Capitalism and Western Civilization: Corporations

William H. Young

The business corporation was a key driver of the metamorphosis that began in the nineteenth-century West and continues to provide unique advantages for our economy. Americans need to understand the important functions of the corporation and its potential evolution in the twenty-first century. 

As William J. Bernstein explains in The Birth of Plenty: How the Prosperity of the Modern World Was Created (2004), private Roman tax collectors “formed the first recorded joint-stock corporations for this purpose, trading their shares in the Temple of Castor.” But Roman law “discouraged large-scale commercial enterprise” by making all partners in a company “personally liable for its debts.” Such extreme penalties for failure discouraged prudent risk taking, the very basis of commerce and economic progress.” 

Fortunately, America inherited from England three key aspects of the rule of law related to business—ownership of property, sanctity of contract, and the limited liability corporation—which enabled innovation through entrepreneurship. The earliest corporations were joint-stock companies created and controlled by a few investors who placed pooled financial capital at risk and hired workers to accomplish, under contractual arrangements, particular projects, in anticipation of a return—from corporate profit—on their investment. The projects were often public works such as roads and canals. Thousands of limited liability corporations—called “soulless instruments” of capitalists by the laboring class—were formed beginning in Tocqueville’s America to undertake mostly private ventures, as Morton Keller describes in The Making of the Modern Corporation (The Wilson Quarterly, Autumn 1997).

From the beginning, such corporations were chartered, or given authorization, by state governments. Over time, corporate charters changed to permit activities of “any legal purpose” over a perpetual life. Investors in corporations gradually came to include large numbers of individual stockholders or shareholders who, not being personally liable for more than their investment, had an incentive to take small risks each and advance free enterprise. Around the start of the twentieth century, a merger binge helped to create the kinds of giant corporations with millions of shareholders that came to dominate the mass-production American economy— offering long-term employment to thousands of individuals.

Understanding the value of intellectual property to a commercial republic, James Madison (over the opposition of Jefferson) inserted into Article 1, Sec. 8 of the Constitution the clause: “The Congress shall have the power…to promote the Progress of Science and useful Arts, by securing for limited times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries….” The first American patent law went into effect on April 10, 1790. The new system dramatically advanced the incentive of entrepreneurs to pursue invention.

The Anatomy of an Entrepreneur by Vivek Wadhwa et al, (Kauffman Foundation, July 2009) explains that the primary motivations of entrepreneurs are: to build personal wealth; to capitalize on a business idea; to own their own companies; and to work for themselves rather than others. Entrepreneurs do not set out to create jobs; jobs are a wonderful byproduct of their effort to realize their nature as creators and innovators. Providers of equity capital produce jobs only if they can realize—from corporate profit—an economic return commensurate with risk relative to alternative investments. Today, such investors are very often the pension plans of public and private employees seeking to obtain retirement security.

Economist Joseph Schumpeter, in Capitalism, Socialism, and Democracy (1942), considered the entrepreneur to be the main source of economic growth, stimulating investment and innovation and making old technologies obsolete, thereby causing what he called “creative destruction.” To illustrate, during a period of strong economic growth from about 1980 to 2005, “some 15% of all jobs were destroyed every year, even as total jobs grew by an average of 2% per year,” reports Holman W. Jenkins Jr. in The Wall Street Journal, January 13, 2012

What are the capitalist principles upon which corporations operate? They produce goods and services to be sold for the satisfaction of customers in a competitive marketplace—reciprocal exchange. The product must be of better quality and lesser cost than competitive products that also may be chosen by customers—comparative advantage. Success in the marketplace depends on economic efficiency through specialization, innovation, technology, and employees who add sufficient value relative to their compensation—productivity. The corporation produces new wealth in both the product sold to customers and the compensation of stockholders, employees, and suppliers.

It is the allocation of corporate income and profit among stockholders, managers, and workers in given industries at given times—the actions of specific capitalists, not the system of capitalism—that constitute the issue of “fairness.” And while Noam Chomsky argues that the word “crony” is superfluous when describing capitalism, cronyism is not in the inherent nature of corporations. Instead, corruption through interaction with government and politicians has long been the incubator for crony capitalists.

In Civilization and its Enemies (2004), Lee Harris explains how the Romans were able to supersede ethnocentric—narrow, sectarian, tribal, and racial—particularism by devising what he calls “team cosmopolitanism,” later adapted by the modern West and the United States. Team cosmopolitanism aims at “creating a society where membership is open to all who wish to embrace the team ethos of the new community.” Its hierarchy is “used to organize total strangers…who occupy any position on the hierarchy purely by virtue of…merit….This gave rise to the corporate principle and its potential for expanding immensely the size and scope of any community that adopted it….As the Roman Empire exhibited in its own epoch, and as capitalism has demonstrated in ours, the corporation has no intrinsic limits to its possible growth”—provided that it embraces team cosmopolitanism and hierarchies of merit.

Ironically, postmodern multiculturalism most undermines the corporation not by its contempt for capitalism, from cultural Marxism, but by the beliefs it has ingrained in our elites. The participation of members of racial or ethnic identity groups is valued over the team ethos. Hierarchy must reflect diversity over merit. Competition harms self-esteem, now awarded by preferences. Equality replaces efficiency; entitlement replaces exchange; and rights replace reciprocity. Specialization and individual competence, enhancing team performance, is supplanted by group sharing.

In a competitive global economy undergoing rapid technological change, capitalism is transitioning away from large domestic corporations providing lifetime jobs to more transnational entities and small businesses, who expect their workers to provide more for themselves. Let’s consider some ideas about the future corporation.

Simantra Ghoshal (London Business School) and Christopher Bartlett (Harvard Graduate School of Business) offer the following perspectives in The Individualized Corporation (1997):

Much of the blame for the breakdown of the old employment contract has been placed at the doorstep of greedy management….Yet, in the end, it is not management but the market that has made the traditional employment nonviable….In a dynamic world, a source of competitive advantage in one period becomes…a source of competitive disadvantage in another…. Valuable knowledge and skills become rapidly outdated…Markets shift, technologies change, prices erode, and new competitors render obsolete not only profitable products but whole business systems.

 Ghoshal and Bartlett recommend a new corporate concept more supportive of individuals who must adapt to such change.In The Sovereign Individual (1997), James Dale Davidson and Lord William Rees-Mogg envision corporations returning to their form in Tocqueville’s America—constituted for specific tasks or projects over a limited time, providing a nexus for a set of contracting relationships with contingent workers.

And, as usual, the late management guru Peter F. Drucker foresaw these developments in “The Rise of the Knowledge Society” (The Wilson Quarterly, Spring 1993) when he predicted that future society would have to be based on “individual responsibility.”

Next week’s article will address the mundane but essential concept of productivity to economic growth.

This is one of a series of occasional articles applying the lessons of Western civilization to contemporary issues relevant to the academy.

The Honorable William H. Young was appointed by President George H. W. Bush to be Assistant Secretary for Nuclear Energy and served in that position from November 1989 to January 1993. He is the author of Ordering America: Fulfilling the Ideals of Western Civilization (2010) and Centering America: Resurrecting the Local Progressive Ideal (2002).

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