By Dr. Diane Suhler
*Editor’s Note: CC Biz Buzz is a new monthly column series that will feature insightful commentary from a member of the Columbia College Robert W. Plaster School of Business faculty.
In 1776, Adam Smith wrote his treatise on The Wealth of Nations, a work often considered the blueprint for capitalism. While few people ever actually read this work, most are familiar with some of the core principles of Smith’s pure capitalism: free markets, freedom of enterprise, limited government, the ‘invisible hand’ and individual self-interest resulting in the greatest good for society. However, Smith’s view of economics and of homo economicus is much more complex than this. As a social philosopher, Smith’s seminal work is A Theory of Moral Sentiments, written in 1759. It is through the lens of this earlier work that one should view Smith’s teachings about capitalism—self-interest must be balanced with empathy; individuals and society benefit if self-interest is pursued through virtuous actions; human beings want attention and self-exultation, but they also want to love and be loved (Roberts, How Adam Smith Can Change Your Life).
Much has happened in the 240 years since Adam Smith emerged on the economic scene. The 1800s witnessed the Industrial Revolution with its mass production and booms and busts; monopolies and trusts dominated the early 1900s; the global depression of the 1930s brought with it unemployment, poverty and bankruptcy; relative prosperity and growth emerged in the mid-20th century. Capitalism evolved and changed over this time in ways that Adam Smith never imagined: Businesses grew larger, market power diminished competition, governments played a more prominent role in the economy—both as a stabilizing force and as a regulator—and corporations emerged as the dominant organizing structure. As Karl Marx aptly foresaw, capitalism evolved and changed over time.
By the mid-20th century, the U.S. economy was characterized by an interesting balance of power, as economist John Kenneth Galbraith described it in his book entitled American Capitalism; The Concept of Countervailing Power. Three entities—big business, big labor unions and big government—engaged in a delicate dance to balance the interests of all stakeholders in the economy. The corporation played a pivotal role in this system. As Berle and Means described in their book, The Modern Corporation and Private Property, corporations were to be run for all stakeholders. The job of insuring that the interests of all stakeholders were respected fell to corporate CEOs. In his book Supercapitalism, Robert Reich described the role of the CEO as a type of statesman, an ombudsman who was tasked to insure that employees were rewarded for their work and had adequate incomes to purchase the goods they produced; that customers purchased products whose prices reflected the value of those goods; that communities flourished and were not harmed by corporate activity; and that shareholders received a fair return on their investment.
This system worked well from the 1940s through the 1970s, but then things began to change. Milton Friedman, an economist at the University of Chicago, championed the reintroduction of neoclassical economics—Smith’s principles of free markets and limited government combined with a gospel of profits-as-purpose. Friedman and his disciples designed a system of shareholder capitalism in which the purpose of a firm was to maximize shareholder wealth. The assumption of this model is that if the interests of shareholders are met, the interests of other stakeholders—employees, customers, community, environment, society—would automatically be served as well. This model has been the modus operandi of business for the past 40 years. It was in the interests of profits and shareholder wealth maximization that changes to corporate activities were made—costs needed to be cut to insure profits for the firm and shareholders. In the name of minimizing costs, salaries stagnated, benefits decreased, jobs were outsourced, research and development budgets were cut, layoffs increased and pensions morphed into 401(k) plans. With these changes came many of the ills we see in our society today: increased income and wealth inequality, devastated communities as jobs moved abroad, increased concentration in industries, and the emergence of the ‘gig’ economy.
But… a change may be coming. On Aug. 19 the Business Roundtable, an association of chief executive officers of America’s leading companies, released a new statement on the ‘Purpose of a Corporation.’ Signed by 181 CEOs of major firms across the country, this statement established that firms have ”… a fundamental commitment to all of our stakeholders … we commit to delivering value to our customers and investing in our employees … this starts with compensating them fairly and providing important benefits, dealing fairly and ethically with our suppliers, supporting the communities in which we work… We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses … generating long-term value for shareholders.”
This is a major movement away from Shareholder Capitalism and a renewal of Stakeholder Capitalism as the guiding principle of corporate behavior. It is a move “back to the future”—back to the principles of Adam Smith’s capitalism as tempered by his moral philosophy and to the practice of capitalism in the mid-20th Century. Perhaps Adam Smith is still alive and well.
Dr. Diane Suhler is a Professor of Business Administration at Columbia College. She holds a Master of International Affairs degree from Columbia University in New York City, and a Ph.D. in finance with minors in economics and quantitative methods from the University of Maryland. Her research interests are in the areas of economic development and microfinance, and has taught at Columbia College since 2000.