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CHAPTER 1

Capitalism: Marvelous, Misunderstood, Maligned

In the long arc of history, no human creation has had a greater positive impact on more people more rapidly than free-enterprise capitalism. It is unquestionably the greatest system for innovation and social cooperation that has ever existed. This system has afforded billions of us the opportunity to join in the great enterprise of earning our sustenance and finding meaning by creating value for each other. In a mere two hundred years, business and capitalism have transformed the face of the planet and the complexion of daily life for the vast majority of people. The extraordinary innovations that have sprung from this system have freed so many of us from much of the mindless drudgery that has long accompanied ordinary existence and enabled us to lead more vibrant and fulfilling lives. Wondrous technologies have shrunk time and distance, weaving us together into a seamless fabric of humankind extending to the remotest corners of the planet.

So much has been accomplished, yet much remains to be done. The promise of this marvelous system for human cooperation is far from being completely fulfilled. Too much of the world still has not embraced the core principles of free-enterprise capitalism, and as a result, we are collectively far less prosperous and less fulfilled than we could be.

Much of the twentieth century can be seen as an extended intellectual war between two diametrically opposed social and economic philosophies—free-enterprise capitalism (free markets and free people) and communism (dictatorship and governmental economic control). By every objective measure, free-enterprise capitalism has won this battle. The United States was far more economically dynamic and socially evolved than the Soviet Union, its chief communist rival. The same held true for West Germany versus East Germany; South Korea versus North Korea; and Taiwan, Hong Kong, and Singapore versus China. With the fall of the Berlin Wall in 1989, country after country began to turn toward greater political and economic freedom in the 1990s and 2000s, as the dismal economic and societal results of the various socialistic experiments conducted in the twentieth century became better known. As this transition to greater freedom took root, many countries experienced rapid economic growth, and hundreds of millions of poor people were able to escape grinding poverty.

Of course, much of the Western world has benefited from the fruits of free-enterprise capitalism for about two centuries now. The success of free-enterprise capitalism in improving the quality of our lives in countless ways is the most extraordinary but poorly understood story of the past two hundred years. It has enabled humankind to progress at a rate unprecedented in all of history. Consider these facts:

 Just 200 years ago, 85 percent of the world’s population lived in extreme poverty (defined as less than $1 a day); that number is now only about 16 percent.1 Free-enterprise capitalism has created prosperity not just for a few, but for billions of people everywhere.

 As figure 1-1 shows, average income per capita globally has increased 1,000 percent since 1800.2 It has increased 1,600 percent in developed countries. Japan’s income per capita has increased by 3,500 percent since 1700. Adjusting for affordability and quality improvements, the standard of living of ordinary Americans has increased 10,000 percent since 1800!3 Perhaps most startling, the gross domestic product (GDP) of South Korea has grown 260-fold since 1960, transforming it from one of the poorest countries in the world to one of the richest and most advanced.4

 Over tens of thousands of years, the human population grew very slowly and declined frequently as huge epidemics such as the plague and influenza claimed millions of lives. It finally crossed one billion around 1804 and has grown rapidly since to over seven billion, primarily because of progress in sanitation, medicine, and agricultural productivity.5

 In the past two hundred years, average life expectancy across the world has increased to sixty-eight years, from its long historical average of thirty years or less.6

 In just the past forty years, the percentage of undernourished people in the world has dropped from 26 percent to 13 percent.7 If current trends continue, we should see hunger virtually eliminated in the twenty-first century.

 From a world of almost complete illiteracy, we have transformed, in only a couple of hundred years, into one in which 84 percent of adults can now read.8

 With the growth of economic freedom, 53 percent of people now live in countries with democratic governments elected by universal suffrage, compared with zero people just 120 years ago, as even democracies denied women or minorities, or both, the right to vote.9

 Contrary to popular belief, prosperous countries have a higher level of life satisfaction. The self-determination associated with free markets, along with greater prosperity, leads to greater happiness. The top quartile of economically free countries has a life satisfaction index of 7.5 out of 10, compared with 4.7 for the bottom quartile.10

FIGURE 1-1

World population and gross domestic product (GDP) per capita

Source: Data from Angus Maddison, “Statistics on World Population, GDP and Per Capita GDP, 1–2008 AD,” Groningen Growth & Development Centre Web page, March 2010, www.ggdc.net/MADDISON/oriindex.htm.

Entrepreneurs: The Heroes of Free-Enterprise Capitalism

In her recent book Bourgeoisie Dignity, Deirdre McCloskey, an economist at the University of Illinois in Chicago, argues persuasively that the most important factors in free-enterprise capitalism’s success have been entrepreneurship and innovation, combined with freedom and dignity for businesspeople.¹¹ The inventions that have changed the world—automobiles, telephones, gasoline, the Internet, antibiotics, computers, airplanes—didn’t happen automatically or by government edict; they all required massive amounts of innovation. Human creativity, partly individual but mostly collaborative and cumulative, is at the root of all economic progress.

Entrepreneurs are the true heroes in a free-enterprise economy, driving progress in business, society, and the world. They solve problems by creatively envisioning different ways the world could and should be. With their imagination, creativity, passion, and energy, they are the greatest creators of widespread change in the world. They are able to see new possibilities and enrich the lives of others by creating things that never existed before.

Educator Candace Allen, wife of economics Nobel laureate Vernon Smith, writes movingly about the need for entrepreneurial heroes in society and the great impact they have on our lives: “Ultimately, the hero is the representative of the new—the founder of a new age, a new religion, a new city, the founder of a new way of life or a new way of protecting the village against harm; the founder of processes or products that make people in their communities and the world better off. What I will contend here is that in our modern world, the wealth creators—the entrepreneurs—actually travel the heroic path and are every bit as bold and daring as the heroes who fought dragons or overcame evil.”¹²

Why Capitalism Is Under Attack

Despite enabling widespread prosperity, free-enterprise capitalism has earned little respect from intellectuals and almost no affection from the masses. Why is it so disliked by so many people? Does it need to change? Do we need to think about it differently?

Rather than being seen for what they really are—the heroes of the story—capitalism and business are all too frequently vilified as the bad guys and blamed for virtually everything our postmodern critics dislike about the world. Capitalism is portrayed as exploiting workers, cheating consumers, causing inequality by benefiting the rich but not the poor, homogenizing society, fragmenting communities, and destroying the environment. Entrepreneurs and other businesspeople are accused of being motivated primarily by selfishness and greed. Meanwhile, the defenders of capitalism frequently speak in a jargon that not only fails to inspire people, but often reinforces the ethical critique that capitalists only care about money and profits and that businesses can only redeem themselves through “good works.” This is a fundamentally misguided view.

We believe that capitalism has long been under attack for several reasons:

1 Businesspeople have allowed the ethical basis of free-enterprise capitalism to be hijacked intellectually by economists and critics who have foisted on it a narrow, self-serving, and inaccurate identity devoid of its inherent ethical justification. Capitalism needs both a new narrative and a new ethical foundation, one that accurately reflects its intrinsic goodness and virtue.

2 Too many businesses have operated with a low level of consciousness about their true purpose and overall impact on the world. Their tendency to think in terms of trade-offs has led to many unintended, harmful consequences for people, society, and the planet, resulting in an understandable backlash.

3 In recent years, the myth that business is and must be about maximization of profits has taken root in academia as well as among business leaders. This has robbed most businesses of the ability to engage and connect with people at their deepest levels.

4 Regulations and the size and scope of government have greatly expanded, creating the conditions for the spread of crony capitalism, restricting competition in favor of politically well-connected businesses. Crony capitalism is not capitalism at all, but is seen as such by many because it involves businesspeople.

These are significant challenges, but they must be overcome if we are to continue to spread freedom and bring dignity and the fruits of modernity to the billions on the planet who are still in dire need.

The Intellectual Hijacking of Capitalism

The early intellectual case for capitalism was built almost exclusively on the theory that people create businesses to pursue only their personal self-interest. Economists, social critics, and business leaders largely disregarded the second and often more powerful aspect of human nature: the desire and need to care for others and for ideals and causes that transcend one’s self-interest. The founding father of modern capitalism, Adam Smith, recognized both of these powerful human motivations. His book The Theory of Moral Sentiments preceded his far better-known book, The Wealth of Nations, by seventeen years. In the earlier book, he outlined an ethics based on our ability to empathize with others and to care about their opinions. Through our ability to empathize, we are able to understand how other people are feeling and imagine what it would be like to be in their shoes.

Smith was far ahead of his time, both in his economic philosophy and in his ethical system. If the intellectuals of the nineteenth century had embraced and integrated his economic and ethical philosophies, we might have avoided the extraordinary strife and suffering that occurred in the nineteenth and twentieth centuries over competing political and economic ideologies.

Unfortunately, that did not happen. Smith’s views on ethics were largely ignored, and capitalism developed in a stunted way, missing the more human half of its identity. This created fertile conditions for ethical challenges to capitalism, which were not long in coming. Karl Marx attacked capitalism as inherently exploitative of workers. Critics used the Darwinian idea of the survival of the fittest to describe markets as inherently ruthless and brutal. Just as nature was seen as “red in tooth and claw,” business was seen as harsh, dehumanized, and uncaring. These descriptions ignored the higher-level human aspirations and capabilities that free-enterprise capitalism potentially taps into so well.

Another factor that fed distrust of capitalism was a failure to distinguish between the fixed-pie or zero-sum concept of mercantilism and the expanding-pie concept of free-enterprise capitalism. Much of today’s animosity toward capitalism stems from a misconception that we need to share all resources fairly and equitably. But the reality is that by artfully combining resources, labor, and innovation, wealth can be greatly expanded. The poor can become wealthier without requiring the well-off to become poorer. The pie grows, and there is more for everyone. This idea is at the core of capitalism’s extraordinary and unique ability to generate wealth.

The Unintended Consequences of Low-Consciousness Business

When businesspeople operate with a low level of consciousness about the purpose and impact of business, they engage in trade-off thinking that creates many harmful, unintended consequences. Such businesses view their purpose as profit maximization and treat all participants in the system as means to that end. This approach may succeed in creating material prosperity in the short term, but the resultant price tag of long-term systemic problems is increasingly unacceptable and unaffordable. Too many businesses fail to recognize the significant impacts they have on the environment, on other creatures that inhabit the planet (such as wildlife and livestock animals), and on the physical health and psyches of team members and customers. Many businesses have created stressful and unfulfilling working conditions and fostered and fed unhealthy appetites and addictions in their customers. Many companies tend to treat all these as externalities, outside the scope of their own concerns.

Symptoms of dysfunction and disaffection abound in the corporate world. The average level of engagement that American team members have with their work has remained at 30 percent or less for the past ten years, and almost as many people are hostile to their employers.¹³ Top executives at the helm of many major corporations have rigged the game to enrich themselves at the expense of the company and its stakeholders. While employee wages in the United States have been virtually stagnant for decades, executive pay has skyrocketed, fracturing workplace solidarity. According to the Institute for Policy Studies, the ratio between CEO pay and average pay was 42:1 in 1980, 107:1 in 1990, and 525:1 in 2000. It has fluctuated in recent years, standing at 325:1 in 2010.¹⁴

Given all this, it is not surprising that the reputation of business has suffered. Corporations are widely seen as greedy, selfish, exploitative, and untrustworthy. Big business, in particular, has a terrible reputation today. Gallup has found that Americans’ confidence in big business has declined steadily, from about 34 percent in 1975 to a historic low of 16 percent in 2009, rebounding to 19 percent in 2011.¹⁵

The Myth of Profit Maximization

The persistent myth claiming that the ultimate purpose of business is always to maximize profits for the investors probably originated with the industrial revolution’s earliest economists. How did this myth originate? It appears to have come from two sources: a narrow view of human nature and an inadequate explanation of the causes of business success.

Looking to create elegant mathematical models of economic systems, academic economists adopted the narrow view that we humans are maximizers of economic self-interest to the exclusion of all else. By logical extension, businesses, too, were deemed to be pure profit maximizers. These simplistic assumptions enabled economists to create models that seemed to explain some of the workings of the larger economy.

The classical economists also formulated their theories by observing and describing the behavior of various entrepreneurs and their businesses. They observed correctly that successful businesses were always profitable and that, indeed, the entrepreneurs who organized and operated these successful businesses always sought to make profits. Businesses that were not profitable did not survive for long in a competitive marketplace, because profits are essential to the long-term survival and flourishing of all businesses. Without profits, entrepreneurs cannot make the necessary investments to replace their depreciating buildings and equipment or to adapt to the always-evolving and competitive marketplace. The need for profit is universal for all businesses in a healthy market economy.

Unfortunately, early economists went far beyond merely describing how entrepreneurs always seek profits as an important goal, to concluding that maximizing profits is the only important goal of business. Taking it one step further, the economists soon asserted that maximizing profits is the only goal entrepreneurs should seek. The classical economists went from describing the behavior in which they observed successful entrepreneurs engage while operating their businesses, to prescribing the behavior as the correct one that all entrepreneurs should engage in all of the time. How did they come to this conclusion?

In the United States, we often take for granted the availability of large pools of capital to invest in new businesses because our economy has been producing these pools for more than 250 years. However, at the beginning of the industrial revolution, capital was quite scarce. Successful enterprises accumulated profits, and entrepreneurs and investors redirected accumulated capital into promising new opportunities, at unprecedented levels. Not surprisingly, then, classical economists became enamored with the importance of profits, because profits had historically been rare and were essential to the continued progress of society.

The principle of profit maximization even became codified into corporate law as the de facto definition of fiduciary responsibility. Economists and eventually business scholars integrated these ideas into their textbooks, shaping the thinking of virtually every student who pursued higher education thereafter. The enemies of capitalism used the ideas as powerful points of attack on the ethical basis of capitalism, to great effect.

But with few exceptions, entrepreneurs who start successful businesses don’t do so to maximize profits. Of course, they want to make money, but that is not what drives most of them. They are inspired to do something that they believe needs doing. The heroic story of free-enterprise capitalism is one of entrepreneurs using their dreams and passion as fuel to create extraordinary value for customers, team members, suppliers, society, and investors.

This is a very different narrative than the one that sees history through the lens of profit maximization. Bill Gates did not start Microsoft with the goal of becoming the richest man in the world. He saw the potential of computers to transform our lives and was on fire to create software that would make them so useful that eventually all of us would own one. He followed his passion and, in the process, became the richest man in the world—but that was the outcome, not his goal or purpose.

The myth that profit maximization is the sole purpose of business has done enormous damage to the reputation of capitalism and the legitimacy of business in society. We need to recapture the narrative and restore it to its true essence: that the purpose of business is to improve our lives and to create value for stakeholders.

The Cancer of Crony Capitalism

True free-enterprise capitalism imposes strict accountability and strong internal discipline on businesses. For over a century, the U.S. economy demonstrated to the world that free-enterprise capitalism can deliver great benefits to all humankind. It created a large and prosperous middle class, belying the current inaccurate critique that free-enterprise capitalism necessarily concentrates wealth among a privileged few at the expense of everyone else.

But as the size of government grew, a mutant variation of capitalism has also grown, spurred on by those unable to compete in the marketplace by creating genuine value and earning the affection and loyalty of stakeholders. Instead, they have thrived by using the power of government for their own enrichment. Crony capitalists and governments have become locked in an unholy embrace, elevating the narrow, self-serving interests of the few over the well-being of the many. They use the coercive power of government to secure advantages not enjoyed by others: regulations that favor them but hinder competitors, laws that prevent market entry, and government-sanctioned cartels.¹⁶

While free-enterprise capitalism is inherently virtuous and vitally necessary for democracy and prosperity, crony capitalism is intrinsically unethical and poses a grave threat to our freedom and well-being. Unfortunately, our current system has the effect of corrupting many honorable businesspeople, pushing them into becoming reluctant crony capitalists as a matter of survival.

Moving to Higher Ground

This is what we know to be true: business is good because it creates value, it is ethical because it is based on voluntary exchange, it is noble because it can elevate our existence, and it is heroic because it lifts people out of poverty and creates prosperity. Free-enterprise capitalism is one of the most powerful ideas we humans have ever had. But we can aspire to even more. Let us not be afraid to climb higher.

Sandy Cutler, the chairman and CEO of Eaton Corporation (a global power management company with over $16 billion in revenue), says it well:

In a period of time when so many questions and doubts have emerged about major institutions in society, business has not done a particularly good job of telling its own story—not in the form of puffery, but really trying to help people understand the role of capital formation, how important it is to providing livelihoods for families, what business does for communities and for institutions like our schools and universities, and the role business has in helping solve so many societal problems. That is not the way so many people today think about business; they think of it as the source of societal problems. The great majority of companies are involved in doing pretty exciting work where people are having vital, exciting careers, earning a livelihood for their families and making a difference for their communities. That’s a story that is worth telling.¹⁷

Far from being a necessary evil (as it is often portrayed), free-enterprise capitalism is an extraordinarily powerful system for eliciting, harnessing, and multiplying human ingenuity and industry to create value for others. It must be defended not just on the basis of the profits it generates but also on the basis of its fundamental morality. Free-enterprise capitalism must be grounded in an ethical system based on value creation for all stakeholders. Money is one measure of value, but it is certainly not the only measure.

Marc Gafni is the cofounder and director of the Center for World Spirituality. Honoring the tremendous impact of capitalism and business on human well-being, he says:

Capitalism has lifted more people out of poverty than any other force in history, and it has done so through voluntary exchange. Communism tried to lift people out of poverty through coercion, but wound up killing countless millions. What does it mean to lift people out of poverty? It means babies not dying, it means mouths being fed, it means girls going to school and getting educated, it means a response to slavery that never existed in the world before. It means that all the values of the great (spiritual) traditions get enacted on two levels: by ending the physical oppression of poverty, and by opening a gateway for human beings to be able to grow emotionally, morally, spiritually, and socially.

Lifting people out of poverty was never the conscious intention of business; it was the by-product of a business well-enacted. Now business is awakening to itself and becoming conscious. It is recognizing that it is a force with enormous power and responsibility. By becoming conscious, it can do what it does even better. It can create more community, more mutuality, and paradoxically, more profit, by engaging everyone in the system.¹⁸

Correcting the Narrative

In a way, the practitioners of capitalism created their own trap and fell into it. They accepted as fact a narrow conceptualization of business and then proceeded to practice it in that way, creating a self-fulfilling prophecy. Had they rejected the caricaturized version and embraced a richer, more complex definition of capitalism, this would not have happened. As pioneering stakeholder theorist Ed Freeman and his colleagues write: “Business is not about making as much money as possible. It is about creating value for stakeholders. It is important to say this and to enable businesspeople to enact the story. We need to hold up the numerous companies, large and small, that are out there trying to do the right thing for the stakeholders, as the real paradigm of business, rather than deeply flawed companies like Enron.”¹⁹

We need to discover anew what makes free-enterprise capitalism what it has been: the most powerful creative system of social cooperation and human progress ever conceived. We next need to rethink why and how we engage in business to better reflect where we are in the human journey and the state of the world we live in today. We need a richer and more ethically compelling narrative to demonstrate to a skeptical world the truth, beauty, goodness, and heroism of free-enterprise capitalism, rather than continuing to harp on the tired maxims of self-interest and profit maximization. Otherwise, we risk the continued growth of increasingly coercive governments, the corruption of enterprises through crony capitalism, and the consequential loss of both our freedom and our prosperity.

Those who recognize and embrace the life-affirming power of free-enterprise capitalism must reclaim the intellectual and moral high ground. Gafni is eloquent on the need for a new narrative for capitalism:

Narratives are the stories that infuse our life with meaning. The narrative of business matters greatly, not only to the business community, but to every human being alive. The majority of people on the planet work in some form of business. But the dominant narrative about business is that it is greedy, exploitative, manipulative and corrupt. The majority of human beings on the planet thus experience themselves as furthering and supporting greed, exploitation, manipulation and corruption. When people experience themselves that way, they actually begin to become that way. But the true narrative is that by participating in business, they are creating prosperity and lifting people out of poverty. They are creating stable conditions for families to be raised, they are helping build communities that can create schools, they are creating places for people to exchange value, find meaning, build relationships and experience intimacy and trust. When people realize that they are part of the largest force for positive social transformation in history, their self-perception changes.²⁰

In the next chapter, we introduce the core tenets of Conscious Capitalism, an approach to thinking about and practicing business that holds the rich promise of elevating the narrative of business in a way that accurately reflects its enormous power for good.