Social Market Economy

The Dark Side of Capitalism

Demonstranten protestieren am Sonntag (16.10.2011) vor dem Reichstagsgebäude in Berlin. Nach einer Demonstration gegen das globale Finanzsystem blieben viele Menschen am Vortag vor dem Bundestag. Die Polizei räumte den Platz in der Nacht. Foto: Hannibal dpa/lbn [ Rechtehinweis: Verwendung weltweit, usage worldwide ]
Protestors in front of the Reichstag in Berlin.
  • Why it matters

    Why it matters

    Capitalism faces a fundamental dilemma: the unethical practices of those who have risen to the top of the market economy are inflicting more damage on the system than the biggest anti-capitalists ever could have imagined.

  • Facts

    Facts

    • The Panama Papers leak, and soaring executive pay at companies where ordinary workers are losing their jobs, are convincing the public that capitalism is broken.
    • The bosses of blue-chip DAX-listed companies today earn, on average, 54-times more than their employees.
    • According to a survey by public broadcaster ARD, 77 percent of Germans believe the social market model has been corrupted to the extent that it now makes “the rich richer and the poor poorer.”
  • Audio

    Audio

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On the eve of the Detroit Auto Show in January, Volkswagen’s new chief executive, Matthias Müller, appeared to embody all that is wrong with capitalism today.

It was Mr. Müller’s first trip in the United States since U.S. environmental watchdogs accused the carmaker of cheating emissions standards with sophisticated software installed in around half-a-million diesel vehicles.

Americans felt deeply betrayed. They expected the head of Volkswagen to show humility, shame and regret for the carmaker’s transgressions.

But such expectations were soon quashed. Addressing several hundred journalists at Fishbone’s restaurant, Mr. Müller, the 62-year-old chief executive delivered a long, dispassionate, detached statement in choppy English. Although the word “sorry” was uttered, this was anything but a sincere apology.

Read stoically from a piece of paper, while tenaciously avoiding eye contact, Mr. Müller’s monologue seemed more like a lecture from some tired pedant.

Surrounded by reporters after his prepared remarks, the boss of Europe’s mightiest industrial company then really put his foot in his mouth.

Responding to a question from a correspondent at U.S. broadcaster National Pubic Radio about how the carmaker could change the perception that VW had “an ethical problem that’s deep inside the company,” a visibly irritated Mr. Müller countered, “I cannot understand why you say that.”

Rather than conceding Volkswagen’s deception, the chief executive claimed, “We didn’t lie.”

As surprising as it was, Mr. Müller’s performance apparently was no aberration from VW’s code of ethics for executives. Just the opposite: It appears to have been a reflection of their ongoing audacity.

A truly free market economy relies on the leading capitalists playing by the rules – written and unwritten.

Facing legal claims and government fines in the double-digit billions of euros, the company is tightening belts across its industrial empire, reducing workforce and reeling in expenses. But that has not stopped members of executive and supervisory boards from recently debating for weeks whether top managers should still receive their full performance-based bonuses for scandal-tainted profits from 2015.

Following a wave of outrage, VW executives then recanted, saying they would forgo some of their bonuses after all. But given the magnitude of the Dieselgate scandal, involving around 11 million vehicles worldwide, that did little to undo the additional dent to the carmaker’s reputation.

It didn’t help that amid the debate over bonuses, VW’s new supervisory board chairman – former Chief Financial Officer Hans Dieter Pötsch – was guaranteed a special payment of €10 million, or $11.3 million, for his services.

“That is the opposite of a positive signal,” said Christoph Lütge, a business ethics professor at the Technical University of Munich.

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The case of Volkswagen points to a fundamental problem of capitalism. On the one hand, the economic model has enabled more prosperity than any other system ever could have achieved. Since the beginning of the new millennium, more than a billion people have emerged from poverty thanks to capitalism.

But a truly free market economy relies on the leading capitalists playing by the rules – written and unwritten. To an overwhelming extent, these rules consist of a tacit understanding between the 1 percent and the 99 percent about what is fair and what is not.

Without a moral compass, exactly this fork in the road is where capitalism has lost its way.

Million-dollar bonuses appear legitimate to top VW executives, despite Dieselgate, because their contracts say they are entitled to them. The rest of the world, meanwhile, is disgusted. But this vast gap in values goes far beyond Volkswagen. It pervades our entire economic system and increasingly undermines society’s acceptance of the free market economy – which many fear isn’t that free after all.

“Criticism of capitalism comes in waves, but skepticism of the market economy has taken on alarming proportions since the financial crisis and the recent affairs.”

Hans-Werner Sinn, Former head of think tank Ifo Institute

“Criticism of capitalism comes in waves, but skepticism of the market economy has taken on alarming proportions since the financial crisis and the recent affairs,” warns Hans-Werner Sinn, former head of the Munich-based think tank Ifo Institute for Economic Research.

Moral norms, as complements to laws and regulations, are essential to the functioning of national economies, he adds. Without morality, economies eventually break down.

Over the past three years, however, the lack thereof has been alarming.

Mr. Müller’s counterparts at Daimler, Opel, Mitsubishi and Fiat have not been as systematic and insidious as Volkswagen, but they too have deceived regulators and consumers over tailpipe emissions.

But unethical business behavior goes well beyond automakers.

Drugstore czar Anton Schlecker is said to have hidden away millions before his Schlecker empire imploded in spectacular fashion, evaporating the livelihoods of thousands of employees.

Steel giant Thyssen-Krupp colluded with competitors under the code name “friends of rail” to illegally fix prices and scam national railroad operator Deutsche Bahn.

Deutsche Bank executives manipulated interest-rate benchmarks LIBOR and EURIBOR, which earned Germany’s biggest bank a multi-billion dollar fine from U.S. and U.K. authorities, while Siemens executives maintained a slush funds for years to grease palms with million-dollar bribes to secure lucrative contracts overseas.

The Panama Papers recently revealed countless examples of the moral equity deficit throughout capitalism’s corridors of power. The highly explosive treasure trove of 11.5 million leaked internal documents from an influential Panamanian law firm catering to the rich and famous detail a vast network of shell companies.

There can be many motivations for creating paper companies in places like Panama, the Cayman Islands, British Virgin Islands and other tax havens. But experts overwhelmingly agree that the purpose of the majority of shell companies is to shield assets from taxation.

Firms listed on the blue-chip DAX index alone have created up to 2,500 such legal shell companies in tax havens for the purpose of reducing taxes.

Some take advantage of loopholes to legally reduce their tax burdens; others engage in outright tax fraud. Prominent global players such as Apple, Ikea and Amazon attract criticism for using offshore companies in tax havens to cleverly minimize their tax burdens within the law.

German companies are also guilty of this. Firms listed on the blue-chip DAX index alone have created up to 2,500 such legal shell companies in tax havens for the purpose of reducing taxes.

Legal or not, most Germans consider the practice unethical.

Similarly, powerful industries and companies deploy legions of lobbyists – 5,000 alone in Berlin – to buy political influence and game the system to their advantage. Energy companies and automakers in particular have turned this into an art form. It’s all legal, but far from fair.

The credibility of capitalism also suffers from the fact that the profits of many Western companies, such as fashion producers and coffee roasters, still rest firmly on the backs of sweatshop laborers in developing nations.

The collapse of a textile factory that killed more than 1,000 workers in Bangladesh two years ago shocked the public and launched a wave of global supply-chain sustainability initiatives. But Western companies are not prepared to take the necessary big steps to fundamentally improve the working conditions of their low-wage contract laborers abroad – such as by embracing the pan-Asian minimum wage standards proposed by some advocacy groups.

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A growing crisis of capitalism? Source: Getty

One doesn’t even have to be anti-capitalist to sense that something has gone horribly wrong.

Consider the ever widening income gap between executives and their employees. The bosses of DAX-listed companies today earn, on average, 54-times more than their employees. But a Harvard Business School survey in 40 countries revealed that employees only consider it acceptable when the top executive earns five times as much as they do.

How do these colleagues then feel when, on top of earning disproportionately more money, top executives then spend their time and energy seeking out tax loopholes for their millions in bonuses?

“The times when Milton Friedman could still claim that the social responsibility of business was limited to maximizing profits alone are long gone.”

Christoph Lütge, business ethics professor

The irony of the situation is that the unethical practices of those who have risen to the top of the market economy are doing more damage to capitalism than the biggest anti-capitalists ever could have imagined.

Marcel Fratzscher, president of the German Institute for Economic Research, believes the end is near for Europe’s social market economies. Even in Germany, financial freedom is “not much more than an empty catchphrase and the privilege of an ever smaller elite,” he says.

Most Germans agree. According to a survey by public broadcaster ARD, 77 percent of Germans believe the social market model has been corrupted to the extent that it now makes “the rich richer and the poor poorer.” Some 73 percent agreed it “no longer functions as before,” while 51 percent of those surveyed said the social market economy “must be fundamentally changed.”

Was Karl Marx right in the end with his assertion that capitalism inevitably leads to “exploitation and alienation?” Did Adam Smith misplace his belief in an “invisible hand” guiding individual wealth creation toward a greater, common good?

At least since the global financial crisis that peaked in 2008, it has been obvious that the “invisible hand” either suffers from acute arthritis or it is reaching into people’s pocketbooks. That was the birth of the current skepticism of the economic system.

Banks became monsters, totally detached from the real economy and the moral values of most people. Investment bankers gambled it all on the markets, collecting bonuses of dizzying dimensions, until the system itself came to its knees. One bank after another collapsed. Many were then bailed out with taxpayer money when governments began to fear that the entire global financial system could be in jeopardy.

In response, the Occupy Wall Street movement was born in Manhattan and quickly spread to more than 900 cities in 82 countries. The battle lines, rather than drawn between labor and capital, increasingly separated good capitalists from bad capitalists.

Today, eight years after the outbreak of the financial crisis and several corporate scandals later, it may not always be clear where to draw such lines. But the global economy as a whole clearly has ethical issues.

“The times when Milton Friedman could still claim that the social responsibility of business was limited to maximizing profits alone are long gone,” says business ethics expert Mr. Lütge.

What Mr. Friedman, the Nobel Prize-winning economist, meant when he addressed the issue in a 1970 New York Times article was essentially that if managers wanted to engage in socially responsible activities, they should do so on their own time. “The business of business is business,” he wrote. Whoever placed undue demands of social responsibility on corporations jeopardized their competitiveness, for which society would have to pay.

The economist could not suspect at the time that some of the very managers and future executives who read his message too literally now threaten what he held most dear: the market economy itself.

But some executives today do understand that the business of business is everybody’s business.

Mr. Lütge sees signs of hope: “There are many examples of multinational companies that do more than just business, not only in the USA and other industrial countries, but also in developing countries. They voluntarily set environmental or social standards higher than legal requirements and engage in dialogue with non-governmental organizations.”

Germany, however, has ground to make up on such sustainable business issues, the ethics expert adds.

Nevertheless, such trends show that capitalism still can be saved. But there are three prerequisites: a functioning market, functioning institutions and a moral compass – without which neither markets nor institutions can find their way.

In the end, capitalism is too important to leave to business leaders who act without business ethics. No economic model or social system has ever provided as more freedom and prosperity. That’s why its time to protect capitalism – even against some of its most ardent proponents.

Jens Münchrath is an editor at Handelsblatt who covers the European Central Bank and monetary policy. Torsten Riecke is Handelsblatt’s international correspondent, reporting on international finance and economic topics.

To contact the authors: muenchrath@handelsblatt.comriecke@handelsblatt.com

 

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