By Simon Caulkin Tuesday, 23 August 2011

Saving capitalism from itself

A victim of its own success, could capitalism be in mortal danger? As almost every major economy struggles with overwhelming problems, we enlist some expert help to examine alternatives to the status quo.

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Consider: three years after the Great Crash there is still no recovery in sight. Indeed, savage cuts administered by 'advanced' economies to slash deficits incurred to save the banks are bringing citizens onto the streets. The euro is in crisis. The increasing incidence and severity of financial crashes, lurid accounts of corporate wrongdoing, unsustainable inequalities, increasingly volatile commodity prices and the plunging reputation of business all point in one direction. US-style capitalism, sums up Roger Martin, dean of Toronto's Rotman School of Management and author of Fixing the Game, a forceful critique of today's state of play, is in danger of rotting out its moral core and destroying itself from within.

Who'd have thought that, 20 years after the collapse of capitalism's only direct rival, Karl Marx's famous prediction that the system would collapse under the weight of its own contradictions would have become so much less unthinkable?

Martin isn't the only one ringing alarms. It's hard to find a business thinker who isn't. 'We're in a dreadful crisis and it's accelerating by the hour,' warns Henry Mintzberg, the veteran strategy guru at McGill, Montreal, who berates short-termism and overweening corporate entitlement for today's tensions. Charles Handy, the respected UK business observer, sees yawning inequality bringing capitalism into irreconcilable conflict with democracy itself. The defiantly red-blooded US sage Gary Hamel concluded his defence of capitalism by conceding that it has never faced more, or more daunting challenges. Even pillars of the establishment such as Michael Porter, doyen of strategy teachers at Harvard Business School, and Dominic Barton, global managing director of consultancy McKinsey, see 'capitalism under siege' and 'deep reform' needed for survival. Umair Haque, author of The New Capitalist Manifesto and a fiery and influential blogger, argues that pulling levers to activate recovery is futile because the problem isn't recession: it's the wholesale implosion of worn-out, industrial-age capitalist institutions.

How did we get into this mess? Ironically, as often in business, the roots of failure lie in success. 'When communism fell, we thought it was capitalism that triumphed,' muses Mintzberg. 'It wasn't, it was balance'. The west, he says, had a much better balance of the public, private and social sectors that make up a resilient economy. Communist societies were completely unbalanced towards the public sector, 'just as we're now completely unbalanced towards the private'. The problem isn't capitalism as such, he argues: 'It's the assumption that capitalism is the be-all and end-all of human existence, rather than a means to create and fund enterprise.'

The embodiment of this world view is the uncompromising shareholder-first doctrine that has ruled English-speaking business since the 1980s. The effects, charges Martin, have been the exact opposite of those intended. Together, stock-based compensation and shareholder-value maximisation have destroyed value and aligned executives not with shareholders but with their own wallets. The theories have driven damaging short-termism, fostered amoral and immoral executive behaviour, and favoured the mushrooming growth of parasitic players in the expectations market to whose tune real-market actors are increasingly made to jump. The most egregious are the hedge funds, pure value extractors which have been legitimised to 'make ginormously supernormal returns by wrecking the system on which they depend to make money', he fulminates.

It's not even as if shareholders have done better under their privileged regime. Martin calculates that shareholder returns have actually been lower in the era of shareholder capitalism than in the post-war decades when managers were supposedly feathering their own nests.

Others voice similar preoccupations. 'The metrics (of shareholder value) are just too narrow and short-term for the wider issues we face,' says McKinsey's Barton. 'That's why I have an allergic reaction to the notion that the business of business is shareholder value alone.' By focusing solely on shareholder value, says Hamel, executives mistook the scorecard for the game, losing sight of the need to answer 'not just to shareholders but to society which has granted them extraordinary privileges' - privileges which in extremis could be taken away, he warns. For Mintzberg, the short-term, antisocial policies followed have trashed so many companies that the US economy is faltering: 'It won't be fixed by Obama's economists because it's a managerial crisis, not an economic one, and they don't have a clue about how enterprise functions.'

Given increasing demands on limited resources (health, climate, food, water, to name the most basic), companies urgently have to do better as well as good. Can the circle be squared? In a Harvard Business Review article, 'Capitalism for the Long Term', Barton argues that much of the problem is due to institutionalised myopia, for which the solution is revamping incentives and structures to focus managers on the long game. In another article (headlined 'How to Fix Capitalism', with characteristic grandiosity), Porter and Mark Kramer urge companies to seek sources of competitive differentiation and wealth creation in addressing social problems. By creating 'shared value', they argue, they can make 'profits that create societal benefits rather than diminish them'. Kramer emphasises that 'we really are talking about value as well as social benefit here'. Not only does shared value have the potential to reconnect business and society, 'it is the key to unlocking the next wave of capitalist innovation and growth'.

Meanwhile, writing with Old Testament passion and rhetorical flair, Haque depicts a business future made by individual decisions. The concepts of 'thick' and 'thin' value outlined in his book and his direct calls to action to put eudaemonia (wellbeing) and meaning at the centre of both enterprise and consumption are a combination that may prove vital for the next phase of capitalist evolution.

So much for the grand ideas about getting business and capitalism back in harmony. What about the bootstrapping business of making it happen? While it's too early for anything like fully formed solutions to have emerged, some important experimental work is well underway. Hamel's McKinsey-supported Management Innovation eXchange and London Business School's Management Lab are two examples. Plans for a social stock exchange to make it easier for social entrepreneurs to raise capital are afoot. Barton is working with pension funds on reshaping incentives to foster long-term investment, while Porter and Kramer are rounding up interested companies to research measures of shared value.

Perhaps most interesting, beneath the obsolete radar of conventional theory, many industries harbour at least one company that succeeds by using radically different assumptions from its peers: Apple, Toyota, Whole Foods Markets, WL Gore, Handelsbanken, are just a few. The crowning exception, of course, is Warren Buffett's Berkshire Hathaway, the most successful investing outfit ever (although even its stainless star has recently been tarnished by allegations of insider trading). It's testimony to the straitjacket of received wisdom that these companies' difference is either ignored or dismissed as the exception that proves the rule, rather than identified as the smoke signals of an emerging, better management model.

Yet these are tiny advances compared with the gigantic institutional changes needed. Take ownership. As Handy and others point out, the universally held assumption that shareholders own companies is not only a perversion of the legal position - in an age when ultra-high-speed transactions account for 70% of Wall Street trading, when hedge funds borrow shares to vote them in their own interest and many AGM participants no longer own the shares they vote - it has driven a wedge between the real world and the casino that increasingly dominates it.

Ownership is just one of the interlocking assumptions that are so institutionally entrenched that it sometimes seems that only revolution could shift them - a spectre that after the Arab spring hangs over the debates like a whiff of tear gas in the air. 'That's you in Syntagma Square: you just don't know it yet,' tweeted Haque, in firebrand form over the summer.

Barton worries that declining trust in business and mounting social pressures will bring about change that won't be 'nice and linear, but in step changes, like earthquakes'. If business doesn't put its own house in order, and soon, Barton echoes Handy in warning that governments will step in, increasingly fettering it as a force for growth and expansion. Indeed, the process is already under way.

Yet even this isn't the biggest fear. That comes from the enormous and growing sense of corporate entitlement that Mintzberg highlights. 'US democracy is under real threat right now from the weight of corporate lobbying,' he says. 'Recent Supreme Court decisions make it look as if free people are being replaced by free enterprises.' Hamel too deplores the fact that for many CEOs the return on an hour's lobbying is now so much greater than the return on innovation or serving the customer. The situation is made worse by the ever-growing concentration of power in the hands of remote, imperial CEOs, the weakness of regulators and governments that are at least as short-term in outlook as business. The UK is by no means immune to these pressures, as the Murdoch scandal makes clear.

However, for all the hand-wringing, few think there is any alternative to the market economy. Most are optimistic that human ingenuity will succeed in turning it into the force for good that some have always believed it to be. But the journey will be turbulent and messy, and as and when solutions do emerge they may not come from the developed world.

It's the paradox of success. Having triumphed over socialism, capitalism's only enemy is other capitalists. In the past, there have always been contrarians and practical reformers - anti-slavery campaigners, Quaker industrialists, New Dealers, trade unionists, even corporate raiders - strong and determined enough to rescue it from its own excesses. The question this time is: having done such a good job of bullying, bribing and battering its enemies into submission, is there anyone left to save capitalism from its fundamentalist friends?

CAPITALISM ON THE CRITICAL LIST

MICHAEL PORTER

Who is he?
Michael Porter, Bishop William Lawrence University Professor at Harvard Business School, is the most cited, most taught and, according to many, most famous business professor in the world.

Best known for his work on strategy - the seminal Competitive Strategy (Free Press, 1980) with its Five Forces analysis is still taught in almost every business school in the world - Porter has also been widely consulted by governments for his work on national competitiveness.

Diagnosis?
Porter concedes that even if capitalism is not quite broken, it is 'under siege' - no small admission from such a pillar of the corporate establishment. The forces laying that siege, he says, emerged from the sense that business success too often comes at the expense of society as a whole.

Some critics charge that he may be partly to blame for this. The late Sumantra Ghoshal, for example, said that Porter's original model of strategy placed the company and society in opposition to one another, since under shareholder value the job of managers is, crudely, to prevent others, including society, from eating the shareholders' lunch. Managers are therefore condemned to harm broader societal interests in pursuit of the narrower interests of shareholders.

Treatment
Porter's response to the financial crisis is the concept of shared value, as elaborated in the Harvard Business Review with co-author Mark Kramer earlier this year. Shared value seeks to meet the objections of Ghoshal and others by demanding that companies innovate (ie create new value) by addressing unmet social needs, treating societal problems as opportunities to create both wealth and competitive advantage while providing a clear benefit to the community. But it also faces big challenges from the powerful incentives and structures that currently cause managers to act as they do.

UMAIR HAQUE

Who is he?
At the opposite end of the establishment spectrum from Porter is Umair Haque, director of Havas Media Labs and author of The New Capitalist Manifesto - Building a Disruptively Better Business (Harvard Business School Press, 2010), a man who has little time for the grand old men and women of business. He began one post-crash blog entry: 'Dear Old People Who Run the World, my generation would like to break up with you ...' And another: '20th-Century Business, you're fired.'

His powerful writing and distinctive voice have made him a cult figure in the blogosphere (as well as raising the hackles of those of a more conservative disposition). But Haque is no crude rabble-rouser. London-based, he trained as a neuroscientist before doing an MBA at LBS, where he studied business and economics with Gary Hamel (see below).

Diagnosis?
In a nutshell, Haque berates the Faustian bargain in which the west has traded meaning for material opulence and spiritual drought. He thinks that too many businesspeople single-mindedly pursue wealth at the expense of everything and everyone else. To Haque, business should be about much more than the old cliches of making piles of cash, retiring early and buying a yacht/castle/helicopter/all three.

Treatment
It's time for a new brand of capitalism, says Haque, who defines two kinds of value created by business. Narrow shareholder value - the kind which may generate money but leaves us worse off through side effects such as pollution, obesity or stupidity - he calls 'thin' or inauthentic value. By contrast, 'thick' value is the kind that is not only good for business but makes society better off in the broadest sense.

Creating more 'thick' value and less 'thin' value is Haque's route to building the 'disruptively better business' of his book's subtitle. But it will require new institutions and plenty of self-discipline to choose the worthy but unglamorous virtues of wellbeing and meaning over the trashy appeal of more cheap stuff. Do we have the necessary gumption?

GARY HAMEL

Who is he?
Another business school superstar, visiting strategy professor at LBS and consultant to the corporate elite, Gary Hamel has been named by the Wall Street Journal as one of the 'world's most influential business thinkers'. Alongside CK Prahalad, Hamel was the originator of the hugely influential concept of core competencies.

Diagnosis?
An ardent and articulate defender of capitalism, Hamel is vehement in his criticism of the regulatory and government failings that contributed to the crisis in 2008 and the corporate abuse that fed on it. 'If there was a worse moral nadir in the last 20 years than hearing Goldman's Lloyd Blankfein before Congress, I don't know what it was,' he sighs. 'And parsing it that because they're sophisticated investors it gives us (Goldman Sachs) the right to screw them if we choose - that's unbelievable'.

Yet it's illogical for consumers to blame capitalism for successfully giving them what they've asked it for, he argues. Instead, the question should be whether we as consumers are prepared to change what we want. 'As a business school professor and long-term defender of capitalism there are days when you wish there were another team to bat for,' he concedes. 'But there isn't. It's the only bloody team, so we'd better get it in shape.'

Treatment
Innovation in management is as important as innovation in products and services, says Hamel, but widely neglected. In The Future of Management (Harvard Business School Press, 2007), he argues that it's time for a new model of management, because its old mainstays - hierarchy, control, standardisation, reliance on material rewards and sanctions - were designed for an industrial age when the business imperatives were compliance and replicability. Now they fall at the first contemporary hurdle: the need to make firms 'as nimble as change itself'. In an effort to restart management evolution, Hamel set up the Management Innovation EXchange (the MIX) website and co-founded LBS's Management Labs, with Julian Birkinshaw, both dedicated to the 'reinvention of management' for the 21st century.

DOMINIC BARTON

Who is he?
The master of the Masters of the Universe, Barton is McKinsey's global managing director. McKinsey of course is the world's pre-eminent consulting firm, a behemoth with revenues of $6bn and a presence in 50 countries. Its consultants 'whisper in the ear of government leaders, international regulators and the chief executives of 95% of the world's largest corporations', as one recent profile put it.

Diagnosis?
The mild-mannered Barton pedals a radical line, insisting there can be no return to business as usual, that short-term shareholder value maximisation has become the problem not the solution, and that capital's interests need to be realigned with capitalism.

He says much that went wrong before, during and after the crisis 'stemmed from failures of governance, decision-making and leadership within companies' - that is, the crisis was a result of how organisations are run much more than it was an economic phenomenon.

Treatment
He is disarmingly frank about the role that consultancies and business schools have played in embedding the doctrines that are now dramatically unravelling. 'Yes,' he says simply. 'That's why I feel strongly we have an duty to do something now'. Business schools too, he believes, need to engage in 'deep introspection' about their teaching and leadership, since not only technical skills but also the character of business have been found wanting.

Cynics murmur that after the Anil Kumar affair, when the firm's senior partner admitted passing client secrets to a hedge fund manager, a shaken McKinsey badly needs some high ground to stand on; and that in true consultancy style, having sold its clients shareholder value, it can now move on to the next big thing. Whatever it is. For once that matters less than the fact the deep change Barton proposes is much more likely to happen with McKinsey pushing for it than against.

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