The biggest myths about capitalism
Thirty years ago, in the face of a serious economic challenge from Japan and Europe, the United States embraced a form of free-market capitalism that was less regulated, less equal, more prone to booms and busts. Bolstering that embrace was a set of useful myths about motivation, fairness and economic growth that helped restore American competitiveness. Over time, however, the most radical versions of these ideas have polarized our politics, threatened our prosperity and undermined the moral legitimacy of our system. Here are four of the most persistent ones.
MYTH NO. 1: Greed, a natural human instinct, makes markets work.
Adam Smith, the father of economics, first pointed out in his most famous work, “The Wealth of Nations,” that in vigorously pursuing our own selfish interests in a market system, we are led “as if by an invisible hand” to promote the prosperity of others. Years later, Smith’s theme that capitalism runs on selfishness would find its most famous articulation in a speech by a fictional corporate raider, Gordon Gekko, in the movie “Wall Street”: “Greed ...is good, greed is right, greed works.” (Defenders of free markets have been desperate to disown the “greedy” label ever since.)
Smith, however, was never the prophet of greed that free-market cheerleaders have made him out to be. In other passages from “The Wealth of Nations,” and in his earlier work, “The Theory of Moral Sentiments,” Smith makes clear that for capitalism to succeed, selfishness must be tempered by an equally powerful inclination toward cooperation, empathy and trust. These insights have now been confirmed by brain researchers, behavioral economists, evolutionary biologists and social psychologists. An economy organized around the cynical presumption that everyone is greedy is likely to be no more successful than one organized around the utopian assumption that everyone will act out of altruism.
MYTH NO. 2: Corporations must be run to maximize value for shareholders.
This is an almost universal belief among corporate executives and directors – that it is their principal mission and legal obligation to deliver the highest possible return to their shareholders. The economist Milton Friedman first declared in the 1970s that the “one social responsibility of business [is] ...to increase its profits,” but the corporate raiders of the 1980s were the ones who forced that view on executives and directors, threatening to take their companies or fire them if they didn’t go along. Since then, “maximizing shareholder value” has been routinely used to justify layoffs and plant closings, rationalize an orgy of stock buybacks, and defend elaborate corporate schemes to avoid paying taxes. It is now widely taught by business schools, ruthlessly demanded by Wall Street’s analysts and “activist” investors, and lavishly reinforced by executive pay packages tied to profits and share prices.
In fact, corporations are free to balance the interests of shareholders with those of customers, workers or the public, as they did routinely before the 1980s, when companies were loath to boost profits if it meant laying off workers or cutting their benefits. Legally, corporations can be formed for any purpose. The only time a corporation is obligated to maximize its share price is when it puts itself up for sale.
MYTH NO. 3: Workers’ pay is an objective measure of economic contribution.
The theory of “marginal productivity” holds that a worker’s wage or salary reflects the “amount of output the worker can produce,” according to Harvard’s Greg Mankiw, author of a best-selling economics textbook. This idea is useful in constructing economic models, but Mankiw and others have also relied on it to justify widening income inequality and to oppose proposals to redistribute income based on subjective notions of what is “fair.” It is why we are supposed to accept that private-equity king Steve Schwartzman, at $800 million, should earn 20,000 times what the average American worker earns.
In reality, however, the pay set by markets is also subjective, reflecting the laws and social norms under which markets operate. The incomes earned by workers who planted tobacco – and those who owned tobacco plantations – changed considerably after slavery was abolished, and again after laws protecting sharecroppers were enacted, and again when minimum-wage laws were passed, and again when farmworkers won the right to unionize. Changes to trade law, patent law and antitrust law also alter the distribution of income. While it is probably better to rely on markets rather than government to set pay levels, that doesn’t mean that the way the markets set pay is a purely objective assessment of economic contribution or that redistribution is theft.
MYTH NO. 4: Equality of opportunity is all people need to climb the economic ladder.
No moral intuition is more hard-wired into Americans’ concept of economic justice than equality of opportunity. The reason Americans tolerate higher levels of income inequality is because of our faith that we all have a fair chance at achieving the American Dream or becoming the next Bill Gates. “In America we stand for equality,” writes Arthur Brooks of the American Enterprise Institute, a leading defender of the morality of capitalism. “But for the large majority of us, this means equality of opportunity, not equality of outcome.”
But while the United States has made great strides in removing legal barriers to equal opportunity, at least half the difference in income between any two people is determined by their parents, either through inherited traits like intelligence, good looks, ambition and reliability (nature), or through the quality and circumstances of their upbringing and education (nurture). As our society has become more meritocratic, we’ve simply replaced an aristocracy based on title, class, race and gender with a new and equally persistent aristocracy based on genes, education and parenting.