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30 January 2020

Capitalism Must Reform to Survive

By Klaus Schwab 

Companies today face an existential choice. Either they wholeheartedly embrace “stakeholder capitalism” and subscribe to the responsibilities that come with it, by actively taking steps to meet social and environmental goals. Or they stick to an outdated “shareholder capitalism” that prioritizes short-term profits over everything else—and wait for employees, clients, and voters to force change on them from the outside.

This assessment may seem harsh coming from someone who has always believed in the pivotal role companies play in the global economy. But there is no alternative. Our ecological footprint has expanded far beyond what the earth can sustain. Our social systems are cracking. Our economies no longer drive inclusive growth.

Today’s younger generations simply do not accept that companies should pursue profits at the expense of broader environmental and social well-being. We know that a free-market economy is essential for producing long-term development and social progress. We should not want to replace that system. But in its current form, capitalism has reached its limits. Unless it reforms from within, it will not survive.

FROM SHAREHOLDERS TO STAKEHOLDERS


Last year, the Business Roundtable, an organization representing many of the largest American companies, announced that it wanted to move away from shareholder primacy and toward a commitment to all stakeholders. It redefined the purpose of a corporation to promote “an economy that serves all Americans”—not just those who own shares.

The CEOs signing the Business Roundtable statement were a veritable Who’s Who of American capitalism. As chair of the Business Roundtable, JPMorgan Chase CEO Jamie Dimon was the first to endorse it. Among the 181 signatories were also Alex Gorsky of Johnson & Johnson, Ginni Rometty of IBM, Mortimer J. Buckley of Vanguard, and Tricia Griffith of Progressive. 

The announcement was met with mixed reactions. Some saw it merely as a maneuver to preempt pressure from an ascendant left. Others dismissed it as disingenuous, a mostly symbolic move without concrete actions to back it up. How can a company claim to have implemented a major change, asked skeptics, if its quarterly reports still focus on maximizing the financial bottom line?

But such skepticism misses how significant the shift is—and the opportunity to turn it into real change. Since 1997, each previous set of principles endorsed by the Business Roundtable had put shareholder primacy first. For the group to drop that principle was revolutionary. But it is also true that unless these words are translated into collective actions, the revolution will be short-lived.
WHAT IS THE CORPORATION?

So what can be done to ensure that the move to stakeholder capitalism is real and lasting? To answer that question, it is worthwhile looking back to the postwar global economic system and the role played within it by companies, governments, civil society, and international organizations. Some may think Western capitalism has always put shareholders first. That is not so.

The World Economic Forum was founded five decades ago in Davos to promote the “multistakeholder concept”—a model that had grown out of my knowledge of both the European and the American approaches to capitalism. U.S. companies in the postwar era had perfected business and financial management, optimizing for growth and profits. It made American companies and American management thinkers the envy of the world. But European managers at the time were also getting something right. They had a social reflex, evident in a deep commitment to their workers, clients, and suppliers. As an engineering student, I had worked on the shop floor in several factories. Spending time with my fellow workers confirmed to me that blue-collar workers are just as bright, and add just as much value to a company, as their white-collar peers or the shareholders of the companies they work for.

Western capitalism has not always put shareholders first.

The ideas of stakeholder capitalism (which I first described in my 1971 book, Modern Enterprise Management in Mechanical Engineering) inform the Davos Manifesto signed at the newly created World Economic Forum. The manifesto’s opening line declared that “the purpose of professional management is to serve clients, shareholders, workers, and employees, as well as societies, and to harmonize the different interests of the stakeholders.” 

The Davos Manifesto was rooted in recent postwar experience, but it was also a restoration of a longer historical arc. Companies have always been social units as well as economic units. Indeed, corporations were first created in medieval Europe as an independent vehicle to achieve economic progress but also to create prosperity for society or to build institutions for the public good, such as hospitals and universities—what we now call “shared value.”

But this vision of the corporation was not universally embraced. Around the same time, the University of Chicago economist Milton Friedman put forth a very different vision. “There is one and only one social responsibility of business,” he wrote, and that is “to use its resources and engage in activities designed to increase its profits.” The business of business, in short, was business. The idea of shareholder primacy was born. Before long, it was embraced by the Business Roundtable and other leaders in the field.
INCONVENIENT TRUTHS

For the next few decades, it appeared that shareholder capitalism really was superior to stakeholder capitalism. U.S. companies increased their dominance, and shareholder primacy became the norm in international businesses. No person captured the atmosphere better, perhaps, than Michael Douglas’s Gordon Gekko in the film Wall Street. “Greed, for lack of a better term,” he said, “is good.” His words were fiction, but many in the business and financial world agreed.

But the high growth of the 1980s, the 1990s, and the early years of this century masked some inconvenient truths. Wages in the United States started to stagnate from the late 1970s onward, and union power significantly declined. The natural environment deteriorated as the economy improved. And governments found it increasingly difficult to gather taxes from multinational corporations. All those problems have combined in the current crisis—and the only viable response is a turn back to the stakeholder capitalism that the shareholder model displaced.

In the four decades since 1980, economic inequality of all forms has significantly increased. In the United States, most notably, inflation-adjusted income growth within the bottom 90 percent has been virtually zero, while incomes of the top 0.01 percent have risen more than fivefold. Wealth inequality has grown even more. And the trends are similar, if sometimes less pronounced, virtually everywhere else in the world. In the 1960s, a CEO might earn 20 times what his workers earned. Today, American CEOs earn on average 287 times the median salary.

The environment has suffered as a result of economic activity driven by profit maximization.

At the same time, the world’s leading companies have grown bigger and bigger, leading to increased market power and a change in their relationship to communities and governments. Whereas companies were once deeply embedded in the communities where they operated, those connections have diminished over time. As they cleverly exploit intellectual property and global transfer pricing, many companies—driven by profit maximization—have become less reliable taxpayers. And as the financial sector has grown in a way that is increasingly decoupled from real economic growth, it has pursued short-term results to the detriment of long-term sustainability.

The overall result has been a deterioration of the bond between business and society. And governments, faced with fresh social and economic challenges, are often unable to make the investments that are needed, deprived as they are of necessary tax incomes.

Finally, and perhaps most important, the environment has continued to suffer as a result of economic activity driven solely by profit maximization. This, too, was a concern as early as the 1970s. At Davos in 1973, the Club of Rome’s Aurelio Peccei spoke of the imminent “limits to growth.” And the Davos Manifesto noted that management “must assume the role of a trustee of the material universe for future generations” and “use the immaterial and material resources at its disposal in an optimal way.”

We now know that if our use of the world’s natural resources had remained at early 1970s levels, we probably would not be facing a climate crisis today. According to the Global Footprint Network, 1969 was the last year in which humanity’s ecological footprint was small enough to be sustainable. Since then, we’ve consistently exceeded this limit. Now, in 2020, we use resources at almost twice the sustainable rate.
A LAST CHANCE

As young people from around the world have been reminding us of late, now is the time to rectify our historical error. The only way to save capitalism is to return to—and double down on—the stakeholder model we discovered, and then forgot, decades ago. But with the social, economic, and environmental situation now several times worse than it was, we’ll more than ever need to make changes that go beyond mere words. How can we do this?

To start, companies and their shareholders must agree on a long-term vision of their objectives and performance, rather than let quarterly results dictate everything. From there, companies must make more concrete commitments to pay fair prices, salaries, and taxes wherever they operate. And finally, we have to integrate environmental, social, and governance measurements into formal business reporting and auditing systems.

The only way to save capitalism is to return to the stakeholder model from decades ago.

These steps will require major changes. But the alternative will be even more difficult and potentially disruptive. Companies will be forced by new generations of workers, consumers, and voters to change their ways, whether or not they want to. Many companies, rejected by these groups, could slowly wither away. Or governments could take a heavier hand in enforcing new norms, reasserting themselves as the leviathan referee in markets.

If companies want to avoid such scenarios, 2020 will be a pivotal year. At the World Economic Forum, we will continue to advance and advocate for stakeholder capitalism, with the concrete commitments to make it inclusive and sustainable. This may be our last chance to reform capitalism from within. We should take it.

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