Essay: Saving Capitalism From Death

Economic inequality is the great business challenge of our time.

By Anthony W. Orlando

 

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Image credit: Mike Austin

American business leaders rallied around Franklin Delano Roosevelt in 1932 during his candidacy for the presidency, after which he immediately embarked on the most progressive legislative agenda in U.S. history to tackle the Great Depression. From today’s vantage point, it may seem surprising that titans of industry, executives from General Electric to Standard Oil to IBM, not only contributed to Roosevelt’s campaign but helped author many of his famous New Deal reforms. To the men who ran these companies, it was a simple matter of fiduciary responsibility—to current shareholders and to future ones—that they should ensure a more equitable distribution of prosperity, lest their own wealth be dashed to bits on the jagged rocks of a shrinking economy.

Today, we face a similar predicament. The great challenge of business in our time is reversing the destabilizing threat of inequality. While at first this may seem anathema to our profit-maximizing mission, distribution of income lies at the very heart of sustainable capitalism.

For this reason, today’s titans of industry have stepped forward to protest the growing distance between them and the rest of the country. Warren Buffett, Lloyd Blankfein, Stanley Druckenmiller, Bill Gross—legends whose lives and words are studied and idolized at the Wharton School—have all gone public with the wise advice that we steer away from those jagged rocks.

It is time that we recognize inequality for the negative externality that it is, slowing our productivity growth, roiling our markets.

They are not alone in their concern. According to a recent analysis by the Center for American Progress, 68 of the top 100 retailers cite the flat or falling wages of the average American household as a risk to their business—a number that has doubled in the past eight years. A recent poll of small businesses similarly found a strong majority of them in favor of raising the minimum wage.

These business leaders sense an essential truth about our capitalism: Workers are consumers. They spend what they earn—or what they borrow. While the latter may work for awhile, it has limits—and calamitous risks. The only sure way to grow the economy in the long run is to grow consumer spending—and that means growing worker incomes.

In recent decades, workers’ incomes have not grown much, on average. Since the beginning of the Great Recession, the average household has lost 8 percent of its income, after adjusting for inflation. All the growth—and then some—has gone to the richest 10 percent of Americans. And most of that growth—95 percent of total growth, to be precise—has gone to the richest 1 percent. And most of that growth has gone to the richest 0.1 percent. And so on.

Unsurprisingly, economic growth has been slower since the advent of this new trend. From 1950 to 1980, real GDP grew 3.8 percent per year, versus only 2.7 percent from 1980 to 2010. On the rare occasions when it has approached its previous faster rate, it was fueled by unsustainable borrowing. This is no coincidence. Recent work by economists Özlem Onaran and Giorgos Galanis has shown that most developed countries experience lower growth when the share of their income going to wages (as opposed to profits) declines. In the United States, for example, every 10 percent decline in the wage share causes the economy to shrink by 9.2 percent. In fact, that has been the experience of the global economy as well.

High wages are what economists refer to as a “positive externality.” They generate “spillover effects” that benefit the people who don’t pay for them. When workers receive high wages, they invest more in health and education, increasing their productivity and reducing the costs we all pay for a sicker, less-informed population. They motivate firms to invest in advanced technologies to reduce labor costs, making them more innovative and globally competitive. Workers who receive high wages are less likely to go out on strike, vote against free trade and immigration, protest in the streets, shirk on the job and commit crimes. That’s why, in an analysis of 19 developed nations from 1960 to 2004, economists Robert Vergeer and Alfred Kleinknect found that higher wage growth consistently led to higher productivity growth.

In other words, low wages may be good for one firm, but high wages are better for all firms. Yet many businesses would like to raise wages, but they fear losing ground to their competitors.

The only solution is collective action.

Economists have a collective action for precisely this sort of “coordination failure”: taxing the negative externality and subsidizing the positive. It is time that we recognize inequality for the negative externality that it is, slowing our productivity growth, roiling our markets with volatility, gridlocking our political system, and starving our economy of willing and able consumers. Inequality is a risk to our businesses, and it ought to be treated as such.

We should therefore see taxes not as penalties but as investments in a better, more equitable, more sustainable system. We should strive to prevent a “race to the bottom” in workers’ incomes; if we don’t, the day will come when no one will be left to pay the profits our shareholders demand. Business schools should teach courses about this issue, and business leaders should address it in their boardrooms. It is not merely a political issue. It is very clearly the business of Business.

Joseph Kennedy thought so when he went to work for President Roosevelt. As one of the nation’s most notorious stock manipulators, Kennedy might have been the last person we’d expect to join Roosevelt’s crew, but when Roosevelt named Kennedy as the first chairman of the Securities and Exchange Commission, he saw it as an opportunity to save the market from itself.

“We of the SEC do not regard ourselves as coroners sitting on the corpse of financial enterprise,” said Kennedy in a radio address to the nation. “On the contrary, we think of ourselves as the means of bringing new life into the body of the security business.”

As Wharton graduates, let us think of ourselves in the same manner, and act accordingly.

Anthony W. Orlando W09 received his bachelor’s degree from Wharton and his master’s in economic history from the London School of Economics. He is a lecturer in the College of Business and Economics at California State University, Los Angeles, and a public policy research fellow at the University of Southern California. His latest book Letter to the One Percent is available at www.LetterToTheOnePercent.com.

 

 

  • Martha

    Dear Anthony,

    Thank you for your article on the potential demise of Capitalism.

    I wish there were more prominent business leaders and academics speaking out about the impact of economic inequality on both Capitalism and Democracy. In my opinion, Capitalism has run amok and is indeed threatening our democratic way of life and leading to corruption. I believe this problem was made even worse in Jan, 2010 when our Supreme Court ruled in favor of Citizens United. This ruling is all about economic inequality and to call it freedom of speech is laughable. If we don’t change course soon then I think we are headed for a fall, not unlike all of the other empires that came before us. I only hope that by ringing this alarm bell, we wake up and smell the coffee before it’s too late!

    Sincerely,

    Martha B.

    W’ 1980

  • Yair

    This reads like White House propaganda. Why is such a simplistic, myopic view of such a complex topic even in Wharton’s magazine? This essay focuses exclusively on the rise of income inequality in the US and completely ignores the rise of globalization. Using the Great Depression as a lesson today is completely useless. Back then FDR and the “Business Titans” lived in a US economy that was pretty much self contained. Back then a massive wealth redistribution plan did wonders. Today all it would do (other than generally be squandered by government inefficiency) is enrich Chinese factory owners when US workers buy their stuff. The lot of the middle class in the US has stopped improving because they now compete for relatively low skilled jobs with hundred of millions in other parts of the world. This article has said nothing about the more than 1 billion humans taken out of poverty world wide – in China, Brazil, India, part of Africa etc. A massive redistribution of wealth and income and has taken place on a worldwide scale and this article completely ignores that. The only way for Americans to compete going forward is to out skill everyone else and that starts at primary schools. If the American middle class is being screwed somewhere it is by the awful state of our public schools – the US is the country that spends the most per pupil in the OECD and yet student’s results rank in the mid 20s. That is something no one ever talks about. Grabbing from the rich and giving to the poor in and of itself does nothing for the long term health of a country and there is a massive volume of research that also shows that – none of which was mentioned in this article.

    If Wharton won’t defend Capitalism and Globalization and the massive good both do to so many around the world no one will.

    Yair
    W94

  • Hank

    If our economy is the relationship between the firms and the households, as modulated by the government, supposedly resulting in the circular flow of capital, labor, supply and demand yet our interpretation of capitalist philosophy mandates that the firms concentrate wealth and in the interest of concentrating wealth be as efficient as possible and in the interest of efficiency reduce or eliminate labor costs so that, in effect, the firms sole endeavor is to suck as much wealth as possible out of the circular flow, pooling it in the hands of as few as possible while, at the same time, impeding the ability of as many as possible to participate in the economy (while contributing to the destruction of the planetary life support systems as well as life itself) then capitalism has reached the point of diminishing returns as a viable strategy for fostering the equitable and sustainable distribution of the domestic and global economy. We’ll need to look elsewhere.

  • Yair

    This argument is based on erroneous assumptions (which I suspect come from a predetermined ideological positioning but since I don’t know you I can’t be sure). “Our” interpretation of capitalism is not yours. I’m not sure who you are referring to by “Ours” (teachers of Marxism/Leninism? Che Guevara? not sure). I know mine isn’t. I know it isn’t the interpretation of my teachers at Wharton nor of pretty much of any other ‘capitalist’ I’ve come across in my professional career. Also your statement of reaching the point of diminishing returns is yours and isn’t the only logical conclusion from your premises even if those were correct. In my humble opinion it doesn’t follow at all. There are plenty of other systems of economic organization that have been tried and all proved way inferior in “fostering equitable and sustainable distribution”. Feudalism resulted in 99.999% of the wealth owned by a King and his coterie of blood relations. Communism resulted in the total impoverishment of entire populations so even if before the poor had very little after they had even less. If you don’t believe that ask the Chinese government. Capitalism works because it allocates resources efficiently across countries, industries and companies with the net result that the total size of the pie of resources keeps getting bigger. Your statement that in capitalism firms must concentrate wealth is erroneous – companies regularly shed wealth by selling parts of businesses, shutting unproductive ones, paying dividends, etc. Not sure what “sucking wealth out” means? Is the wealth shipping to Mars or Neptune. From my experience in capitalism the wealth that is obtained by shareholders of companies is either 1- put in a bank account – in which case banks reuse it to give out loans which can be further used in the economic cycle in numerous forms 2- reinvested in another company resulting in employment 3- spent on conspicuous consumption thus generating those businesses that get that wealth (which can be a big conglomerate but can also be a gardener, plumber, baby sitter, small farmer selling in farmer’s markets, etc). The biggest problem with your argument is the fact that it focuses on the actions of 1 company and condemns the entire system as predatory and cruel when in reality the system is the relevant unit of observation. The wealth generated in 1 company is recycled and redistributed into others which grow. This dynamic can (and demonstrably has) resulted in all that surplus labor you refer to being absorbed in other firms. Finally the whole statement about “impeding the ability of as many as possible to participate in the economy”??? What the heck is that all about. Who exactly are these firms selling their things to? Is Wal-Mart really trying to reduce the ability of as many as possible to participate in the economy? I suspect your biggest issue is the increasing income inequality we see in the US. I reiterate my point that in places like China 400 million people have been taken out of the most miserable and abject poverty by capitalism. Countless other millions also in India, Brazil and parts of Africa. This is undeniable and can be seen on the ground in those countries. Much remains to be done of course but it wasn’t until these countries adopted a more capitalistic economic model did these changes happen. In those countries firms came to use cheap unskilled labor. Those jobs came from the developed world. They are not coming back to the US ever. This has led directly to the increase in income and wealth distribution we see today in all the developed world. Practically and pragmatically: Americans shouldn’t whine to their governments about not finding cheap and unskilled jobs in the US. They should be given the opportunity to skill up to jobs that are available here. Hundreds of thousands of good jobs are open and available (a fact not an ideological opinion – just check the figures on demand for H1 and L1 visas) – we just need to prepare people here for them with good schools and universities that sadly is rarely if ever on the national agenda. I thank you for your attention if you made it this far. I enjoy these sort of chats.

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