Moral Capitalism: Why Fairness Won't Make Us Poor

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For Wendy

Who Made Everything Possible

Introduction

to the Paperback Edition

For former Colorado governor and Democratic presidential candidate John Hickenlooper, it should have been a soft pitch at the letters, one easily knocked out of the park. Appearing on MSNBC’s highly rated Morning Joe program, the successful brew-pub-owner-turned-politician was asked if he considered himself a proud capitalist. But rather than embrace his—and his country’s—entrepreneurial roots, Hickenlooper dissembled, desperate to avoid offending the growing army of liberal party activists for whom capitalism has suddenly become a dirty word. Shocked by the candidate’s nonresponse, host Joe Scarborough invited him a second time to affirm his capitalist leanings, and then a third, and twice more the candidate demurred. His candidacy never quite recovered.

When a moderate, pro-business Democrat running to be president of the United States refuses to endorse capitalism, you know something fundamental has changed. For all his rhetorical bumbling, what Hickenlooper had come to understand is that the economic system and business culture that had made the United States the world’s richest and most powerful country was now viewed by a growing number of Americans as ruthless, unfair and morally corrupting.

This disenchantment has already energized an army of camp followers for avowedly socialist politicians like Bernie Sanders of Vermont and Alexandria Ocasio-Cortez, the influential new congresswoman from Brooklyn, who tells anyone who listens that capitalism is irredeemable and unsustainable, and whose top adviser famously declared every billionaire to be a policy failure. Almost overnight, ideas such as wealth taxes, guaranteed jobs, national health insurance and debt-free college have moved from the fringes of the policy debate to the red-hot center. More Democrats and Democratic-leaning voters now have a positive view of socialism (57 percent) than capitalism (47 percent). Among younger voters, the gap is even wider.¹

And it is not just politicians who have noticed the change in the zeitgeist. So have captains of business and finance, who have begun to worry publicly that unless something is done to reform capitalism and make it work for more Americans, more radical fixes will be thrust upon them.

For several years, for example, Larry Fink, the chief executive of BlackRock, which manages and invests more of the world’s savings than any company on the planet, has written to the chief executives of all the country’s large public companies to warn them to demonstrate that their companies serve a larger social purpose than enriching shareholders and executives. Ray Dalio, the billionaire founder of the world’s largest hedge fund, recently penned a two-part manifesto warning of revolution unless American capitalism is reengineered to do as good a job at dividing the economic pie as it now does growing it. And in his 2019 letter to shareholders, Jamie Dimon, the chief executive of JPMorgan Chase, the country’s largest bank, felt the need to come to the defense of capitalism while acknowledging that the social needs of far too many of our citizens are not being met.

Amid all this angst, it’s easy to forget that it was only 25 years ago that the world was celebrating the triumph of American capitalism. After a long cold war, communism had been vanquished and discredited, with China, Russia and Eastern Europe seemingly rushing to embrace the market system. American capitalism had widened its economic lead over European-style socialism while the once-unstoppable export machine, Japan Inc., had finally hit a wall. Developing countries such as India, Brazil and Russia were moving to embrace the Washington consensus of privatization, deregulation and free trade. Around the world, this embrace of market capitalism would lift more than a billion people from poverty.

In recent years, however, confidence in the superiority of the American system has been badly eroded. A global financial crisis that started in Asia and spread to Russia and Latin America shattered the Washington consensus. Americans have lived through the bursting of two financial bubbles, struggled through two serious recessions and toiled through several decades in which almost all of the benefits of economic growth have been captured by the richest 10 percent of households. A series of accounting and financial scandals, a massive government bailout of the banking system, the inexorable rise in pay for corporate executives, bankers and hedge fund managers—all of these have generated widespread resentment and cynicism. While some have prospered, many others have been left behind.

Part of this disquiet has to do with the market system’s inability to continue delivering a steadily rising standard of living to the average household, as it had for the previous half century. In the 15-year period from 1953 to 1968, the inflation-adjusted income of the median American family increased by 54 percent. In the 15-year period from 2001 to 2016, the increase was just 4 percent. No wonder that just 37 percent of Americans now believe they will do better financially than their parents, the driving idea behind the American Dream.²

But another part of our disquiet reflects a nagging suspicion that our economic system has run off the moral rails, offending our sense of fairness, eroding our sense of community, poisoning our politics and rewarding values that easily degenerate into greed and indifference. The qualities that once made America great—the optimism, the commitment to equality, the delicate balance between public and private, the sense that we’re all in this together—no longer apply.

It has got to the point that we are no longer surprised when employees of a major bank sign up millions of customers for credit cards and insurance they didn’t want or even know about, just to make their monthly numbers.

We are reluctantly reconciled to a system that lavishes $800 million in compensation a year—that’s $250,000 an hour—on the head of a private equity firm simply for being clever about buying and selling companies with other people’s money.

We are now barely shocked when a company tells longtime workers that their jobs are being sent overseas and that they will get a modest severance—but only if they train the foreign workers who will be taking their jobs.

We are both outraged and resigned when yet another corporation renounces its American citizenship just to avoid paying its fair share of taxes to the government that educates its workers, protects its property and builds the infrastructure by which it gets its products to market.

While we may have become desensitized to these individual stories, however, collectively they color the way we think about American capitalism. In less than a generation, what was once considered the optimal system for organizing economic activity is now widely viewed, at home and abroad, as having betrayed its ideals and its purpose and forfeited its moral legitimacy. We seek a new, more moral capitalism.

*   *   *

To understand how we got to this point, we have to travel back to the mid-1970s. After decades of dominating U.S. and foreign markets, many of America’s biggest and most successful corporations had become complacent and lost their competitive edge. They were less efficient, less innovative and less willing to take risk. Excessive government regulation had raised costs and sapped the dynamism of sectors such as transportation, communication, finance and energy, with government officials dictating which companies could compete, what services they could provide, what prices they could charge and what profits they could earn. Overzealous antitrust enforcement had prevented mergers among rivals that would have allowed them to achieve economies of scale. Unions had pushed wages and benefits to unsustainable levels, driving up prices and draining companies of the capital needed for investment and modernization. Loose interest-rate policy at the Federal Reserve and overspending by Congress had triggered double-digit inflation.

All that was happening at a time when European and Japanese exporters were beginning to make inroads into the American market. It began with shoes, clothing and toys, then spread to autos, steel, consumer electronics, computers and semiconductors, cameras, household appliances, chemicals and machine tools. Initially, the appeal of these foreign products was that they were cheaper, but before long these foreign firms began to offer better quality and styling as well. By the time American firms woke up to the competitive challenge, many were already playing catch-up. In a few industries, it was already too late.

With their costs rising and their market share declining, the large blue-chip companies that had dominated America’s postwar economy suddenly found their profits badly squeezed—and their share prices falling. Although few remember it today, the Dow Jones index, reflecting the share prices of the 30 largest industrial companies, essentially ran in place for the ten years between 1972 and 1982, resulting in a lost decade for investors. Indeed, it was worse than that. When adjusted for inflation, the Dow lost half its value over that period.

By the mid-1980s, serious people were wondering if the days of American economic hegemony were quickly coming to an end. When Japan’s Mitsubishi conglomerate purchased Rockefeller Center from the descendants of America’s most celebrated business mogul in 1989, it seemed to many as if the American Century had come to a premature and inglorious end.

The central task of the next quarter century is to regain American competitiveness, declared MIT economist Lester Thurow in a widely read jeremiad, The Zero-Sum Solution. Blue-ribbon panels were commissioned, studies were published, hearings held. In the corridors of government, at think tanks and business schools, on the covers of magazines, there was a sense of urgency about America’s industrial decline and a determination to do something about it. And do something they did.

With support both from Republicans and from a new generation of centrist Democrats, federal and state governments deregulated whole swaths of the economy, unleashing a burst of competition from upstart, low-cost rivals in airlines, trucking, freight rail, telephony, financial services and energy. Government spending was cut, along with taxes. Antitrust regulators declared that big was no longer bad, unleashing a flood of mergers and acquisitions. New trade treaties were negotiated that lowered tariffs while opening overseas markets for American products.

Across the manufacturing sector, inefficient plants were shuttered, production was reengineered, employees laid off and work shifted to non-union shops down South or overseas. Companies that once employed their own security guards, ran their own cafeterias, operated their own computer systems and delivered products with their own fleet of trucks outsourced those non-core functions to cheaper, non-unionized specialty firms. Over-indebted companies used the bankruptcy courts to wash their hands of pension and retiree health-care obligations and force lenders to accept less than they were owed. Japanese management gurus were brought in to lower costs, improve quality and create new corporate cultures.

Meanwhile, in the fast-growing technology sector, established giants selling mainframes and tape drives suddenly found themselves out-innovated and out-maneuvered by entrepreneurial startups peddling minicomputers, disc drives and personal computers that were smaller, cheaper, easier to use and surprisingly powerful.

The transformation was messy, painful, contentious and often unfair, generating large numbers of winners and losers—exactly what the economist Joseph Schumpeter had in mind when he identified creative destruction as the essential characteristic of capitalism. Along the way, the old social contract between companies and their workers—and more broadly between business and society—was tossed aside. No longer could workers expect pensions, full-paid health insurance, job security or even a Christmas bonus from their employers. And no longer would business leaders feel the responsibility, or even the freedom, to put the long-term interests of their country or their communities ahead of the short-term interests of their shareholders.³ Chief executives found it useful to cultivate an aura of ruthlessness, winning sobriquets such as Neutron Jack and Chainsaw Al.

And it worked. By the mid-1990s, the hemorrhaging stopped and corporate America was again enjoying robust growth in sales, profits and stock prices. Chief executives and Wall Street dealmakers were lionized on magazine covers and on the front pages of newspapers, their dalliances chronicled in the gossip columns, their soaring pay packages a source of both fascination and controversy. Students at the best universities flocked to business schools, and from there to high-powered jobs on Wall Street or at management consulting firms. Individual investors began piling into the stock market through new tax-exempt retirement accounts and a dazzling array of new mutual funds.⁴ For the first time, business books with titles like In Search of Excellence, Reengineering the Corporation and Competing for the Future regularly made it onto the bestseller lists.

America—and American capitalism—was back, stronger and more globally competitive than ever.

*   *   *

In June 1998, I tried to capture this turnaround with a long front-page story in the Washington Post that ran under the headline Reinventing Xerox Corp.⁵

Xerox was something of an American icon, a homegrown company that sprang from American ingenuity, conquered the world and was run with old-fashioned American values. With the introduction of its 914 copier in 1959, which at the push of a button could turn out six plain-paper copies a minute, Xerox had become a ubiquitous presence in every corporate office. Its sleek machines became the spot where gossip was exchanged and romances begun, while its name was turned into a verb. With a 97 percent global market share and 70 percent gross profit margins, Xerox shares topped the Nifty Fifty list of hot stocks during Wall Street’s go-go years of the 1960s.

In many ways, Xerox was the model American corporation, cossetting its workforce with generous pay and benefits packages and lavishing its largess on its hometown of Rochester, New York, where entire families could be found on the Xerox payroll. Its sales force—proud, slick and high-commissioned—inspired countless imitators. At a corporate research laboratory in Palo Alto, California, Xerox scientists were encouraged to push back the frontiers of knowledge even if their innovations didn’t seem to have much to do with xerography.

All that began to crumble, however, by the mid-1970s. The Federal Trade Commission launched an antitrust investigation that restrained the company’s competitive impulses and ultimately forced Xerox to license its technology not only to American rivals, such as Kodak and IBM, but to Japanese firms such as Canon and Savin, which soon began flooding the market with low-cost alternatives. Around the world, meanwhile, once-loyal customers were growing frustrated with Xerox machines that were so poorly designed and manufactured that Clear Paper Path became a frequent butt of jokes from late-night talk show hosts and a metaphor for the decline in quality of American products.

Perhaps the biggest challenge, however, would come from the advent of the personal computer, which when hooked up to desktop printers threatened to make the Xerox machine a thing of the past. As it happened, much of the foundational work for the personal computer had actually been done at Xerox PARC, where the pathbreaking Alto personal computer system had been designed and built, mostly for internal use. Then, on a day in 1979 that is now the stuff of Silicon Valley legend, Steve Jobs and a team from a fledgling Apple Computer arrived for a visit, part of a carefully negotiated arrangement in which Xerox bought a $1 million stake in the young computer company in return for Apple’s access to Xerox’s computer technology. Jobs was so excited when he saw the mouse that was used to move a cursor around the computer screen, and the graphic interface that allowed the user to click on a function rather than type in commands, that he could barely contain himself. Why aren’t you doing anything with this? he demanded of the Xerox engineers. This is the greatest thing! This is revolutionary!

Two years later, Xerox finally came out with a line of computers that was clunky and expensive and never caught on with users, and Xerox soon exited the market. Instead, it was the Apple Macintosh, with its Xerox-inspired menus and windows and sleek little mouse, that captured everyone’s fancy when it was introduced in 1984. And the rest, as they say, is history.

If Xerox had known what it had and had taken advantage of its real opportunities, Jobs would say years later, it could have been as big as IBM plus Microsoft plus Xerox combined—the largest technology company in the world.⁶

Back in Rochester, however, Xerox executives remained in denial about the twin existential threats posed by lower-cost copiers from Japan and computer technology still in its infancy.

The reality, which nobody wanted to admit back then, was that manufacturing was abysmal, research disconnected to products, corporate headquarters was bloated and smug and profits evaporating before our eyes, recalled Paul Allaire, at that time a top Xerox executive in Europe, who would go on to become chairman and chief executive.

Although the company’s financial statements continued to tell a favorable story, that was largely a reflection of a one-time boost to earnings as corporate customers switched from leasing copiers to buying them. In reality, gross margins had declined from 70 percent to 10, and Xerox’s share of the world copier market was hovering precariously around 10 percent. Then-chairman David Kearns told associates that unless something radical was done, Xerox would soon be forced out of the industry it had invented.

As Kearns remembered it, the turnaround began at one of his annual meetings with employees at the company’s manufacturing center in Webster, New York. At the time, Xerox was ramping up production on a new low-cost copier, the 3300, which was supposed to be the answer to the Japanese competition. Unfortunately, the company hadn’t really designed a low-cost machine—it had just simplified one of its old designs and then used a lot of cheap, shoddy parts to make it. Even at that, the $7,300 price tag was significantly above the competition, but well below a price that the commissioned sales force thought was worth its time. As the employees gathered under a tent in the parking lot, a line of idled rail cars sat nearby, each one packed with unsold 3300s.

David, why didn’t you ask us what we thought about this? a union shop steward asked at the meeting. We could have told you it was a piece of junk. At that moment of utter humiliation, Kearns recalled, he vowed to turn the company inside out to ensure it never happened again.

The renewal process proved anything but smooth, and at numerous points Kearns feared it would collapse under the weight of cynicism, poor execution and out-and-out resistance. While a new combination laser printer and copier boasted a fresh commitment to quality, it came to market too early, before much demand had developed. And an ill-timed foray into real estate and insurance eventually cost the company more than $1 billion. Plants were closed, pay cut and frozen, top executives fired and more than 40,000 jobs eliminated. Slowly but surely, however, Xerox was learning to do things faster, better and cheaper. For the typical corporate customer, the four-cent-per-copy cost was cut in half, and then half again, along with the frequency of machine breakdowns.

To report the story, I had traveled to Aguascalientes, an industrial town north of Mexico City, to visit what had become the showcase production facility. Not only were labor rates in Aguas a fifth of what they were in the United States, but with its just-in-time inventory system, robots, laser-guided assembly and computerized production system, the plant there could produce 48 variations of the same copier on a single production line, using fewer man-hours and with fewer defects than other plants in Xerox’s newly globalized supply chain. Ten percent of the 2,000 Mexican employees had engineering degrees, and they were responsible for making all design changes for all of Xerox’s mid-range copiers.

Meanwhile, a joint venture with Fuji, Japan’s photo giant, had allowed Xerox to get to market with a quality color