Connect with us

Hi, what are you looking for?

Right Decision NowRight Decision Now

Politics

“Stakeholder Capitalism” Is an Incoherent Term

At the annual World Economic Forum meeting in Davos this year, Klaus Schwab gave a televised interview where he said that stakeholder capitalism will become the ideal economic system for efficiently allocating resources in order to “master ze future.” However, the problem with Schwab’s stakeholder capitalism is that it is inconsistent with its stated ends. Furthermore, Schwab’s ideas are not new. Most of them are variations of old ideas like social responsibility and fixing market failures.

In an article from March 2021, Schwab argues there are three types of capitalism: shareholder, stakeholder, and state. However, in formal comparative economics, neither shareholder nor stakeholder capitalism is recognized as its own system. Shareholder capitalism just means capitalism (or liberalism, formally). Since stakeholder capitalism claims to respect the private property regimes of capitalism, its difference lies in proposing alternative institutional arrangements that structure market activity. On the other hand, state capitalism is closest to political capitalism or fascism in the literature.

In developing his argument, Schwab says that stakeholder capitalism is capitalism in that

private actors own and control property in accord with their interests, and demand and supply freely set prices in markets in a way that can serve the best interests of society.

To him, the difference is whether shareholders, stakeholders, or the state are the dominant group in society. Curiously, this framing deviates from most macroeconomic textbooks which propose four actors: households, firms, the state, and the rest of the world. Nevertheless, Schwab writes:

In both shareholder and state capitalism, the dominance of one stakeholder over the others is the system’s greatest flaw. . . . But stakeholder capitalism does fundamentally differ from the other forms of capitalism we saw. . . . First, all those who have a stake in the economy can influence decision-making. . . . Moreover, a system of checks and balances exists, so that no one stakeholder can become or remain overly dominant. Both government and companies . . . thus optimise for a broader objective than profits: the health and wealth of societies overall. (emphasis added)

Let us unpack his claim about interest-group dominance under capitalism. Generally, it is true that shareholders as a category direct firm activity to earn profits. However, there is no single group of shareholders that directs all economic activity. In fact, there are many shareholder groups that compete against each other. Moreover, shareholders can also be stakeholders under different contexts; it is all specific to time and place. But to the degree that economics recognizes a dominant group in capitalism, it must be the consumer. It is the consumer that must be satisfied for shareholders to earn a profit. So why does Schwab emphasize the firm? Well, it’s simple: is it easier to change the consumption preferences of the entire market or is it easier to change the rules that guide firm activity?

By framing the discussion in terms of interest groups that compete for shares of society, Schwab is making a political case, not an economic one. By promoting the idea that there are shares of society up for grabs, this invites zero-sum thinking about what is a “fair” share. After all, if one group “wields too much power,” this implies it must come at the expense of others. In short, this persuasion trick is designed to get people to view capitalism as unfair and demand an alternative. Sound familiar? Additionally, it allows Schwab to promote the idea of market failure.

Schwab insists that shareholder dominance results in myopic competition, which often causes social disorders like pollution. This view is hardly original. John Maynard Keynes made a similar argument in 1926:

It is not a correct deduction from the Principles of Economics that enlightened self-interest always operates in the public interest. . . . More often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these.

In short, the complaint is that real-world markets frequently fail to live up to the standards of perfect competition (itself a dubious standard). As a result, the market is deemed incapable of fixing the problem and thus requires outside forces, like government, to intervene.

However, Schwab takes a different approach in addressing market failure in two ways. First, he argues that shareholder interests must be weighed against those of “stakeholders” in firm activity. To Schwab, if these stakeholders are included in company decision-making, then negative externalities like pollution could be avoided altogether. Second, Schwab argues that a system of checks and balances is necessary to prevent any one interest group from becoming dominant.

For the remainder of the article, I will focus the analysis on the first “solution.” The reason is that the second ultimately requires a political process that utilizes political knowledge. And as I will show below, political knowledge cannot rationally allocate resources, so we can ignore it.

Although there are myriad practical issues in diluting shareholder interests with those of third parties, I want to focus on where Schwab ends up in his logic. He says that “government and companies . . . optimize for a broader objective than profit.” First, governments are not residual claimants to their activity and therefore do not incur economic profits or losses. Second, if stakeholder capitalism is supposedly more efficient, then how will this be accomplished if profit and loss signals are diluted by “broader” considerations? What other than profit will leverage the self-interest of entrepreneurs to take risks? Schwab never answers this part; it is left up to the reader’s imagination.

This is the core problem with stakeholder capitalism. Schwab is in effect arguing that the process of economic calculation can be improved with arbitrary metrics. And somehow, these metrics will lead to a more efficient allocation than in a market economy.

Socialist economists tried the same trick by promoting labor time as a substitute for market prices. However, as Ludwig von Mises and Friedrich Hayek showed, the only type of information that communicates economic realities are market prices that are generated from a system of private property. Since owners of private property fully bear the costs and benefits of ownership, these prices communicate all entrepreneurial discoveries up to that point and all entrepreneurial errors currently being made.

Or, in the efficient market hypothesis, market prices fully reflect all available information. Therefore, using these market prices is the only way to engage in economic calculation such that profits can be obtained and a rational allocation achieved. Since arbitrary metrics like labor time, or “health” as Schwab proposes, do not communicate concrete economic realities like scarcity of resources or the opportunity costs of ownership, they are fundamentally useless for economic calculation. And it is on this basis that stakeholder capitalism is incoherent.

Furthermore, even if you believe that firms should be socially responsible, however defined, having them optimize for something other than profit impairs their ability to be responsible! Since arbitrary metrics have no economic foundation, they will have to be articulated by political authorities. And because political authorities wield monopoly power of imposing costs through regulation, this encourages firms to compete against one another to satisfy the preferences of the political authorities, otherwise known as rent seeking. Since rent seeking is a negative-sum process that destroys wealth, it is therefore inconsistent with socially responsible behavior.

    You May Also Like

    Business

    The head of the International Monetary Fund has warned of increased risks to the stability of the financial system after weeks of banking sector...

    World News

    BEIJING — China landed an uncrewed spacecraft on the far side of the moon on Sunday, overcoming a key hurdle in its landmark mission...

    World News

    LONDON — Talks aimed at reaching a global agreement on how to better fight pandemics will be concluded by 2025 or earlier if possible,...

    World News

    SINGAPORE — Ukrainian President Volodmyr Zelensky’s unscheduled appearance at Asia’s biggest security conference dominated proceedings on Sunday after China’s defense chief slammed “separatists” in...

    Disclaimer: rightdecisionnow.com, its managers, its employees, and assigns (collectively “The Company”) do not make any guarantee or warranty about what is advertised above. Information provided by this website is for research purposes only and should not be considered as personalized financial advice. The Company is not affiliated with, nor does it receive compensation from, any specific security. The Company is not registered or licensed by any governing body in any jurisdiction to give investing advice or provide investment recommendation. Any investments recommended here should be taken into consideration only after consulting with your investment advisor and after reviewing the prospectus or financial statements of the company.

    Copyright © 2024 rightdecisionnow.com | All Rights Reserved