Against Creative Capitalism

by Richard Posner

My reaction to “creative capitalism” as lauded by Bill Gates, Warren Buffett, Michael Kinsley, and (somewhat to my surprise), Professor Glaeser of the Harvard Economics Department is a skeptical one. The embrace of massive corporate charity, the criticism of capitalism by its greatest beneficiaries, and the frequent resort by the advocates of “creative capitalism” to platitudes (such as: “the world is getting better, but not fast enough and not for everyone”; “today’s miracles of technology only benefit those who can afford them”; “economic demand is not the same as economic need”), along with the vagueness of the term itself, leave me with an uncomfortable feeling.

The managers of corporations have a fiduciary duty to maximize corporate profits. This duty does not exclude the possibility of corporate philanthropy, although the word “philanthropy” used in the context of profit maximization is misleading. Corporations have long made charitable donations, quite properly from a profit-maximizing standpoint, in order to curry favor with politicians and interest groups, advertise the corporation to potential consumers (as by underwriting cultural events), create diffuse goodwill, disguise greed, and ward off criticisms. Call this PR (public relations) charity. With the rise of economic inequality in the United States, and in particular the emergence of a tier of unbelievably wealthy businessmen, the pressures for PR charity have increased. In addition, with increasing globalization, there is a growing incentive for another kind of profit-maximizing corporate charity--call it jump-start charity--in which charitable donations are directed to building future demand for the donor’s product in poor countries. This is particularly important with respect to products that involve network externalities, so that being first in a market may give one a head start that is difficult to overcome. The more people who use Windows, the more valuable Windows is to other people. And once hooked on Windows, a person is likely to buy Microsoft’s applications programs, such as Office. Because the marginal cost of an operating system is essentially zero, giving it away may be profit maximizing by inducing the purchase of applications programs that run on it and by creating a network effect; but the giveaway can be advertised as being philanthropic. Also, the very low marginal cost of pharmaceuticals makes their sale in poor countries at very low prices profit maximizing, provided that the re-export of the drugs to rich countries can be prevented. The low prices can be represented as being motivated by altruism.

A corporation that makes charitable donations that are not profit maximizing is not only breaking faith with its shareholders (unless they unanimously support the diversion of corporate profits to the managers’ preferred charities), but also weakening itself in competition with profit-maximizing firms. The “creative capitalism” movement equivocates on this point. Gates seems to argue that giving up profits is good business, primarily because it attracts the idealistic young to work for a “creative capitalist” company, presumably at a lower wage than if they had to be paid to overcome their scruples about working for a straight profit maximizer. (He also says that “recognition [that the corporation is charitable] enhances a company’s reputation and appeals to customers,” but that is PR charity, and is consistent with unalloyed profit maximization.) I doubt there are many such companies. But what may be true is that some of the charitable projects that Gates would like Microsoft and other big companies to pursue may be more interesting than some of the firms’ pure business projects, and thus may provide nonpecuniary income to employees that would enable the firm to pay them a lower income. There is an analogy to pro bono work by law firms, which is attractive to young lawyers because it is more interesting than much of their ordinary work, or at least provides welcome variety. But if “creative capitalism” reduces labor costs by enough to offset the cost of the charitable undertaking, it is consistent with strict profit maximization. I am reluctant to attribute corporate philanthropy to altruism because altruism, outside the family, tends to be a very weak force compared to self-interest. Most people are largely indifferent to the suffering of people in remote countries unless that suffering is made visible in television images.

Gates and Buffett believe that corporations are more efficient than foundations and government, and so if the charity function is turned over to the corporate sector it will be performed better. (Buffett suggests that 3 percent of the revenue from the corporate income tax might be allocated to a fund “that would be administered by some representatives of corporate America to be used in intelligent ways for the long-term benefit of society.”) But corporations are more efficient because they operate under the discipline of profit maximization, which is dissipated if they direct significant resources to charitable projects. There is even a danger that altruistic corporations would exert pressure on the government to compel their nonaltruistic competitors to undertake charitable projects as well, in order to prevent those competitors from taking over the market.

I am troubled by the emphasis that advocates of “creative capitalism” place on foreign charity centered on Africa. The problem of Africa is not a lack of money but political corruption and incompetence. We know this because of how China and India have been able to lift themselves by their bootstraps once they got the rudiments of competent market-friendly government in place, and because Africa’s development slowed with the replacement of the colonial governments by less efficient indigenous ones. Foreign charity can actually worsen the quality of government in poor countries by reducing the pressure for reform. The creative capitalists seem oblivious to the problem. Their neglect seems related to a lack of interest in systematic data. At least in the literature of creative capitalism that I have read, I see no reference to evidence beyond the anecdotal that corporate philanthropy in Africa has produced net benefits for Africans. It is possible that efforts by businessmen of the caliber of Bill Gates will succeed where governments and the World Bank have failed, but one would like to see some evidence, especially since the Gates foundation and other private foundations compete with governments and the World Bank for staff and so may either weaken the charitable efforts of governments and foundations or, what amounts to the same thing, make those efforts more expensive by increasing staffing costs.

I wonder too why rich Americans seem so eager to send their surplus money abroad. (Granted, the Gates foundation also makes large domestic grants.) It is not as if the United States lacks appropriate objects of charity. Nor do I see any recognition of the downside of efforts to reduce poverty in Africa beyond their effect in strengthening the rulers of African countries: increased demand for scarce commodities such as oil, increased carbon emissions, and overpopulation.

Professor Glaeser is a very fine economist and a good friend. I am surprised to see him saying “that while laissez-faire capitalism has worked many miracles, it has never been particularly well targeted towards righting social inequities. Private firms usually have better incentives to cater to the rich than to the poor.” That is misleading. The incentive of private firms is to maximize profits, and often that is done by catering to the poor (not of course the absolutely indigent), who in the aggregate often far more buying power than the rich, depending on relative numbers and the degree of economic inequality. American industry historically catered to middle-class, including lower-middle-class, consumers, and the rich bought imported luxuries. Henry Ford made the Model T, not the Rolls-Royce.

I also disagree with Glaeser that “the case for creative capitalism is based as much on the failures of government as on the failures of private business.” The failures of government are the case against charity, because charity entrenches those failures by reducing pressure for reform. None of the examples that Glaeser gives of successful philanthrophy--Hoover’s American Relief Administration, Rockefeller’s personal (not Standard Oil) charities, Solidarity (not a philanthropic enterprise), or the Roman Catholic Church--illustrates corporate charity (“creative capitalism”). Nor is it realistic to suppose that corporations will as he hopes be able to bypass corrupt governments; why would a corrupt government permit that? I am also not persuaded by Glaeser’s proposal for quasi-worker cooperatives in lieu of the conventional business corporation. Worker coops do not have a good record and a hybrid version is unpromising.

Comments

[Daniel Yokomizo]

Whenever I read economists arguing that some behavior is or isn't profit maximizing I ask myself: what definitions of profit and maximization is this scholar using. Surely not every single action a firm does is profit maximizing, some actions even reduce profit: investing reduces immediate profits with the promise of bigger profits later. If a firm invests its resources to lift a country out of poverty it also creates a whole new market for its products and services, on the long run the benefits of reducing poverty give much higher profits than most other investments. of course the firm is not the only one to reap the benefits of this new market, but when economists assume that firms are the sole agents of the economy they incur in a severe mistake. Bill Gates is an agent trying to maximize his benefits, so are the workers in his companies and all of his investors. Also all those people participate in larger groups that acts as agents trying to maximize their own benefits, so seeing the whole picture a firm could "sacrifice" itself to raise profits to the other agents that are also intertwined. This interplay of different interests in firms isn't against the basics of capitalism, it just shows how complex human relations are and yet how well does capitalism works in such situations.

[Michael F. Martin]

The fiduciary duty to maximize profits is derived from the decision in Dodge v. Ford. By revisiting that decision, we can understand what "creative capitalism" better, and resolve some false dichotomies.

What Ford, and now Toyota, have learned by spending lots of time doing manufacturing -- which is a cyclical process -- is that sustainable growth in profitability requires parallel growth in all inputs to the firm -- land, labor, and capital, including (in fact, especially, human capital).

As Thomas Schelling was the first to point out, the rational hypothesis does not demand symmetry. Symmetry is only one focal point among many that could be chosen in coordinating collective action through tacit agreement.

Our focal point in the United States for most of the last century has been on maximizing profits for shareholders. To find our way forward, we have to step back and find a more sustainable focal point, one that balances the interests of every stakeholder in the corporation.

For my part, I have been advocating that measures of liquidity should be added to each balance sheet account. As Peter Drucker used to say, what gets measured is what gets managed.

[Faustino (aka Genghis Cunn)]

"Nor is it realistic to suppose that corporations will as he hopes be able to bypass corrupt governments; why would a corrupt government permit that?" Recent actions of the Burmese and Zimbabwean governments strongly reinforce this point.

[enoriverbend]

"To find our way forward, we have to step back and find a more sustainable focal point, one that balances the interests of every stakeholder in the corporation."

And of course "every stakeholder" usually gets interpreted as "everyone who has political power". This way we can have the "tragedy of the corporation" to add to the "tragedy of the commons". Mugabe, for example, was a stakeholder in Zimbabwe farming, and was successful in forcing farmers pay attention to something other than maximizing their profits. Their horizons have now been broadened, and their profits diminished, so the technique certainly works.

[Michael F. Martin]

@enoriverbend:

Like the focal point profit maximization, a focal point of sustainable growth maximization does not guarantee a particular outcome. It only makes it easier for a large group (in this case, I have in mind the people who work for large international corporations that compete against one-another) to avoid wasteful conflict.

Your point is salient because Mugabe understands (at least implicitly) the importance of focal points very well. That's why he's so dangerous. He knows exactly what to say to get cooperation. But we should deal with people like Mugabe the same way that we deal with psychopaths -- isolate them from other people, or make their implicit goals as explicit and transparent to the people who can't be isolated from him.

Mugabe is dangerous not because he understands that a focal point can be useful in organizing groups, but because the focal points he chose were death and destruction of "them."

[ken goldsholl]

The case against creative capitalism is based mainly on the premise that corporations shouldn't be donating profits to charity, without all of the shareholders' approval. I wasn't aware that shareholders had to approve every expenditure, though. I suppose one way of looking at these actions is as a purely charitable event, but that is simplistic and shortsighted.

A business that wants to outlast its' current management must look 20, 30, even 50 years ahead. As specific populations cease to grow, the only way to grow business will be to attack new markets. Rather than viewing spending in Africa and other third world nations as charity, they should be seen as investments in market development. A company that improves the health (and subsequent lifespan), education, and infrastructure of an undeveloped country will be in the best position to utilize that country as both a market for their products and services, and a source of talent and materials.

Similarly, companies that invest in reducing carbon emissions, by deploying renewable energy, are actually investing in reducing future energy expenses, which increases the probability of future profitability. Even if you don't believe the scientists who predict massive changes to the climate, and ultimately, economy, reducing your carbon footprint effectively means reducing your energy expenses, which increases profits.

Using the argument that "creative capitalism" is the right or moral thing to do leaves the claim that these kinds of expenditures are bad for business unchallenged. It is similar to foes of regulation of air, water, and climate who claim that it will "wreck the economy" - such assertions are groundless, and lack even anecdotal evidence. The battle for environmental protections does not need to be moved from the economic arena, that's actually where it makes the most sense. If policies to conserve energy and develop renewable sources are implemented, it won't harm the economy - it will result in growth, just like investment in communications drove the economy in the last decade. There will obviously be individual losers if the world shifts to an economy based on renewable energy, but overall most people and businesses will benefit. Yet the debate on energy and climate policy is never fought on economic terms, as it should be, and so should the idea of the creative capitalism.

Conservatives and blind faith defenders of "conventional" capitalism typically have knee-jerk reactions to the word "sustainable", but sustainability should be one of the guiding principals of every publicly owned corporation. Corporations are supposed to outlast the people who work for it, and leave something of value for the heirs of their shareholders. It is their fiduciary responsibility to run a sustainable organization, one that will thrive as the world evolves. Instead of calling it creative capitalism, maybe it should be called sustainable, or long term capitalism.

[Nanne]

Richard,

First, you write that altruism is not a strong motive and that people have low attachment to Africans (except when they are shown on TV). Then, you wonder why Americans still send so much money abroad. Wouldn't this indicate an empirical obstacle to your estimation of the altruism motive?

Attributing the development of India and China to getting 'the rudiments of market-friendly government in place' is misleading, as these countries (especially China) in effect used a mercantilist development policy, coupled with large-scale intellectual property violations.

Intellectual property might be at the centre of future development issues, as western governments continue a strategy towards developing a 'knowledge-based economy'. Certainly, people in developing countries worry a great deal about IPR provisions in international trade deals. This puts Microsoft and pharmaceutical companies in something of a bind, as their business strategy relies on IPR protection.

On the Becker-Posner blog the question of the societal efficiency of patents in the area of software and pharmaceuticals has gotten some interesting discussion, in the setting of the American economy. I hope someone (perhaps Stiglitz) will also address its implications for developing countries, and the benefits of having an open source market model for development.

[indiana jim]

Milton Friedman's ethos stands in stark contrast to the "stakeholder theory" that is so popular in the academic disciplines of Marketing and Management. For more see:

hhtp://web.bsu.edu/jmcclure/SOCIAL%RESPONSIBILITY.pdf

Like Posner (and Friedman), I am "uncomfortable" with the focus of managers and CEOs seriously straying from the bottom line.

[indiana jim]

Speedo is bringing 2500 of its new swim suits to the Olympics and will provide them free to any of the swimmers. The company and its spokesperson are calling it just what it is, good business. This is the type of "altruism" that IS ethical according to Friedman's ethos; of course, it is simply a strategy to enhance Speedo's bottom line. I applaud Speedo for its transparent and aggressive pursuit of profit (for openly explaining that this is not "altruism" it is an advertising "investment"). BRAVO SPEEDO!

[Michael F. Martin]

Indiana Jim,

What does it mean to "stray" from the bottom line?

In some sense, isn't "creative capitalism" just capitalism at a larger scale? At some point, to further increase profitability, managers have to start worrying about the social environment that constitutes the market for labor and inputs. Shareholders and managers have taken a larger share of residual income from corporations over the past few decades not because that larger share is morally justified, but because the phenomenal growth of demand because of globalization has permitted corporations to ignore the dynamics of supply and demand.

The larger the group of people, the more the needs of its members will have to be met by decentralized organizations, such as markets.

There is no a priori reason to believe that a decentralized organization that takes as its goal the earning of profit for shareholders should be required to ignore the question of whether that profit is sustainable without sharing some larger portion of it with the people who make it possible.

[Michael F. Martin]

Re Speedo,

Others have reported that there was a severe shortage in the supply of those suits. I do not know whether that shortage was strategic or the result of poor planning by Speedo. But if it was the former, I'm pretty sure that giving away "free" suits at the Olympics is a smart move from the point of view of avoiding antitrust investigation. Unfettered competition doesn't always lead to efficient results. Sometimes a nudge from government authority is required.

[indiana jim]

Michael,
You write: "Unfettered competition doesn't always lead to efficient results." Of course. This is why Friedman has a caveat "within the rules of the game" that is within the rules of law and custom and with "neither fraud, nor deception." The "law of the jungle" is literal unfettered competition and no one with any sense wants a return to the jungle.

[indiana jim]

Michael,

In addition to my previous point, I have another though about your obviously correct observation that "unfettered competition doesn't ALWAYS lead to efficient results."(my emphasis) The point here is: does any method of resource allocation ALWAYS lead to efficient results. Of course not. The important question is the comparison of alternative that exist, not to the province of the next world or narvana. The "nudge" that you hope will be applied by a benevolent "government" is often something else again, being nothing like benevolence.

In your previous post you wrote: "At some point, to further increase profitability, managers have to start worrying about the social environment that constitutes the market for labor and inputs." Yes; to maximize profits managers must pay attention to workers and inputs, but not just at "some point". This must be pursued from the outset. Managers who could have increased profits by, say, improving workers' conditions to reduce costly labor turnover but did not do so as soon as profitable have, by definition failed to maximize profits.

You may have misunderstood what Milton Friedman meant in advocating the pursuit of profits.

[Michael F. Martin]

Indiana Jim,

It sounds like there is less theoretical disagreement between us than I had imagined from your first comment. Thanks for clarifying what you meant by "straying from the bottom line." If your sense of "the bottom line" did, in fact, include a broader consideration of all stakeholders and the comparative institutional advantage of government vs. private institutions in dealing with large-scale and long-term cooperation, then I have little room left for disagreement.

[indiana jim]

Michael,

Again, there is a stark difference between Milton Friedman's ethos and the "stakeholder theory" being pontificated about in departments of Management and Marketing across the U.S. Friedman's approach is the only one that is intellectually defansible in my view; stakeholder theory is either irrelevant (at best) or harmful.

It is also important to keep in mind that Schumpeter defined capitalism as the process of creative destruction. So when I hear people suggesting that creativity is something that now needs to be introduced to capitalism strikes me as odd.

[Tom McKendree]

Richard Posner's description of "PR Charity" is correct, but one must also consider the target market. For many who could be impressed by corporate charity, a key characteristic they look for in the charity is that that its motivation was altruism (i.e., the charity was given without any expectation of return).

One approach is to deceive, creating an arms race between the ability of the corporations to obscure their "true" movitivation for their charity, and the ability of the consumers to ascertain or trust the corporations' motivations.

In a world of sufficiently discriminating consummers of PR Charity (i.e., when the companies do not and perhaps cannot win the arms race), a company may only be able to sell charity when bundled with a sincere motivation for the charity to be "real" charity. That means that there would be a market segment for companies that engage is sincerly altruistically-motivated charity, as long as the discriminating consummers can reasonably learn of the charity and that is is of their preferred flavor. This really is just moving the "line of deception" so that charity-providing company is also deceived. If "Creative Capitalism" is just a recognition that the market segment for consumers of altruistically-motivated corporate charity is real (and with enough concern from enough consumers, it could be large), then CC is true but only mildly interesting.

[Michael F. Martin]

@indiana jim

"Creative destruction" could be more creative and less destructive through better coordination. Institutional designers (a/k/a choice architects) could minimize instabilities by making better use of dynamic equilibrium theories of economics, for example, by implementing accounting standards that provide managers and investors more information about how fast changes occur within the firm.