Our mental models and the financial crisis

Cover of "The Divine Right of Capital: De...

Cover via Amazon

Marjorie Kelly, in her book The Divine Right of Capital, constructs a bold critique of the role that stockholders play modern corporations.     She compares stockholders to the aristocratic feudal lords of yore, who made rent on “assets” into perpetuity without lifting a finger.  Instead, Kelly argues that both the employees who work to create corporate wealth, and the communities that provide the resources necessary to create that wealth, should earn a larger share of the wealth.  Kelly examines the framework of the corporation as it was first conceived, how the corporations in the United States were initially granted state charters to only serve the public good, and how that public purpose was eroded in our courts.  Examining the state of affairs today, Kelly concludes that all players, including stockholders, CEOs, Wall Street firms, and even you and I, are all complicit, but no one is guilty:

“We fool ourselves if we think we can find the enemy somewhere.  Our anger at the system leaves us like the farmer in The Grapes of Wrath, who when his farm was repossessed couldn’t find anyone to shoot.  There isn’t anyone to shoot.  The problem is our internal maps, and rethinking those can require some vilification of outmoded views.  But we must remember that we’re vilifying the value system of wealth discrimination – not the wealthy themselves.  Respect for the right to attain wealth is integral to the American psyche.”  (Kelly 99)

Kelly is absolutely right here; we all operate based on the internal maps, with their arbitrary assumptions and logic, to try to make a good life for ourselves.  Certainly, when one examines the litany of shenanigans that occurred in the recent financial crisis, it is easy to spot villains like Bernie Madoff; when reading deft accounts of the crisis, like Michael Lewis’s The Big Short, it is easy to ask how our economic game could be rigged as it is, and how we could have been so blind to the massive speculative bubble that would take down the global economy.  However, Lewis’s narrative is perhaps the most relevant to Kelly’s critique here, because the 20 or so people that saw the asset bubble for what it was were outliers, consistently critiqued by the establishment.  Their mental models were slightly off from the mainstream, most memorably Michael Burry, the one-eyed medical school graduate who was obsessed with the stock market from the age 12, and built a successful stock-picking blog that he wrote in the wee hours as a resident into his own hedge fund.    However, the majority of operators in our economy are simply following the rules of the game, to the best of their ability.  The idea of the American dream, which is echoed whenever a mother tells a child, ‘you can do anything you want,’ is a critical part of the American psyche.  Kelly is attempting to shift our mental models, so that we can see that our current paradigm doesn’t quite live up to the ideals of that American Dream; we are not the ‘Land of Opportunity’ we think we are.

Kelley identifies a critical fault in the current paradigm: the idea that shareholders ‘own’ the company, and the companies they own are required to maximize shareholder return above all other concerns.  Employees, who’s knowledge and ideas create the wealth of the 21st century, should under that paradigm be paid as little as possible.  However, Kelly brings a different mental model to bear:

“The principle is simple: efficiency is best served when gains go to those who create the wealth.  Thus, instead of aiming to pay employees as little as possible, corporations should distribute employee rewards based on contribution – while recognizing that in any humane social order, a living wage is the basic minimum.  Likewise, corporations might aim for a decent minimum stockholder gain but drop their focus on maximum gain.  The legitimate goal is reward based on contribution.  Since the contribution of stockholders has shrunk dramatically, their gains should shrink also.  It simply defies market principles to continue giving speculators the wealth that employees create.” (Kelly 108)

In light is the recent Global Financial Meltdown, it is helpful to consider what role those speculators played in the inflating asset bubbles, and the growth of subprime mortgage bonds into the dominant investment vehicle between 2005-7.  But step back for a moment and consider what would have happened if the rising productivity of the last decade were not entirely bequeathed to stockholders, but if employees got their share?  What if communities, instead of giving tax breaks to draw corporations like Boeing to move, instead received their share, and invested it in our crumbling infrastructure and public schools?  In short, both individuals and communities would bear some of the fruit of their own industry.  The system would be more efficient, and given the recent speculative disasters, we certainly wouldn’t be any worse off.

 

Works Cited

 

Kelly, Marjorie. The Divine Right of Capital.  San Francisco: Berrett-Koehler, 2003.  Print.

 

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Capitalism, Justice, and Inequality

In the United States, the concept of the American Dream is accepted as the natural state of order, in which citizens are not tied down by caste, class, or family background, but can go as far as their ambition, initiative, hard work, and discipline will take them.  The growth of the American economy throughout the 19th and 20th Centuries provided opportunities that inspired immigrants the world over to travel to Ellis Island, and nurtured the development and dominance of capitalist economies around the world.  John Rawls, philosopher and author of A Theory of Justice, wrote in 1971 that:

“No one knows his place in society, his class position or social status, nor does anyone know his fortune in the distribution of natural assets and abilities, his intelligence, strength, and the like. I shall even assume that the parties do not know their conceptions of the good or their special psychological propensities. The principles of justice are chosen behind a veil of ignorance. They are the principles that rational and free persons concerned to further their own interests would accept in an initial position of equality as defining the fundamentals of the terms of their association.” (Rawls)

Rawls echoes the idea of the American Dream, that in a free, capitalist society, justice is opportunity, through the effort put forth by individuals, to improve their station in life.  Rawls believed that each individual should have a right to the maximum amount of liberty, but that any economic inequality should be arranged so that they are the greatest benefit to the least advantaged members of society.  In short, Rawls was egalitarian, consistent with the concept of the American Dream.

After the fall of the Berlin Wall and the dissolution of the Soviet Union, economists like Francis Fukuyama, who wrote The End of History and the Last Man, argued that an unending era of prosperity and peace under capitalism was upon us.  However, despite the rapid growth of capitalism during the last 50 years, and despite the end of the Cold War, inequality continues to grow globally.  In the United States, the percentage of total income that went to the top 1% of Americans increased from 8.9% in 1976 to 23.5% in 2007.  In 2007, the combined net worth of the Forbes 400 Wealthiest Americans was $1.5 Trillion, while the combined net worth of the poorest 50% of American households was $1.6 Trillion (IPS). Globally, the Gini Index, which measures the degree of income inequality in countries, shows that the level of global inequality is very high, and has risen during the last four decades (Anand).    This global inequality brings into question the concept of justice espoused by Rawls, and embodied in the idea of the American Dream.  What is it about capitalism that precludes equality?

Successful countries have advantages over developing countries that include superior educational institutions, superior and patented technology, and greater capital that allows for economies of scale and efficiency of production.  These same advantages hold true when you look at income groups instead of countries; even in the United States, the ‘land of opportunity,’ the son of a Harvard educated investment banker has significant advantages over the daughter of a working class family.  A recent examination by the New York Times of the epidemic of law school graduates, unable to find work and saddled with debt, featured a telling quote:

“Many Thomas Jefferson [School of Law] students are either immigrants or, like [Michael] Wallerstein, the first person in their family to get a law degree; statistically those are both groups with generally little or modest means. When [Beth] Kransberger [Associate Dean of Students at Thomas Jefferson] meets applicants engaged in what she call ‘magical thinking’ about their finances, she advises them to defer for a year or two until they are on stronger footing. ‘But I don’t think you can act as a moral educator,’ she says. ‘Should we really be saying to students who don’t have family help, No, you shouldn’t have access to law school? That’s a tough argument to make.’” (Segal)

The problem experienced by Mr. Wallerstein and many other law school graduates is a lack of capital; he overleveraged himself, with the American dream that he would get a job in a high-powered law firm.  Unfortunately, he made a bad bet.  John Perkins, author of Confessions of an Economic Hit Man, has written about the systematic overleveraging of developing nations through massive loans from the International Monetary Fund and the World Bank; like Mr. Wallerstein, those developing nations, such as Panama and Indonesia, were not positioned to undergo the kind of economic development that took place in the United States.  They are inherently at a disadvantage, and stunted by the game that is capitalism.  Unfortunately, the equality that Rawls proposed is not fundamental in our global economic system.  The American Dream, and by extension our globalized economy, is inherently rigged towards those that are already successful.

Works Cited

Anand, Sudhir and Paul Segal.  “What Do We Know About Global Income Inequlity?”  University of Oxford, 2006.  PDF.  Worldbank.org. January 12, 2011, Web.

The Institute for Policy Studies (IPS).  “Inequality By the Numbers”  wealthforcommongood.org, November 2009, PDF.  January 12, 2011, Web.

Rawls, John.  A Theory of Justice. Cambridge: Belknap, 1999.

Segal, David.  “Is Law School a Losing Game?” New York Times, Jan. 8 2011.  Nytimes.com, Jan. 12 2011, Web.