that this growth results from policy choices, not a reflection of really any of these things.

Thinking about this in terms of fairness, Pearlstein reminds us that what we learned from socialist countries is that if incomes are too equal, there is no incentive to work by the talented and no disincentive to slack off by the lazy. But there is the opposite extreme that is often ignored... if incomes are too divergent, it dis-incentivizes productive workers from wanting to work, leading them to "withhold their excellence and head for the beach." Further, as examples from Major League Baseball and other studies have shown, teams with more unequal pay do not perform as well than those with more equal pay, as inequality engenders bad feelings and weakens cooperation and teamwork.

Americans don't picket and strike anymore, Pearlstein writes, but the evidence for dissatisfaction with the inequality wages can be seen in low rates of workforce participation, a support for raising the minimum wage, and surveys that show low levels of engagement at work and a majority belief that they are underpaid for what they do. So, Pearlstein argues, if making wages more equal would discourage work at the highest levels of society, the same logic should mean that lower inequality would encourage work in the medium and lower levels of society, where most workers statistically are. An interesting point.

Pearlstein also considers our educational system from kindergarten through higher education, noting that research supports the link between education attainment and a child's family income, and how educational attainment then determines an adult's lifetime income; education then has become an infinity loop of inequality. And while there were a few golden decades in which educational opportunity allowed for social mobility (looking at you, Boomers), recent changes to funding for higher education have drastically reduced the opportunities for education, and thus reduced social mobility.

"We need a new framework and a new vocabulary for talking about economic justice. Too much of the academic debate has been dominated by technical squabbles over data, philosophic hairsplitting and outdated economic ideologies. Too much of the popular debate is framed in terms of greed and envy or what will create the most jobs."

Pearlstein believes that we can build a better capitalism, once we develop a set "of morally intuitive first principles about what kind of society we want to live in and what kind of social contract should govern our relationships with each other. It is only by judging economic institutions and outcomes against a broader set of criteria that it is possible to free ourselves from the natural tendency to think of things in terms of where things are, and instead begin to think of things in terms of where we want them to be. An economic system is a means to an end, not an end in itself, and if it is not serving those ends, we ought to change it."

He suggests a series of prescriptive ideas that to help repair capitalism: the biggest two being a constitutional amendment to guard against big money in elections and a SEC requirement that companies be transparent about their purposes and priorities each year, so investors know what kind of company they are investing in. More ideas include mandatory national service for youth, and a universal basic income; forced corporate profit sharing with employees; legitimate equalizing of the public education system, and anti-monopoly action to help expand competition among key industries. "That these sound like radical and politically unachievable ideas," he writes, "speaks to the paucity of our political imagination and the lack of faith in our institutions to adapt to new circumstances."

Pearlstein is a journalist, and he applies his prowess to clear-eyed presentation of the rationales for capitalism in Can American Capitalism Survive. This is a non-academic take on the history of the ideas that have got us where we are now, and an important read for thinking about what exactly the assumptions are keeping the boat afloat.

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