Capitalism must evolve to solve the climate crisis

There are two extremes in the debate over capitalism’s role in our present climate change problem. On the one hand, some people see climate change as the outcome of a consumerist market system run rampant. In the end, the result will be a call to replace capitalism with a new system that will correct our present ills with regulations to curb market excesses.

On the other hand, some people have faith in a free market to yield the needed solutions to our social problems. In the more extreme case, some see climate policy as a covert way for bigger government to interfere in the market and diminish citizens’ personal freedom.

Between these two extremes, the public debate takes on its usual binary, black and white, conflict-oriented, unproductive and basically incorrect form. Such a debate feeds into a growing distrust many have for capitalism.

A 2013 survey found that only 54% of Americans had a positive view of the term, and in many ways both the Occupy and Tea Party movements share similar distrust in the macro-institutions of our society to serve everyone fairly; one focuses its ire at government, the other at big business and both distrust what they see as a cozy relationship between the two.

This polar framing also feeds into culture wars that are taking place in our country. Studieshave shown that conservative-leaning people are more likely to be skeptical of climate change due, in part to a belief that this would necessitate controls on industry and commerce, a future they do not want. Indeed, research has shown a strong correlation between support for free-market ideology and rejection of climate science. Conversely, liberal-leaning people are more likely to believe in climate change because, in part, solutions are consistent with a resentment towards commerce and industry and the damage they cause to society.

This binary framing masks the real questions we face, both what we need to do and how we are going to get there. Yet there are serious conversations within management education, research and practice about the next steps in the evolution of capitalism. The goal is to develop a more sophisticated notion of the role of the corporation within society. These discussions are being driven not only by climate change, but concerns raised by the financial crisis, growing income inequality and other serious social issues.

The market’s rough edges

Capitalism is a set of institutions for structuring our commerce and interaction. It is not, as some think, some sort of natural state that exists free from government intrusion. It is designed by human beings in the service of human beings and it can evolve to the needs of human beings. As Yuval Levin points out in National Affairs, even Adam Smith argued that “the rules of the market are not self-legislating or naturally obvious. On the contrary, Smith argued, the market is a public institution that requires rules imposed upon it by legislators who understand its workings and its benefits.”

And, it is worth noting, capitalism has been quite successful. Over the past century, the world’s population increased by a factor of four, the world economy increased by a factor of fourteen and global per capita income tripled. In that time, average life expectancy increased by almost two-thirds due in large part to advances in medicine, shelter, food production and other amenities provided by the market economy.Some view capitalism as the primary cause for environmental degradation, part of growing concerns over economic inequality and other social issues.stephenmelkisethian/flickr, CC BY-NC-ND

Capitalism is, in fact, quite malleable to meet the needs of society as they emerge. Over time, regulation has evolved to address emergent issues such as monopoly power, collusion, price fixing and a host of other impediments to the needs of society. Today, one of those needs is responding to climate change.

The question is not whether capitalism works or doesn’t work. The question is how it can and will evolve to address the new challenges we face as a society. Or, as Anand Giridharadas poiunted out at the Aspen Action Forum, “Capitalism’s rough edges must be sanded and its surplus fruit shared, but the underlying system must never be questioned.”

These rough edges need be considered with the theories we use to understand and teach the market. In addition, we need to reconsider the metrics we use to measure its outcomes, and the ways in which the market has deviated from its intended form.

Homo economicus?

To begin, there are growing questions around the underlying theories and models used to understand, explain and set policies for the market. Two that have received significant attention are neoclassical economics and principal-agent theory. Both theories form the foundation of management education and practice and are built on extreme and rather dismal simplifications of human beings as largely untrustworthy and driven by avarice, greed and selfishness.

As regards neoclassical economics, Eric Beinhocker and Nick Hanauer explain:

“Behavioral economists have accumulated a mountain of evidence showing that real humans don’t behave as a rational homo economicus would. Experimental economists have raised awkward questions about the very existence of utility; and that is problematic because it has long been the device economists use to show that markets maximize social welfare. Empirical economists have identified anomalies suggesting that financial markets aren’t always efficient.”

As regards principal-agent theory, Lynn Stout goes so far to say that the model is quite simply “wrong.” The Cornell professor of business and law argues that its central premise – that those running the company (agents) will shirk or even steal from the owner (principal) since they do they work and the owner gets the profits – does not capture “the reality of modern public corporations with thousands of shareholders, scores of executives and a dozen or more directors.”

The most pernicious outcome of these models is the idea that the purpose of the corporation is to “make money for its shareholders.” This is a rather recent idea that began to take hold within business only in the 1970s and 1980s and has now become a taken-for-granted assumption.

If I asked any business school student (and perhaps any American) to complete the sentence, “the purpose of the corporation is to…” they would parrot “make money for the shareholder.” But that is not what a company does, and most executives would tell you so. Companies transform ideas and innovation into products and services that serve the needs of some segment of the market. In the words of Paul Pollman, CEO of Unilever, “business is here to serve society.” Profit is the metric for how well they do that.

The problem with the pernicious notion that a corporation’s sole purpose is to serve shareholders is that it leads to many other undesirable outcomes. For example, it leads to an increased focus on quarterly earnings and short–term share price swings; it limits the latitude of strategic thinking by decreasing focus on long-term investment and strategic planning; and it rewards only the type of shareholder who, in the words of Lynn Stout, is “short-sighted, opportunistic, willing to impose external costs, and indifferent to ethics and others’ welfare.”

A better way to gauge the economy

Going beyond our understanding of what motivates people and organizations within the market, there is growing attention to the metrics that guide the outcomes of that action. One of those metrics is the discount rate. Economist Nicholas Stern stirred a healthy controversy when he used an unusually low discount rate when calculating the future costs and benefits of climate change mitigation and adaptation, arguing that there is a ethical component to this metric’s use. For example, a common discount rate of 5% leads to a conclusion that everything 20 years out and beyond is worthless. When gauging the response to climate change, is that an outcome that anyone – particularly anyone with children or grandchildren – would consider ethical? Adam Smith: a lot has changed since he captured the notion of the liberal economy in the 18th century.surfstyle/flickr, CC BY

Another metrics is Gross Domestic Product (GDP), the foremost economic indicator of national economic progress. It is a measure of all financial transactions for products and services. But one problem is that it does not acknowledge (nor value) a distinction between those transactions that add to the well-being of a country and those which diminish it. Any activity in which money changes hands will register as GDP growth. GDP treats the recovery from natural disasters as economic gain; GDP increases with polluting activities and then again with pollution clean-up; and it treats all depletion of natural capital as income, even when the depreciation of that capital asset can limit future growth.

A second problem with GDP is that it is not a metric dealing with true human well-being at all. Instead, it is based on the tacit assumption that the more money and wealth we have, the better off we are. But that’s been challenged by numerous studies.

As a result, French ex-president Nicolas Sarkozy created a commission, headed by Joseph Stieglitz and Amartya Sen (both Nobel laureates) to examine alternatives to GDP. Their report recommended a shift in economic emphasis from simply the production of goods to a broader measure of overall well-being which would include measures for categories like health, education, and security. It also called for greater focus on the societal effects of income inequality, new ways to measure the economic impact of sustainability, and ways to include the value of wealth to be passed on to the next generation. Similarly, the King of Bhutan has developed a GDP alternative called Gross National Happiness which is a composite of indicators that are much more directly related to human well-being than monetary measures.

The form of capitalism we have today has evolved over centuries to reflect growing needs, but also has been warped by private interests. Yuval Levin points out that some key moral features of Adam Smith’s political economy have been corrupted in more recent times, most notably by “a growing collusion between government and large corporations.” This issue has become most vivid after the financial crisis and the failed policies that both preceded and succeeded that watershed event. The answers, as Auden Schendler and Mark Trexler point out, are both “policy solutions” and “corporations to advocate for those solutions.”

We can never have a clean slate

How will we get to the solutions for climate change? Let’s face it. Installing efficient LED light bulbs, driving the latest Tesla electric car and recycling our waste are admirable and desirable activities. But they are not going to solve the climate problem by reducing our collective emissions to a necessary level. To achieve that goal requires systemic change. To that end, some argue for creating a new system to replace capitalism. For example, Naomi Klein calls for “shredding the free-market ideology that has dominated the global economy for more than three decades.”

Klein’s is performing a valuable service with her call for extreme action. She, like Bill McKibben and his 350.org movement, is helping to make it possible for a conversation to take place over the magnitude of the challenge before us through what is called the “radical flank effect.”

All members and ideas of a social movement are viewed in contrast to others, and extreme positions can make other ideas and organizations seem more reasonable to movement opponents. For example, when Martin Luther King Jr. first began speaking his message, it was perceived as too radical for the majority of white America. But when Malcolm X entered the debate, he pulled the radical flank further out and made King’s message look more moderate by comparison. Capturing this sentiment, Russell Train, second administrator of the EPA, once quipped, “Thank God for [environmentalist] Dave Brower; he makes it so easy for the rest of us to be reasonable.”

But the nature of social change never allows us the clean slate that makes sweeping statements for radical change attractive. Every set of institutions by which society is structured evolved from some set of structures that preceded it. Stephen Jay Gould made this point quite powerful in his essay “The Creation Myths of Cooperstown” where he pointed out that baseball was not invented by Abner Doubleday in Cooperstown New York in 1839. In fact, he points out, “no one invented baseball at any moment or in any spot.” It evolved from games that came before it. In a similar way, Adam Smith did not invent capitalism in 1776 with his book The Wealth of Nations. He was writing about changes that he was observing and had been taking place for centuries in European economies; most notably the division of labor and the improvements in efficiency and quality of production that were the result.

In the same way, we cannot simply invent a new system to replace capitalism. Whatever form of commerce and interchange we adopt must evolve out of the form we have at the present. There is simply no other way.

But one particularly difficult challenge of climate change is that, unlike Adam Smith’s proverbial butcher, brewer or baker who provide our dinner out of the clear alignment of their self-interest and our needs, climate change breaks the link between action and outcome in profound ways. A person or corporation cannot learn about climate change through direct experience. We cannot feel an increase in global mean temperature; we cannot see, smell or taste greenhouse gases; and we cannot link an individual weather anomaly with global climate shifts.

A real appreciation of the issue requires an understanding of large-scale systems through “big data” models. Moreover, both the knowledge of these models and an appreciation for how they work require deep scientific knowledge about complex dynamic systems and the ways in which feedback loops in the climate system, time delays, accumulations, and non-linearities operate within them. Therefore, the evolution of capitalism to address climate change must, in many ways, be based on trust, belief and faith in stakeholders outside the normal exchange of commerce. To get to the next iteration of this centuries-old institution, we must envision the market through all components that help to establish the rules; corporations, government, civil-society, scientists and others.

The evolving role of the corporation in society.

At the end of the day, the solutions to climate change must come from the market and more specifically, from business. The market is the most powerful institution on earth, and business is the most powerful entity within it. Business makes the goods and services we rely upon: the clothes we wear, the food we eat, the forms of mobility we use and the buildings we live and work in.

Businesses can transcend national boundaries and possess resources that exceed that of many countries. You can lament that fact, but it is a fact. If business does not lead the way towards solutions for a carbon-neutral world, there will be no solutions.

Capitalism can, indeed it must, evolve to address our current climate crisis. This cannot happen through either wiping clean the institutions that presently exist or relying on the benevolence of a laissez faire market. It will require thoughtful leaders creating a thoughtfully structured market.

For all of Andrew Hoffman’s previous articles and columns, click here.