Invisible Hand versus Iron Fist
On August 19th, 2019, the Business Roundtable, a non-profit corporation made up of the CEOs of major US corporations issued a Statement on the Purpose of a Corporation. Previously, the purpose of a corporation was to maximize the return to shareholders. But recently, under pressure from millennials and progressives (not quite the same thing) many CEOs have opined that corporations and capitalism, in general, need to come up with a kinder, gentler persona.
The new definition of the Purpose of a Corporation includes additional stakeholders that the corporation is intended to serve. These include customers, employees, suppliers and also local communities and the environment in addition to shareholders. These were broad aspirational goals that few people could object to. And, in fact, most corporations already do most of the things on the list. It is just good corporate governance. Companies that don’t value their customers, invest in their employees, and deal fairly and ethically with suppliers and other companies in the marketplace will not be around very long. And that is not good for shareholders or their returns.
I don’t know why the CEOs felt the need to issue this redefinition of the Purpose of a Corporation. None of the new goals interfere with the goal of maximizing shareholder return. Adam Smith stated in The Wealth of Nations, that we shouldn’t care what the motives of businessmen and their businesses are, because the invisible hand of the marketplace will not only determine the relationship of supply and demand, it will also weed out companies that cheat their customers or supply shoddy products. Further, the marketplace for will make sure that companies that treat their employees well will get the best, most productive employees.
Of course, in a modern industrial economy, where consumers do not know the corporations that supply their goods and services very well, there is a role for government to assure consumers that the products they buy are safe and conform to the stated specifications. There are labor laws to protect workers from the worst abuses and, in the case of unionized workers, a formal contract between the company and the workers.
So we don’t know what the motives of the Business Roundtable CEOs were to redefine the purpose of the corporation, but if those aspirational goals were designed to soften their image with the progressive left, they have another think coming.
Senator (and presidential candidate) Elizabeth Warren responded by writing a letter to Jamie Dimon, JPMorgan Chase Chairman and also Chairman of the Business Roundtable, on October 3rd demanding not only “information about the tangible actions you intend to take to implement the principles” but also telling him that to “make good on your commitment, you will implement the steps laid out in the Accountable Capitalism Act I plan to reintroduce in the coming weeks.” She, further, demanded that Mr. Dimon respond in writing no later than Friday, October 25th whether or not he will support her bill.
The Accountable Capitalism Act drafted by Senator Warren is intended to assert and intensify the government’s control of the American economy. The Act spouts a lot of gobbledygook economics created by the Institute for New Economic Thinking; a far-left think tank created to invent economic analyses or theories that support the far-left’s progressive goals. The Institute has been very busy churning out papers that denounce capitalism and support progressive goals, but all the papers boil down to one concept. They think profits are evil. They do not believe that you should profit from your hard work and ingenuity, let alone the financial risks you take when investing. To them, profits are the return that the government allows preferred companies to receive as long as they toe the government line.
It all boils down to Marxism. Marx believed that profits were created by the exploitation of labor and were, therefore, illegitimate and subject to confiscation by the state. Ultimately, under Marx’s conception of socialism the means of production would be owned by the state. Most people envision the means of socialist production as massive factories and collective farms. But all means of production are subject to state control, that includes the services you provide, the crafts you make or the music or art that you create. It all belongs to the state.
Senator Warren does not go quite so far (yet). But she intends to replace the invisible hand of the market with the iron fist of the state. Under her act, all large corporations would have to get a federal charter as a United States Corporation. Such federally chartered companies would have to take all stakeholders into consideration which in the case of diffuse or uncounted stakeholders would mean the federal government. Boards of directors would have to include stakeholders as determined by the government (sort of like how the Communist party of China has board representation of the large companies there). Options on company shares and other forms of management compensation would be subject to government control. And finally, any company that does not follow the directives of the administrative state would have their charter revoked.
Many of you will say, “So, what? Those greedy bastards will only be getting what they deserve.” But be careful what you wish for. The progressive’s lust for control is not limited to just large corporations.
While the free market controls the supply and demand of products and services through the mechanism of price discovery, the government must do it by force. When a company misjudges the market for its goods or services, it pays a price. The price they pay is lower profits or even losses. If a company cannot adjust to changing market conditions, developing consumer preferences or emerging technological improvements it is likely to go bankrupt. That is the process that Joseph Schumpeter called Creative Destruction. The market is continually creating new and better products and services that replace old-fashioned products and unwanted services.
There are no adjustment mechanisms when governments make mistakes. And when unintended consequences that government policy makers did not think about undermine their policies, the response is to increase the role of government. A good example is the double tax exemption of healthcare costs. During World War Two and its aftermath many companies provided health insurance for the employees as a perquisite to attract employees in a tight labor market. Government policy makers thought this was a great idea and, in order to promote this concept, allowed companies to deduct this expense but did not require the employees to include the income value of this benefit on their taxes. This is called a tax expenditure and once it worms its way into the administrative innards of government it is almost impossible to extricate.
Some of you may find this hard to believe but many years ago people were expected to pay normal out-of-pocket medical expenses themselves just as they did for food and housing. Health insurance was designed to cover unexpected expenses just as automobile insurance is designed to cover accidents or other unexpected events. But because health insurance was doubly tax exempt, soon companies and their employees began including everything but the kitchen sink in the insurance coverage courtesy of the American taxpayers. So, health insurance morphed into a gigantic healthcare payments system that is subject to such endemic abuse and fraud that it requires a welter of regulations and administrative procedures, which have driven the cost of American healthcare to be the most expensive on the planet.
In addition, the double tax exemption has embedded health insurance costs so deeply into private sector companies, that people are trapped into staying with companies primarily to retain healthcare coverage. In the fifties, employment was usually for very long periods if not a lifetime. My brother joined General Motors as an engineer shortly after he graduated from college and worked there until he retired. It did not matter that his health insurance and pension were inextricably linked to GM, because he never wanted to quit. But the job market is very different now. Younger workers hop around jobs with wanton abandon.
All the disfunction in American healthcare was generated from that one small tax expenditure that remains embedded deep within all healthcare policy proposals. And what is the proposed solution to this healthcare mess – more government involvement!
Or take Fannie Mae and Freddie Mac. These gargantuan institutions are Government Sponsored Entities or GSEs that purchase mortgages from banks and other mortgage originators to provide liquidity to the finance industry and promote home ownership. For many years (Fannie Mae was created in 1938) these GSEs chugged along nicely by purchasing “qualified” mortgages which, in those days, meant that the mortgagees had put down 20% of the purchase price as surety for the loan. This down payment covered Fannie and Freddie for potential losses if the mortgagee fell into arrears and the mortgage was foreclosed. In 1992, the Democratically controlled Congress approved the Housing and Community Development Act, which stated that the GSEs "have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families in a manner consistent with their overall public purposes".
But minority home ownership still remained well below that of whites, so in 1999, the Clinton Administration pressured them to lower credit standards to meet the goals of the Community Reinvestment Act. Fannie and Freddie lowered their credit standards and started buying riskier “sub-prime” mortgages with low down payments and also interest only mortgages and no-doc mortgages. With lower credit standards, low interest rates and easy liquidity it is no wonder the housing market exploded, until 2008 (only 9 years later), then it blew up. Government blamed the bankers, and they are not without fault. But they could not have done it without the government’s insistence and assistance.
And now Senator Warren wants to “fix” the US private sector with more government regulation and oversight and she is conscripting Jamie Dimon and the Business Roundtable as her allies. If Jamie Dimon responds positively to Senator Warren’s demands, he will be signing over control of the US private sector to the progressives even if Senator Warren is not elected. But if he responds negatively, he and the rest of the Roundtable CEOs will be subjected to the harshest vilification imaginable and even more draconian control by the government should the progressives ever win.