Tuesday, February 24, 2009

From Marx to Madoff: A Modest Proposal To Help Save Capitalism From Itself

This piece, like our last entry, is written by Gordon Medlock, an instructor at the University of Chicago Graham School, in the program on Human Capital Management. Gordon has a Ph.D. in philosophy from Yale, an M.A. degree in clinical social work from the University of Chicago, School of Social Service Administration, and currently works as a counselor, educator, and talent management consultant. Gordon also facilitates a public dialogue initiative to enable individuals to discuss and influence current political issues.

The Problem

Karl Marx once claimed that the pathology of capitalism was what he called the “fetishism of commodities.” What he meant was that under capitalism, the actual use-value of commodities (goods and services produced to meet our needs) is displaced by the exchange value (money) – with the latter becoming the dominant focus. The danger of distancing ourselves from real use-value is that we fool ourselves into thinking that value creation is about managing and making money, rather than about providing jobs and meeting basic human needs.

The ultimate extension of this pathology is Bernard Madoff’s now infamous Ponzi scheme. Madoff was able to convince thousands of trusted firms, colleagues, friends, and family to part with over $50 billion in a scheme that created absolutely no real value. It was the ultimate in the fetishism of commodities.

It would possibly be comforting to regard Madoff as an anomaly of the system. But unfortunately he is a logical extension of a system that considers the management of money to be the primary driver of wealth creation, rather than the actual production of goods and services. Just as Enron pushed the limits of accepted business and accounting practices to generate the appearance of extraordinary profits, Madoff pushed the limits of unregulated financial markets to give the appearance of extraordinary returns on investment. Neither scheme had anything to do with genuine value creation.

Of course Madoff was only the tip of the iceberg. By now you are probably familiar with how the financial crisis unfolded. You have read about the culture of greed of the eighties and de-regulation of the finance industry in the nineties. You are probably aware – at least to some extent – of the recent history of the subprime mortgage market, Ninja loans (no income, no job, no assets), CDOs (collateralized debt obligations), credit-default swaps, and hedge fund practices that represent the complete dissociation of the world of investment from the value creation process. You may even be familiar with the more distant history of the 14th Amendment after the Civil War, where laws designed to assure political rights for newly freed slaves were used more often to protect corporations – considered to be “persons” under the law – from “threats” of government regulation. But this is not the place or time to examine this important history. The more urgent question facing us is: what is to be done now? Given that we have gotten this far from the genuine purposes of business and investment, what can we do to get us back to fundamental values and sound business practices?

A Modest Proposal

I would like to put forth a modest proposal: that the current financial crisis is a consequence of a basic confusion of means and ends. I propose that we have mistaken the world of investment as an end in-itself, when it was originally conceived as a means for funding commercial enterprises. The true end or purpose of the economic system is the creation of value in the form of quality goods and services, efficiently produced, leveraging human talent and knowledge.

We have fooled ourselves into thinking that the most important activity of the American economy is the activity of Wall Street – as though actual value were created there. In fact, as we have seen, investors are perfectly willing to put the entire economy at risk, in order to maximize their own potential for accumulating private wealth. My proposal is that we as citizens and taxpayers take over the investment and commercial banks that are failing, re-organize them to ensure that they are fulfilling their primary purposes toward citizens and companies, and to pass the legislation required to keep investors focused on their primary purpose – to receive a fair return in exchange for the value they help to create.

I also propose that we structure our system of rewards, penalties and regulations so that organizations that develop new jobs in good times, and retain employees in hard times, are rewarded for their attention to the primary human purposes of enterprise, whereas those that fail to do so pay a penalty tax for each employee laid off. Perhaps more creative alternatives could be found to the lemming-like solution of mass layoffs in tough financial times.

Finally, I propose that government adopt the same principles for generating value that we expect from the private sector. That is to say, government needs to be committed to delivering quality products and services to citizens, to run lean, engage in continuous process improvement, respect and value employees, and focus on high performance and accountability. If government is to be part of the solution and not part of the problem, it needs to be accountable to the citizens that fund and benefit from it.

This should all sound like basic common sense. Indeed, most business analysts recognize that the leading indicators of organizational success are such things as customer and employee satisfaction and retention. Shareholder value and stock price are lagging indicators – highly variable measures of a company’s financial health. They are extremely important to investors trying to turn a profit on fluctuating stock prices. They are not, however, a viable focus for management decisions about the long term profitability of a company. The fetishism of short-term shareholder value obscures the organization’s basic purpose.

The irony is that long term profitability is actually associated with genuine value creation. On this point Marx was decidedly wrong. There is an entire movement of progressive companies, business leaders, managers, and scholars who are making the case for restoring the human side of capitalism. For the past 40 years or more they have been demonstrating that successful organizations are the ones that value and respect their employees, understand the needs and requirements of their customers, create quality products and services that satisfy (and even delight) customers, that engage in continuous improvement initiatives, that run lean, that grow gradually, and that assume a long-term strategic perspective. Organizations such as Toyota, FedEx, and Southwest Airlines are examples that truly walk the talk of human capital management and quality service to customers. They are able to avoid large layoffs, and even adopt no-layoff policies, because their business models include a long-term strategic perspective that anticipates economic downturns as well as periods of prosperity. They don’t just give lip service to the idea that people are our most important asset; they demonstrate that commitment in tough financial times. It is no accident that Toyota has become the leading automobile manufacturer in the world, and that taxpayers are now being called on to bail out financial strapped and mismanaged General Motors.

The human capital movement is much more than a new management fad. It is potentially a revolution in the way we think about American business, education, and government. In the spirit of this movement, and in the spirit of saving capitalism from its own folly, I propose that we:

1. Regulate banking and investment practices to ensure that they focus on their primary purposes – to provide stability to the economic system and enable genuine value creation, rather than simply optimizing opportunities for private wealth acquisition.

2. Pass legislation to prevent government regulators from profiting from relationships with the organizations they regulate – during or following their tenure as regulators.

3. Require that executive compensation be tied to the long term health and performance of the organization, and limited to a reasonable multiple of average worker compensation. Prevent extravagant executive compensation unrelated to genuine value creation or organizational performance.

4. Reward companies that adopt long term strategies that enable them to retain employees during economic downturns, rather than displacing costs through massive layoffs.

5. Use the current stimulus package to invest in our human capital infrastructure – including early childhood education programs, general public education, vocational education, and ongoing adult education and professional development training.

6. Address the problems of the growing federal deficit and the culture of consumption and consumer debt – to create a culture of ecologically sustainable and financially responsible development.

7. Make the hard choices needed to have a viable and affordable system of universal healthcare.

8. Create a culture of service where contribution to socially valued goods is prized and incentives are in place to attract needed talent.

These are the steps that are needed – and I am sure there are many others as well – to get our economy and our society back on track. This modest proposal is just good common sense, reflecting what ordinary working people, consumers, and business experts know to be the source of true value creation. We can no longer afford to treat the investment sector as the primary business of America, nor continue to privatize rewards when Wall Street is doing well, and then displace costs – on the backs of taxpayers and their children – when things go terribly wrong.


UzhasKakoi said...

.... and this guy is teaching at the U of C? And U of C is using this piece ... .as a marketing tool????

I am speechless ...

If I may make my suggestion, it would be nice if econ department looks through the econ pieces that come out under the U of C banner. Is this too much to ask ... speaking about a reasonable regulation ...

Steve said...

Thanks for your response, but I think you misunderstand the purpose and objectives of the essay. This isn't economic analysis, it is a comment on the news based on a Human Capital Management perspective, and informed by a deep rootedness in philosophy. The goal is to remind professionals working in management, human resources, and organizational development that it is crucial to link your work to outcomes - outcomes beyond, or in addition to, or more primary than wealth accumulation. If you go back and reread Adam Smith you'll see that, among the many things Smith accomplishes in The Wealth Of Nations, Smith wants to criticize the accumulation of wealth for the mere purpose of accumulation. The problem with the aristocracy is they don't invest their wealth toward the production of improvements that increase the overall wealth of the nation. Medlock's critique aims at the same concern. From his essay we find the following quote: "The true end or purpose of the economic system is the creation of value in the form of quality goods and services, efficiently produced, leveraging human talent and knowledge." In The Wealth of Nations we find: "There is one sort of labour which adds to the value of the subject upon which it is bestowed: there is another which has no effect. The former, as it produces value, may be called productive; the latter unproductive labor." The link is unmistakable. One of the roles of a great university is to preserve original ideas, which have a habit of being picked up and used and distorted over time. We want to shine a bright light on some of Smith's sentiments and say: let's consider the implications of this forgotten concern.

Scott Powell said...

Please excuse my directness, but frankly, I was insulted by the key premise of this article. To suggest that the crimes committed by Madoff and Enron were logical extenstions of the system of capitalism is intellectually bankrupt.

Madoff was a sociopathic thief of the lowest level and his actions had nothing to do with capitalism. He was acting in absolutely bad faith, misrepresenting himself and his firm and was not a legitimate actor in our capital markets. He committed grand larceny on a scale not seen before; he stole friends', charities' other people's money rather than investing it in any markets or securities. He lied about every aspect of his business until the music stopped on the Ponzi scheme. He committed a capital crime many times over, by robbing people and charities of resources whose purposes included funding retirements and conducting life-saving research and development. In sum, Madoff betrayed capitalism and destroyed "value" for his own selfish ends.

No doubt Graham School instructor and UC graduate Gordon Medlock has some worthwhile points. The problem is that those get lost when the author bases an important part of his thesis on a misrepresentation and faulty logic right at the beginning. You might be able to get away with that in academia, but you can't in the real world. And where there is a fundamental flaw in reasoning, why should anyone spend time reading further and into the thesis? A good academic must win the trust of the reader early on to compell him or her to follow the development of the argument.

In the end, this article by UC graduate Gordon Medlock is not in keeping with the rigorous intellectual tradition that is the hallmark of the University of Chicago. You simply cannot make a successful case for talent-centered approaches to managing firms, organizations, and society itself by basing it on a false foundation and logic.

Steve said...

Thanks for your comment Scott. I think you are missing an important connection, one I pointed out in my earlier comment. If we track the origins of our capitalist system back to Adam Smith, we see an original concern with the employment of capital to create value - not just accumulate wealth. I think the term "capitalism" is often used imprecisely. Let's be clearer. For Smith, a nation's wealth should be placed into the hands of those who will invest it - with "skill, dexterity and judgment" - in improvements in industry and production. A system or a society built upon this ideal could be called "capitalist." I agree with your point, given this definition, Madoff was not a capitalist. But, following Medlock's argument, it also seems clear that enterprises that focus mainly on wealth accumulation, rather than its productive use, aren't "capitalist" enterprises either, at least not by Smith's reasoning. Such enterprises - spending exorbitant amounts on executive bonuses or luxury decor for CEO offices - are closer in spirit to the aristocracy Smith was seeking to displace. Consider this quotation from Medlock's essay:

"There is an entire movement of progressive companies, business leaders, managers, and scholars who are making the case for restoring the human side of capitalism. For the past 40 years or more they have been demonstrating that successful organizations are the ones that value and respect their employees, understand the needs and requirements of their customers, create quality products and services that satisfy (and even delight) customers, that engage in continuous improvement initiatives, that run lean, that grow gradually, and that assume a long-term strategic perspective."

If Smith were to peek at the business page of a 21st century newspaper, he would agree with Medlock - this is closer to the spirit of capitalism he imagined than, say, short selling would be or John Thain spending $1.2 million on his bathroom. That might not be theft, but it isn't the productive use of capital either. One of the forgotten contributions of Adam Smith is his philosophical text, The Theory of Moral Sentiments. There he laments that: "wealth and greatness are often regarded with the respect and admiration which are due only to wisdom and virtue." What is virtue? For Smith: "to feel much for others and little for ourselves, to restrain our selfish, and to indulge our benevolent affections, constitutes the perfection of human nature." This sentiment, voiced by the father of modern capitalism, suggests how far afield many practices on Wall Street have strayed from Smith's original blueprint. I understand your concern - Medlock's piece might have reached you if he employed a different filter, separating Madoff's crimes from Wall Street's legal excesses. But I hope you grasp his central concern: our economic system has always functioned best - and is most admirable - when capital is reinvested in ways that build value and benefit the wider society. This current economic crisis, to some extent, was produced because too many people in influential positions forgot this.