Capitalism and Western Civilization: Corporatism

William H. Young

In his Annual Report to shareholders in February 2009, General Electric CEO Jeffrey Immelt predicted that capitalism “will be ‘reset’ in several important ways. The interaction between government and business will change forever. In a reset economy, the government will be regulator, and also an industry policy champion, a financier, and a key partner.” Shortly thereafter, Immelt became Chairman of President Obama’s Council on Jobs and Competitiveness. Crony capitalism—or more broadly, corporatism—was envisioned as the new model for American business. 

Corporatism is a system of economic, political, or social organization in which corporate groups associate and act on the basis of common interests. Mercantilism, the system opposed by Adam Smith and our Founders, exemplified corporatism, in which the state and bankers were partners with monopolistic trading companies. 

American progressivism was founded upon the belief that history moves forward, not on the basis of individual action, but instead by that of organic bodies or groups with concerted purposes and power, as I discussed in Individual Responsibility. Historian and biographer Arthur S. Link notes that Woodrow Wilson adopted Herbert Croly’s idea that corporations should be “express economic agents of the whole community.” (Wilson, 1947) 

Columbia University economist Edmund S. Phelps explains (“Capitalism vs. Corporatism,” Critical Review, January 11, 2010) that capitalism is founded on private ownership and is characterized by free enterprise in which private managers make commercial decisions which are enabled by private suppliers of capital. Corporatism is also founded on private ownership and management, “but has been modified by introducing institutions aimed at protecting the interests of ‘stakeholders’ and ‘social partners’”—groups with which the corporation is associated. 

In the 1930s, the question of whether corporate boards should be held accountable for the interests of non-shareholder constituencies participating in the corporation’s activities was raised. Such constituencies—or stakeholders—included employees, lenders, and others. Existing property law that corporations exist for the sole purpose of making profits for shareholders was upheld. Control of corporate governance is exercised through shareholder election of company directors, called shareholder democracy or shareholder capitalism. (Margaret M. Blair, Ownership and Control, Brookings Institution, 1995) Also see my article Corporations, which points out that in capitalism, jobs are a “wonderful byproduct” of wealth creation for shareholders. 

During the 1960s, the progressive idea that corporations have a “social responsibility” was embraced by academia and activist movements. Moreover, corporatism took form in big American companies that joined with big labor and big government to seek full employment in a mixed economy, following the advice of academic economists. This is called the era of  “stakeholder capitalism” by Michael Lind in “The Failure of Shareholder Capitalism,” CNN, March 29, 2011. Lind explains: 

According to the theory of stakeholder capitalism, corporations are and should be quasi-public entities with responsibilities to the nation-state and to the communities in which they are embedded….Managers serve the company and the country, not merely the investors.

But as Milton Friedman had explicated some three decades earlier (“The Social Responsibility of Business is to Increase Profits,” The New York Times Magazine, September 13, 1970):

In a free society 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.

During the 1970s, labor productivity and corporate profitability under stakeholder capitalism or corporatism fell drastically, ultimately by about half, and economic stagflation reigned. Lind notes that “the rise of shareholder capitalism in the U. S. is often dated to an influential article…in 1976…by Michael C. Jensen and William H. Meckling” (“Theory of the Firm,” Journal of Financial Economics, Vol. 3, Issue 4). “They argued that shareholders should demand higher returns from complacent corporate managers. The idea of shareholder value was published in a 1981 speech by Jack Welch, who had just taken over General Electric.” Restructuring of big corporate America to become more productive and profitable in global competition began in the 1980s, as I elucidated in Finance. The economy expanded, as I described in Growth

The idea of stakeholder capitalism has continued in academia. In Strategic Management: A Stakeholder Approach (1984, reprinted 2010), the Wharton School’s R. Edward Freeman offered a theory of how businesses could succeed in a new and changing environment in which powerful stakeholder groups were playing a greater role, and how directors and managers of the business should anticipate and proactively deal with potential stakeholders. Many businesses follow that advice. But Freeman turned to the Kantian (and collectivist) idea that each stakeholder group has a right to be treated as an end in itself, and not as a means to some other end—“and therefore must participate in determining the future direction of the firm in which…[it has] a stake.” (William M. Evan and R. Edward Freeman, “A Stakeholder Theory of the Modern Corporation: Kantian Capitalism,” in Thomas L. Beauchamp and Norman E. Bowie, Ethical Theory and Business, 1988, reprinted 2008) 

President Bill Clinton, in an interview with Aaron Task on September 19, 2011(The Daily Ticker, Yahoo), declared: 

The American Dream has been under assault for 30 years….About 35 years ago, the notion of what a corporation is changed. Previously, corporations were ‘more or less’ equally responsible to shareholders, employees, customers and the communities where they operated. Now, shareholders are up here and everybody else is way down there. 

More than half of Americans are shareholders. (Gallup, April 2011) 

Lind calls the shareholder capitalism that began in the 1980s “a tragic mistake,” in which private-equity firms made “short-term profits by dismantling or destroying companies and laying off their workers,” a charge I debunked in Finance. Further, Karl Rove demonstrates (“Obama’s Public-Equity Record,” The Wall Street Journal, May 10, 2012) that President Obama’s signal achievement of corporatism—bailout of the bloated giants from the 1970s, General Motors and Chrysler—had far more adverse consequences than private-equity restructurings. 

Professor Phelps (and co-author Salfedean Ammous) remonstrates in “Blaming Capitalism for Corporatism” (Project Syndicate, January 31, 2012): 

In various ways, corporatism chokes off the dynamism that makes for engaging work, faster economic growth, and greater opportunity and inclusiveness. It maintains lethargic…and well-connected firms at the expense of dynamic newcomers and outsiders. The costs of corporatism are visible all around us…sclerotic economies with slow…growth…increasing concentration of wealth in the hands of those connected enough to be on the right side of the corporatist deal… 

Corporatism’s apologists and beneficiaries have the temerity to blame failures on ‘reckless capitalism’ and ‘lack of regulation,’ which they argue necessitates more oversight and regulation, which in reality means more corporatism and state favoritism….The legitimacy of corporatism is eroding along with the fiscal health of governments that have relied on it. If politicians cannot repeal corporatism, it will bury itself in debt and default. 

Speaking of demands by Occupy Wall Street to “end corporate welfare,” the editors of The Wall Street Journal (“Review & Outlook,” November 8, 2011) responded, “Well, welcome aboard. Some of us have been fighting crony capitalism for decades.” They cite numerous examples including $80 billion “investments” in clean energy (some to General Electric and an Obama crony’s Solyndra). In Washington, an old joke goes, Republicans love corporations and Democrats love welfare. 

Ironically, General Electric has turned from a 1980s’ archetype of shareholder capitalism to a prototype for corporatism, in which the state exerts influence or control without ownership. Such a turn does not bode well for our economy, as the discussion above reveals. Government should instead be enabling free enterprise and small businesses, America’s job creators (see my article Jobs). 

The kind of college education sought by NAS should include a perspective on the various forms of corporate capitalism—and why the Founders’ foresight in rejecting corporatism should again guide us. 

Next week’s article will discuss factors in corporate taxation.

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This is one of a series of occasional articles applying the lessons of Western civilization to contemporary issues relevant to the academy.

The Honorable William H. Young was appointed by President George H. W. Bush to be Assistant Secretary for Nuclear Energy and served in that position from November 1989 to January 1993. He is the author of Ordering America: Fulfilling the Ideals of Western Civilization (2010) and Centering America: Resurrecting the Local Progressive Ideal (2002).

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