Milton Friedman versus stakeholder capitalism

Jomo Kwame Sundaram

KUALA LUMPUR: Milton Friedman was arguably the most influential economist of the second half of the 20th century, associated with promoting ‘neo-liberal’, free-market, shareholder capitalism.

Friedman’s monetarist economics is now widely considered irrelevant, if not wrong, especially with the low inflation associated with ‘unconventional’ monetary policies following the 2008-2009 global financial crisis.

Friedman’s doctrine challenged

Nevertheless, Friedman’s ‘shareholder capitalism’ doctrine remains influential in most financial markets, especially emerging ones in the developing world.

His doctrine, prioritizing short-term profit maximization, has long dominated Anglo-American corporate governance despite chatter about ‘stakeholder capitalism’ and ‘corporate social responsibility’ (CSR).

Chicago University’s Raghuram Rajan claims that long-term share value maximization can advance almost everybody’s long-term interests.

But even Glenn Hubbard acknowledges that long-term shareholder-value maximization cannot address many problems faced by firms, let alone societies. Having served George W. Bush’s conservative administration, he recognizes the need for public policy interventions.

Friedman’s shareholder primacy principle can also become absurd. Rajan’s former co-author Luigi Zingales argues, “if you take Friedman to an extreme, I should sue a CEO who doesn’t buy off all the members of Congress”.

More importantly, Zingales points out that corporations have duties as public institutions with special privileges granted by the state such as “limited liability, especially with respect to tort claims, is an extraordinary privilege granted by the state”, implying reciprocal obligations.

Friedman’s manifesto insisted that companies focus on making money, leaving ethical matters to individuals and government. US law enshrines shareholder rights as owners able to challenge or replace boards whose members stray from their fiduciary duty.

Stakeholder capitalism?

Friedman vehemently opposed stakeholder capitalism, whose proponents argue that companies have responsibilities to all stakeholders, not only shareholders, but also employees, customers, society and even nature.

He argued that ‘stakeholders’, typically ill-defined, will insulate directors from shareholders, reduce their accountability, and compromise corporate performance. This would allow executives to pursue their personal priorities or cover up their own failures.

Straying from Friedman’s singular focus on profit maximization would mean that corporate executives are no longer loyally and exclusively serving shareholders, worsening the ‘principal-agent’ problem.

For Friedman, government and other stakeholders should not be allowed to interfere with shareholder corporate governance in any way, or worse, undermine incentives for investors to risk their capital. In his doctrine, profit alone should be corporations’ sole motive.

Joseph Stiglitz has noted that US courts have ruled that firms are obliged to maximize profits and shareholder value, excluding all other objectives. Hence, ‘stakeholder capitalism’ is not rooted in US law as corporate executives are not accountable by law to the communities in which they operate, or even to society at large, let alone to nature.

What a wonderful world?

Friedman also presumed market imperfections did not exist, or would be fully taken care of by regulation. However, the rule of law has never really been adequate to such challenges.

Thus, he effectively gave companies ‘moral cover’ to be ruthless, free and unregulated to pursue their own interests, at the expense of the public good, while not worrying about society’s larger interests.

Friedman also criticized business leaders for straying from maximizing profits and worrying about their public image, the social good and public welfare.

While dismissing talk of stakeholders as attempts by company directors to be free to run companies as they like, and for public relations, Friedman approved of companies that “generate good will as a by-product of expenditures that are entirely justified in its own self-interest”.

But he was conspicuously silent about business interests lobbying, rigging elections, making campaign contributions, compromising research and public discourse, while reputation laundering with philanthropy and public relations.

Friedman’s world view is remarkably simplistic, typically ignoring broader, ‘longer term’ consequences. For him, business efficiency -- due to shareholder primacy, not undermined by company directors, managers, government taxes and regulations -- can and will solve all problems.

Stakeholderism challenged

Friedman’s neoliberal ‘doctrine’ shaped major economic reforms the world over from the 1980s until the 2008-2009 global financial crisis. Lacklustre growth since then has given rise to various new challenges to shareholder capitalism, not least in the name of other stakeholders, and appeals for corporate governance reform and CSR.

Multi-millionaires, even some billionaires and chief executive officers (CEOs), have joined the dissent, whom influential businessman writer Andrew Ross Sorkin would have us believe represent the future.

To be sure, many have undoubtedly turned away from Friedman’s thinking in recent years.

In 2019, the influential Business Roundtable, which had long advocated shareholder primacy, issued a pro-stakeholder statement. It replaced its Friedmanite Statement on the Purpose of a Corporation with “a fundamental commitment to all of our stakeholders”.

A few months later, the World Economic Forum issued a similar 2020 Davos Manifesto, embracing stakeholder as well as environment, social and governance (ESG) principles.

Nevertheless, legendary investor Warren Buffett remains sceptical of ‘purpose-over-profit’ stakeholder advocacy. “In representing your interests, business-savvy directors [will] seek managers whose goals include delighting their customers, cherishing their associates and acting as good citizens of both their communities and our country.”

Meanwhile, most advocating a stakeholder approach to corporate governance argue that considering the interests of employees or other stakeholders is good for company profits and shareholders. Yet, they privately acknowledge that profits must come first, even if they feel constrained to say so in public.

Corporate social responsibility?

Some argue they are defending capitalist free enterprise in the long term by having a ‘social conscience’ and taking responsibility for providing employment, avoiding pollution and pursuing other trendy CSR reforms, ostensibly in companies’ ‘enlightened self-interest’.

Others insist that many contemporary problems are too urgent for slowly meandering political processes. Instead, they argue, CSR “is a quicker and surer way to solve pressing current problems”.

CSR is said to be a useful, if not necessary complement to government policy and regulation. Friedmanite critics object that CSR involves spending shareholder money for a typically vague public interest, reducing company returns and spending ‘other people’s money’.

Friedman warned that the doctrine of ‘social responsibility’ would take over if not checked. But the converse is more true today as ‘greed is good’ and the ‘short-termist’ shareholder mentality is clearly hegemonic.

Others object that CSR involves the ‘socialist’ view that political, not market mechanisms are better for allocating scarce resources to alternative uses. But CSR has also been invoked to justify wage curbs against trade union demands, ostensibly for some higher public purpose.

CSR has also been invoked when philanthropy and charity have been abused to minimize tax liability, and for public relations and marketing, e.g., by ‘greenwashing’ products and services.

W(h)ither capitalism?

Embarrassingly, US corporations that signed the ‘stakeholder capitalism’ statement have been more likely to lay off workers in response to the COVID-19 pandemic, and less likely to donate to relief efforts.

With growing opposition to neoliberal capitalism, ‘stakeholderism’ and CSR have been invoked to save capitalism by offering a more sensitive ‘human’ face.

As capitalism may well be the only ‘show in town’ for some time to come, popular demands for more thoroughgoing reforms, checks and balances are likely to grow as the realities of stakeholder capitalism and CSR become increasingly apparent.

Stop blaming industrial policy

Vladimir Popov, Jomo Kwame Sundaram

BERLIN, KUALA LUMPUR: Industrial policy – or the promotion of particular investments, technologies, industries, regions and enterprises – has been practiced by a variety of governments to try to accelerate economic growth and transformation.

The ascendance of the Washington Consensus, inspired by the neoliberal counter-revolution in economics, focused on alleged national macroeconomic mismanagement in developing countries and later, transition economies. This was typically blamed on ‘soft budget constraints’ (SBCs) in socialist states and enterprises, macroeconomic populism and industrial policy.

Blaming industrial policy

Enterprise-level SBCs have also been wrongly blamed on industrial policy to promote certain economic activities, usually manufacturing with more advanced technologies. In practice, most industrial policy was quite selective, i.e., involving support of some industries, regions and enterprises at the expense of others.

While such selective support may or may not have been successful in promoting targeted industries, industrial policy has been wrongly, and sometimesdeliberately blamed for both enterprise and national level fiscal SBCs. Fiscal SBCs have been wrongly blamed on enterprise-level SBCs in socialist states, macroeconomic populism and industrial policy.

But contrary to many economists’ presumptions, in most economies, including many centrally planned ‘socialist’ ones, few enterprises were exempted from budgetary discipline. SBCs were therefore the very rare exception, not the rule, to promote desired new economic activities.

Enterprise-level SBCs did not “permeate all organizations” in socialist countries, as often claimed and assumed, but were instead quite selective, i.e., subsidies were provided to some enterprises, industries or regions, typically at the expense of others.

All centrally planned economies had both explicit and implicit subsidies. In most Eastern European and Soviet countries during 1989-1992, on the eve of transition, direct subsidies in the government budget amounted to 10-15% of national income.

In addition to direct subsidies for public utilities, housing and food, there were implicit price subsidies, particularly for users of fuel, energy and raw materials. Besides explicit subsidies from government budgets, rents from unsustainable, non-renewable resource extraction were shared with industries and consumers via lower prices.

Dwarf infant industries

The fiscal problem was not due to subsidization per se, or even to subsidization of manufacturing – at the expense of resource industries, trade and financial services. Rather, the problem was in the way such subsidization was carried out, i.e., by maintaining higher domestic prices for manufactured goods.

Such import-substituting industrialization (ISI) typically created industries which rarely became internationally competitive and viable. There have been all too many examples of failed ISI requiring ongoing subsidization of ‘infant industries’ incapable of ever becoming internationally uncompetitive.

These industries were exposed as unviable and unsustainable with trade liberalization and the end of Soviet era trade arrangements in the 1990s. Soviet industrialization from the 1930s had survived before that due to its insulated economic environment, with the ratio of Soviet exports to GDP not rising until fuel sales abroad rose with higher prices from the 1970s.

Perestroika reforms, initiated by reformist Soviet leader Gorbachev after the mid-1980s, failed to accelerate needed enterprise reforms or economic growth, but instead led to the ‘transformational recession’ of the 1990s, greatly exacerbated by the reforms during Boris Yeltsin’s first presidential term.

Many other enterprises – mainly in heavy industries, and often relying on Soviet technology, advice and aid – in other ‘socialist’ economies and developing countries subject to Soviet influence, experienced similar fates.

Thus, nations which tried to challenge Western hegemony met similar fates despite trying to make a virtue of ‘self-reliance’ compelled by the need to cope with Western-led trade and investment sanctions.

Successful industrial policy

Most countries trying to industrialize or to accelerate industrialization started with ISI, with effective protection enabling new enterprises to produce for domestic markets by keeping out imported foreign substitutes with prohibitively high tariffs and non-tariff trade barriers.

But many IS enterprises continued to survive, even profit from such supposedly temporary tariff protection and other government support, never becoming internationally competitive as promised by the ISI strategy.

In more successful ‘late developing’ economies, government support was conditional on meeting performance criteria which effectively attracted private investments. Such investors sought more handsome ‘rents’ by accelerating technological progress, productivitand international competitiveness.

Thus, for example, ‘effective protection conditional on export promotion’ enabled the emergence of internationally competitive enterprises in some East Asian economies. Export orientation has been especially important in improving output quality to meet internationally competitive product quality and performance standards while achieving cost competitiveness.

Without more effective means for disciplining enterprises to accelerate development, export-orientation – promoted by government policy, incentives and other support – has contributed to successful catch-up growth. East Asian economies subsidized competitive export-oriented industries which accelerated economic growth and transformation, some more successfully than others.

In China, for instance, exports compared to GDP increased from 5% in 1978 to 35% in 2006, before declining to 20% in 2018, while its GDP grew at an average of 10% annually, with its population rising slower than in most other developing countries due its ‘one child’ policy.

Appropriate industrial policy needed

Budget constraints in socialist economies were generally stronger than in developing countries and no less strict than in developed countries on average. SBCs in socialist economies were never pervasive, as widely believed, but selective, i.e., subsidizing some enterprises or industries at the expense of others.

Such selective support, while typical of industrial policy, may or may not successfully promote internationally competitive enterprises, but certainly provides no empirical support for the claim of pervasive SBCs in ‘socialist’ economies.

With state-owned enterprises, strict fiscal and enterprise-level discipline, including budget constraints, have led to restructuring, and more rarely, closures. But even when budget constraints have been less than strict, they have not been pervasive, as fiscally disciplined ‘socialist’ economies could not afford otherwise.

National-level macroeconomic mismanagement in developing countries and transition economies has all too often by ideologically defined by neoliberal economics. In so far as macroeconomic challenges are real and demand pragmatic policy attention, they should not be defined by distracting neoliberal chimera of alleged SBCs variously blamed on socialism, populism and industrial policy.

Unfortunately, the mythology surrounding SBCs has been used to throw the industrial policy baby out with the bathwater of ISI cul de sacs. Much more appropriate, yet pragmatic industrial policy is needed for developing countries and transition economies to ‘catch up’, as achieved by some East Asian and other economies.

Shareholder capitalism’s ugly legacy

Jomo Kwame Sundaram

KUALA LUMPUR: Milton Friedman’s libertarian economics advocating shareholder capitalism has influenced generations trying to understand the economy, not only in the US, but all over the world.

He was not just an academic economist, but an enormously influential celebrity conservative ideologue who legitimized ideas for the like-minded, including the belief that ‘greed is good’. Now, shareholder capitalism’s consequences haunt the world and threaten humanity with stagnation and self-destruction.

Friedman’s lasting influence

In 1962, Friedman published his most influential book, Capitalism and Freedom. In September 1970, the New York Times Magazine published his essay, The Social Responsibility of Business is to Increase Its Profits. The fiftieth anniversary of its publication has triggered an international debate of its contemporary significance, especially with the resurgence of ethno-populist jingoism embracing his neoliberal economic agenda.

In 1962, Friedman published his most influential book, Capitalism and Freedom. In September 1970, the New York Times Magazine published his essay, The Social Responsibility of Business is to Increase Its Profits

The article -- reiterating the Friedman Doctrine, presuming perfectly functioning markets that only exist in the minds and writings of some economists -- is a manifesto for American shareholdercapitalism. It inspired the counter-revolution against Keynesianism, development economics and other state interventions.

The word ‘competition’ appears only once, in the last sentence. Yet, some supporters insist that Friedman was not ‘pro-business’, but rather ‘pro-market’. But, unlike capitalism, the market has been with us for several millennia and has happily co-existed with unfreedoms of various types.

Perfect competition rarely exists due to inherent tendencies undermining it. Hence, various challenges to Friedmanite wisdom. For half a century, information and behavioural economics have challenged his many assumptions, certainly much more than the Austrian School advocacy and defence of capitalism.

Thus, Friedman conveniently ignored ‘market imperfections’ in the real world, although or perhaps because they undermined the empirical bases for his reasoning. So, even if Friedman’s logic was true, reality prevents profit-maximizing firm behaviour from maximizing societal welfare, if not cause the converse.

Meanwhile, Friedman’s monetarist economics has been discredited, and has little practical influence anymore, especially with the turn to ‘unconventional monetary policies’, particularly after the 2008-2009 global financial crisis. Yet, his ideological sway remains strong, as it serves powerful interests.

Greed is good

Hence, Friedman’s 1970 essay remains influential in the world, and has long served as the mainstream manifesto on corporate governance. Even then, Friedman denounced dissenting CEOs as “unwitting puppets of the intellectual forces that have been undermining the basis of a free society”.

Generations of Friedmanites have insisted that ‘the only business of business is business’, and their sole responsibility to society is to make money. He emphasized, ‘‘there is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.’’

When Friedman insisted “make as much money as possible while conforming to the basic rules of the society”, he may have presumed that market imperfections do not exist, or were fully addressed by the ‘minimal’ state, although it is well-known that the rule of law has never been adequate to the challenge.

His singular focus on maximizing profits for shareholders justified ignoring all problems due to corporate practices. The doctrine thus absolved the firm of social responsibility. It justified and encouraged generations of corporate leaders committed to the primacy of ‘shareholder value’. Almost like religion, this thinking became the hegemonic ideology, legitimizing ‘greed-is-good’ behaviour.

Government the problem?

Friedman’s ideology spread throughout the world with the ‘neoliberal’ counter-revolution from the 1980s.

Unsurprisingly, neoliberal economists’ claims have been discredited by their policies’ failure to significantly increase investments in the real economy in recent decades.

And without sufficient investments to enhance productivity, growth has declined, if not stagnated, while dimming future economic prospects. With labour incomes declining relatively, if not absolutely, consumer spending has declined, reducing aggregate demand while feeding a vicious circle of stagnation.

Meanwhile, deregulatory initiatives have not increased real investments and output growth.Market finance ideology claims that the stock market can best allocate investment resources among companies. But share buybacks imply that US corporations have no better investment options than to further raise already high, over-valued financial asset prices, thus reducing resources for real investments and future growth.

The Friedman doctrine also celebrated and justified short-termism, and undermining protection for employees and the environment to maximize shareholder value by increasing corporate profits. This type of capitalism has spread throughout the world with the ‘neoliberal’ counter-revolution since the 1980s.

‘Getting government out of the way’, the neoliberal ‘free market’ mantra, was supposed to boost private investments. But more handsome corporate profits due to cost savings – from weaker anti-trust and other regulations, lower wages and taxes – have not significantly increased real investments in the US.

The 2007-2009 US financial crisis exposed some problems of short-termism, particularly related to financialization and ‘shareholder value extraction’. The crisis cast doubt on Friedman’s legacy and its implications, encouraging new challenges to corporate governance norms and regulations.

Business and politics

Friedman would have us believe that power and politics are not exercised in free markets. But this ostensible insulation of politics from supposedly power-free markets is a fiction which thoughtful Friedmanites knew only too well, not least from their own advocacy, behaviour and conduct.

All markets are shaped by various historical and contemporary influences, economic, cultural, social and political. These are often driven by business and other lobbies. Thus, politics, collective action and advocacy shape policies, in terms of design, implementation and enforcement.

To be fair, Friedman’s view of politics and business seems contradictory. His writings argue that business should stay out of politics, and not use shareholder money to influence politics. But he is remarkably understanding when it happens:

“I can’t blame a businessman who goes to Washington and tries to get special privileges for his company”. “If the rules of the game are that you go to Washington to get a special privilege, I can’t blame him for doing that. Blame the rest of us for being so foolish as to let him get away with it.”

Neoliberal inequality

Former Clinton Labor Secretary Robert Reich has argued that larger US corporations have acquired so much influence over government, undermining US democracy. Instead, he argues for public financing of electoral campaigns while curbing corporate influence, e.g., via lobbying and campaign spending.

He cites an old study of 1,779 policy issues during 1981-2002 which found lawmakers acceding to the demands of big businesses with the most lobbying capabilities while the average American had “only a miniscule, near-zero, statistically nonsignificant impact upon public policy”.

With the Citizens United ruling in the new century, the US Supreme Court has legally enabled powerful corporate interests to lobby politically. Unsurprisingly, corporate taxation has been dramatically reduced, while social protection and public investments, e.g., in health and education, have declined further.

Instead of gains being shared by top executives and shareholders with workers, as during the post-Second World War Golden Age, benefits have become increasingly skewed to the very wealthy in the past four decades, thanks to Friedman’s increased influence.

From 1948 to 1979, US worker productivity more than doubled while wages fell slightly behind as the stock market grew over six-fold. But from 1979 to 2018, worker productivity rose 70 per cent, as worker pay rose by only 11.6 per cent, while CEO compensation rose almost ten-fold and the stock market 22-fold!