A Case for Compassionate Capitalism

Some may argue that John McCain lost the election saying – “fundamentals of the economy are strong”. The deep recession that we are in right now has indeed raised questions about the rigidity of the free market capitalist system. Under the new president the government is taking control of the economic activities in unprecedented proportions. This has understandably evoked the outcry of socialism, something quite unacceptable in the social fabric of America. Interestingly, a walk through the history of economy activities in America shows that pure Capitalism had never dominated the socio-political landscape for a long stretch of time. In fact it has been an intriguing battle between the government controlled mixed economy and free market Capitalism all along.

Laissez-faire Capitalism, in which the means of production and capital are unregulated and free of state intervention, had gradually captured the imagination of the Western World throughout the Industrial revolution in the 19th century and the early 20th Century. However the great depression in 1930’s and the world war after that brought a regime of government control and market regulation in America. Economist John Keynes put forward the idea that an ailing economy will need government stimulus to boost consumption which in turn will increase production and consequently reduce unemployment. Keynesian economics got a shot in the arm as President Roosevelt saw the country out of the depression and this model dominated the political landscape for the next few decades. Government spending as a percentage of GDP increased threefold between 1930 and 1970. Pure Capitalism was set aside as classical.

The economic meltdown in the 1970’s turned out to be a major setback for Keynesian philosophy and revived the free market views. Economist Milton Friedman spearheaded an alternate economic model arguing against the role of government in stabilizing economic growth. Ronald Reagan was a strong supporter of the free market capitalism and introduced measures to reduce government control and taxes. He famously said – government in not a solution to our problems, government is the problem. However during Clinton and even under republican president George Bush government gradually came to become more intrusive.

Broadly though, USA holds the most favorable view of the Capitalist philosophy among all nations. It is also undeniable that, such young a nation as USA being able to generate an incredible amount of wealth in a short period of time is a great success story of its economic system. Why hasn’t then Capitalism won its case convincingly across the globe and even in America and darwinized other economic systems – just as cell phones today are driving land-phones out of the market. Capitalism is often vilified as the symbol of greed and injustice even in the developed nations where it has been most effective and evidently Europe is veering off towards socialism.

Here are a few reasons worth discussing –

First, our material expectations are not based on our absolute needs, but based on our relative standing in the society and are challenged in the Capitalist society, a system that accentuates wealth inequality. To illustrate this point, let’s compare the occupants of two fictional islands, one named ALLEQUAL and the other ALLDIFFERENT. ALLEQUAL is relatively poor, underdeveloped and unproductive. Everyone in this island has the same inefficient productive capacity. They work very hard but only make just enough to meet the basic needs – food, cloth and shelter. They often complain about the hardship but they see others are also struggling and accept life with a sense of providence. On the contrary, ALLDIFFERENT is wealthy, technologically superior and have a perfect market economy in operation. Everyone has car, insulated house and enough food. But each person on this island has different productive capability and hence different amount of accumulated wealth. A small section of the population enjoys a much better living standard than most others. Of that group, a select few can afford an extravagant lifestyle unimaginable to the rest of the population. In this society a bigger section of the population will have a greater feeling of hardship. They will feel deceived and suspect that those at the top of the value chain are manipulating the social system. Capitalism can create an enormous amount of aggregated wealth but also the disparity that provokes class warfare.

Second, economic fluctuations in a capitalist system draw irrational response from the society. Expansion and contraction of economic activity, known as business cycles, are intrinsic features of the capitalist system. However, the contraction has a bigger negative impact on the social psyche than the expansion has a positive effect. This stems from the fact that we fear our losses more than we relish our gains. People remember the hardship during tough times with greater degree of discontent than they remember the improved standard of living during growth and prosperity. This unique aspect of human psychology is well captured and quantified by Daniel Kahneman and Amos Tversky in their Prospect Theory, which has now become the cornerstone of analysis of behavioral finance. To our point, the downturn leaves a long lasting emotional scar and is perceived as the overall failure of Capitalism.

Third, success of free market Capitalism relies on the doctrine that market is efficient in processing information and that all relevant information is readily available to everyone. But truth be accepted that we do not live in that perfect world. Today’s marketplace is very complex and diverse in nature with its tentacles spread all around the globe. The social, economic, political environments that contribute to this global marketplace are non-uniform and often do not compliment each other. Complexity of the structure regularly put some people in the vantage position of more information about the market, rules, regulations and processes compared to others. This creates excesses and inefficiencies. This also creates opportunity for short term profit by using means that undermine the principles of free market operation. The recent revelation of 50 Billion dollar Ponzi scheme orchestrated by Bernie Madoff, a once venerable businessman, is a glaring example of the vulnerability of the system to scavengers. Eventually the free market mechanism throws out the glut and exposes the manipulators but not before substantial damage is done. Such exploitations give Capitalism the bad name that it promotes one’s accumulation of wealth at the expense of others’.

In spite of all the criticism, Capitalism will stake its claim in creating wealth and improving living standards for more people in the society than has otherwise been possible. However it will also need to change ideologically to keep up with the changing world. No longer can it function on the tenet that the sole purpose of a firm is to maximize profit for its shareholders. An organization will need to play a greater role in maximizing utility for the society in which it operates – addressing the needs of the shareholders, employees, customers, the local community, government and the environment.

In the paradigm of profit maximization, a lot of firms have gone the route of unethical, illegal, overtly risky or mere foolish decisions to achieve short term gains and have eventually self-destroyed. The long term viability of the firm can only be achieved by creating value for as many entities engaged in the society as possible, value that goes beyond just monetary return.   

Corporate world will have to swear allegiance to a more compassionate form of capitalism – not only because it is their moral obligation to the society but also because their long run sustainability will depend on it. It requires instituting a form of governance that put corporate ethics and social responsibility at its core. It requires abiding strictly to fair and ethical business practices at all times; treating suppliers, customers, employees and shareholders with integrity; conforming to government regulations and tax policies with honesty; and acting sensibly to environmental challenges. It also requires looking beyond profit motif and putting portion of productive capacity in philanthropic use. It requires mobilizing the firm’s resources and capabilities to serve the community in which it operates and contributing equity capital and profit earnings to social causes.

Investors on their part should recognize creation of social value that is not returned in monetary terms. Health of a firm should no longer be judged based only on operational measures like inventory turnover or price-earnings ratio but also by suitable measures of social engagement.  

For their part, firms have more to gain than just goodwill and PR.

People have entrusted government with the responsibility to maintain law, order and justice in the society. Every time an organization takes the path of greed and cause destruction of wealth (think Enron) the public opinion sways against the free market. Government gains stronger support from its citizens to impose stricter regulatory environment, thus hurting business productivity and profitability in the long run (think Sarbanes–Oxley). A collective commitment to self-regulation, discipline and fair practice will create an environment of trust and harmony between the corporate world and the society and will act as a natural boundary against government intrusion.

Also, firms today realize that human capital is the biggest asset they hold that can lead them to long term growth and stability. Maintaining high standards of ethics and contributing to community development draws attention because it serves people’s higher emotional needs. This creates a better workplace environment, instill pride and esteem in the employees, attract talents, lower attrition and improve productivity.

Analyzing the action of firms that are strong advocate of Compassionate Capitalism, it is also observed that often their philanthropic activities take form of strategic alliance.  Firms leverage their resources in community development or in championing a cause that eventually open up new market, provide access to untapped resources or trigger new innovation ideas. Some criticize this view of “strategic philanthropy” as opportunistic but nonetheless it creates value for all parties involved.

The 21st century has brought new challenges that are changing people’s view about individual freedom and collective bargain to survive in this world of diminishing resources. To support the new world order Capitalism will have to embrace socialism.



3 responses to “A Case for Compassionate Capitalism

  1. The defects of free-market capitalism are well put.

    Combining capitalism and socialism will require the good-will of few leaders, which can not be guaranteed. How do you see such an alliance ? How can the system be set up once to roll smoothly forever ?

  2. Arnab,

    First of all, a really nice article.

    Reading through this a lot of thoughts raced my mind.
    To start off, let me say this, a market needs an environment to function properly. The cornerstone idea of capitalism is the concept of private ownership. One of the biggest reasons of flourishing capitalism is the fact that everyone knows that ‘private ownership’ will be honored. A system of checks and balances, regulations, law enforcement ensure that it remains so. Several countries present a glaring example of why they could not successfully implement capitalism — the essential prerequisite was missing.
    The point I was trying to make was this – even the free markets which may be considered a self cleansing and perpetuating system, needs several regulations and controls enforced by an entity – likley to be the government. Therefore to dissociate the state (or government) from the market is not a productive task.
    Having said that I do agree that the question really is the extent of which free markets should be allowed to take their own course. This would be something that I would recommend to pen your thoughts on.

    What I really want to talk about the need of a radical new approach. No doubt capitalism is a wonderful theory (not distinguishing between neocapitalists and followers of Smith) and it has served well, I deeply believe that we need a paradigm shift in the new century. The way capitalism is structured prevents it from realizing long term gains. Let me explain. Think of a power generation company that generates electricity using coal and a world without the EPA. The company has no real incentive(by the way this is why I like capitalism – the incentives make it self-sustaining) to worry about the pollution, the affects of which are not felt just by the company alone but communally. Now this is where socialism creeps in. If an entity is driven by its personal gains but in the process it creates an externality that forces some cost on others, would it not be a good idea to eliminate the personal gains and make them communal? As all of us know, this has its flaws and big ones. Now I am not comparing socialism with capitalism but am rather trying to point the flaws of each. A new theory would most likely be a blend of the two.

    The society doesn’t wait for the academia to come up with new theories which they implement. It’s the other way round. Innovators come up with new ideas and academicians study it. I would argue that we are witnessing such a turn of events in our times. Look around, a few of the most successful concepts cannot be really explained by capitalism. Wikipedia- how would you explain an online portal with anyone having the access to modify any piece of it be the most accurate source of information? How would you justify people all over the globe devoting time and energy to ensure that the content is up to date and most accurate? Now don’t get me wrong, you can explain these but what I am talking about is how would you explain these in a strictly capitalistic framework.
    Another example- Microfinance, how the seemingly anti-capitalistic venture is turning out to be the next biggest thing?
    Another- Cloud Computing
    If you look closely, all of these are based on collaboration. That’s the common thread. Whatever will surpass both socialism and capitalism would be based on collaboration. The key is to unite the seemingly contradictory views of both into a unified framework. The best pearls from each theory will be shared – concept of incentives that sustain performance, innovation and competition. Concept of pricing the externalities and internalizing them; but most importantly the concept of collaboration.

  3. Madhumita Bhattacharya

    Collective commitment sounds best and natural approach–but can you explain how can you measure its effectivity without govt.rules and regulations?

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