In my last post I outlined the six pillars of capitalism and discussed how each has been damaged, resulting in skewed distribution of both income and wealth. Over the next three weeks, I will suggest some possible changes to how we regulate business and industry that will help mitigate the damage and begin the process of restoring a free and fair market economy. These changes would, over time, reduce inequality and ensure that both income and wealth were more fairly distributed. And yes, that means fewer billionaires, but that’s a feature, not a bug.
Let’s take a look at the first two pillars of capitalism.
1. Private ownership of the means of production
Vast sectors of the American economy are either directly owned or controlled by both the federal and state governments, including critical infrastructure, land and public services. These are all used by the private sector in the production of goods and services. The government also subsidizes certain industries, such as agriculture and energy. The subsidies were originally provided to stabilize markets and ensure that needed goods, such as grain and oil, were readily available. However, too often those subsidies have become giveaways to wealthy farmers, ranchers, and energy companies, among others. The measures we need to take are pretty obvious and straight-forward.
· We need to evaluate all government-owned assets to determine their highest and best use, and base those uses on clear policy objectives, not just because powerful people are involved.
· We need to review all existing subsidies to industry to determine whether they are still justified based on the country’s policy goals.
The solutions may be simple, but they would be very difficult to enact. There are far too many vested interests involved.
2. Self-interest, properly understood
The pursuit of profits at the expense of the community as a whole is not compatible with capitalism. Last week I identified two ways the self-interest pillar was damaged. First businesses too often pursue selfish interests rather than self-interest by pursuing profits at the expense of the community as a whole. Second, the profit motive has been replaced by what I call the stock price motive, whereby businesses focus on increasing the price of a company’s stock rather than growing profits over the long term.
Businesses need to be encouraged – with both carrots and sticks – to take the greater good into account. A few years ago, the concept of ESG (Environmental, Social and Governance) developed as a framework to help investors identify companies that were committed to being “good corporate citizens.” Many businesses have now explicitly adopted ESG in their corporate ethics guidelines. Unfortunately, these companies often pay lip service to good practices, and there is a growing pushback as part of the “anti-woke” movement. Florida, for example, recently passed a law prohibiting the use of ESG factors in state and local investment decisions and government contracting. Nevertheless, we need to push for laws that prevent businesses from offloading their externalities – the costs associated with their business activities – onto taxpayers. We already have laws that – on paper at least – prohibit dumping waste, but they should go further and have more consequences for noncompliance. Additionally, penalties and enforcement should be applied consistently across the country. For example, the fine for violating the Clean Water Act in Montana is $300 (a slap on the wrist), while it is $30,000 in Colorado.[i]
We also need to take a broader view of externalities to include the myriad ways private industry benefits from public resources funded by taxpayers. Two examples are the federal government guarantee of bank deposits, and the large number of people with full-time jobs that require public assistance benefits.
One person’s secure deposit is another person’s free money
Following the 1929 stock market crash, there were widespread bank failures, and nervous savers caused a “run on the banks” as they rushed to withdraw their money. In recognition that a stable financial system is essential to a stable economy, the U.S. government moved to shore up the financial sector by providing a system to guarantee the bank deposits. Today, when people deposit money in a bank they do not worry about its safety because the deposits are guaranteed by the government. In return for that guarantee, commercial banks (which take deposits) were precluded from engaging in investment banking activities, which have a higher return but also a higher degree of risk. In 1999, that prohibition was repealed, and commercial banks began engaging in proprietary trading. In practice, that means they were speculating with their client’s deposits. When the 2008 financial crisis hit, banks were bailed out by the federal government, one of the more egregious examples of private gain and public pain.
Now, if you talk to most bankers about this, they will tell you two things. First, many banks did not require a bail-out but were prevailed on to take money from the government so that all banks would be treated equally – no one wanted to “name” the real culprits to prevent a run on those banks (looking at you, Citibank). JP Morgan’s Jamie Dimon has missed very few opportunities to remind people how well he ran his institution. But that doesn’t change the fact that even well-run institutions benefit from the government guarantee of deposits. Absent FDIC insurance, most banks would have faced a massive outflow of deposits in 2008 that would have led to insolvency. So, JP Morgan gets to keep making money thanks to guarantees provided by society at large. And by the way, he made $34.5 million last year and has an estimated net worth of $1.7 billion.[ii] [iii]
The second thing bankers will tell you is that banks paid back the funds they received during the bailout. Technically that is true, but that doesn’t mean they didn’t end up imposing a huge cost on society as a whole. JP Morgan might not have needed a bailout, but they were actively involved in the types of financial activities that led to the crisis. And the people who ended up paying the price were average citizens – taxpayers – who were the targets of their predatory lending and who suffered the most from the fallout from the crisis.
Billionaires on public assistance
A number of highly profitable businesses with billionaire owners (think Walmart and Amazon) have a large proportion of their employees on public assistance. A Forbes article published in 2014 reported that “Walmart workers cost taxpayers $6.2 billion in public assistance.”[1] That comes out to about $1.54 per hour that other Americans pay for Walmart employees. It also means that Walmart shareholders – already among the richest people in the world – are able to pocket an additional $6.2 billion in profits because the rest of us are subsidizing Walmart wages. A 2020 article by The Counter reported that, while Amazon raised its minimum wage to $15/hour in 2018, it earned nearly a quarter of a trillion in profits in 2022 but was still among the top 20 companies with employees on public assistance.[iv] These companies would like you to believe that the only way they can keep prices low for you, the consumer, is by keeping wages so low. The alternative, reducing corporate profits, would cause the price of the stock to fall (about which, see next section). But absent higher wages, taxpayers are funneling money directly into the pockets of Jeff Bezos and the Walton family by subsidizing their underpaid workforce.
So far, the only solution that has been proposed is to mandate a higher minimum wage. But even at $15/hour many employees still require government assistance. A better approach is to create a link between the level of a company’s corporate profits and the number of its employees on public assistance. For example, companies above a certain size that report net income above a certain level should have to compensate the government for the employees that receive public assistance. This could be accomplished through payroll taxes by requiring those businesses to pay higher rates on their contributions to Social Security and Medicare. By the way, this should also apply to the U.S. military. 14% of U.S. service members are food-insecure[v] and many rely on public assistance. They either need to be paid a living wage, or the cost of their public assistance benefits should come out of the defense budget.
Another way billionaires slurp at the public trough is by using accounting tricks to reduce their taxable net income. In many cases they pay no income tax at all, despite reporting high earnings to their shareholders. Businesses should be subjected to some type of “alternative minimum tax,” similar to what individuals are required to pay.
Higher profits lead to higher stock prices
In last week’s post, I talked about how the profit motive, one of the pillars of capitalism, has been replaced by the stock price motive, the idea that a company’s management maximizes shareholder value by taking measures to increase the price of the stock. While it seems obvious that people invest in the stock market because they want stock prices to go up, in the long term a singular focus on rising stock prices – and the measures companies take to achieve that – will perversely result in lower stock prices in the long term.
A company’s stock price reflects three things:
1. How much money a company earns per share of stock (Earnings per Share, or EPS). EPS is calculated by dividing total profits of the company by the number of outstanding shares. EPS goes up when profits go up.
2. How fast those profits are growing (profits grow when companies reinvest earnings back into the company, thereby growing the productive capacity and allowing them to earn higher profits in subsequent years).
3. How much investors are willing to pay for one year of earnings (measured by the Price Earnings Ratio, or P/E Ratio).
An increase in any one of those factors will result in an increase in the price of the stock. But another (quick and easy) way to increase the price of a stock is by reducing the number of outstanding shares. EPS will go up because there are fewer shareholders to divide profits among. Assuming the P/E ratio remains stable, the price of the stock will go up. But using profits to buy back shares is a short-sighted way to reward shareholders. Fewer profits reinvested in the company means slower profit growth over time. There is an outer limit to how many shares a company can reacquire, so eventually the firm will have less productive capacity than it would have absent stock buybacks, profits will be lower than they would have been, with stock prices commensurately lower as well.
Prior to 1982, the SEC treated stock buybacks as (illegal) market manipulation. They have been legal, albeit controversial, since then. The Inflation Reduction Act of 2022 includes a modest excise tax on buybacks, but it does not appear to have slowed the practice. No less an eminence than the “Oracle of Omaha” (Warren Buffet) has defended stock buybacks as a way to return money to shareholders. Newsflash Warren! There’s this thing called dividends which were invented so companies could return money to shareholders. I know, I know, dividends are taxable as ordinary income, while price appreciation resulting from stock buybacks is treated as capital gains that are only taxable if realized. Warren Buffet has argued that he shouldn’t have a lower tax rate than his secretary… but isn’t this just one more example of billionaires getting a better deal than their secretaries?[vi] And one more point: why should we reward CEOs with huge salaries and bonuses if they can’t find profitable investment opportunities? Any idiot can implement a stock buyback. It takes a real management genius, worthy of his multi-million-dollar paycheck, to make a company more profitable through new product development, opening new markets and building a strong, skilled (well-paid) workforce.
Stock buybacks should be banned. Companies that want to return money to the investors can pay dividends.
The Lost Concept of Ownership
Part of the “self-interest” concept is the idea that the owner of a company has a vested interest in its long-term success. Owners of small businesses typically are involved in their local communities, they personally know and care about their employees, and they have a moral and emotional investment in the success of the business. Company owners are also more cognizant of risk because losses come out of their own pockets. As an example, investment banking firms used to be structured as partnerships, where the partners who managed the business were liable for company losses. After Goldman Sachs went public in 1999, investment banks took on more risks, because losses came out of the bottom line of the company, not the CEO’s pocket.
Unfortunately, publicly traded companies have no true owners, that is, people with a vested interest in their long-term success. The vast majority of shares of publicly traded companies are owned by large, institutional investors who buy and sell stocks on behalf of their customers, who may be individual investors, pension funds or other group plans. Their job is to manage the assets in the best interest of the investors, which means buying stocks which are likely to go up in price. Their performance is measured on a quarterly basis, so there are some pretty strong short-term incentives to focus on stock price as opposed to long-term profits.
Compounding the short-term incentives is the fact that the same institutional investors own stocks in hundreds of companies, often in competing industries. For example, the two largest institutional investment firms, Vanguard and Blackrock, together own more than one quarter of the total value of the S&P 500. They are the largest shareholders of both Pepsico and the Coca Cola Company, and of both Pfizer and Johnson & Johnson. Vanguard is the largest shareholder of both Ford and General Motors. As the largest shareholders, they help shape the composition of the boards of directors of these companies, who in turn hire the CEOs and senior management, and set their compensation. These boards are often comprised of other CEOs and industry insiders who share the same myopic vision of how companies should be run. For example, Pfizer’s board of directors includes the CEO of Coca Cola, the retired Vice Chairman of Goldman Sachs, the managing partner of a private equity firm, and the CEO of Adobe. What do these people know about pharmaceuticals? How do they best represent the interests of all of Pfizer’s stakeholders, including employees, customers, and the community as a whole? And when it comes time to set the CEO’s compensation, do you really think CEOs (whose own compensation is based in part on what other CEOs make) will be impartial?
Vanguard and Blackrock, as well as all the other institution money managers, are required to act in the best interests of their investors, but if they define that almost exclusively as orchestrating higher stock prices, is that a real ownership interest? They don’t know or care about the employees, may not even know what communities are affected, and they have no emotional stake in the company. If you own both Ford and GM, do you really care which one does better over time?
The solution to the “ownership gap” is not an easy one. The millions of individual investors who own shares that they acquired through these institutional money managers would have to (1) understand that over time, focusing solely on stock price will negatively affect their investment; and (2) advocate for a more long-term approach. The ESG initiative I mentioned earlier was a start, but – aside from the reactionary blowback it engendered – it has been undermined by firms who found a way to tick the “ESG box” without actually changing their governing practices. Additionally, given the huge number of shares any one individual might own through multiple accounts, there is no way for them to have the information they need about board composition, CEO pay, and environmental and social practices.
Another solution is to broaden the composition of boards of directors to include representatives of employees, communities, and other stakeholders. Many European countries require boards of directors to include employees or allow employees to elect a number of board members. Studies show that employee pay is higher in firms with employee representation on the board, but it is not clear if the pay gap is due to board representation, or the high level of unionization in those countries.[vii]
As long as the “shareholder” investment firms and CEO compensation are aligned with the “stock price motive,” change will be difficult. However, as I will discuss next week, the focus on stock prices also impacts the competition pillar. Addressing the anti-competitive practices of so many firms may have the additional benefit of forcing them to take a longer-term approach to profits and growth.
[1] https://www.forbes.com/sites/clareoconnor/2014/04/15/report-walmart-workers-cost-taxpayers-6-2-billion-in-public-assistance/#26be8618720b
[i] https://theconversation.com/fines-for-breaking-us-pollution-laws-can-vary-widely-among-states-that-may-violate-the-constitution-201457#:~:text=The%20median%20state%20penalty%20is,more%20lenient%20state%20penalty%20provisions.
[ii] https://www.bankingdive.com/news/jpmorgan-chase-jamie-dimon-34-5-million-morgan-stanley-goldman-sachs-special-award-gorman-solomon/640850/#:~:text=JPMorgan%20Chase%20paid%20CEO%20Jamie,compensation%20he%20received%20in%202021.
[iii] https://www.capitalism.com/jamie-dimons-net-worth/
[iv] https://www.google.com/search?q=amazon+annual+profits&oq=amazon+annual+profits&aqs=chrome..69i57j0i512l4j0i22i30l5.2678j0j7&sourceid=chrome&ie=UTF-8
[v] https://thehill.com/opinion/national-security/3524996-americas-shame-about-14-percent-of-military-families-are-food-insecure/
[vi] https://www.fool.com/taxes/2020/09/25/why-does-billionaire-warren-buffett-pay-a-lower-ta/#:~:text=Through%20the%20years%2C%20famed%20investor,his%20income%20than%20his%20secretary.
[vii] https://www.nber.org/system/files/working_papers/w28269/revisions/w28269.rev0.pdf
Great ideas.
Sadly I doubt “vested interests” (the wealthy, corporations in general, the financial industry complex) will allow any major change.
The real challenge will be to “awaken the masses”, but by then the masses might no longer be permitted to vote on anything meaningful.