What are corporations for?

Peoples and cultures are largely defined by the rules and institutions they have created to manage their relationships and interactions with their fellow man. Speaking in the broadest terms, I tend to think of the political struggles of our time as between those who trust individuals to make the decisions that best serve their own interests and those who do not thus preferring to give such power to higher authorities.  Safety nets consisting of a minimum guaranteed income to be used as its recipient sees fit vs government designated expenditures targeted at what the government thinks is best represent the two extremes of these attitudes.  All societies exist somewhere between these polar cases.  Those of us who trust individuals to make decisions for themselves rather than for others, look to government to provide a secure legal framework for individual liberty (the establishment and protection of property and human rights) and to provide frameworks for developing and communicating the information that can help inform individual decisions.

Between the state (municipal, state, federal) and individual families (the fundamental unit of existence), every society has developed intermediate groups/institution to facilitate cooperation and coexistence with other families. We come together in groups of common interest (clubs, churches, cultural centers, etc.) for fun, learning, cooperative undertakings. The rules and quality of these institutions profoundly influence the nature and quality of our societies and thus of our individual lives.

Importantly, in the area of production, the advent and expansion of specialization and trade has enormously increased what individuals could produce and thus our standards of living. This led to new structures of cooperation in which individuals worked together to enhance their productivity (cooperatives, partnerships, companies, corporations).  As collaborative production became more and more complex (and productive) and benefited more and more from the use of equipment (machines, factories, i.e. capital), new forms of organizations emerged including a distinction between the owners of capital and the suppliers of labor. These were codified in laws of the state to document the rights of each. Ronald Coase’s foundational work on this subject is well worth rereading: “The Nature of the Firm”

The owners of capital were responsible for its uses and workers were responsible for their labor.  The establishment of a limited liability company–a corporation–fundamentally altered the relationship between owners of capital and renters of labor (workers). It was a new institution that weakened the responsibility and role of owners in the operation of firms but greatly broadened access to ownership. The owners of companies often no longer managed them.  Ownership shares were held by people with little direct involvement in the firms they owned (e.g. pension funds). They were sometimes traded from one owner to another frequently.  This weakening of owner oversight and control increased the quasi-independent control of businesses by corporate managers, creating the so called “managerial class.”  The challenge became how to incentivize corporate managers to act in the interest of the owners for whom they worked.  “When corporations changed their social role and upended our politics”

Tying the interests of managers to those of a company’s owners is a work in progress. Incentives were created, such as stock options, to reward managers for serving the interests of the owners as reflected in share prices. When poorly structured they incentivized short term gains at the expense of the long-term profit and value of firms.  Lessons were learned and are still being learned. But key to the harnessing of the managerial class was acceptance that the goal of a firm (of any economic activity) is to maximize the profits of its owners.  Attention focused on how best to do that in the long run.

A profitable firm is one that has created and produces products valued by customers at the least cost. Costs are minimized by using capital and labor efficiently. Labor costs are minimized by providing a work environment that attracts and keeps workers with the relevant skills at the least cost. This often involves firms providing training in the skills needed, etc.  Approaches vary between countries and are reflected in different business cultures and institutions.

In Japan, for example, until recently firms offered their employees lifetime employment with wages and promotions based on seniority. Choosing a university and course of study was simultaneously the choice of a career in a particular firm.  While providing great security for Japan’s labor force, it did not encourage innovation and entrepreneurship and made corporate adaption to changes in market preferences and conditions difficult.

Germany has taken a different approach in which workers are more formally involved in how labor is reduced during recessions or more permanent declining product demand. As reported by the Wall Street Journal, “rather than resorting to mass layoffs or plant closures, they will often reach for instruments created by government and unions that allow executives, often with considerable state support, to weather economic storms, or reduce their workforces through voluntary methods….  Sparing staff in a short downturn can allow companies to ramp up activity quickly when demand rebounds without having to hire and train new workers. But it can also slow necessary adaptations when companies are faced with structural changes, resulting in some businesses sticking to outdated business models for too long.”  “Germany offers a model to corporate America on labor relations”

U.S. labor practices are very different. Jobs are less secure, and promotion is based on performance. More of the burden of corporate adjustments to new products and/or new conditions fall on workers who thus rely more on governmental programs to facilitate the transition to new skills and/or firms. The inadequacy of such programs may have contributed to anti-immigrant and anti-trade sentiments fanned by President Trump.  Trade is often unfairly blamed for the loss of manufacturing jobs (the primary cause is increased productivity allowing fewer workers to produce the same output), though a strong majority of American’s still think that trade is a good thing. “Trends in international public opinion”

Until recently discussions of corporate governance focused on how best to maximize share holders’ value. As The Economist magazine recently put it: “In a free market, pursuing shareholder value would in and of itself deliver the best goods and services to the public, optimise employment and create the most wealth—wealth which could then be put to all sorts of good uses.” “Big business is beginning to accept broader social responsibilities”  This was recently challenged by the prestigious Business Roundtable, which stated in August that hence forth the objective of American corporations should be “to create value for all our stakeholders.” “Lobbying group powerful CEOs is rethinking how it defines corporations purpose”

“On August 19th the great and good of CEO-land announced a change of heart about what public companies are for. They now believe that firms should indeed serve stakeholders as well as shareholders. They should offer good value to customers; support their workers with training; be inclusive in matters of gender and race; deal fairly and ethically with all their suppliers; support the communities in which they work; and protect the environment.”

Many of these goals are fully compatible with and contribute to maximizing shareholder value.  But obviously, there are some potential business behaviors beyond producing desirable products cheaply that can impact society as a whole, such as one form of pollution or another. These externalities are rightly dealt with through taxes and subsidies or legal restrictions. But should companies keep some of the shareholders profits to support or promote other social objectives? Directing the resources of a firm to all stakeholders, the community and general public in essence, sounds like a very decent thing to do.  For example, should a company donate to the political campaign of a candidate expected to support policies favorable to the company or to the local YMCA?

“The most quoted assertion of the primacy of shareholder value comes from Milton Friedman, an economist. In 1962 he wrote that ‘there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.’” (The Economist 8/22/2019)

The prevailing model has been for companies to maximize their profits from the production of the products they were established to provide and to leave to their owners the choices of how to use those profits for the betterment of the community. Diverting shareholders’ profits to other worthy causes chosen by firm managers would be a bad idea for several reasons:

  • A firm that has succeeded in profitably suppling things the public likes might not have the expertise to make the best choices about using the company’s resources to serve the community in other ways. Put that way it should be obvious that the talents needed for the one are not very likely to be the same ones needed for the other.
  • Some corporate donations will almost surely go to support and protect business interests of the donating company thus invariably reducing economic competition. This incentive has very likely contributed to the increased concentration of corporate empires.
  • In an excellent oped Phil Gramm and Mike Solon note that: “Seventy-two percent of the value of all domestically held stocks is owned by pension plans, 401(k)s and individual retirement accounts, or held by life insurance companies to fund annuities and death benefits. This wealth accumulated over a lifetime and benefits all Americans…. Eliminating corporations’ duty to serve investors exclusively and forcing them to serve political interests would represent the greatest government taking in American history.” “Warren’s assault on retiree wealth”

The following articles explore these, and other dangers posed by the pollyannaish appeal of serving the interests of stakeholders at the expense of shareholders: “A reexamination of ownership in the age of the public corporation”,  “Stakeholder capitalism-business roundtable”  In claiming to set out how it should be done, none other than Larry Summers knifes the idea to death: “If business roundtable CEOs are serious about reform here’s what they should do”







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Where does the desire to explore come from?

Long ago I had the pleasure of introducing a young friend to types of food he hadn’t tasted before.  He was quite comfortable with his American style hot dog and hamburger meals and wasn’t certain he wanted to try new and strange dishes.  People differ in this regard.  Some are eager to try new cuisine, see new places, and encounter new people and cultures. Some are not.  And some are even rather intimidated and reluctant to leave their familiar comfort zone. There is a lot to be said for the predictability of the familiar, perhaps similar to well-worn shoes.

After some gentle persuasion, my friend agreed to sample a few dishes.  I reassured him that nothing would be forced on him and that he might even discover some exciting new tastes.  If he found that he didn’t like a dish he would not have to finish it.  But he would never know what he might be missing if he didn’t explore a bit.  Once he started, however, it was hard to stop him.  He was pleasantly surprised at how interesting and tasty some dishes were.  He was particularly reluctant to try foie gras knowing it was goose liver, though he fell in love with it by the second bite.

As I noted earlier, people differ in their tastes for adventure.  We might just leave it at that but for two reasons.  The first is that being rich is more interesting and exciting than being poor.  I am speaking here of experience rather than money.  Seeing and engaging new and different places, meeting new and different people of different cultures, listening to new and different music can make life richer.  The core of a liberal arts education (as opposed to acquiring professional skills) is the introduction to and broadening of our understanding and appreciation of ours and other cultures. It makes our lives richer.

The second is that openness to change is a necessary aspect of economic progress.  Technical progress disrupts the established order but increases our productivity and standards of living.  Global trade not only significantly increases our material standard of living but confronts us with other people and cultures as well.  Both–technical progress and global trade often impose changes on us (such as the job skills demanded in the market) that we might otherwise not choose or want.  If people can choose to live where their opportunities are greatest and if firms are able to employ people with the skills that best fit the firms needs, economies will be more efficient and will raise the standard of living for everyone.  By allowing the disruption of innovation and trade we will have the opportunity to, or be forced to, confront and deal with strangers more often.

This can have a negative side for those who do not easily embrace adventure—those who prefer the familiar (hot dogs and hamburgers). If new neighbors come from different backgrounds and cultures, adventure lovers can enjoy the excitement of learning more about other places and people.  But those uncomfortable with strangers can be – well – uncomfortable.  Economic advances can also have negative impacts on those whose skills are no longer needed and we would be wise to develop and support government measures to soften and facilitate the needed adjustments.

A predisposition to seek and embrace adventures or to shun them is given to us by nature. However, civilization and its advance builds on nurturing more social skills and openness. Failure to teach/convince our fellow citizens of the rewards of adventure (or merely accepting and adjusting to change) can lead to disastrous results.  In extreme cases unease can turn to fear/hate as in the recent white nationalist terrorist attack in El Paso by Patrick Crusius.  As-his-environment-changed-suspect-in-el-paso-shooting-learned-to-hate.  The nature of public debate on race relations, religious freedom, globalization, etc., and the words of role models can have a profound impact on how those confronting change formulate their views on these subjects.

The world is a better, richer place when all of its people respect one another and live peaceably together. We and our education systems (school, churches, clubs, jobs) should do our best to encourage those reluctant to welcome strangers of the positive experiences it can open to them.  By learning to understand different ways of thinking and doing, we not only enrich our lives but can strengthen our own ways of doing things (our own cultures). Such interactions can show us what we like and value about our own ways and what we might adjust in light of the interesting practices of others. This is what the American melting pot is all about. It has produced a vibrant, dynamic and economically flourishing country. However, it is more friendly to the adventuresome types than to those resistant to change. We would do ourselves and our country a favor to kindly encourage those “left behind” to open up more to the wonders of our changing world.  With regard to a difference subject of misinformation Anne Applebaum explores multiple approaches to this task: Italians-decided-to-fight-a-conspiracy-theory-heres-what-happened-next?


Posted in Discrimination, immigration, Musings, trade | Tagged , , , , , , , , , | 1 Comment

Health Care in America

Late night’s Democratic Presidential debates hit us in the face with how complicated the healthcare debate is. Trying to address it in one-minute sound bites is unpromising so I don’t blame the candidates for failing to be clear. We spend twice as much on healthcare as Canada or our European friends with similar or worse results. We must reduce spending without compromising outcomes while ensuring that everyone receives the care they need.

Our approach to covering the cost of care is to provide insurance to pay for some or most of privately provided care. Insurance spreads the financing of medical costs, whatever they are, among a defined group. Those lucky enough to stay healthy help cover the costs of those not so lucky. Defining the “group” whose costs are thus shared is important. In the U.S. typically the employees of large companies define the group (the risk pool). In this way, there should be a random distribution of lucky and unlucky health-wise within each group. The government subsidies employer provided health insurance by excluding it from the employees’ taxable wages. This creates problems when a worker is fired or wishes to change jobs.  If those with preexisting medical issues join an insurance pool, its overall medical expenses will predictably increase as will its insurance premiums needed to cover the higher cost. If the risk pool is the entire population, as it would be with Medicare for All, it would be the tax payer who pays the cost. These features flag only a few of the challenging issues that healthcare policy needs to address.

The elephant in the room is the high cost of care.  How insurance is structured profoundly influences the bloated cost of care.  Requiring patients to pay at least a bit of the cost (copays) introduces an element of cost consciousness on the part of patients and their doctors that can influence the care chosen.  But there are also other factors, such as restrictions on who can provide what care (MDs, nurses, teleconferencing, etc.) that influence the cost of care.

I have explored some of these issue in the past in more detail and am providing several links here for those of you who are interested. The first blog was written ten years ago: https://wcoats.blog/2009/07/29/econ-lesson-the-rationing-of-medical-care/.  The second link is to a blog written two years ago:  https://wcoats.blog/2017/07/31/finally-health-care-reform/

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Is Trump killing his own re-election?

The Fed (Federal Open Market Committee) is meeting this week to review and set or reset monetary policy.  I don’t know whether it should increase its policy rate, leave it the same or reduce it. https://www.adamsmith.org/blog/returning-to-currencies-with-hard-anchors  The market expects a one quarter percent reduction in the rate.  President Trump is quoted yesterday as saying it should be reduced more than that. WSJ: the confusing Fed

There are several problems with Trump’s statement. One is that if the Fed reduces the rate, its claim to be reacting to the data and its mandate is undercut by the President’s interference. Is the Fed doing what seems best or responding to political pressure?

But if the U.S. economy is heading South, as it may be, it is probably because of the damaging effects on the U.S. and world economies of Trump’s trade wars with almost everyone but especially with China. Trump’s tariffs have imposed significant costs on the American consumers who pay them with higher prices for targeted imports. More importantly, his trade wars have injected significant uncertainty into the continued viability of the global supply chains that have helped lower costs here and abroad and increased world output.  Their retrenchment is lowering world income and pushing many economies, including potentially the U.S. economy into recession. A U.S. recession a year from now will seriously damage Trump’s chances of reelection.

Trump’s wars on trade seem to be motivated by his mistaken belief that the U.S. trade deficit with China, Germany and others reflects unfair trade practices on their part. His misuse of a national security concern to impose protectionist tariffs and restrictions on foreign competitors (protecting inefficient U.S. industries we would be better off allowing competition to shrink) seems motivated by vote buying. https://wcoats.blog/2018/09/28/trade-protection-and-corruption/  The result is a reduction in our income and potentially his electoral defeat. Our trade deficits largely reflect the use of the U.S. dollar in international reserves (which require a deficit to supply them) and our large and growing fiscal deficits (much of which is being financed by China and other trade surplus countries). Trump’s abandonment of government spending restraint is the cause of those twin deficits https://nationalinterest.org/feature/who-pays-uncle-sams-deficits-26417

It’s not that we don’t have real issues with some of China’s trade related practices, but Trump’s approach to addressing them is not productive. Rather than working with the EU and Japan and others who share our concerns to confront China together, he is attacking all of them with threats of more tariffs. Rather than strengthening the WTO, he is weakening it. Rather than using the Trans Pacific Partnership (a significant advance in modern trade agreements) to encourage China to adopt its rules, Trump withdrew the U.S. from the agreement– a huge mistake. The real question is how much more damage will Trump inflict on the world economy before he surrenders and declares victory or is voted out of office. https://wcoats.blog/2019/06/07/the-sources-of-prosperity/

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Whither Libra?

Every other day, it seems, we witness the launch of a new crypto (digital) currency.  Each combines a medium of exchange (a currency) and a means of payment (a technical process of delivering the currency—of making a payment with it). While many of us have watched the ups and downs of bitcoin and its imitators with amusement, none of us (hopefully) take it seriously as a currency. Bitcoin is a speculative vehicle for gambling.  Processing bitcoin payments is too slow, and its value is too volatile to succeed as a medium of exchange or as a means of payment. Only about 1% of bitcoin transactions are actual payments.  Many new means of payment do not involve a new currency.  Thus, debit and credit cards, checks, wire transfers, PayPal, Popmoney, Zelle, etc., are means of payment of US dollars, or Euros or other sovereign currencies.

Unlike the bitcoins of the world, Libra is a currency and means of payment that is designed to ensure that its tokens will have a stable value.  The legacy members of Facebook, Visa, Uber, and other partners in the Libra Association promise the possibility of rapid adoption. Libra’s value will be fixed to that of a basket of major currencies, its supply will be regulated by market demand at that fixed price (issued via currency board rules), and it will be fully backed by assets of the same value ensuring that holders of Libra can redeem them for the same value at any time.

Suddenly potential regulators are on high alert such as witnessed in the recent Congressional testimony of David Marcus, head of Facebook’s Calibra, to Congress.  By whom and how should Libra be regulated?  Obviously, it will need to comply with Anti Money Laundering (AML/CFT) requirements and whatever else each jurisdiction in which its participants reside (holders of “accounts” with Libra or of its tokens) require of money service providers. Banks take deposits and lend, so Libra would not be a bank. While its tokens might be treated as deposits, it will not lend (its purchases of government debt and other securities with the money paid to buy Libra are investments not loans).  In this short note I will explain why Libra—the coin/token/currency—is not a claim on a mutual fund and thus should not be regulated in the US by the Securities and Exchange Commission.  I will not, however, examine its claim to be a more efficient means of payment.

The nature of Libra’s claim of stability rests on how its value is determined.  Its value is to be fixed to the market value of a basket of currencies yet to be determined. But how does that work exactly?  The world already has an internationally determined and managed unit of account, the Special Drawing Right (SDR) of the International Monetary Fund.  Rather than introduce yet another, competitive unit the case for Libra to fix to the SDR is so overwhelming that I will illustrate the difference between a currency basket as a unit of account and as an investment portfolio with the SDR. The composition of the SDR’s valuation basket is established by international agreement following a well-specified and transparent process.  Fixing the value of a Libra to that of the SDR would remove any risk of its value being manipulated by Facebook or other Libra shareholders. That would strengthen the status of the Libra but also contribute to enhancing the IMF’s SDR as a supplement or substitute for the dollar in international reserves, as called for in the IMF’s Articles of Agreement.

The SDR’s value is determined by a basket of five currencies (the dollar, euro, pound sterling, yen and renminbi).  The IMF computes the dollar value of one SDR (and thus the value in every other currency) daily on the basis of the market exchange rate of each of the five currencies in the valuation basket into dollars.  The dollar values of each currency are added up to determine the dollar value of the basket.  By fixing the value of one Libra to one SDR it sets the price at which Libra can be purchased and the currency value that would be returned if Libra were redeemed.

This might seem similar to, but is in fact very different than, the value of one Libra being determined by the value of the portfolio of investments that back it.  The “Reserve” backing Libra would consist of SDR denominated assets (e.g., SDR bonds) or assets in each of the five basket currencies in the same proportion as in the SDRs valuation basket. Thus, it would bear no exchange rate risk.  However, the investment would have other risks, specifically interest rate and default risks.  To the extent that some of the Reserve’s investments are relatively long term (say ten-year Treasury bonds), changes in market interest rates would change the current market value of these investments. While Reserve investments would presumable be made only in the safest assets and would be limited to relatively short-term instruments, the risk of default or loss in value would not be zero.  So, if one Libra is a claim on its share of the Reserve, its value could differ from the daily dollar value of the SDR valuation basket.

Libra wishes to include the unbanked in its market, thus opening financial and payment services to this broad group now unable to enjoy them. If Libra’s value is fixed to the value of its Reserve, and thus regulated by the SEC (in the US), consumer protection investment regulations would likely exclude the very people Libra is most interested in serving. Thus, Libra should fix its value to that of a unit of account and not to the value of its Reserve.


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Should we subsidize college educations?

“According to a national report by the State Higher Education Executive Officers Association (sheeo.org), high school graduates earn an average of almost $30,000 per year. Bachelor’s graduates earn an average of just over $50,000 a year. And those with a higher level degree (master’s, doctorate or professional) average nearly $70,000 per year. This translates to a significant earnings gap over the course of one’s life.” https://www.educationcorner.com/benefit-of-earning-a-college-degree.html “According to the SSA, the average wage in 2017 was $48,251.57.” https://wallethacks.com/average-median-income-in-america/  Moreover, college graduates generally have more interesting and secure jobs.

Who should pay for those advantages? The students themselves, or their families, have often borrowed the money to cover their educational expenses. Currently they owe $1.6 trillion  “Here’s-what-trillion-student-loan-debt-is-doing-US-economy”. Democratic party presidential candidate Bernie Sanders proposes to cancel all of it. He would also make all public colleges and community colleges tuition free.

Is that a good idea? Is it fair and does it encourage or enable a better use of our human resources? A proper evaluation requires indicating who would pay for it if not the students themselves. From the above data we see that college graduates make a lot more than everyone else on average—almost double the income of high school graduates.

If the $1.6 trillion in education debt is cancelled, the burden of repaying it (most of it was lent by banks, often guaranteed by the government) will be shifted from the better off (students who will receive higher incomes in the future because of their college educations) to tax payers. Total tax collections by the federal government in 2018 were $3.3 trillion, half of which was income tax, 35% was payroll tax (social security) and only 6% was corporate income tax.  https://www.pgpf.org/budget-basics/who-pays-taxes

Senator Sanders says he will cancel all student debt within six months. Does he plan to cut spending on other programs by $1.6 trillion, a 36% cut, or to increase taxes by $1.6 trillion (the deficit for FY 2019 is already forecast to be $0.9 trillion), or some mix of these?  According to Charles Lane: “Sanders and other left-leaning Democrats promise to pay for tuition-free college and Medicare-for-all with higher taxes on the top 1 percent of earners. Most Nordic countries, by contrast, have zero estate tax. They fund generous programs with the help of value-added taxes that heavily affect middle-class consumers…. The Nordic countries tried direct wealth taxes such as the one that figures prominently in the plans of Sen. Elizabeth Warren (D-Mass.); all but Norway abandoned them because of widespread implementation problems.”   “Democrats-use-Nordic-nations-as-models-of-socialism”

The Tax Policy Center “estimates that 69 percent of taxes collected for 2019 will come from those in the top quintile, or those earning an income above $157,900 annually. Within this group, the top one percent of income earners — those earning more than $783,300 in income per year — will contribute over a quarter of all federal revenues collected.”  Can we and should we try to squeeze even more out of them?

The effective federal tax rate for the top 1% income earners in 2018 was 29.6%, compared to 12.1% for the middle quartile of income earners and 2.9% for the bottom quartile (almost none of which was income tax). It is not obvious where the burden of this gift to the prospectively better off college grads will fall. But it seems to involve a lot of income transfers, which seem to sound nice to our new “socialists.”


Posted in Government, taxes, Uncategorized | Tagged , , , , , , , | 2 Comments