Capitalism

The Invisible Hand Won’t Solve the Climate Crisis. Capitalism Must Evolve.

New economics to deal with the biggest global issue

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By Andrew J Hoffman

There are two extremes in the debate over capitalism’s role in our present climate change problem. On the one hand, some people see climate change as the outcome of a consumerist market system run rampant. In the end, the result will be a call to replace capitalism with a new system that will correct our present ills with regulations to curb market excesses.

On the other hand, some people have faith in a free market to yield the needed solutions to our social problems. In the more extreme case, some see climate policy as a covert way for bigger government to interfere in the market and diminish citizens’ personal freedom.

Between these two extremes, the public debate takes on its usual binary, black-and-white, conflict-oriented, unproductive and basically incorrect form. Such a debate feeds into a growing distrust many have for capitalism.

A 2013 survey found that only 54% of Americans had a positive view of the term, and in many ways both the Occupy and Tea Party movements share similar distrust in the macro-institutions of our society to serve everyone fairly; one focuses its ire at government, the other at big business, and both distrust what they see as a cozy relationship between the two.

This polar framing also feeds into culture wars that are taking place in our country. Studies have shown that conservative-leaning people are more likely to be skeptical of climate change, due in part to a belief that this would necessitate controls on industry and commerce, a future they do not want. Indeed, research has shown a strong correlation between support for free-market ideology and rejection of climate science. Conversely, liberal-leaning people are more likely to believe in climate change because, in part, solutions are consistent with resentment toward commerce and industry and the damage they cause to society.

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This binary framing masks the real questions we face, both what we need to do and how we are going to get there. Yet there are serious conversations within management education, research and practice about the next steps in the evolution of capitalism. The goal is to develop a more sophisticated notion of the role of the corporation within society. These discussions are being driven not only by climate change, but concerns raised by the financial crisis, growing income inequality and other serious social issues.

The market’s rough edges

Capitalism is a set of institutions for structuring our commerce and interaction. It is not, as some think, some sort of natural state that exists free from government intrusion. It is designed by human beings in the service of human beings and it can evolve to the needs of human beings. As Yuval Levin points out in National Affairs, even Adam Smith argued that “the rules of the market are not self-legislating or naturally obvious. On the contrary, Smith argued, the market is a public institution that requires rules imposed upon it by legislators who understand its workings and its benefits.”

And, it is worth noting, capitalism has been quite successful. Over the past century, the world’s population increased by a factor of four, the world economy increased by a factor of 14 and global per capita income tripled. In that time, average life expectancy increased by almost two-thirds due in large part to advances in medicine, shelter, food production and other amenities provided by the market economy.

Capitalism is, in fact, quite malleable to meet the needs of society as they emerge. Over time, regulation has evolved to address emergent issues such as monopoly power, collusion, price-fixing and a host of other impediments to the needs of society. Today, one of those needs is responding to climate change.

The question is not whether capitalism works or doesn’t work. The question is how it can and will evolve to address the new challenges we face as a society. Or, as Anand Giridharadas pointed out at the Aspen Action Forum, “Capitalism’s rough edges must be sanded and its surplus fruit shared, but the underlying system must never be questioned.”

These rough edges need be considered with the theories we use to understand and teach the market. In addition, we need to reconsider the metrics we use to measure its outcomes, and the ways in which the market has deviated from its intended form.

Homo economicus?

To begin, there are growing questions around the underlying theories and models used to understand, explain and set policies for the market. Two that have received significant attention are neoclassical economics and principal-agent theory. Both theories form the foundation of management education and practice and are built on extreme and rather dismal simplifications of human beings as largely untrustworthy and driven by avarice, greed and selfishness.

As regards neoclassical economics, Eric Beinhocker and Nick Hanauer explain:

Behavioral economists have accumulated a mountain of evidence showing that real humans don’t behave as a rational homo economicus would. Experimental economists have raised awkward questions about the very existence of utility; and that is problematic because it has long been the device economists use to show that markets maximize social welfare. Empirical economists have identified anomalies suggesting that financial markets aren’t always efficient.

As regards principal-agent theory, Lynn Stout goes so far to say that the model is quite simply “wrong.” The Cornell professor of business and law argues that its central premise – that those running the company (agents) will shirk or even steal from the owner (principal) since they do the work and the owner gets the profits – does not capture “the reality of modern public corporations with thousands of shareholders, scores of executives and a dozen or more directors.”

The most pernicious outcome of these models is the idea that the purpose of the corporation is to “make money for its shareholders.” This is a rather recent idea that began to take hold within business only in the 1970s and 1980s and has now become a taken-for-granted assumption.

If I asked any business school student (and perhaps any American) to complete the sentence, “the purpose of the corporation is to…” they would parrot “make money for the shareholder.” But that is not what a company does, and most executives would tell you so. Companies transform ideas and innovation into products and services that serve the needs of some segment of the market. In the words of Paul Pollman, CEO of Unilever, “business is here to serve society.” Profit is the metric for how well they do that.

The problem with the pernicious notion that a corporation’s sole purpose is to serve shareholders is that it leads to many other undesirable outcomes. For example, it leads to an increased focus on quarterly earnings and short-term share price swings; it limits the latitude of strategic thinking by decreasing focus on long-term investment and strategic planning; and it rewards only the type of shareholder who, in the words of Lynn Stout, is “shortsighted, opportunistic, willing to impose external costs, and indifferent to ethics and others’ welfare.”

A better way to gauge the economy

Going beyond our understanding of what motivates people and organizations within the market, there is growing attention to the metrics that guide the outcomes of that action. One of those metrics is the discount rate. Economist Nicholas Stern stirred a healthy controversy when he used an unusually low discount rate when calculating the future costs and benefits of climate change mitigation and adaptation, arguing that there is a ethical component to this metric’s use. For example, a common discount rate of 5% leads to a conclusion that everything 20 years out and beyond is worthless. When gauging the response to climate change, is that an outcome that anyone – particularly anyone with children or grandchildren – would consider ethical?

Another metric is gross domestic product (GDP), the foremost economic indicator of national economic progress. It is a measure of all financial transactions for products and services. But one problem is that it does not acknowledge (nor value) a distinction between those transactions that add to the well-being of a country and those that diminish it. Any activity in which money changes hands will register as GDP growth. GDP treats the recovery from natural disasters as economic gain; GDP increases with polluting activities and then again with pollution cleanup; and it treats all depletion of natural capital as income, even when the depreciation of that capital asset can limit future growth.

A second problem with GDP is that it is not a metric dealing with true human well-being at all. Instead, it is based on the tacit assumption that the more money and wealth we have, the better off we are. But that’s been challenged by numerous studies.

As a result, French ex-president Nicolas Sarkozy created a commission, headed by Joseph Stieglitz and Amartya Sen (both Nobel laureates), to examine alternatives to GDP. Their report recommended a shift in economic emphasis from simply the production of goods to a broader measure of overall well-being that would include measures for categories like health, education and security. It also called for greater focus on the societal effects of income inequality, new ways to measure the economic impact of sustainability and ways to include the value of wealth to be passed on to the next generation. Similarly, the king of Bhutan has developed a GDP alternative called gross national happiness, which is a composite of indicators that are much more directly related to human well-being than monetary measures.

The form of capitalism we have today has evolved over centuries to reflect growing needs, but also has been warped by private interests. Yuval Levin points out that some key moral features of Adam Smith’s political economy have been corrupted in more recent times, most notably by “a growing collusion between government and large corporations.” This issue has become most vivid after the financial crisis and the failed policies that both preceded and succeeded that watershed event. The answers, as Auden Schendler and Mark Trexler point out, are both “policy solutions” and “corporations to advocate for those solutions.”

We can never have a clean slate

How will we get to the solutions for climate change? Let’s face it. Installing efficient LED light bulbs, driving the latest Tesla electric car and recycling our waste are admirable and desirable activities. But they are not going to solve the climate problem by reducing our collective emissions to a necessary level. To achieve that goal requires systemic change. To that end, some argue for creating a new system to replace capitalism. For example, Naomi Klein calls for “shredding the free-market ideology that has dominated the global economy for more than three decades.”

Klein is performing a valuable service with her call for extreme action. She, like Bill McKibben and his 350.org movement, is helping to make it possible for a conversation to take place over the magnitude of the challenge before us through what is called the “radical flank effect.”

All members and ideas of a social movement are viewed in contrast to others, and extreme positions can make other ideas and organizations seem more reasonable to movement opponents. For example, when Martin Luther King Jr first began speaking his message, it was perceived as too radical for the majority of white America. But when Malcolm X entered the debate, he pulled the radical flank further out and made King’s message look more moderate by comparison. Capturing this sentiment, Russell Train, second administrator of the EPA, once quipped, “Thank God for [environmentalist] Dave Brower; he makes it so easy for the rest of us to be reasonable.”

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But the nature of social change never allows us the clean slate that makes sweeping statements for radical change attractive. Every set of institutions by which society is structured evolved from some set of structures that preceded it. Stephen Jay Gould made this point quite powerfully in his essay “The Creation Myths of Cooperstown,” where he pointed out that baseball was not invented by Abner Doubleday in Cooperstown New York in 1839. In fact, he points out, “no one invented baseball at any moment or in any spot.” It evolved from games that came before it. In a similar way, Adam Smith did not invent capitalism in 1776 with his book The Wealth of Nations. He was writing about changes that he was observing and had been taking place for centuries in European economies; most notably the division of labor and the improvements in efficiency and quality of production that were the result.

In the same way, we cannot simply invent a new system to replace capitalism. Whatever form of commerce and interchange we adopt must evolve out of the form we have at the present. There is simply no other way.

But one particularly difficult challenge of climate change is that, unlike Adam Smith’s proverbial butcher, brewer or baker who provide our dinner out of the clear alignment of their self-interest and our needs, climate change breaks the link between action and outcome in profound ways. A person or corporation cannot learn about climate change through direct experience. We cannot feel an increase in global mean temperature; we cannot see, smell or taste greenhouse gases; and we cannot link an individual weather anomaly with global climate shifts.

A real appreciation of the issue requires an understanding of large-scale systems through “big data” models. Moreover, both the knowledge of these models and an appreciation for how they work require deep scientific knowledge about complex dynamic systems and the ways in which feedback loops in the climate system, time delays, accumulations and nonlinearities operate within them. Therefore, the evolution of capitalism to address climate change must, in many ways, be based on trust, belief and faith in stakeholders outside the normal exchange of commerce. To get to the next iteration of this centuries-old institution, we must envision the market through all components that help to establish the rules; corporations, government, civil society, scientists and others.

The evolving role of the corporation in society

At the end of the day, the solutions to climate change must come from the market and more specifically, from business. The market is the most powerful institution on earth, and business is the most powerful entity within it. Business makes the goods and services we rely upon: the clothes we wear, the food we eat, the forms of mobility we use and the buildings we live and work in.

Businesses can transcend national boundaries and possess resources that exceed that of many countries. You can lament that fact, but it is a fact. If business does not lead the way toward solutions for a carbon-neutral world, there will be no solutions.

Capitalism can, indeed it must, evolve to address our current climate crisis. This cannot happen through either wiping clean the institutions that presently exist or relying on the benevolence of a laissez faire market. It will require thoughtful leaders creating a thoughtfully structured market.

Originally published at the Conversation here.

2016 February 15

For all of Andrew Hoffman’s previous articles and columns, click here.


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  • X-7

    Lots to address here. Statements that I simultaneously agree with, but want to add complexity to? or generate counters? Not sure.
    Here’s 1 foundation premise:
    “Any final state contains information about the system’s initial state and about what has happened to it since. So, the motion of any physical system, because it obeys definite laws, can be regarded as information processing.” physicist David Deutsch
    So, Dr. Hoffman’s statement: “But the nature of social change never allows us the clean slate that makes sweeping statements for radical change attractive.”
    Yes, information has been processing over time, so a Now comes from past motion by def (add the ubiquitous qualifier per uncertainty: “or seems to”). In that sense the slate is never clean. But there is the when-not-if physics, alphabet coded as self-organized criticality: a rapid and significant restructuring of a non-equilibrium system. Plagues, meteor hits, genocides, droughts, world wars, Arab Spring like uprisings, etc. There are also generative forms of self-organized criticality.
    Redomaining is “ … the expressing of a given purpose in a different set of components …” Brian Arthur “The Nature of Technology.”
    Examples: agriculture redomained food procurement from hunting and gathering; alphabet code redomained writing from pictograph code; electricity redomained power generation from steam power; democracy redomained government from monarchy; eukaryote cells redomained biotech from prokaryote cells.
    That isn’t sanding the rough edges, that’s metamorphosis.
    The statement: “Capitalism’s rough edges must be sanded and its surplus fruit shared, but the underlying system must never be questioned.” “Must never” brings a “Huh?” There’s a link to a 30-minute talk, but I could give that time. So, I don’t have much context. I can imagine that some embedded elements of capitalism are a genuine mirroring or part of reality, so is that what ‘must never be questioned’?
    While I’d prefer to avoid a “wiping clean of institutions”, given physics, I don’t think that is off the table. And there are imaginable scenarios where the transition can be done without “revolution” or the “overthrow” of gov’t, so the chaos, anarchy and destructiveness of “wiping clean” can be avoided. (Transition modes can evolve too.)
    On to metrics. Too much to cover here, so a link: http://ow.ly/YkD0s

  • X-7

    Andrew, agree about systemic fraud, not sure for the same reasons?
    Promise language sounds a bit like new code? an added interface for transactions?
    Also, your pt. #1 sounds interesting. Can you expand on it, the relationship between discrete particles and counting molecules? And can that be scaled up?

  • Much agree. Like capitalism, the invisible hand emerges from the interaction of people exchange value which became more efficient with the metric of money. One of the first economic systems was that of agriculture and likewise it is reasonable to envision a new dimension of capitalism, let’s say, “eco-commerce” to begin from the landscape as well. Sure the atmosphere gets all the attention, but it is the surface of earth where the action is. Several small scale eco-commerce models with two metrics – indices and money – creates this new dimension. A Taylor & Francis book due in August 2016, Negotiating Sustainability: the role of multi-sided platforms in sustaining landscapes describes this emergent business ecosystem. Yes, the solution and the capacity to deliver it already exists, it must now enter the memes of the minds to make it real

  • ChrisBuors

    Where are we going to find these wise overlords that will foresee the wants of the people and make all the right decisions at the right time to coordinate energy use in production of said goods and service? Not only wise and all-knowing, the overlord will have to have the morals of an angel not to be corrupted as whoever gets in charge of distributing energy usage will become very powerful. There is no such persons or committees that can coordinate the wants of the market to please all customers. There are 7 billion people on the Planet today. Who shall get electricity to create cell phones? Shall the power be allocated to Apple, Samsung or Motorola? Today the market decides through their purchases which of those companies will get rich and which will go broke. I’m not so sure the wisest of overlords would know who best to get the right to pollute when manufacturing those and every other product on Earth!

    • Much like the metric of ‘price’ is able to create the wisdom of efficiency, other metrics will be able to create the wisdom of efficacy. Evolution is difficult to see forward, but no matter how seemingly complex, in hindsight, it seems to take the most simplest path forward. The world and its people have a lot more collective wisdom than is apparent.

  • If you dislike pollution, the only way to permanently end it is to make each molecule, each atom, a valuable resource. No one ever throws away what he or she values. And the only way to do that is to permit, even encourage technological development to continue to accelerate until each molecule and each atom that we use can be readily put into a very precise place in our food, water, consumer items, roads, energy generators, housing, etc., and not left or ejected into the land, water, or sky. In short, develop nanotechnology. Politicians will solve nothing.

    • SimoneNonvelodico

      That would basically violate the second law of thermodynamics. “Pollution” of some kind is the unavoidable byproduct of life. The best we can do is delay the inevitable as much as possible by being clever about it. But in the end, dust to dust, ash to ash, etcetera. Luckily we’re not the generation who’s going to have to cope with the problem of the incumbent Heat Death of the universe.

  • Bruce Preville

    Interesting article, but unfortunately the author misses the most important point. Business under capitalism exists to make the most profit possible. It will not change voluntarily. The restraining hand must be government. But when government is controlled by business, as it often is today worldwide and especially in the US, capitalism doesn’t take into account issues of public well-being. The best answer is an elected government that is not dominated by business. That will only happen when there are effective limits on campaign contributions so elected leaders represent the public’s interests, as opposed to those who pay to get them elected.
    Why does Hoffman barely touch on this fundamental fact?

  • David Whitlock

    The only reason that any markets ever “work” is because the price paid reflects the cost to produce and delivers value above the bare minimum necessary for the transaction.

    The price a producer receives for a good or service must reflect the cost the producer incurs to produce that good or service, plus some extra; aka “profit”. If the price a producer receives is not greater than the cost to produce that good or service, the producer will go out of business.

    If producers are forced to sell below cost, they go out of business. If workers are forced to work for less than living wages, then they can’t live. Both producers and consumers need to achieve some “profit” in each transaction. Profit can be considered utility above the bare minimum necessary for “break even”.

    The precise balance of price vs cost cannot be imposed from the top down. It needs to emerge from the bottom-up.

    The problem of “free” markets is that of unpriced externalities, including monopoly power. A monopoly can dictate prices that greatly exceed costs. A price that greatly exceeds the cost of production leaves no “profit” for the buyer of that good or service. With no “profit”, the consumer has nothing with which to expand or grow beyond bare survival.

    To use an ecology or ecosystem analogy; money is like “biomass”. Plants, the primary producers generate biomass from sunlight, minerals, water. They need their pollen and seeds dispersed. Plants use “biomass” (nectar and pollen) as “payment” to “hire” bees, to distribute pollen. If plants didn’t produce enough nectar and pollen to sustain a sufficient bee population (including future generations of bees), the bees would go extinct and then so would the plants (but on a different time scale). The same is true for the animals that plants use to distribute seeds. Oak trees produce nuts of sufficient nutritional quality to sustain a sufficient population of squirrels (including future generations) to provide sufficient seed distribution services. If oak trees didn’t produce enough to sustain the squirrels, then squirrels would go extinct, and eventually so would the oak trees.

    The problem with human economies is that not everything has a price that accurately reflects its cost. The most important thing that a society needs is new adults to form the next generation. Every society that doesn’t have new adults to form the next generation will go extinct. Infants and young children are completely helpless and need care 24/7 for the first few years of life. Any society that doesn’t provide care to infants and young children for the first few years of life will go extinct. The cost to provide 24/7 care to infants and young children is not high. However, it is not zero. Current economic policies make it more expensive to provide care to infants and young children, and as a result (?) birth rates are declining.

    The economy now is largely based on “rents”; payments required as a result of monopoly power over a limited resource. For example the “price” of a cable subscription doesn’t reflect “competition” or the cost to provide that service, it reflects the monopoly power of the cable company.

    In a market economy, when prices don’t reflect costs, new producers can enter the market and provide better goods and services at lower costs. That can’t happen now because of monopoly power and the barriers to entry that the monopolists impose. New banks can’t enter the market because the very largest banks have monopoly power. New cable companies can’t sell cable because of monopoly power. New and carbon-free energy sources can’t compete with the monopoly power of the fossil fuel industry and with the subsidies that the fossil fuel industry has enacted for itself. The fossil fuel industry has the gigantic subsidy of being allowed to freely release CO2 into the atmosphere. With any reasonable cost attached to that CO2 release, solar and wind power would be more economic than fossil fuel combustion right this moment.

    It is the monopoly power of the fossil fuel industry that has “captured” regulators and allowed CO2 release to be an unpriced externality.

    • wofford

      “It is the monopoly power of the fossil fuel industry that has “captured” regulators and allowed CO2 release to be an unpriced externality.”

      I’m waiting for the magical trees that would make that statement true.

      • SimoneNonvelodico

        It IS true. The point is simply: CO2 in the atmosphere has a cost. But that cost is not paid by those who release it.

        It’s not saying that there’s necessarily another form of energy that is as abundant and cheap as fossil fuels. Rather, it’s saying that the fact that fossil fuels were “cheap” was actually an illusion in the first place; rather, they were like accruing debt on a card with unlimited credit, where at the beginning it all looks easy and wonderful, and then the interests grow and start slowly crushing you. Solar and wind may in fact be cheaper, overall; they cost more because you have to pay the money upfront rather than delay it.

    • John Hannah

      Don’t know what you do for a living, but this is one hell of a good short course in economics. I have read some of Adam Smith, partially to gain some insight into whether the fundamentalist conservatives really have much of a basis for what seems to be their radical ideas. It did not take much reading and much to my surprise I found many places where Smith speaks out strongly against monopolies – which it seems that most of today’s conservatives never met a monopoly they didn’t like. Your view on rents and current economic policies affecting birth rates don’t get discussed or recognized much. My son and his wife are high school teachers with two children. They want and should have another child but have foregone because the cost of child care for another is such as to erase the effect of all her earnings teaching, and they can’t afford that. Unfortunately it is society’s loss because they are Super-parents as anyone that meets their kids finds out in short order. Thanks for the piece.

  • Gary Erickson

    There is no need for a market solution to climate change, the climate changes irrespective of the flow of capital. This is readily seen in evolutionary terms as ice ages, interglacials and extensive warm periods that the earth has experienced over the last 4.5 billion years.

  • wofford

    Enjoyed the essay. The radical flank effect is a great concept for framing our fractured politics and points a way out and evidence of that is the fact that ideologically diverse groups now support Hillary for president from corporate titans to libertarian economists. Thanks for that. On the evolutionary aspects of the essay, it seems you are giving a nod to convergent evolution that once in motion an evolutionary path converges on a solution. The implication of convergence to the climate problem is that perhaps there is subtle social signaling going on via the radical flank effect that directs convergence to a solution.

  • acuvox

    Fiat currency is a construct that is easily and frequently manipulated. It therefore makes a poor metric. Imagine if large amounts of mass flow changed the reference Kilogram, or increasing the electrical grid capacity changed the threshold voltage of transistors. Machines and electronics would become unreliable and equations of Physics would be skewed by the second.