Many people believe that society needs to change for market capitalism to be sustainable – and it turns out a surprising number of business leaders are among them. That’s the finding of a recent series of forums, organized by three Harvard Business School professors in Europe, East Asia, Latin America and the United States and hosted by such prominent figures as Jamie Dimon, CEO of JPMorgan Chase. Based on these discussions, the HBS professors advance a bold proposal – that business itself – not government, or even public-spirited nonprofits – should lead the charge to make the necessary changes to our capitalist system.
The book that chronicles these forums and presents the organizers’ resulting proposal is Capitalism at Risk: Rethinking the Role of Business, by Joseph L. Bower, Herman B. Leonard, and Lynn S. Paine, who say their research resulted in a set of “radical conclusions.” First, the authors concluded that the global social, political, and economic environment is not an immutable external framework to which businesses must passively respond, but rather something that firms themselves can affect through their actions. Second, it’s therefore not appropriate to consider this external environment to be “outside the appropriate purview of management.” Their third conclusion, then, is that “business leaders must, for the sake of the health and sustainability of the very system on which they depend, become better positioned to ameliorate the disruptive forces that may otherwise impinge on market capitalism.”
This is a message worth paying some attention because it addresses what future leading minds in the business world must learn to be successful. A practical graduate school education – a business school education more than others, and a Harvard Business School education perhaps most of all – permanently shapes the outlook of future industry leaders. And yet even Harvard itself has recognized the heavy criticism of the MBA industry of late. A cohort of current managers, many of whom received Harvard MBAs, have come under attack for failing to take into account externalities like financial systemic risk, extremes of income inequality, and environmental impacts.
The influence of prevailing business teachings were evident among forum participants, some of whom agreed that “executives are fiduciaries for their shareholders, and spending money to benefit the public beyond what the law requires would violate these duties.” Some also agreed that “business efforts to promote public goods may also be challenged as a usurpation of governmental authority or an illegitimate interference in the democratic process, particularly if the goods at issue are not (yet) highly valued by the broader society.”
Bower, Leonard, and Paine say that this outlook is outmoded. Business, they say, must see itself as part of the broader policy-making sphere and as a leader to serve the public good. They see this not as an act of corporate social responsibility, but as enlightened self-interest.
The authors even dabble in a critique of neoclassical economics – though you have to read carefully to realize it. “From a theoretical perspective,” they write, “a good deal of the logic hinges on a very special definition of public welfare. The definition assumes that public welfare is determined solely by the self-perceived individual welfare of the participants and is incomparable across individuals.” They say, however, that “pure” capitalism “can create some very undesirable outcomes indeed” – because, among other problems, “consumers have preferences that are not fixed in advance (and instead, for example, can be altered by advertising)”.
Bower, Leonard, and Paine are not, however, out to dump capitalism, and neither were any of the forum participants. All of them believe that, properly applied, capitalism can save the system. The differences arise over how best to apply it.
How business can bring about a better form of capitalism
What the authors are saying, in a nutshell, is that economic “externalities” are threatening the stability and sustainability of the capitalist system. Externalities are incidental effects (usually negative) experienced by third parties whenever a market transaction takes place.
The classic example is pollution. To take a currently fashionable, but important example, when a U.S. automobile owner buys a tank of gas from a gas station and burns it in his vehicle, neither the driver nor the provider pays an insurance premium to cover the costs associated with the increased risk of future climate change that results. These costs – or prospective costs – are foisted on the public. (There is a broad spectrum of informed climate change skeptics, but none believes greenhouse gas emissions pose no threat whatsoever, though some believe it is negligible.)
The HBS authors list 11 “potential disruptors of the global market system,” including: the functioning of the global financial system; income inequality and consequent populism; migration; environmental degradation; and failures of education and public health.
Of these, forum participants saw income inequality and environmental degradation – particularly the climate change threat – as the greatest concerns; but their concern was as much about possible disruptive political reactions to these threats as about the threats themselves.
The authors apparently also regard global poverty as an externality that needs to be alleviated by broad-minded business action. (I question whether it really is an externality -- more on that later.)
The theory of externalities and their amelioration falls within the field of environmental economics. The theory shows that, when externalities occur, the market’s ability to act as an optimizing “invisible hand” dissipates – that is, externalities create market failure. In my example, pollution by automobile drivers, if left unchecked, would impose an uncompensated risk on society. Consequently, government must step in to “internalize the externalities,” by – for example – taxing the externality (carbon dioxide emissions in the case of the gasoline-powered auto driver), to the extent of its cost to society (which is, admittedly, extremely difficult to measure).
Normally, we assume that a properly functioning business will continue producing the negative externality until and unless government steps in with a regulation that internalizes the cost. It is not the role of business to internalize the cost of its own externalities, the traditional view holds, and it cannot profit by doing so (except perhaps indirectly, if it receives good publicity for its social responsibility). As long as competitors do not internalize that same cost – and why should they? – an individual company that does will not remain competitive. Hence, government must require it for everyone.
What the authors of Capitalism at Risk are saying is not that this conventional wisdom is incorrect, but that it is incorrect to assume that such a state of affairs means business should play no role whatsoever. On the contrary, the authors believe that business should take two leadership roles, to each of which the authors devote a chapter. The first is to adopt innovative business models that address themselves to broad societal needs. The second is to undertake “institutional activism,” to help government and pan-industry institutions adopt regulations and standards that will create an environment in which these business models can flourish.
Institutional activism is, in my opinion, the more important approach, and I will explain why; but it goes hand-in-hand with innovative business models. Of course, both approaches require businesses to keep the end goal – improving and preserving capitalism for future generations – in mind.
Leading Through Innovative Business Models
Bower and his coauthors give four examples of corporate leadership through innovative business models, although at least half of these models are flawed. Their examples are GE’s “Ecomagination” effort, China Mobile’s closing of the digital divide by widely distributing mobile phones in rural China, Indian generic-drug maker Cipla Limited’s distribution of low-cost antiretroviral drugs to AIDS victims in poor countries, and Generation Investment Management, the asset management firm chaired by former U.S. Vice President Al Gore.
Of these, I believe only GE’s Ecomagination program comes close to a pure example of the kind of corporate leadership the authors advocate, though all have some elements of it. The Ecomagination effort “was aimed at driving innovation and generating superior returns by tackling some of the planet’s biggest problems – energy efficiency and harmful environmental impacts.” CEO Jeff Immelt “believed that GE could prosper by helping its customers improve their environmental performance.” At the same time, “GE deepened its engagement with government officials and regulators on environmental issues and hired a consulting firm to help it understand the NGO landscape.” This is a good example of an innovative business model designed for the public good combined with engagement with regulators and other public institutions.
The case of China Mobile raises the question of whether poverty is an externality requiring both out-of-the-box corporate thinking and government intervention to fix. Recently it has been pointed out that the poor are a vast market, the “Bottom of the Pyramid.” Wherever people have a need for a product, and their lives will profit greatly from it, there is, at least in principle, a way for a provider to profit from selling it to them. In a case where the target market is the bottom of the pyramid, the product must be affordable. China Mobile innovated ways to make mobile phones available to rural poor people at affordable costs, and with very attractive benefits – and China Mobile profited. This is nothing but business as usual, whether or not it was motivated by a desire to alleviate poverty.
In the third case, Cipla, the company did provide a valuable product to needy customers – AIDS sufferers – at an affordable cost; but crucial to its ability to do so was a kind of intellectual property arbitrage, exploiting a loophole in the IP laws of India to reverse-engineer and copy a brand-name product. The loophole later closed. The example leaves unaddressed the question of whether Cipla’s practice – beneficial as it may have been for poor AIDS victims in the short-term – may have eroded the willingness of pharmaceutical companies to fund the expensive R&D to create more life-saving drugs in the future.
The authors’ fourth example, Generation Investment Management, a “boutique asset-management firm that invests in companies whose business models are aligned with the needs of a sustainable global economy,” is in my opinion the worst illustration. “The fund’s goal,” they say, “is to outperform the MSCI World Index by 9 to 12 percent (on a three-year rolling-average basis).”
That’s an outlandish goal, so the question is how do they expect to be measured? The fund seems to have a hedge-fund structure, so one wonders whether the managers will be compensated in the usual way, based on annual (or in the cases of some hedge funds, even quarterly) returns. Bower and his coauthors admiringly say that although Generation does not publicly disclose its holdings or its performance, it is “rumored to have … met or exceeded its performance goals in recent years.” Setting aside how unlikely that is to be true – much less that such outperformance could continue – one wonders why the company employs such standard short-term performance goals and metrics. It would be more convincing if the firm announced it would not measure its investment performance at all – or perhaps only after a ten- or even 20-year period (a “generation”) and be compensated based on that. I may be jaded by familiarity with the investment management field, but touts like this one – uncritically transmitted by Bower and his coauthors – sound like the usual nonsense: “…the decision to buy – or sell – involves a careful evaluation of the company’s price and value. Even though Generation focuses on long-term trends and how well companies are positioned relative to those trends, its portfolio managers are highly disciplined when it comes to buying and selling.”
Leading Through Institutional Activism
Here is where Bower and his coauthors are proposing the most radical – and the most important – departure from the conventional role of corporations in society. Most institutional activism, as of now, takes the form of lobbying; we know what a negative image that has. Lobbying of government is presumed to seek – and usually does – an advantage for a specific firm over its competition, or an advantage for a specific industry over others. It is not usually done to help government or other central institutions bring about the future regulatory regime that the company perceives to be the most beneficial for all; rather, it is done for whatever private gain can be most directly assured. This, according to the old-school thinking, is what business is supposed to do.
Bower and his coauthors believe that thinking has to change. They argue that lobbying must have as its most basic aim to internalize externalities. That is, business, not government, should take the lead in working out how to do this. Moreover, they should eagerly assume such leadership, because that will enable them to pursue innovative business models that will have the best chance of succeeding sustainably in the future. For example, by working out CAFE rules (corporate average fuel economy) with regulators, U.S. automakers leveled their own playing field, internalized some of the externality of harmful auto emissions, and put themselves in a better position to compete globally.
In short, the authors believe that the business leader of the future must have a broad vision, and he or she must not believe that his or her broad vision is something to indulge only outside the office – channeling that civic-mindedness only into philanthropy, for example. Instead, that sense of what’s good for society must inform and drive not only business, but lobbying and institutionalized, industry-wide collaboration and self-regulation.
This is an important book. Even if that is true largely because it was written by Harvard Business School professors and a buzz is emerging around it, the book does carry the right message. I warn you, however, that it is drab reading. In my limited experience of business books, professors of business and management do not offer scintillating prose, and this book is no exception. I’ll give the interested reader a tip: if you want to abbreviate your experience, read only Chapters 5, 6, and 7, in which the authors usefully categorize the mind-sets of current business leaders and then propose their dual models of new business leadership.
It would not surprise me – and it would be a salutary development – if Bower, Leonard, and Paine now launch a follow-up series of business forums to discuss how to implement their new model of business leadership. And the Harvard Business School itself should – and I hope, will – adapt its teaching to incorporate this forward-thinking approach.
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