The Price of Capitalism

Put on the defensive by Bernie Sanders, who is a self-described socialist (albeit not in the true definition of the word), Democratic candidates for president have been asked to take a side. Are you a socialist or a capitalist? So far, they all profess to be capitalists. Their rhetoric, however, would suggest they don’t always understand what this means. Just recently, Joe Biden criticized companies for not paying their employees a living wage while buying back stock. In her autobiography, Kamala Harris attributes the decline in middle-class wages to corporate greed. Elizabeth Warren’s invective against Wall Street is legendary. How can they be both against it and for it? Perhaps we can help them to reconcile their inconsistency. 

Unfortunately, a fair treatment of this topic will require a little more space, and a little more history, than usual. Since the beginning of our republic, America has relied on private ownership of capital and production and on free markets and free trade to determine the allocation of capital. Price, whether for labor or materials, is the mechanism by which supply and demand functions. This is the essence of capitalism. The good news about capitalism is that it generates more wealth for more people than any other system in the world. The bad news is that in so doing, industries come and go; companies come and go; jobs evolve, appear, and disappear. It is a dynamic, often painful process, particularly for the lives of those disrupted. One of the most wrenching of such transitions was the evolution from a country that was 95% agrarian at the end of the 18th century to one that is only 2% agrarian today. Millions fled their unprofitable farms during this transition, seeking employment in the cities. One need only read a bit of Dickens to know what life was like in those days. 

At that time, there was no manufacturing sector and industrialization was decades away. We are witnesses today to a similarly painful transition, this time from the manufacturing to the service industries. Manufacturing jobs peaked in America in 1979 at 19.4 million and have declined to 12.4 million today. Meanwhile, due primarily to automation and technology advancements, output has increased. The wonder of capitalism—creating more with less. A component of this transition, however, is that the demand for jobs subject to automation has declined and so has the price, or wage, paid for them. We have seen this phenomenon beyond just manufacturing, where compensation for all forms of lower-skilled labor has fallen, while compensation for higher-skilled professions such as doctors, dentists, lawyers, bankers, and those with technology skills has steadily increased. 

In 1811, the Luddite movement emerged in protest of the loss of jobs due to technological progress, and those who have protested technological progress ever since have often been referred to as Luddites. There has in fact been virtually no time in history when there was not some form of resistance to the change that capitalism brings. In this respect, the current rhetoric of some Democratic candidates is no exception and part of a long tradition. While their motives stem from compassion for the dislocated, their placement of so much blame on the agents of capitalism (corporations and the CEOs who lead them) is an easy but misguided approach.

If we are truly capitalists, as they profess to be, we need to allow capital markets to work. In this respect, corporate executives’ responsibility is to provide the highest possible return on the capital made available to them. If they don’t, that capital will migrate to other opportunities, here and abroad. This is their role, period. It is not their role to overpay for labor or any other input. It is not their role to create jobs that are unnecessary. It is not their role to manufacture in a place that is more expensive than their alternatives. And finally, it is not their role to retain capital if they believe it would achieve a higher return if returned to shareholders, either via dividends or stock buybacks. 

So, does this mean that corporations in a capitalist system should be free to take advantage of employees, pollute our environment, or produce unsafe products? Of course not. Although there will always be bad actors who make headlines, most CEOs understand that they must maximize returns while being fair to their multiple constituents. They must compete for employees in the free market, and they do so by striking a balance between creating a desirable work environment with competitive benefits (such as healthcare, sick pay, vacation pay, subsidized cafeterias, savings programs, etc.) and remaining financially competitive. They know that if they create an unsafe product, their brand and reputation will suffer, and they will lose business. They know that if they pollute the environment, it is not only wrong, but employees and customers will object. The market will provide some discipline. When the market doesn’t, and externalities persist, there is a proper role of government to regulate what is in the best interest of the country. But wages and stock buybacks are not externalities.

So, let’s now return to where we started and make a suggestion for discussion. If a company pays a wage that is sufficient to attract willing workers and still chooses to return capital to its shareholders, it is acting fairly and rationally within the context of the capitalism that we have chosen. Biden’s complaints therefore are misdirected. His empathy for the worker that is not able to earn a living wage, however, is understandable. Our view is that he can reconcile these competing interests by recognizing that the problem is not that the capitalist is “underpaying”: the problem is that the workers’ skills do not warrant higher compensation. We suggest that he let capitalists be capitalists and that he propose to use government to help workers develop the skills that command a living wage. As part of that, he could propose investing in relocation assistance and other forms of transition support to lessen the pain of dislocated workers while they retrain.