Davos 2020 Continuing the Debate on Stakeholder Capitalism

Davos 2020

One of the legacies of economist Milton Friedman was the concept of stakeholder capitalism. People are now looking to modify this, but not in an intelligent way.

While economics and politics share a lot of common ground, the biggest difference between them is that economics takes rationality into account, where politics is based primarily upon opinion, whether the opinion of the politician or even the opinion of the electorate.

We can see this divergence in full bloom when looking at the debate on stakeholder capitalism that has been increasing over the last few years and is currently one of the major points of discussion at the World Economic Forum in Davos this year.

While a lot of the discussion this year is centered around specific issues such as climate change, any issue involving the running of a business that is suggesting changes to the way companies are run falls within the stakeholder capitalism topic, because they are asking companies to deviate from their focus on maximizing profit for their shareholders by also pursuing the preferences of certain others.

Approaching this as a directive, a moral appeal if you will, is the absolute wrong way to do this, as it tries to throw rationality out the window, and we end up trying to defend positions that do not make sense. We have tossed the ideas of the father of this concept, Nobel prize winning economist Milton Friedman, and are seeking to replace them with what cashes out to looking to talk people into just adopting our goals because we think it is the right thing to do.

If we wish to persuade, we actually have to focus on doing just that, providing reasons good enough for those we wish to influence change their preferences more toward ours. If not, should they refuse, which will happen if they simply do not agree, all we’re left with is the disagreement. That will just lead to an impasse where the disagreement remains, and in our zeal to promote our own preferences of how corporations should be run, we are left with neither the power to make changes nor the ability to change their preferences, and just generate a lot of useless and even harmful noise.

Even after this, after we have failed miserably in our fairy tale quest where we have appointed ourselves kings and queens of the world and pretend that this alleged power is not a delusion, we especially miss how ridiculous we are acting. This is because we haven’t thought all this very much, and whenever there is emotion involved, that’s the tendency. If we ever want to come up with a reasonable basis for change, we can’t just expect that stakeholders will just ignore rationality and their preferences and just adopt ours, just because we tell them to.

The principle of the maximization of enlightened self-interest applies to shareholders as well, and we cannot expect them to ever abandon this. Whatever solution we come up with has to allow for them to maximize their preferences, and since we’re talking about business, this means maximizing profits. Otherwise, we’re asking shareholders to act against their interest, which we may do through regulation if we insist, but we cannot expect people to just act against themselves voluntarily.

We might think that we can simply take our beliefs and force them on others, by way of some misplaced moral authority. We pretend that our preferences have some sort of special significance if they are aimed toward things like what we perceive is the greater good, but even an appeal to the greater good is just a preference and unless it is shared, we’re going to have to do much better and provide a real reason.

Real reasons must always involve appeals to happiness, because it is not rational at all to expect someone to be persuaded by something that makes them less happy. They will resist, and while we may collectively pass laws to require them to comply to our demands, expecting people of sound mind to act against their own interests just to make us happy is just plain delusional. If they did comply, they would be acting this way as well.

This is why we have regulation, because it’s just not reasonable to expect people to put others interest ahead of their own without a sufficient reason. They may not share our social goals and they are completely entitled to disagree with us, but if the solution is to be found at the level of voluntary discussion, this cannot happen while disagreement remains.

In order to affect change voluntarily, we must seek common ground here, as opposed to what regulation does, imposing external preferences by force of law. The reason why this works is it usurps the power of companies, but at the level of discussion, we don’t have this power. No matter how much we may plead or cajole, the word no is all that is needed to put an end to any chance of agreement and change.

This is not unlike people demanding that wealthy individuals give more to charity by asking them to do it. They might, but if they say no, our request becomes denied. Unless we can get them to see the same value in this as we do, they can just say no and we have nowhere to go aside from voicing our displeasure.

If we approach this at the level of corporate charity, which is what the current focus is on now, this is just going to lead to failure because this not only goes completely against their most fundamental existential principle, we have neither the standing or the grounds to even engage them in this, let alone command them. Their saying no does not even require a reason. Asking does not either, but expecting to have our wishes complied with sure does.

Imagine knocking on someone’s door and telling them that they drive a Rolls Royce and the next-door neighbor has no car at all, and ask them to sell their Rolls and buy a cheaper car and give the difference to their neighbor so that they can have a car too.

Maybe the person will do it, but much more likely, they will just slam the door in your face. It is their car and when there is a difference of opinion here, they not only get to decide, it would be irrational to expect that they give in and let us tell them what to do with their assets if this did not suit them. We are then left to try to steal the car instead.

We could tell them that we will now try to get a law passed which requires the selling of their car and their buying their neighbor one, essentially letting us steal it, but, we also need to realize that this admits defeat on the level of discussion anyway, and the person is going to fight this and only comply when forced to.

Sticking Our Tongues Out at Corporations Just Serves to Make Fools of Us

This is where the debate is currently at, sadly, and if we are indeed seeking to influence people and we do not do so in a way that allows them to pursue their own preferences and instead want to replace them, that’s not rational at all and we need to realize this. Otherwise, this will never get beyond the level of unreasonableness that we are currently engaged in.

This does not mean that there isn’t anything we can do. We need to conjure up the ghost of the man who first put forward the idea that it may be in the best interest of shareholders to account for the preferences of stakeholders, but confine ourselves to a rational approach, which is not too much to ask and is required lest this remain just a shouting match. If the answer remains no, and we do not successfully show that it should be yes because this really can be made into a win-win situation, we are not going to convince them.

To do this, we need to set our emotions aside, specifically our anger and contempt, and also take a more honest appraisal of the situation, remembering that others may not share our own personal preferences and that we are simply not entitled to pretend that ours are better just because they seem to be in our own minds.

Economics does not just assume rationality as some think, it instead demands it. All capitalism does is allow for the voluntary exchange of value, where we seek to avoid coercion, whether it is used by sellers or buyers. Our system isn’t pure capitalism by any means, as we use regulation to both look to prevent coercion in the marketplace and to also place coercive restraints upon it, such as laws that set a floor on wages.

Political power in a democracy is subject to the will of the populace ultimately, even though this is interfered with quite a bit by interested third parties who fund our political process, for better or worse. Popular does not mean right or rational though, and we need to make sure that our decisions are as informed as we can make them, and this is one of the things that economics helps out with.

If we actually do want to seek to change corporate culture to move it more toward a form of capitalism that does account for stakeholders, and we wish to seek to achieve this voluntarily, we have to work within the framework of rationality as economists do. This means that if we want things to change, we need to make sure that the changes increase happiness, and not just ours. This is especially important if these decisions aren’t even ours to make and we’re left to only make suggestions.

If we believe that the goal of a company should include more charity and more regard for the overall welfare of all, without any reason for anyone to do this other than just giving in to these desires, perhaps we could chip in and take control of some companies, or form our own with this mission. Perhaps the government could step in and create some non-profit companies which would stand alongside the for-profit ones and see how they do.

We know though that the profit motive is such a strong one that it will provide more efficiency, and state-run companies are famous for their lack of this. Just look at how far China has come since they adopted capitalism and that speaks loudly enough about the dramatic difference. There would not be anything anti-capitalist in governments running companies not for profit though, provided that the capitalists were still allowed to compete freely, to allow ideas that fall on their faces to not bring us down with them.

We do need to take a big step back though and follow Friedman’s lead, who understood better than anyone of his time that the mechanism of control with companies does not reside with the owners, as the end users matter a lot as well. In fact, we need to take this a step further and perceive that it all resides in the end users, with owners simply being tools that end users use to further their own utility or happiness.

Once we realize this, we now have the insight we need to realize that if we want to promote change, we need to do it at the level where decisions are ultimately made. We are barking up the wrong trees when we appeal to shareholders to adopt what makes us happy, because if our suggestions do not make them happy as well, we are asking them to behave in a way that is simply not sane. It is also not sane to even ask such a thing.

However, if these things are of sufficient value to end users, this is where the change happens. There is a second insight that this provides, and one of no small importance either, which involves not accounting for the economic repercussions of strong-arm political solutions should we insist on them, because everything comes down to the effects on consumers.

We can use the example of people wishing that workers get paid more than they do to illustrate how both these insights may play out. Let’s say we ask a company who operates supermarkets to significantly increase their wages. Without providing them a good reason, they refuse because they know that if they do it, they will have to increase their prices and lose their competitiveness, losing their capital and seeing their workers lose their jobs. Unless they are both sadists and masochists, they should indeed refuse this.

If we pass a law requiring this, then everyone will have to do it that wants to comply with the law, and people not only get deprived of whatever else they may have spent the extra money that their food costs now, some may not even be able to buy enough food. The decreasing demand will also require workers to be laid off, and in the end, both total wages paid and the total number of workers paid will decline as our economy is shrunk by this. When the economy shrinks, it shrinks us all.

This doesn’t work anything like Paul Tudor Jones thinks, where the greedy capitalists will just ignore their own needs just by asking them to do it and absorb the extra costs. He may be a legendary hedge fund manager, but hasn’t shown he knows anything about economics, thinking companies should just be nicer and accept less return on their capital, as this idea is just ridiculous on many levels.

Understanding the Economics Involved Isn’t Optional

There is a market for capital as well, and as the appeal of an investment goes down, people just won’t want to do it or will find a better way to earn. All of this is connected and Friedman is right in that everything gets passed down to the consumer, including any increase in costs, including raising corporate taxes.

We have now increased the costs of things, in our case with our supermarket example, the cost of food, and while the people working there may still be able to buy the same amounts, others won’t. This can place a much bigger burden on those on fixed incomes and some may not be able to even feed themselves anymore.

This ends up putting down the demand for food, and when you do that, this cannot ever be a good thing. In our blindness to promote overall welfare by seeing these workers earn more, we have decreased it instead.

Any changes must therefore be voted on by the market, and it’s not that the companies decide what their workers earn, it is ultimately decided by the market. Top athletes earn 8 figure incomes because enough fans spend more money on the team to make sense of this. Our workers at the supermarket make so little because the shoppers there can only pay so much a week toward their wages.

We therefore do need to have the market decide, lest we really screw things up. If we want to actually make changes to how business is conducted, we need to make these changes at that level. Perhaps people will be willing to pay more for food at your store if you tell them that you are more generous to their workers and this makes their customers happy enough that they are happy to pay the extra, and this leaves the business at least as well off, which they will always insist on.

If climate change matters enough to people, they will reduce their demand for fossil fuels and we will actually see the reduction that people are screaming for, but when we act unilaterally with no regard for the market, like carbon taxes and other schemes do, unless this is exactly corresponds to what makes people happy, we will decrease happiness instead. It misses by a long shot and this is measured by the entire amount of change we force.

If we truly want to promote our so-called social goals, we need to make sure that they are actually socially beneficial, and the only way to do that is to let the market decide. We may seek to uncover these non-monetary preferences and help people communicate them to suppliers, but beyond that, we will do more harm than good, the opposite of what we claim we seek.

To make stakeholder capitalism work, we need to focus on the real stakeholders first, the people that decide everything companies do ultimately. Perhaps Tudor Jones and others who are slamming their fists on the table in Davos and elsewhere will someday come to realize what stakeholder capitalism is, or even how capitalism itself works, which turns out to be far more populist than their ill-conceived and pompous ideas could ever be.

We just need to realize what population we’re talking about and where real economic power lies. This is not about shareholders at all, who will always pursue their own happiness, it is about everyone else’s. If enough people actually do share their preferences enough, change will happen, at the grass roots level. If not, we can point guns at this issue instead, but if we do choose this regrettable option, we at least need to know who actually gets hit with our bullets, the very people we’re supposed to be helping.

Davos is supposed to actually be an economic forum, and could be so much more if it brought together the world’s brightest economic thinkers to attack all the problems we have. We would even settle for them educating the masses a little about economics.

Instead, it is simply a sounding board for economic and other grievances, which serves no purpose other than to celebrate anger together but fail to come up with solutions that even break the barrier of stupidity. It could be so much more, if only they actually understood economics enough at this pretend economic forum.

Ken Stephens

Chief Editor, MarketReview.com

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.