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.

Grinding through without layoffs

Much of the discussion on this blog has focused on trust, and specifically, building workplaces where trust and respect and reciprocity help engineer employee loyalty and facilitate creativity. Nothing tests trust in a workplace more completely than hard times. The latest numbers are alarming: America lost 600,000 jobs in the month of January. In the past year the country has lost 3.6 million jobs. Some of these job losses were a result of firms closing their doors, but many of these are layoffs. Mark Zando from Moody's reports: “Businesses are panicked and fighting for survival and slashing their payrolls."
Where do layoffs get you? Gordon Medlock, who teaches in the Graham School's Human Capital Management program offers the following set of observations.
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There are several studies that suggest that layoffs during times of economic crisis are negatively correlated with return of customers during the upswing and increase in shareholder (stock price) value. One of the clearest is the analysis of Southwest Airlines' no layoff policy and its responses to the airline industry crisis after 9/11. In a study comparing all the airlines during that period – “layoffs negatively predicted recovery of [a company’s] passenger traffic with 99% certainty, and negatively predicted recovery of its stock price with 95% certainty” (from The Southwest Airlines Way, by Jody Hoffer Gittell, published in 2003). In other words, the more employees you laid off, the longer it took for customers to return and for your stock price to recover.

Another (less rigorous) study by John Dorfman, a money manager and author of the article “Job Cuts Often Fail to Bolster Stocks,” reported that companies that announced job cuts during the period form 1996-1997 underperformed comparable companies from the S&P 500 by a difference of 0.4% growth versus 29.3%. Of course there could be other factors besides the job cuts to account for that difference, but it suggest that companies that, for whatever reasons, feel the need to make those cuts, are also the companies that are not doing as well as their competitors.

The key point in all of this, however, is that you can’t simply implement a no-layoff policy if it is not part of your long term strategy. Companies that have no-layoff policies, such as Toyota and Southwest and FedEx, all have business plans that enable them to retain valued employees during economic downturns. They include strategies related to retention of cash resources, lean organizations, gradual growth, long term strategy perspectives, continuous improvement strategies, and a commitment to valuing their people. If a company is not committed to these values and strategies – and the comparison between General Motors and Toyota is an excellent case in point – then it will be much more likely to use layoffs to cut costs.

Finally, there is a lot of research on the connection between employee engagement (the willingness to apply discretionary effort to achieve results on the job) and the financial success of an organization. It is well documented that layoffs adversely affect employee engagement, morale, trust, and productivity.