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The Profit Trap

Capitalism has become a major source of global problems, when it should be delivering solutions. But as a powerful engine of prosperity that also lends itself to the defense of political liberty, the system is well worth saving – albeit in a revised form.

LONDON – “I will trouble you no more.” That is how Colin Mayer concludes Capitalism and Crises: How to Fix Them, the third book in his trilogy – after Firm Commitment and Prosperity – analyzing the role of the business corporation in the modern world. This final installment aims high, and probably represents the culmination of Mayer’s efforts to provide a deep, nuanced description of contemporary capitalism, its dysfunctions, and what it will take to address them.

Mayer’s premise is that capitalism has become a major source of global problems, when it should be delivering solutions to already-existing challenges. He believes it can be made into a force for good, but only if we can develop a better understanding of business and the dynamics that drive it.

His approach is refreshingly multidisciplinary. He relies on a cornucopia of facts, references, and insights drawn from his decades of experience as both a business consultant and a long-time professor of management studies at the University of Oxford. Anyone hoping to preserve both capitalism and liberalism will find his work as inspiring as it is foundational.

False Profits

Backed by rigorous research and many convincing examples, Mayer advances some arguments that will sound heretical to practicing capitalists, particularly market fundamentalists. For example, he acknowledges that finance is too often poorly directed and distributed, since it typically fails to reach people or countries that need it the most. Instead, investment capital tends to chase purchasing power and existing funding, leading to unfair and inefficient allocations.

Mayer’s central point is that this unsatisfactory outcome derives from capitalism’s singular obsession with the pursuit of profit. It is this incentive, not a higher purpose or the desire to solve problems, that ultimately organizes the system and the behavior of its individual participants. The supervening nature of the profit motive explains why the capitalist system is so consistently oblivious to negative externalities – even those, such as long-term environmental damage, that render the profits morally wrong.

Despite the system’s fundamental flaw, Mayer argues that it should not be abandoned, but rather molded anew. He reminds us that the father of capitalism, Adam Smith, wrote not only An Inquiry into the Nature and Causes of the Wealth of Nations but also The Theory of Moral Sentiments – a work that seems to have been forgotten even though it is equally central to Smith’s thought. Like Smith, Mayer remains confident in capitalism despite his grimly realistic assessment of human egotism, because he knows that it can create “a self-igniting bonfire of virtues from a cesspit of vices.”

Capitalism also provides a foundation for liberalism, since it requires free choice and agency. The problem, as Mayer sees it, lies in the configuration of the system’s two main pillars: competition (the “invisible hand” that creates price signals) and the rules set by governments to protect society. Both elements have the potential to ensure more socially beneficial outcomes; but in their current form, they have entrenched the fundamentally flawed profit-centered model.

New Rules

Examples of undesired outcomes under the current system are of course plentiful. Recounting Volkswagen’s “Dieselgate” scandal and the processes by which tech companies like Alphabet (Google) and Meta (Facebook) became monopolies, Mayer offers a convincing illustration of moral failure. “Me” has replaced “we,” and it is little wonder that public trust in the system, and in elites, appears to be at all-time lows.

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But it doesn’t have to be this way. Mayer’s outlook is not unlike the sentiment Elon Musk recently expressed: “Working hard to make useful products and services for your fellow humans is deeply morally good.” But Mayer would add that a higher purpose needs to come first, with profit following as a healthy, logical consequence, rather than being the sole objective.

The COVID-19 crisis demonstrated the feasibility of such a reset. Faced with a massive and sweeping threat, we expeditiously bypassed all sorts of “fundamental” rules and laws governing markets and competition. There was a widespread consensus around a higher purpose, and the companies that stepped up to solve our new shared problem eventually reaped financial gains from their contributions.

Mayer proposes two new fundamental principles for capitalism. The first is his “moral law,” which holds that those who produce solutions should profit from their efforts, but that everyone should be penalized for the problems they create. The second, related, principle is a reformulated Golden Rule to tackle negative externalities: “Do unto others as they would have done unto them.”

These principles may be quite wide-ranging, but they are essential to reforming the system. Too many corporations have become “psychopathic” in their single-minded pursuit of short-term profits, an inducement that leads them to become ever more exploitative, manipulative, and socially corrosive.

Looking beyond the names we already know from high-profile scandals (from Enron to Danske Bank and Volkswagen), Mayer identifies problematic behavior on a much wider scale. He points to telecom companies that prevent customers from switching providers; water companies that pollute; and oil and gas companies that buy back their own shares instead of investing in renewable energy and decarbonization. All are equally obsessed with profit or share price, and all have behaved immorally as a result.

Where to Begin?

While it is difficult to disagree with Mayer’s assessment of the system’s problems, his suggested course of action does leave unanswered questions. Of course, it would be a good start to insert his moral law into the common law – not unlike what the recent UK Stewardship Code does. But as Mayer himself is quick to admit, the change really needs to be global. His vision of a more enlightened capitalism will remain elusive as long as there are friendly havens such as Delaware in the United States and Luxembourg in the European Union.

Moreover, establishing his reformulated Golden Rule in law presents practical difficulties, because we lack a rigorous and convincing method for assessing many industries’ externalities. Think of all the food companies that create unhealthy addictions to sugar, salt, and fat. Likewise, consider all the ways that automotive manufacturers or construction companies may harm the environment; or the tech, telecom, and media companies that consume massive amounts of information and disseminate sensationalist content and misinform the public.

These problems are clear to see. Yet it is quite another matter to measure them, let alone to articulate and assess what a higher purpose (above profit) would be.

Despite these practical shortcomings, Mayer’s book offers insightful contributions that take us beyond the usual debate of shareholders versus stakeholders. Even if achieving a moral, enlightened capitalism feels unattainable at the global level, there are more decentralized ways to change how business is done.

For example, he argues that equity ownership should be transformed from a bundle of rights into a set of obligations and responsibilities to uphold the delivery of a higher company purpose. Shareholding would no longer be simply about owning a stream of cash flows and some say in governance; rather, one would own the problem the business is trying to solve. In other words, a board would mainly focus on the higher purpose of the company it looks after, tracking how effective it is at solving specific issues and what negative externalities it generates along the way. In a financial world dominated by exchange-traded funds and index tracking, this change alone would be a Copernican revolution.

I have long advocated the kinds of changes Mayer recommends, especially when it comes to publicly traded companies. It takes many years, if not decades, to devise new corporate strategies, solve complex problems, and address negative externalities. But these kinds of time horizons are completely at odds with the short-termism prevailing among owners and managers. Under the current share-price dictatorship, quarterly earnings are all that matter.

There is an urgent need for a new approach. Boards could be required to ensure that every part of the organization is contributing to the pursuit of long-term goals relating to its core business purpose (as opposed to generating short-term profits for the sake of profits). Decentralized sources of funding – such as equity investors or financial institutions – can be given a greater say, thereby facilitating accurate measurement, which aggregation at a global level renders impossible. And the standard time horizon for measuring performance could be significantly expanded through, for example, incentive plans relying on fundamental performance indicators that only get measured after five years or more.

Mayer’s book is an essential contribution to the debate about contemporary capitalism and its descent into dysfunction. Fixing the system, and changing how we think about it, is critical to preserving democracy, free markets, and capitalism itself. Mayer offers a persuasive argument for why higher purpose must replace profit as the primary objective driving companies and markets. Even if it is not yet clear how to do this in practice, it is obvious that this should be our task.

We will need to explore the use of longer time horizons, more decentralized models of corporate governance, and public-private partnerships. Mayer’s core principles will serve us well as we try to save our current form of capitalism from itself.