Thought for the Year Jan Dauman
Thought for the Year: Rethinking Capitalism by Dr Jan Dauman, Chairman, IBLF Global
January 1, 2018
When debating a hugely important topic such as the future of capitalism and the market economy, it is crucial that we spend some time focusing on asking ourselves the right questions. The often used title “rethinking capitalism” is based on the obviously correct notion that something is badly wrong. But then there is an implied assumption that there is something wrong with the system itself and that, therefore, the system must undergo a fundamental change. This may, indeed, be correct but another notion and set of questions that I believe are worth considering in parallel is that it is not the system itself that is to blame but its misinterpretation, distortion and abuse. In other words, my proposition is that most actions in the name of “capitalism” that are being criticised are, in fact, counter to the basic principles of capitalism. Indeed, they are abuses of capitalism and, rather than just focusing on changing the system (and we obviously do need new ideas to update the system to the conditions of the 21st century, including dealing with its imperfections), we need to ask how to do a much better job to control/remove the abuse and abusers, punish the abusers and reward those whose actions are consistent with the basic principles.
This is not the first time of serious questioning of the system and its leadership. Those of us old enough will remember the social revolution of the late 1960s and 70s, with its radical activism, vitriolic anti-capitalist, anti-globalisation rhetoric, militant labour and attacks on established institutions. There are similarities today but also major differences. Although very loud, the previous protests were still largely limited to relatively small groups. The middle classes were barely involved. Today, the protests are everywhere, including by large sections of the middle classes, which feel disenfranchised and helpless. The gap between the very rich and everyone else has always been there. But today the gap has reached unprecedently high and what are seen as wholly unacceptable proportions and, via the internet and social media, the gap is there for everyone to see. Corruption and fraud have always existed and will always exist. But the sheer magnitude of corrupt financial flows (estimated by the World Bank at around $3 trillion per year (about 4% of world GDP) is truly obscene and, while much is attributable to corrupt government officials, we need to remember that, for every taker there is a giver. And there is an impression that so-called elites are bending and often breaking the rules of the game with impunity, while focusing on their own wealth and entitlements rather than on the publics they are supposed to serve.
This has led to the lowest and still declining levels of trust in established institutions since records began and many question whether the elites really get it.
Let’s be clear that profound changes are taking place which are challenging cherished ideas in business and other sections of the community. These changes will come, whether by reform from within or by more forcible pressure from without. The race is between those who seek revolutionary change in the world and those, who seeing the same things that need to be put right, nevertheless believe that the safer and better way is to develop new concepts from within existing structures. History offers little evidence that forcible change has ever resulted in greater happiness and prosperity. But one thing is certain and that is that, if reform does not come, then the alternative will be inevitable and uncomfortable.
Many of the criticisms of business by external groups who should know better are confused and based often on wilful ignorance of how and why business operates. Certainly there is a failure to realise that, in business as elsewhere, people are people and that there is no monopoly of charity, conscience or honesty to be found on the street corner and in the behaviour of those who have chosen to opt out of the system.
Nevertheless, if the market economy and the companies that thrive within it are to survive in anything like the form we know today, four things have to happen.
First, business must take far more conscious steps to be sensitive to the new ideas that are forming around it. Second, it must act, and be seen to act, to counter the blatant distortions and abuses of the system. Third, it must act in ways that will prove that the criticisms leveled at it are without basis.
Fourth, it must learn to articulate its message with a clarity and a cohesion at least equal to that of the voices of those who criticise it. There is no fundamental right of existence for capitalism, the market economy, private enterprise or even a mixed economy. The success of each generation throws up the challenge of the next. In free societies, public permission for business to continue (the “licence to operate”) has to be earned and constantly renewed.
When seeking to define the basic principles of capitalism and the market economy and the rules governing business’ licence to operate within the system, we don’t need to look much further than several key statements from the 1960s and 70s. The first come from the Nobel laureate economist, Milton Friedman, the high priest of the market economy writing in the New York Times Sunday Magazine in 1971. “In a free enterprise, private property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires which generally will be to make as much money as possible while conforming to the basic rules of society, both those embodied in law and those embodied in ethical custom.”
Another direct quote is from his book “Ethical Theory and Business”: “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud”. When I had the privilege of having a conversation with the great man about the shareholder vs stakeholder models, while maintaining his conviction about the shareholder model, he agreed that if there was a solid business case that meeting the needs and expectations of all stakeholders led to meeting shareholder interests in the long-term, there was no contradiction in the models. Also he was categorical that competition, transparency and integrity are fundamental principles of capitalism and the proper functioning of a market economy and that, of course, companies have to take the public interest fully into account as part of the rules of the game.
The second set of statements come from the CBI Company Affairs Committee in its Final Report on “The Responsibilities of the British Public Company”, published in September 1973. 'The company being an artificial creation of law owing its existence to the will of the community, it is the duty of Parliament to ensure, so far as possible, that the operations of companies do not conflict with the public interest. . . . That is the starting point for consideration of the obligations of a company to society at large but it is far from being the end of the matter.'
'A company should behave like a good citizen in business. The law does not (and cannot) contain or prescribe the whole duty of a citizen. A good citizen takes account of the interests of others besides himself, and tries to exercise an informed and imaginative ethical judgement in deciding what he should and should not do. This, it is suggested, is how companies should seek to behave.'
The third statement comes from Tom Watson Jr, the then Chairman of IBM, who writes in his book, “A Business and its Beliefs” (1961): “Anyone engaged in some segment of the economy must recognise and the force of public, or national, interest. Ultimately we are all held accountable to it. We exist at its tolerance. We are bound by its laws. In planning for the future of our own particular interest, we must recognise the rights and requirements of the public and the millions of individuals who make it up.”
Fast forward some 40 years to Section 172 of the 2006 UK Companies Act: “Section 172: Duty to promote the success of the company.
325. This duty codifies the current law and enshrines in statute what is commonly referred to as the principle of “enlightened shareholder value”. The duty requires a director to act in the way he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole and, in doing so, have regard to the factors listed.
326. This list is not exhaustive, but highlights areas of particular importance which reflect wider expectations of responsible business behaviour, such as the interests of the company’s employees and the impact of the company’s operations on the community and the environment.”
Having re-established that the cardinal principles behind the legitmacy of capitalism and the market economy are free and open competition, open and transparent markets and actors acting in the public interest and observing ethical norms, the abuses and distortions are clear for everyone to see.
Most are obvious and so I’ll only mention a few here:
Headlines from one British newspaper in just a few days last summer. And, if you include social media, there were and are dozens more every week. And now, course, we can add some of the revelations in the Panama and Paradise Papers.
….Drug firms face record fines for ripping off the NHS.
….Leading banks fined 500 million euros over Euribor rigging.
….The great credit card con; shoppers unfairly charged hundreds of millions.
….Accountancy watchdog steps up enforcement to tackle varying standards of integrity among overseas units of the Big Four.
….Extreme, artificial tax avoidance measures deprive governments of billions in tax revenues.
Then there are the corruption and fraud cases and associated huge fines involving some of the most respected companies. (See Table 1).
It’s important to point out that most of the companies involved have signed up to international codes of ethics or codes of conduct (these days there are so many, for example OECD Guidelines, PACI Principles, UN Global Compact, etc. etc); have “tone from the top” statements from their CEOs; and have their own codes of ethics and compliance procedures, which they publish and give to all employees.
Indeed, in many countries, business ethics are at the core of the current debate about the role and responsibilities of business. This is as it should be. However, I must admit to having a problem with too much of a focus on ethics and codes. Codes of ethics are usually externally generated general principles of behaviour. But, although pleasing to the ears of moralists, they are usually too general to decide precisely what needs to be done and in what order of priority. And without a very clear translation of ethical principles into operational practice and KPIs, there is a serious risk of contradictions and some principles being ignored.
Another problem with these codes is that, for many companies they are just words and managers are defining the boundary of their behaviour and decisions as “what is not illegal is okay”, while they ignore the spirit of the law and the changing expectations of their publics. What they don’t seem to realise is that “Legal” does not necessarily mean “Right”. Each of you will be able to find many recent examples. Here are just a few:
- 20 years ago, aggressive tax avoidance using artificial mechanisms, while frowned on, was tolerated and was not a big public issue. Today, societal expectations have changed sharply and, while technically still “legal”, such tax avoidance is considered, by just about everyone, as unfair and wrong.
- Wildly excessive bonuses for managers of companies, even if the company is not meeting its business goals maybe legal but are considered unfair and wrong.
- Non-executive directors with conflicts of interest and losing their independence, to the detriment of the company’s stakeholders. You know what I mean: “I’ll join your Board and support you, provided that you use my investment bank for your transactions”. Or, “I’ll sit on your Compensation Committee, if you sit on mine”. Maybe legal? But obviously wrong!
- Google, Facebook, Twitter still repeating the myth that they just provide platforms and are not responsible for content.
My suggestion to you is that what is missing from all these behaviours is integrity.
In my opinion, the difference between ethics and integrity is fundamental. As one CEO put it recently, “Ethics is about following the rules, while integrity is about doing the right thing, regardless of the rules”. “Plenty of people are just trying to stay out of trouble, only because rules have been spelled out for them. That doesn’t mean that they wouldn’t change their behaviours if they were not prohibited. Integrity comes from a greater depth of character and a strong personal sense of right and wrong”.
When I was discussing this very topic with the General Counsel of a large American company a few years ago, he said: “It’s really very simple. If you’re at breakfast with your well- brought up 17-year old children and you can talk about it freely, it’s probably OK; if you can’t, it’s almost certainly wrong”! This may seem simplistic but it works most of the time!
Codes and rules are important, yes……but my contention is that, in order to make sustainable progress towards regaining trust and meeting the goals that we all share, companies, indeed all organisations, should be focusing a bit less on these rules and much more on building a culture of integrity.
Returning to distortions of the system and dealing with them, since when have the short- term actions of a small group of Wall Street whiz-kids or corporate raiders, largely for their own self-interest, been a true measure of company’s performance and sustainability?
Where are the large institutional investors demanding that long-term, sustained value creation and the public interest are the real measures and that all the abuses going on are wholly unacceptable and a huge risk not only for the companies in which they have invested but also for the overall system on which the continued increase in wealth of their customers depends.? There now exist, of course, some signs of greater engagement. But, in my opinion, its level is grossly inadequate. Some, especially in the US but here as well, still argue that company law requires them to put shareholder interests first. But the law does not define or even suggest these interests as short-term. Nor, indeed did Friedman. So maybe an immediate action to be considered is a change in company law so that articles of association include responsibility to invest in the long-term and take into account the interests of all stakeholders and the public interest; after all, in the UK this would be no more than complying with the spirit of Section 172 of the Companies Act.
Actually, companies don’t need a change in the law to change their articles. I believe that Nestle, for example, has already done just that.
Another action is the creation of incentives for companies and their managers who do observe the basic principles and responsibilities and refuse to participate in the abuses. Recognition and rewards can come in many forms, from winning contracts, to tax breaks, to public recognition. At the same time, we need to do much more to punish the abusers. Much more intensive enforcement of the law and regulations is crucial, of course, including having regulators who are truly independent and have real teeth and high levels of competence. However, there are areas of abuse, such as the ridiculously high, often obscene compensation and extreme, albeit still legal, tax avoidance schemes mentioned above, for which the application of the law is very difficult.
In these cases, I am in favour of the “name/blame/shame/isolate” strategy. Top managers are unlikely voluntarily to cut their own compensation significantly. But, at the same they are fiercely protective of their reputations. And governments, major companies and banks can use their purchasing or lending power to simplify refuse to do with business with companies whose CEOs/Boards continue to flout the public interest….. and then publicise the reasons for their actions. The World Bank already has a blacklist of companies with a record of bribery or fraud, which cannot bid for major contracts. Why not add some more criteria?
Some recent research suggests that about 60% of major public and private sector contracts in the US are won through connections, usually undisclosed, rather than on merit. I have no evidence but I doubt if the situation is much different in Europe. It sounds to me like this is usually a blatant abuse of the basic principle of fair and transparent competition. Crony capitalism, including cosy relationships between companies and government officials, regulators, and auditors, whether legal or not, is simply wrong. I am told that I am naïve in thinking that something can be done about it, but this is a central part of the “entitled elite” syndrome that is under attack, with justification, and very damaging and so we need to ask what measures are needed to at least scale it down.
There is a need for determined collective action.
Acting in a way that discredits the system and loses public trust is clearly an abuse of the system. Therefore, those that believe in the system, despite its imperfections, really need to do much more to tackle the perpetrators. Opponents of capitalism and the market economy and large sections of the media paint all companies with the same brush. Public trust and confidence are driven by perceptions which, in turn, are based on what people see and hear. I firmly believe that the majority of executives and their companies act responsibly with high standards of integrity. It may seem risky to speak out but it is time to do so, with real stories.
For those of us who believe that capitalism and the market economy continue to be the best mechanisms to create wealth and the basis for achieving the world’s sustainable development goals, we must stop being defensive. We need positivity and confidence and demonstrate our full commitment to cut out the abuses, redress the gross inequalities and take all necessary measures to restore trust, not through words/PR but through focusing on “doing the right thing” and initiating, implementing and then publicising positive actions.
This paper is mainly about business. But, of course, governments and politicians also have a great deal to answer for in terms of their abuses and distortions of the system, coupled with incompetence, from both over-regulation and misjudged state intervention on the one hand and under-regulation and weak enforcement on the other, being complicit in corrupt practices, cosy relations with corporates and banks, and much more. But these are topics for another discussion paper.
These messages are not new. And, over the past 3-4 years, we have seen an increasing number of governments, companies, business associations and international agencies world-wide make strong efforts to formulate and implement necessary changes. These efforts are laudable and there is some progress….. but they only represent a beginning. The time has come for urgent and massive collective and individual action.
Table 1: Cost of Bribery/Fraud
● Siemens (800M+)
● Daimler (185M)
● Shell (48M)
● Alstom (772M)
● Alcatel (137M)
● JP Morgan (203M)
● Och Ziff (412M)
● HP (110M)
● Avon (135M)
● BAE (400M)
● GE (23M)
● Pfizer (60M)
● Archer Daniels (46M)
● Alcoa (384M)
● JGC (219M)
● Rolls Royce (845M)
● Novartis (48M)
● Teva (519M)
● KBR/Halliburton (579M)
● Vimpelcom (400M)
● ENI (365M)
● Glaxo SmithKline (490M)
●Eli Lilly (29M)
● Technip (338M)
● Walmart (300M)
Note 1: Cost of fines and settlements only……excludes legal costs, disruption costs, reputation loss costs. In several cases , more fines to come.
Note 2: Data up to June, 2017. Many more fines since then Sources: Exiger, IBLF Global, FCPA blog.
Banks
● UK Big 4 banks: $24BN
●US banks: $60BN
●HSBC ($5.6BN)
●Deutsche Bank ($14BN)
● B of A ($16.7BN)
● Citigroup ($7BN)
● UBS ($2.3BN)
● JP Morgan ($18.3BN)
● Credit Suisse ($13.1BN)
● Wells Fargo ($5.3BN) ● Barclays ($6BN) ● BNP Paribas ($8.9BN)
Volkswagen
● $4.3BN fines so far (as at June, 2017) + $14.7BN settlement (US only)*
-The settlement is only a preliminary step ; the automaker still faces possible criminal charges, as well as civil penalties for Clean Air Act violations. DOJ is investigating criminal charges against both the company and individuals.
