2.2 How to fix capitalism: part two
I’m not going to pretend to have all the answers, but I think I’ve at least become better at understanding the problem. Capitalism has lost sight of its original purpose and is too narrowly focused on profit at the expense of society. There are very simple things we can do as citizens to help get things back on track, but we’ll need the help of policy for the heavy lifting.
This is the second post in a two part series. If you missed the first one, you should start here. Sign up to get updates on when all posts are published… and thanks to everyone who has joined the discussion! Please continue to highlight, add notes and write a response to these articles to ensure everyone is heard.
Earlier this week we began an article about what is wrong with capitalism, and highlighted some examples as seen through supply and demand. Today we’ll pick up that conversation where we left on and focus on utility and willingness to pay, value creation and profit, and solutions to the problems we’ve addressed.
Utility, willingness to pay, and price
In economic terms, utility refers to the ‘usefulness’ that a product, service or experience brings to the consumer. The utility that we find in any given thing drives our willingness to pay for that object which in turn helps set the price (also driven by supply and demand).
One of the problems with our current system is that we don’t know what our utility for something is. We don’t know what we want. Why? Could be a lack of purpose or could be societal influences: the billion dollar advertising agency telling us what they want us to want, or a simple case of keeping up with the Jones’ / social pressures. But what do you truly want? What is it that you value?
On top of that, we have become too individualistic in our utility, neglecting the utility that something has on society as a whole. The Book of Life said it best: “individually, we don’t get the happiness we seek. And collectively we end up with a profoundly dysfunctional economy. The forces of production — and therefore jobs, investment and profit — are often at odds with our best interests.”
I don’t have any kids, and I can already count, read and identify shapes and colors quite well, so classic economics would say I should have a very low utility for kindergarten teachers. But because I know that early childhood development is one of the keys to a thriving, sustainable, healthy society, and because I want to live in such a society, I have a very high perceived value for kindergarten teachers.
So why do we pay kindergarten teachers so poorly? That’s easy, supply and demand, the market as we know it isn’t working. It happens to be relatively easy (compared to say becoming a surgeon or rocket scientist) to get the proper credentials to become a teacher, and who doesn’t want summers off?! This is a signal that we, as a society, are not placing enough emphasis on utility in how we price things, including labor.
In contrast, asset managers are some of the wealthiest professions in the world. And this is the part that kills me, studies show there is little to no significant correlation between long term performance and pay. Yes, that’s correct. Asset managers make 6–8 figure salaries and most of their effort comes down to pure dumb luck. Is it more difficult to become an asset manager than a kidergarten teacher? Probably. But do they provide more value to society? Definitely not. So why do they make 3–10 times as much?
As a collective society we need to reframe our willingness to pay based on the value that something brings to our society. We need policies that prioritize the collective utility over our individual needs.
Profit and economic value
Many people argue that value creation is the purpose of any business, and I completely agree with that. The problem is that my definition of value is different from most other peoples’. Value to me is the worth of anything. Value to most other people is the financial worth of anything. When I talk about value creation I’m talking about a company’s ability to create products and services that improve customers’ lives, bring meaning to employees’ lives, improve investors’ portfolios, and at the very least don’t harm the planet (to improve the environment would be much better). Most other people are referring to either market capitalization, a company’s balance sheet, or some other financial indicator of future performance. This is what I mean when I say ‘narrow focus on profit.’
I think I’ve harped on enough about this issue and won’t talk further on the problem. What I really want to talk about is how to fix this problem, and the solution rests on our ability to find better ways to identify, define, and measure ‘value.’
Solutions to help fix capitalism
Good consumer demand: If we want ‘bad’ companies to change, we, as a society, have to demand that change from them. We have to create ‘good demand.’ We have to vote with our dollars and be okay with higher prices for things we value in life, and help realign the prices for things we want to minimize.
Of course this has to start with understanding what it is you value. The best way to know that, is to understand your purpose. I prioritize spending money on experiences, travel, visiting friends and family and spending time with people I love. I spend a lot of money doing this because it brings me a lot of joy (value). Most of us don’t have the luxury of being able to buy whatever we want. By focusing on your purpose, understanding what it is you value most, you can create significant change in both your life and the lives of others in your community just by aligning your spending.
Policies to prioritize societal needs: As we discussed, capitalism was designed to promote the individual’s desires which is thought to lead to the best societal outcomes. That is true, sometimes. And other times we just don’t know what’s good for ourselves. We can be short-sighted, impatient, easily persuaded by the media and our peers, we have flaws, we make mistakes. Humans are not the rational, logical agents that our economy assumes we are (more on that next week).
When governments step in to set policies that prioritize the needs of its collective citizens, over an individual, the market seems to operate more effectively around that issue. This could be anything from subsidizing the salaries for those that offer the most utility to society, to increasing the cost of extracting natural resources or producing pollution, to forcing all companies to offer necessary benefits like healthcare and maternity leave. All of these things might not be in the best interest for any specific individual firm, but we all benefit when they exist.
Let’s look at minimum wage. Most extreme capitalist and free market thinkers say that we should eliminate minimum wage, let the market figure it out. These are normally the same people who want a smaller government and less social services for the poor and disadvantaged.
But the reality is that when companies pay low wages, society and taxpayers are the ones that end up footing the bill. Most Walmart and McDonalds employees don’t earn a living wage and rely on medicare, food stamps and subsidized housing to survive.
But let’s go with this. Say we remove minimum wage and we remove all government social services. This would obviously lead to a short term disaster with many people living in poverty, homeless and hungry. But eventually these people would die, its a competitive world right? So now that the lowest skilled citizens are gone we need to move up the ladder to find someone else to take these jobs. But these better, more educated, more highly skilled people don’t want to work at McDonalds and Walmart. They won’t work for such paltry wages because they have higher bills, student loans to pay off, an established lifestyle to afford, etc. With such a low supply of low skilled labor, companies would be forced to pay more… eventually reaching a higher minimum wage.
If, on the other hand, governments forced all companies to pay the full cost of their labor (with a mandatory minimum wage as dictated by the local cost of living), then the government wouldn’t have to play the role of social worker. We could have the smaller government that most free-market capitalists have always dreamed of, minimum wage would be the same as our ridiculous experiment above, and EVERYONE would be better off as a result.
This is simple economics people. When companies take care of their people, when there is less of a gap between those who make the most and those who make the least, we are all better off. The rich don’t have to pay for the poor, we can all pay for ourselves, and we all live better off in a fair, functioning society.
The moral of the story is that sometimes regulation truly IS in the best interest of everyone, including companies. Most companies simply can’t do it alone… legally, they have to do what’s in the best interest of their shareholders. That’s when government can make a real difference and why such policies are needed.
Better measurement tools: As a strategy consultant, defining success is everything. It becomes the goal you work towards and if its not the right goal, you won’t end up in the right place.
If we collectively decide that the best indicator of success for our society is profit, than GDP is a fine measure on the national scale and profit or financial wealth will work for individuals and firms. But if you are among the growing population that believe that success in society goes beyond per capita income, corporate profits and government spending, then you might want to consider some of these other measures.
“Business management has evolved in a direction so that we’ve narrowed the scope of how you create economic value, and increasingly companies are being perceived as creating profit at the expense of the community, not creating profit that ultimately benefits the communities.”
- Michael Porter
The UN’s response to this is the Human Development Index (HDI) which combines metrics like Gross National Income per capita, average life expectancy, and education levels to create a more holistic metric of how a nation is doing in comparison to others. My favorite New Economics Foundation created the Happy Planet Index which measures sustainable wellbeing, and who doesn’t love Bhutan for their attempt at using a measure of Gross National Happiness since 2010.
At the organizational level I would encourage every company and nonprofit in the world to select 3–5 key performance indicators (not just 1!) and create their own personal dashboard for following success. If you need help with that, this is where I can possibly add value, just reach out.
I am also a fan of the Social Return on Investment model which works well for nonprofits, particularly those that provide social and/or environmental value to society with a particular benefit to government. For example, REDF recently reported that for every $1 invested in social enterprises (in the US), $2.33 is created in societal benefits. SROI can be a bit complicated, and does take a lot of resources to calculate, but it is truly a step in the right direction. To learn more, I recommend you start here.
The UK and Australia have also been experimenting with so-called social impact bonds, or competitive, market-driven bonds where nonprofits compete for funding based on the efficiency at which they can provide pre-specified social outcomes, and where the investors receive a return if the organizations achieve above and beyond. For example in the UK this began with funding from investors to organizations that could reduce recidivism by male prisoners. If they reach their target, the government will repay investors with a return from the cost savings that the government would have spent on housing those prisoners if they had gone back to jail. Pretty cool. A financial instrument with returns based on keeping prisoners out of jail.
As consumers we can leverage tools like Good Guide which tracks the social and environmental attributes of many of the products we use every day and look to buy and work from B Corps which have to apply through a rigorous assessment process to prove their commitment to purpose beyond profit. Of course, the best thing to do is to determine your purpose, and then find tools that track whatever it is you want to pursue.
As for me, I pursue happiness. And the best place to learn how to maximize happiness for yourself, your family and your community is the Authentic Happiness Center developed by the father of positive psychology, Dr. Martin Seligman himself. Enjoy :)
The bottom line: a better purpose for capitalism
The reality is, capitalism is doing just fine. The problem is not the system, the problem is what we tell the system to do. The purpose of capitalism should never have been the pursuit of profit. That is not what it was designed for and that is the reason for all the failings listed above. By rethinking capitalism to focus on a more noble purpose, like human flourishing, then we will all be better off.
We can create an economy geared towards meeting our highest private and public needs, but we need to find better tools to identify what it is we value, how we define success, and then find the measurements and indicators that can help us serve our ultimate purpose. These are the building blocks of any good strategy, and modern capitalism is unfortunately a textbook example of what happens when you don’t have your priorities straight.
Set the right purpose, educate consumers to vote with their dollar, create policies that prioritize collective utility, and measure what matters and capitalism and the power of markets will do the rest.
Next week we’ll continue examining purpose from the perspective of psychology and the social sciences. We’ll keep one foot in the world of economics but begin to expand our thinking of how human irrationality, decision making and motivation affect everything.
Hello, I’m Kim Soko Schaefer, the founder of Ways & Meaning, a curated collection of resources for mindful entrepreneurs.
