29 Jul 2013  Research & Ideas

A Manager’s Moral Obligation to Preserve Capitalism

Harvard Business School's Rebecca M. Henderson and Karthik Ramanna argue that company managers have a moral obligation to preserve capitalism.

 

Most of us tend not to think of capitalism as a moral system. The prevailing view of the free market, among laypeople and economists alike, is that it's one step removed from the law of the jungle. But the fact is that capitalism has always had an explicit moral framework that runs as a thread through the writings of Adam Smith, Milton Friedman, and Friedrich Hayek among other foundational thinkers.

"Many economists think of it as a positivist system that does not impose morality upon society, but this is not the case," says Harvard Business School Associate Professor Karthik Ramanna, who holds appointments as the Henry B. Arthur Fellow, supporting the research and teaching of business ethics, and as a Marvin Bower Fellow, helping faculty launch innovative new business agendas. "Capitalism delivers on certain normative goals such as individual freedom and a fairness of opportunity that are essential to legitimizing that deployment of self-interest."

In other words, capitalism earns its legitimacy through the idea that the pursuit of self-interest explicitly delivers on certain moral goods for society. Individuals could criticize that moral framework—a Marxist, for instance, might argue that capitalism ignores issues of fairness in outcomes—but they can't say that it doesn't exist.

"Our task is not to take immoral people and make them moral. Our task is to add texture to the dominant ethical framework of the markets, which defines what is moral."

Capitalism's moral logic was perhaps most famously articulated by free market champion Milton Friedman when he said that "the social responsibility of business…is to increase its profits." That sentiment puts faith in the market to distribute wealth in the freest, fairest and most efficient way possible—indeed, Friedman went further to say that any attempt to curb the free market was harmful to the good of society.

This is the view Ramanna grapples with in a new working paper, Managers and Market Capitalism, cowritten with Rebecca M. Henderson, the John and Natty McArthur University Professor. Henderson and Ramanna agree with Friedman's moral framework—but only when certain conditions are met. In many cases, they say, it is incumbent upon managers to shift their ethical framework in order to preserve the system of capitalism itself.

In their view, capitalism has two powerful things going for it. First, it has been shown to be incredibly effective in leading to economic growth. "We don't know any better way to solve this problem," argues Ramanna. "If you look around the world, capitalism has lifted hundreds of millions of people out of poverty where previously deployed systems did not."

Second, capitalism tends to be self-correcting. When the free market does fail, the market itself steps in to correct the problem. For example, when investors lack information to properly determine the value of a stock, a raft of institutions—including ratings agencies, analysts, auditors, and accounting standards—rush in to fill that gap. Even in cases where a certain company dominates a market to create a near monopoly, entrepreneurs can find competitive advantages to create new opportunities—think IBM and Apple, United Airlines and Southwest, or Myspace and Facebook. "Markets make markets work," says Ramanna. "That is the good news about capitalism. We don't want to throw the baby out with the bath water."

Henderson and Ramanna argue that company managers are obligated to help preserve the capitalist system as a whole.But that doesn't mean markets always work to self-correct structural problems. The snag, as Adam Smith first identified in The Wealth of Nations, is that free markets require certain conditions in order to function—among them, well-defined property rights, enforceable contracts, non-collusion between parties, and complete knowledge that puts everyone on a level playing field. And while some of these conditions are self-fulfilling in markets, they argue, some are not. Take accounting standards, for example. While it's essential from a standpoint of complete knowledge to have everyone calculating their financials in a comparable and consistent manner, there is no profit motive for a private institution to produce accounting standards. Some public intervention is necessary—and that public intervention manifests itself as institutions operate not through a competitive market process, but through a democratic political process.

Therein lies the rub. Once the market is open to politics, then that market can be corrupted. That is especially true in cases Ramanna and Henderson call "thin political markets," that is, when business interests possess a specialized knowledge unknown to other constituents in the process and face little political opposition. That stands in contrast to a "thick" political process, in which diverse views are able to provide input with no one party able to receive a special voice.

"As the chairman of Goldman Sachs or Citigroup or IBM, you have a substantial capacity to structure the rules of the game when it comes to accounting standards for your industry," says Ramanna, noting that in the case of accounting standards, the knowledge is so esoteric that it only resides in a few individuals, who are most likely embedded in corporations. "If you happen to engage in a political process that structures institutions that underlie capitalism, what are your obligations?"

The traditional free-market answer to that question is that your obligation is to increase profits for your shareholders, period. If that means undermining accounting standards in order to achieve short-term gains, then the traditional free-market logic would say you are not only entitled, but also obligated to do that.

Not so fast, say Henderson and Ramanna. They argue managers have another interest, not just to serve as agents for their shareholders, but also to serve as agents for the system as a whole. It is not in the long-term interest of a society that deploys capitalism to allow its corporate managers to set up an accounting system that distorts the market—potentially leading to corporate scandals or an economic crash—and undermines capitalism itself. Rather, in these "thin" political processes where self-interest can undermine the integrity of capitalism, a manager's moral obligation is put aside his or her own self-interest in order to preserve the interests of the system as a whole.

Of course, that's not an easy sell to someone in a highly competitive market trained to exploit any advantage. This is where norm-setting becomes important, the authors say. Ramanna points to norms that have shifted in the history of capitalism, not necessarily in a company's self-interest. "We have been able to shift the moral boundary of self-interested corporate behavior when it comes to employing child labor and indentured labor," he says. "Part of this norm-shifting was done by carefully laying out the evidence and then building a strong logical case for what is consistent with the ethical imperatives that legitimize capitalism. CEOs are usually not immoral people. When they lobby for self-serving accounting rules, they are acting in the context of an ethical framework that legitimizes self-interested behavior.

Our challenge is to provide evidence and arguments for why the 'self-interest' ethical framework does not hold water in the case of 'thin political markets,'" he continues. "In this sense, our task is not to take immoral people and make them moral; it is to add texture to the dominant ethical framework of the markets, which defines what is moral."

The next step in that goal, says Ramanna, is to determine what institutions might be necessary to shift the ethical consensus. He and Henderson have begun to look at increased disclosure on corporate accountability—particularly as it relates to lobbying—as one possible way to fill the information gap. Further, some industry groups have begun to push a concept called "ethical lobbying," in which they take on only clients that agree to broaden their focus to consider systemic interests beyond self-interest, a trend that Ramanna and Henderson think has potential to help change the prevailing mindset.

"Ethical norms don't shift in an instant; these are the kinds of shifts that take place over a generation," says Ramanna. "But if enough CEOs and lobbyists get together and say there is something not quite right about what we are doing, then we may be able to start changing norms."

About the author

Boston-based writer Michael Blanding is a fellow at the Edmond J. Safra Center for Ethics at Harvard University and author of The Coke Machine: The Dirty Truth Behind the World's Favorite Soft Drink.

Comments

    • WALTER BLASS
    • President, Strategic Plans UnLtd

    I am delighted to see HBS recognize that this macro-economic problem exists. The CEO of AXA, the largest insurance company in France wrote a book several years ago entitled Les capitalistes vont tuer le capitalisme [It's the capitalists who will kill capitalism.] Since Claude Bebear published this book 10 years ago we have seen lots of evidence how accurate his observations were. Your two authors are very low key exponents of the same issue. When I visited a cabaret in East Berlin after the Wall fell, one of the comics said " Communism is dead!" The second banana replied: "Oh, yeah, just wait.Fifty years of capitalism...." The crowd roared in lauughter.

     
     
     
    • Bernard Peek

    Gosh! April 1 already?

    While capitalism has advantages over other philosophies let us not lose sight of its failings. If we have a moral duty it is to leave the planet in a better state than when we arrived. That includes an imperative to strive to find a perfect philosophical framework. Even if we believed that capitalism was perfect we should be striving to prove that belief wrong. We should assume that what we have is imperfect.

    Some will say that capitalism when applied properly cures all ills. But of course if capitalism was indeed perfect it would be impossible to misapply it. The fact that there are people who oppose it, while apparently being able to both walk and chew gum, is prima facie evidence of its imperfection.

    What will replace capitalism as currently implemented is unknown but it will arrive in its time. Assuming that we already have perfection is astonishing hubris.

     
     
     
    • Rob Houck
    • Pa, Eaton & Van Winkle

    There are so many differences between capitalism as practiced here and in Germany, but I will mention two. First, in Germany workers and the business owner are likely to live at most a few miles from each other. Furthermore, the children of the workers and of the owners are likely to go to the same school. These personal, social realities are being diluted in Germany, but still play an important role. Second, ownership and management tend to be in the same hands and those hands are all part of a family. So management thinks in terms of generations, not quarterly results. I consider these differences to be positive ones, but perhaps not if my retirement investments paid out 30% less as a result.

     
     
     
    • Yan Song

    Walter and Bernard made excellent points. The day we stop believing in the possibility of a more perfect union is the day when the corruption of morality, capitalism or otherwise, is complete. That is not to say that any type of union were equally good. Capitalism is a far superior moral as well as economic framework than many others that humanity has experiemented with, such as feudalism and Maxism. But it's far from perfect. The path to a better future must transcend and include capitalism, not throw the baby out with the bathwater as the authors said. It seems to me that the 'Conscious Capitalism' framework laid out by John Mackey, founder and CEO of the Whole Food Market offer a promising start.

     
     
     
    • Mark O'Connor

    A number of years ago as a young executive entering a joint MBA/PhD in Sociology program I proposed a PhD thesis projects to test whether the behavior that it takes to properly lead a large organization is the same as the behavior that leaders must develop and employ throughout their career to get there. My working theory was that it was precisely the opposite in terms of leadership skills and ethical management. I finished the MBA, but not the PhD - so I never proved that thesis. But I've seen little evidence to disprove it, or the points made by Professor Henderson and Associate Professor Ramanna.

    I see endless examples of the temptation of self-interest being too great to resist, despite the consequences to companies, people and society. I offer an example in the public accounting profession in a recent guest post at Re:TheAuditors, where I note that the audit operations of the world's largest public accounting firms subsidize low margin audit services with consulting work that compromises the very independence implicit in term "public accounting". Today the consulting/advisory (including tax advisory) revenues of each of the Big Four firms is larger than the non-audit/assurance, and will continue to increase without intervention from regulators.

    While I believe that increased transparency helps, it will not be effective or sufficient to address the main "system" and societal issues, in my view. As long as there is someone willing to serve a need or provide handsome returns, it is too easy for otherwise honest people to cast a blind eye toward the improprieties associated with achieving that end - where people are effectively outsourcing unethical and illegal action; and somehow, the fact that they played no part directly, allows otherwise complicit people to truly believe they have done nothing wrong. Before we see any movement in a positive direction here, that situation needs to be addressed. And we are far from achieving that goal in any real sense today.

     
     
     
    • Darryl D'sa
    • Manager, Not relevant to this discussion

    See: Milton Friedman's Brilliant 2 Minute Defense Of Greed And Capitalism http://t.co/huDXXiPqub. Clearly he didn't think anyone let alone managers had any moral obligations to society because as Adam Smith figured this would arise automatically. That it hasn't in practice should be proof enough that it cannot exist under capitalism.

    How then to achieve societal end? Joseph Stiglitz argues that pervasive externalities must be costed and included as part of the profit calculation. Good idea but I suspect that balance would be difficult to achieve in practice. As a new producer today why should I pay for pollution caused by those who have gone before and extract er higher profits?

     
     
     
    • Krishna

    There's always the social norm of shunning- i.e. the members of the capitalist system can actively shun those who endanger the survival of capitalism

    Nothing could work faster or more effectively

     
     
     
    • William Hickey
    • RETIRED

    Our capitalistic system is the best. Unfortunately it produces "winners" and "losers". Many in the loser group are there through no fault of their own. Capitalism's biggest challenge is how to treat the losers.

     
     
     
    • Hugh Quick
    • home, none

    The foundation of capitalism is the acceptance of private property and so many people want that that there is really no alternative to capitalism. The USSR certainly never tried it as they accepted private property like everybody else. Most of the rest is trying to sort out how to live with our neighbours - very real problems but not specific to Capitalism.

     
     
     
    • Atul Guglani
    • Director, Mantex Technologies

    Manager`s Moral Obligation to preserve Capitalism is fine, as long as it is not by hook or by crook. There is a difference between Conscious capitalism and Greed Capitalism. Unfortunately the latter seems, more the order of the day.

     
     
     
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited

    Basically, capitalism is an economic system in which the production and distribution of goods and services depends on invested private capital and profit-making. The ultimate intent is the possession of capital or wealth. In such a system there is dominance of private owners of capital and production for profit.

    A capitalist serves the economy by expanding business which leads to employment generation and service to masses thereby. Ethical (unfortunately few and far between) capitalist organisations do take care of the social interests by meeting their Corporate Social Responsibilities in well designed and executed manner. Going in for inclusive growth of the society they do not attach importance only to profit earning eventhough they are aware that this is their prime aim and need for their survival. We should we have greed-free capitalists who do not use illegal and immoral/unethical means to grow. If this is ensured, capitalism would indeed be the best system for the economy.

     
     
     
    • David Physick
    • Consultant

    This is such an important issue and one that we should all fight to keep centre-stage in our thinking. Those original thought leaders like Adam Smith didn't see capitalism as being overtly divisive but, rather, much more inclusive. Many years ago, I remember seeing a German business-man who had just won a European Foundation for Quality Management award (equivalent to US Malcolm Baldridge) remark, "Money is like manure (he used a more colourful word). Pile it high and it stinks. Spead it around and it nurtures growth and well-being." For me that is what was the intent of the Reagan / Thatcher political interference in the 80s, but the "trickle down" never occurred. Instead, a few people created great mounds of wealth and kept it to themselves. Against that greed of the few, the majority experienced huge cognitive dissonance. They disagreed and disliked what they saw happening but shifted their value sets so things became tolerable and they could continue to consume the poor food, sugary drinks and the stodge produced by the TV networks. "No point causing a ruckus!"

    Hopefully, the Gen Ys and Gen Cs coming out of education and into the world of work will realise that capitalism is a good system or philosophy but will through their behaviours and values creatively destroy what now prevails as capitalism and give birth to something more inclusive and globally relevant.

    My favoured phrase from the American Indians, "Only when the last tree has died and the last river been poisoned and the last fish been caught will we realise we cannot eat money" is entirely apposite.

     
     
     
    • Morris McInnes
    • Professor Emeritus, Sawyer Business School, Suffolk University

    I certainly admire the thesis the authors advance. And I am a proponent of the capitalist approach to economic management and political process. The discourse, however, reminds me of the American Liberty League, which, through the Protestant Churches in the United States, advanced from every pulpit in the country, "The blessings of Capitalism come from God." The treatise of "Christianity...Capitalism...Individualism" was adopted by the US Chamber of Commerce..."Freedom Under God"...in 1954 the US Congress added this to the Pledge of Allegiance...so we had better believe, as patriotic Americans, and believers in God, that "free" markets are in some sense "moral", and "American"... As a proud Scot, I do indeed believe in Adam Smith's general treatise...but morality?...let's not claim any moral ascendancy in these matters...let's just be pragmatists.

     
     
     
    • Marlis Krichewsky
    • Researcher on Management Education, CIRPP, Paris Chamber of Commerce & Industry

    In the title you talk about managers' moral obligation to preserve Capitalism, but in the article it says that the preservation of Capitalism is their INTEREST. That is clearly the truth: the only job they learnt is to serve Capitalism. This is also true for HBS teachers. Why make it a moral obligation if it is their interest?! If ever there is a moral obligation (but really it is also a vital INTEREST), it is to develop Capitalism into a system that better respects the biosphere and human beings and their needs. Communism turned out to be worse than Capitalism. So our only chance now is to humanize our economic system and fight greed and the externalization of costs.

     
     
     
    • Mark Lubbers
    • MBA '82 Father of MBA '13

    A Scot eschewing moral ascendency? If that view held, the western world would be stuck with the elite and self-defeating French version of The Enlightenment, with its false emphasis on egalitarianism vs equal opportunity. Fortunately, the Scottish Enlightenment prevailed, in large measure BECAUSE of moral ascendency.

    This is an interesting subject matter and one sorely in need of deeper and broader consideration at HBS. Milton Friedman was right, but not just because of moral duty to shareholders or a macroeconomic defense of Adam Smith's invisible hand. Rather, because making a profit is a MORAL IMPERATIVE.

    The most recently minted HBS grads accepted diplomas under banners extolling "Making a difference." And Dean Nohira made a marvelous (and short) address encouraging Audacity, Adaptability, and Appreciation.

    Yet, thick in the air was the sense that making a profit is a subordinate pursuit, a necessary evil, and -- truth be told -- a greedy, selfish, embarrassing, ugly reality to be risen above. At best, just one of many things to think about on the way to "making a difference" in the world.

    This is a tragic response to present cultural norms rather than the "audacious" leadership the Dean advised.

    Why? Because PROFIT is the ONLY path to assembling the capital to solve the problems of humanity that our newest alums are laudably eager to make a difference on. Profit is the ONLY source of the two cash streams that fund "making a difference" --- those two streams being taxes that support government or contributions that support non-profits.

    Without profit, there IS NO money to cure cancer, pay for education, subsidize early childhood development, or patronize the arts.

    And I'm completely ignoring the moral imperative of providing employment for millions so individual families can enjoy the essentials of life -- HARDLY an insignificant moral imperative, both as it relates to CARE for people OR to the larger concern about order and the devastating consequences when any society becomes unglued.

    Capitalism isn't just "pragmatic" because it tends to efficiency. It is GOOD, and we, the Harvard Business School, should be the chief advocate of that philosophy.

    There is plenty of room in this view to chart a centrist course. Feel free to reject the egoism of Ayn Rand. There is no reason why capitalism is incompatible with altruism. Just understand that for good to triumph over evil, business profits are essential. If that sounds morally ascendent, well ... the truth hurts.

    After faith and family (the micro/personal), the pursuit of profit is THE preeminent moral activity of life. Nothing is more important to "making a difference."

     
     
     
    • Richard John

    I'm intrigued by this paragraph:

    "Not so fast, say Henderson and Ramanna. They argue managers have another interest, not just to serve as agents for their shareholders, but also to serve as agents for the system as a whole. It is not in the long-term interest of a society that deploys capitalism to allow its corporate managers to set up an accounting system that distorts the market--potentially leading to corporate scandals or an economic crash--and undermines capitalism itself. Rather, in these "thin" political processes where self-interest can undermine the integrity of capitalism, a manager's moral obligation is put aside his or her own self-interest in order to preserve the interests of the system as a whole."

    So where would we fit Enron into this view? Surely all of the Enron managers knew that their accounting systems would eventually bring about a collapse - are we accusing them all of being morally bankrupt? Or is there a significant flaw in the capitalist system that could allow a scandal like Enron to happen?

     
     
     
    • Zufi Deo
    • Founder, www.bizstuff.co

    Don't you think that the notions of capitalism, communism, etc, reflect us as people, i.e. we all have the potential of being creative, social beings, moral beings, etc. and at some point in our lives we will swing between them all.
    In other words, they as ideologies reflect aspect of us as human beings and between all of them we more accurately understand our selves as a race.

     
     
     
    • Brad Deal
    • Business Owner, School of Hard Knocks

    I read this article with trepidation. Capitalism brings out man's animalistic nature. It is devoid of morality. The quest for profit is little more than a metaphorical chasing and killing of a mastodon by a group of Neanderthals with spears and clubs. It is primitive with little cognitive understanding of its long term consequences. Mastodons are gone, Neanderthals are gone for the same reasons that capitalism is failing.

    Every company, organization or mob reflects the personality of it's leaders.

    If the leaders are kind and compassionate then the group will reflect those moral values. If the group is lead by sociopaths then the group will reflect those same selfish qualities. Capitalism selects for Neanderthals, and deselects for kindness and compassion. Kind and compassionate people are at a competitive disadvantage when competing with Neanderthals using metaphorical rocks and spears.

    Managers must reflect the core values of the company's leaders if they want advancement. If the leaders are corrupt then all the subsequent moral consequences are corrupt.

    It is impossible to be a good apple in a rotten barrel...We must find a way to combine civilized behavior with Capitalism

     
     
     
    • marxjenn
    • self employed, Invasum

    Interesting and thought provoking comments on capitalism and its future and conscious vs greed based capitalism. I believe that greed based capitalism is, and must, end. In this global economy, we all sink or swim together. We are all connected. Regardless of what economic system we are in, or will be in - we, especially with the uniting power of the internet, can take ownership to shape and create the economy and world we wish to live in. It is important that we keep pushing for education and technological literacy for all people (women, children and minorities). That way, everyone has a voice and stake in reimagining and impacting change for the better. We are going in the right direction holding companies to account for their behavior impacting their internal and external environments. Change is slow, but if you keep chipping away at the mountain, it eventually must - and will - move.

     
     
     
    • Mariano Ospina H.
    • CEO, Fundacion Mariano Ospina Perez

    Not so fast, Professors Henderson and Ramanna: Very commendable your effort to find Moral Values underlying and supporting economic liberalism, but just look at the real situation of the people in the capitalist world and you will find the tremendous gap between those in the high profit levels and the majorities living in poverty. This information is available in all sorts of Web statistics charts. Of course, the other extreme economic model, socialism, is even worst in its effects on the peoples, as found in the countries under such regime such as Cuba, Venezuela, et al. In conclusion, not only is necessary the intervention of politics oriented by the principles of Social Justice but even more necessary are determined efforts in the Educational System to elevate human behaviour from the laws of mere instinct or the profit motive to the level of moral responsibility by self determination, not from imposed norms.