- Business Insider
- Business Insider
This post is part of Business Insider’s ongoing series on Better Capitalism.
Over the past few decades, the US economy has undergone a profound change.
This change has helped rich Americans get richer. But it has also contributed to growing income inequality and the decline of the middle class. In so doing, it has fueled populist anger across the political spectrum and slowed the growth of the economy as a whole.
What is this change?
The embrace of the idea that the only mission of companies is to maximize short-term profit for shareholders.
Talk to some people in the money management business, and they’ll proclaim that this is a law of capitalism. They’ll also cite other supposed laws of capitalism, including the idea that employees are “costs” and competent managers should minimize these costs by paying employees as little as possible.
But these practices aren’t actually laws of capitalism.
They’re choices that arose out of the shareholder activism movement that began in the early 1980s – a movement that was reasonable and necessary back then but has since been taken too far.
And they’re choices we should revisit if we want to restore a sense of fairness and opportunity to reinvigorate our economy.
Not long ago, America’s corporate owners and managers made different choices – choices that were better for average Americans and the economy. These managers and owners also had a profoundly different understanding of their responsibilities.
“The job of management,” proclaimed Frank Abrams, the chairman of Standard Oil of New Jersey, in 1951, “is to maintain an equitable and working balance among of the claims of the various directly interested groups… stockholders, employees, customers, and the public at large.”
By paying good wages, investing in future products, and generating reasonable (not “maximized”) profits, American companies in the 1950s and 1960s created value for all of their constituencies, not just one. As a result, the country and economy boomed.
Over more recent decades, however, this balance has radically shifted.
The stagnation and bear market of the 1970s contributed to the rise of shareholder activism, a trend immortalized in the 1980s by the fictional corporate raider Gordon Gekko in the movie “Wall Street.” In that era, American companies had become bloated and complacent, and they needed a kick in the ass. “Greed is good,” Gekko declared, while firing smug, overpaid managers and restructuring weak companies. Beleaguered shareholders justifiably cheered.
But 30 years later, Gekko’s shareholder revolution is still going strong, and the pendulum has now swung too far the other way. Urged on by a vast and hypercompetitive money management industry, American companies now increasingly serve a single constituency – shareholders – while stiffing employees and minimizing investments in future products.
This “shareholder value” religion is visible in the divergence between profits and wages.
Corporate profit margins have been rising for 15 years and are now near their highest levels ever. Corporate wages, meanwhile, have been declining for four decades and are near their lowest level ever.
Profits as a percent of the economy:
Wages as a percent of the economy:
Nor are these the only ways that the “shareholder value” obsession has warped our economy.
The richest 1% of Americans now own nearly 45% of the country’s wealth, near the highest level since the “Gilded Age” of the 1920s. These Americans had an average net worth of $14 million in 2013. At the same time, the average wealth of “90%-ers” has plunged in recent years to just above $80,000, the same level as in the mid-1980s. Millions of Americans who work full time for highly profitable corporations earn so little that they’re below the poverty line. The bottom 50% of Americans own nothing.
Beyond fairness and decency – the ethical decision to share more of the economic value a company creates with the people who devote their lives to creating it – the profit-maximization obsession also hurts the economy.
Because wages and investments at one company become revenue for other companies.
Consumers account for about 70% of the spending in the economy, so our spending is what drives economic growth. Most consumers work, so another name for them is “employees.” And except for the richest Americans, most of us spend almost everything we make.
When we are paid less, we have less to spend, and economic growth slows. When we are paid more, we spend more, and growth accelerates.
Consumer spending also drives business investment. When consumers are flush, businesses invest aggressively to meet demand. When consumers are strapped, however, companies sit on their cash – or just hand it to shareholders. Amid today’s already weak demand, companies are exacerbating the problem by cutting investments and increasing dividends and stock buybacks.
To be clear: There’s nothing necessarily wrong with some hedge fund managers making $500 million a year – or a president being worth a self-reported $10 billion. Capitalism is the best economic system known to man, and the “profit motive” helps drive it.
The problem is that when capitalism is practiced the way it is today, wealth becomes so concentrated that much of it doesn’t get spent. Billionaires and centimillionaires can hire only so many service providers and purchase only so many cars, houses, and islands. Their spending accounts for only a tiny fraction of the spending in the economy.
Economists cite many factors that have contributed to the rise of profits and decline of wages over the past few decades – globalization, the “skills gap,” the decline of unions, the loss of “high-paying manufacturing jobs.”
These trends are real, but they obscure the real cause: Company owners are choosing to maximize short-term profit by paying their employees as little as possible.
It’s time for a more balanced approach.
Happily, in recent years, we’ve seen some encouraging signs. Many companies, from Walmart to Apple to Starbucks to JPMorgan, have voluntarily given their lowest-paid hourly employees a pay increase. The increases aren’t extravagant – at Walmart, an employee can still work full time all year and be below the poverty line. But they are a step in the right direction.
Some corporations have begun emphasizing the need for companies to have a triple or even quadruple bottom line, creating value for customers, employees, and society in addition to shareholders.
Perhaps most encouragingly, one of the world’s largest asset managers, BlackRock, now expects companies to create value across multiple dimensions.
“Society is demanding that companies, both public and private, serve a social purpose,” BlackRock CEO Larry Fink wrote in an open letter to corporate CEOs. “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.”
That’s better capitalism. Practicing it will make the world a better place.