December 11, 2015

Sustainability is key to the future of capitalism

Capitalism has served us enormously. It remains the predominant economic system in the world today. And despite the gloomy state of current global affairs, our society has made tremendous progress over the last century.

All the metrics used to measure human development, indicated by our health, economics and education, have globally improved ranging from 80% to 400% between 1900 and 2012. This is despite over a 300 percent increase in the global population during the same period.

Looking into the future, however, it is clear that the methods and the approach we used to achieve the above progress need fundamental change. The current path is simply not sustainable and also poses serious ethical concerns.

The fruits of capitalism are not being shared equally, causing massive income and wealth inequality. The richest 85 people in the world have the same wealth as the bottom 3.5 billion people. The combined wealth of the richest 1 percent will overtake that of the other 99 percent by next year. More than one billion people go to bed hungry every night.

We are presently consuming earth’s natural resources at an alarmingly unsustainable rate, using 150 percent of its sustainable capacity. Continuous overconsumption reduces planet’s long-term carrying capacity. The excessive use of fossil fuels has brought our planet to the brink of irreversible climate change. Our actions have already resulted in the extinction of hundreds of thousands of species.

This situation will worsen as our population balloons to around nine billion people by 2050.

The very survival of the human race hangs in the balance.

So, what is the solution?

Sustainable Capitalism

Sustainability — in all endeavors of human growth, prosperity and happiness — has to be the mantra. It should be the litmus test for everything we do.

I believe capitalism is still the right economic system. Taking a cue from Winston Churchill’s comment about democracy, it can similarly be said that capitalism is the worst economic system - except for all the others that have been tried. However, we need to fundamentally evolve capitalism and put sustainability at its core.

At the heart of a sustainable capitalist system is the goal of maximizing the interests of all stakeholders. 

The current system maximizes only shareholders’ interests. Stakeholders in an economic system include all the parties who are impacted by the economic operations of an enterprise. Company shareholders are its obvious stakeholders. But so are its employees, customers, business partners, the local community and the environment.

No business operates in a vacuum. It owes its health to that of the society in which it operates. No business can survive without happy employees, satisfied customers, enthusiastic partners, a vibrant local community and stable environment.

The corporate pursuit to solely maximize shareholders’ interest encourages a zero-sum mindset at the expense of other stakeholders. To illustrate its ill effects, let’s look at the current economic stagnation in the U.S., the model of capitalism in the world and its largest economy. Our economic growth has been stymied despite companies sitting on billions of dollars in profits. Companies have squeezed profits for themselves at all costs, with their ‘zero-sum’ mindset, consequently leaving fewer customers with available purchasing capacity to buy their products and services. And, it has left in its wake a polluted planet desperately crying for responsible behavior. Major Wall Street indices are showing record gains. But the Main Street is struggling. And the global leaders are currently huddled together in Paris at the 2015 United Nations Climate Change Conference to figure out how to save our planet.

New Leadership Skills

A sustainable capitalist system will require its leaders to have new skills, in addition to all the traditional management skills.

Business leaders will need to acquire a ‘win-win’ mindset while dealing with other corporate stakeholders, outside of shareholders, whose long-term health is critical to the long-term survival of their business.

Business leaders will need to think and plan long-term. They will also need to ensure, through an appropriate incentive plan, that the long-term focus permeates down the management chain. Short-term thinking, often pressured by the grueling quarterly reporting cycle imposed by investors and Wall Street, can be blamed for many disastrous corporate decisions. The quarterly cycle creates a perverse incentive for managers whose performance bonuses are tied to short-term corporate metrics. In an age when people are switching jobs more frequently than ever before, there is no incentive for them to worry about their decisions’ long-term impact that may show well after they have left the company. 

The above purpose-driven approach with an inclusive growth model for running a business also boosts employee morale and engagement and reduces their turnover. Numerous studies have clearly proven that going to work every day in order to make a positive difference in our society is one of the biggest motivators for employees.

Alignment between corporate management and shareholders on long-term view

There has to be an alignment between corporate management and its shareholders on long-term business focus. Too often, companies have operated with an eye on short-term quarterly performance with no long-term discipline imposed by its shareholders, many of whom themselves are guilty of focusing on short-term investment returns.

Companies need to attract shareholders focused on long-term returns. And all long-term investors need to apply pressure on companies to institute long-term corporate planning and execution.

For companies, attracting right shareholders may be a hard and time-consuming task. Investors focused on short-term gains may anyway not be the right fit for companies. They are most likely short-term speculators looking to make a quick profit from short-term price fluctuations in stock price. In the U.S., institutional investors hold the vast majority of public capital, and many of these are, or should be, focused on long-term returns. For example, pension funds own 75 percent of public capital in the U.S. The primary mission of these funds — preserving and growing capital for retirement — requires long-term investment focus. Their goal is therefore totally aligned with the goals of companies that are operating their business with a longer-term horizon in mind. However, many funds have incentive structure for their fund managers that rewards managers based on monthly and quarterly returns, thus promoting short-term investment policies that are contrary to the fund mission. Companies therefore need to do their homework before identifying and attracting the right institutional investors that are aligned with the management objectives.

Regulators too can play a role by ensuring financial reporting requirements and tax code encourage long-term value creation for all stakeholders in the economic system.

Sustainable Capitalism in Action

I’m very encouraged to notice changes emerging to promote sustainable capitalism across-the-board.

With respect to sustainable practices affecting our planet, this summer, Norway’s US$900 billion sovereign wealth fund, the world’s biggest, divested out of coal, the largest fossil fuel divestment yet, affecting 122 companies across the globe.

An eye-opening decision came earlier when the Rockefeller Brothers Fund, one of the world’s renowned family foundations, divested out of fossil fuels. The irony was that the direct descendants of John D Rockefeller, founder of the oil empire that eventually became ExxonMobil, started the fund 75 years ago.

Both these decisions provided impetus to the UN-backed Summit on climate change currently underway in Paris. The Divest-Invest campaign, whose aim is to sign-up investors that will divest from fossil fuel industries and instead invest in clean energy, has already signed up over 110 investors worldwide.

My four-year old daughter at the People’s Climate March held
in New York City on September 21, 2014. With over 300,000
activists participating to advocate global action against climate
change, the event was the largest climate change march in history.
On the corporate side, companies like Unilever, a US$59 billion consumer goods global giant, are setting an example that sustainable and equitable growth model can be achieved without sacrificing financial returns. Unilever, with over 400 consumer brands that are used by two billion people around the world every day, is the perfect candidate to test sustainable capitalism. In 2009, Paul Polman, the CEO of Unilever, established a sustainable living plan for the company. Six years into its new direction, Unilever is already showing impressive results.

Finally, there seems to be an alignment emerging amongst investors and corporations to suggest a global resurgence on long-term wealth creation instead of short-term gains. Hillary Clinton, the U.S. Democratic Presidential candidate, has called for an end to ‘quarterly capitalism’ in America. If elected, she is likely to push for regulatory changes necessary to promote sustainable capitalism in the country.

To conclude, while adopting a sustainable capitalist system may at first seem a tall order, early results prove that it can be successfully done, and winds of change across the board are already underway. It’s the only way to create an economic system for the 21st century that ensures we create wealth in a sustainable and equitable manner. We owe it to our children and future generations.