The Identity Crisis of American Capitalism

Several months ago, I wrote a post titled “Capitalism As A Cocktail” that argued that the American economic system is a hybrid of a lot of capitalism with some – yet crucial – social programs (Social Security, Medicare and Medicaid to mention the most popular). We basically rely on the income and wealth generating capacity of our capitalist economy to produce the resources that support the social programs.

The point we often miss is that the structure and performance of our capitalist economy is not free of consequences for the overall health and stability of the American society and the ability of government to manage social welfare programs.  Therefore, we all have an interest in ensuring that the capitalist part of our economic system delivers outcomes that are consistent with having a financially safe, well-educated, healthier and socially content populace.

Unfortunately, this is not what we have now.  Despite an unprecedented, in its duration, growth of the economy, several indicators show that in education, health, and social advancement and contentment we have a bi-polar system in which the lucky few who reap the lion’s share of incomes and wealth have advanced but not the many who have been left financially behind. *

It is not surprising, therefore, that we currently have strong populist movements on the right and the left that clamor for righting the unequal distribution of economic and social gains.  The respective solutions of these movements, more inward and nativist on the right and more socially activist on the left, are challenging the economic orthodoxy of the two major parties and their respective power centers.

Besides the economic populists, a growing number of successful business people and true capitalists, from Bill Gates of Microsoft to Larry Fink of Blackrock, are voicing their concern about the current course of American capitalism.  Therefore, the pressure to move to a more sustainable kind of capitalism is all around us.  To put it differently, American capitalism is facing an identity crisis.  The cocktail has to be mixed again to give it a more popular taste.

So, how did we end up with the present kind of capitalism?  This is how I see its post-war evolution.  The recovery of the civilian economy after the WW II saw the rise of corporatism in the hands of all-powerful managers.  The fast gains of the American economy gave them the wherewithal to accommodate the interests of labor unions.  This social contract kept both the aggregate pie as well as its slices growing for workers, businesspeople and shareholders.  That was the period of managerial American capitalism.

This economic compact came to an end under the pressure of foreign competition, especially from Japan.  By the early 1980s, American corporations had realized that their complacency had left them exposed to aggressive competition from nibbler foreign rivals.   Private investors also realized that shareholders were not getting maximum value on their investment.  Soon, corporate raiders, like Carl Icahn and T. Boon Pickens, ushered in a period of takeovers and leveraged buy-outs that brought firms under the control of more profit-oriented owners.  Now factories would close not because of slow business but because they had to be moved in lower-cost areas, though, still inside the US.  The drivers were greater economic efficiency and value creation.

Corporate takeovers and leveraged buy-outs, along with the corporate restructurings they effected, were accepted as the epitome of “creative destruction” that allows economic resources to be moved to their best use.  Much less attention was paid, though, to their costs for the communities and individuals that were caught on the losing side of restructurings.  The emphasis on generating value gains at the firm level – mostly captured by shareholders – is at the heart of the “shareholders first” capitalism.

The third stage of American capitalism was the outgrowth of globalization and digital technology that made possible the management of global operations.  Now the corporate restructurings could be done on a global scale.  American communities and workers would no longer lose to rivals within the US; they would also lose to China and other low-cost countries.   Thus, the resentment against business dislocation and loss of jobs mutated from the parochial to the nationalist level.  As American workers were losing because of the global rearrangement of the economic system, income and wealth inequality started to become glaring.  The knowledge economy started to bifurcate the economy into sectors of high incomes and sectors of low wages.  Among 21 OECD countries the US has both the highest income inequality and highest compensation of elite professionals.  On top of that, tax rates and tax loopholes became extremely favorable to high income earners.  As always, high concentration of wealth goes hand-in-hand with high concentration of political influence and power.  The result is the “plutocratic capitalism” we have today.

The current American capitalism ascribes to several questionable principle.  The first is the utilitarian principle that what matters is aggregate economic growth; if winners gain more than losers lose it’s fine.  A second related principle is that as long as all income groups gain, disproportionate gains are fine; in other words, individuals are strict wealth maximizers and don’t care about the fairness of the distribution.  The third principle is that financial incentives (including state help though taxes, subsidies, etc.) should be allocated with priority to the job creators, i.e., firm owners and investors.  This is the trickle-down principle.  The fourth principle is that the cost-benefit analysis should be done at the firm level.  That leaves the side costs of “creative destruction” on communities and individuals out of consideration.

The problem is that these are principles without empirical support or validation.  The utilitarian theory has its problems and people are not strict wealth maximizers; fairness does matter.  The trickle-down principle has not worked.  And ignoring the costs of “creative destruction” can harm social cohesion and trust.

Moving toward a more inclusive and socially responsible American capitalism requires that we seriously rethink its current principles and purpose and we return it to the service of society.

*  A good account of how America has fallen behind in various indicators of economic and social progress can be found in Winners Take All by Anand Giridharadas.

Author: George Papaioannou

Distinguished Professor Emeritus (Finance), Hofstra University, USA. Author of Underwriting and the New Issues Market. Former Vice Dean, Zarb School of Business, Hofstra University. Board Director, Jovia Financial Federal Credit Union. View all posts by George Papaioannou