Lady Lynn Forester de Rothschild on Reinventing Capitalism

Can capitalism be fixed? Ever since the financial crisis, scholars and academics have been pondering over this vexing question. Capitalism began on the right note after all—it seemed like the ideal system that would spur economic growth, encourage private enterprise, crank up the innovation machinery and lift millions out of poverty. But over the last few years the flaws of the capitalist system have come to the fore: it has led to the concentration of power with a few big corporations, short-term thinking, joblessness and increased income inequalities.

Lady Lynn Forester de Rothschild, CEO of investment company E.L. Rothschild , believes that capitalism can be fixed. She recently became Co-chair of the Henry Jackson Initiative for Inclusive Capitalism, a non-profit working towards nurturing a more inclusive capitalist system. Dominic Barton, Global Managing Director of McKinsey & Co., is the other Co-Chair. The initiative has the support of members like Carly Fiorina (Chairman, Fiorina Enterprises and Good360, Former CEO of Hewlett-Packard), Larry Summers (President Emeritus and Charles W. Eliot University Professor of Harvard University) and Laura Tyson (Professor, S. K. and Angela Chan Chair in Global Management, Haas School of Business, University of California-Berkeley).

During a recent visit to CKGSB, Lady de Rothschild explained that the world needs to move towards a more inclusive idea of capitalism. Excerpts from an interview:

Q. Despite the big financial crisis, all the big excesses and abuses, you still remain a firm believer in the power of the capitalist system. Why?
A. I’m a firm believer in the principle of free markets and free trade. An economic system that focuses on consumers rather than producers lifts more people out of poverty and creates more wealth. That was Adam Smith’s fundamental thesis in The Wealth of Nations: take away the power from the producers, create more entrepreneurs and there will be better wealth for everyone.

Crony capitalism, where big business and big government collude for their own advantage against the ordinary person, is not the kind of capitalism that we can defend. The kind we can defend is one that has a profit motive, but also sees its responsibility in terms of the larger society—not only because of a moral imperative, but also for (its own) sustainability.

Because at the end of the day, if the ordinary man and woman does not believe in the system, they are going to bring it down. So it’s not possible for capitalists to live in some gated community with big cars and big houses. That’s alright if it’s honestly earned in a level playing field where everyone has an opportunity to the top. That’s what I mean by inclusive capitalism.

Q. You also draw a very interesting metaphor on this whole idea of big building with many floors. Can you explain what that is, and you know, what really went wrong?
A. That is a metaphor that I can’t take credit for, because it comes from Larry Katz at Harvard. The metaphor is that the Anglo-Saxon capitalist model 30 years ago was the envy of the world. It was like the apartment block that everyone wanted to move to. But now the apartments on the top of that block have marble and they are beautiful and spacious. In the middle they are cramped and kind of dodgy, and the lower floors they are flooded with water.

The worst part about the apartment block today is that the elevator is broken, and the elevator being broken is not a sustainable (thing) for any economic system. An economic system has to be one that gives opportunity to all, opportunity to people to be on the elevator and to go up. That’s all anyone can ask from a society: not an equality of outcome, not that everyone is going to be rich, but that everyone has an opportunity to be rich.

When I was young, we called that the American Dream: that if you worked hard and you played by the rules, anything was possible. Now I think it’s the Chinese Dream, and I think China is doing a remarkable job. The number of people brought out of absolute poverty in this country is such an admirable achievement. I know it’s not called capitalism here, but I think it is called a market economy.

Q. What parts of the Chinese model do you admire the most?
A. Well, I am learning about the Chinese model. Certainly, the absolute fact of 600 million people coming out of poverty is an enormous achievement. I am always impressed when we meet with leaders here and ask questions. Inevitably, the first part of their answer is “the people believe”. Although this is not a democracy in the way that I know it as an American, there seems to be deep concern with creating a peaceful and prosperous society. So I can’t say that it is the model in that way, but the emphasis on hard work, the emphasis on entrepreneurialism—although it is different from American entrepreneurs—it is very impressive.

Q. One of the problems with companies today is this extremely myopic view of who the stakeholders really are, and who they should really focus on. Within the idea of inclusive capitalism, how does the conventional notion of stakeholders need to change?
A. That’s a very important question all through the world. In the 1960s, Milton Friedman was really the champion of shareholder value, and he proposed that the objective of a corporation is to make profits for its shareholders. We know now that a focus only on shareholder value is too narrow, and that for a company to be sustainable, it has to focus on its customers, employees, shareholders, and of course management. There has to be an ecosystem for business of taking care of the broader society, and there are some wonderful examples today of international corporations that make it clear that they care about all the stakeholders. The one that comes to mind for me is Paul Polman, (CEO) of Unilever. He has said to his investors, ‘If you care about long-term sustainability, if you care about the good of all individuals involved our enterprises, invest in Unilever. If you care about quarterly results, if you are short-term (focused), invest in someone else’s stock. You are a perfectly good person, but you are not the kind of investor I want.’

More and more corporations are saying we need to invest for the long term, which means that we can’t give quarterly earnings every quarter, an increase every quarter. We are going to have to reinvest in the company and have a long-term view. And that is very much our view and we’re seeing it more and more around the globe.

The Ontario Teachers’ Pension Plan, a Canadian teachers’ pension, has $125 billion under management. They have made it very clear that they are going to make direct investments, take larger positions. They are going to be involved in CEO compensation.

CEO compensation has gotten way out of whack, because of this emphasis on shareholder value and stock options. From 1943 to 1983, the average CEO in the US made 40 times the average worker. Today, it’s 243 times. That’s really not sustainable, and it’s not justified. (So) you have investors beginning to say, ‘Well, wait a second, those pay packages that were tied to share results in a market that until 2008 rose for 13 years, (and) created disequilibrium’. The top was compensated too much, and I think there’s definitely going to be a reversal of that.

CalPERS, the California pension plan, which is about $300 billion, (is) saying the same thing. There is a readjustment of shareholders’ understanding of long-term value creation from corporations, which means corporations engage more in their society.

Q. What you are saying is still not a universally accepted phenomenon. By and large, we are still seeing short-term behavior: an excessive focus on getting the stock price up, no matter what it does to the company in the long run. So where do you think the push for change will come from?
A. The most certain trigger will be if investors demand it. In the work that we’ve done with the Henry Jackson Initiative on Inclusive Capitalism, one of the pathways we focus on is how to get investors to demand long-term thinking, and how do they measure it. If the capital requires better behavior, then the behavior will become better. Look at what happened to Barclays Bank after the LIBOR scandal. or JP Morgan after the Whale scandal. Doing the wrong thing, Enron blew up. Very bad behavior gets punished. Those are all companies that made huge fortunes for people and had meteoric stock rises, but they got too greedy and (then) crashed and burnt. If shareholders demand long-term businesses that care about the sustainability of their business and the community in which they live, management will change.

Q. Within inclusive capitalism, you talk of three things that companies can do: education, nurturing small and medium-sized enterprises (SMEs) and good corporate governance. Talking of the first two—education and nurturing SMEs—what is the imperative for a big corporation to really do that? How will it tie in with their existing business model? In some ways, they are creating competition for themselves by nurturing these enterprises. So can they do it in a way that they also benefit, and it’s good for society in the long run?
A. That’s a very important way to position the issue, because the point has always got to be that a corporation’s first obligation is to stay in business and therefore be profitable. It’s not a charity, and so the first consideration for behavior by corporations that take a broader view is that this will make their company more sustainable for the long term.

 Why would a company get involved in education? The reason is that they need employees who can do the work that’s required.

 Twenty-five years ago, Rolls-Royce decided—not because of corporate social responsibility, or because of any philanthropic reason—that they need people who have Rolls-Royce ‘inside’ them working for them. So they created an academy, an apprenticeship program, where they would send their employees to basically be educated later on in their career. Twenty-five percent of the current management of Rolls-Royce went through that academy. That’s an example of a corporation, for business reasons, teaching its employees how to work.

In terms of the small and medium-sized enterprises, if you nurture Facebook will it eat up Google? Facebook didn’t need this kind of help, but what we really focus on is the large corporations that can give ordinary supply opportunities to small and medium-sized enterprises. Hewlett-Packard is an example. They opened their operations in the UK and said that by 2015, 10% of everything that they buy as a company will come from SMEs. That doesn’t mean that they’re buying circuit boards from SMEs, but they are buying their pencils, glassware and furniture from SMEs. That’s good for them because it diversifies their supply chain.

IBM created something called the Supplier Connection. Granted they started it with $10 million of Foundation money, so it wasn’t a business decision, it was a charitable decision. They created a website, and then they invited other Fortune 500 companies—UPS, Federal Express, JP Morgan, AT&T,… They got about 20 companies to put their supply requirements for mundane things: carpeting, chairs, lighting, food, simple things that SMEs can do very well. They put their requirements on the website, and companies that employ fewer than 50 people can compete online to supply to the biggest corporations in America. That is good. It creates jobs, it creates a diversified supply chain.

That’s what we did with the Henry Jackson Initiative on Inclusive Capitalism. We said, ‘We’re not into government policy. We are executives. Let’s see what we can do to make the free market more acceptable to more people. How can we help these very bad results that have happened, including unemployment?’

Q. Does this intersect with the idea of socially responsible business?
A. Yes, it does. In an ideal world, socially responsible business will be a redundancy, because business will not survive if it’s not socially responsible. Unilever started as a business because Lord Lever got worried that the sanitary conditions in Victorian England were so awful, so he created a little cheap soap powder that people could wash their hands with and get rid of bacteria. It became a global business that would survive for a 150 years. He started with a social concern and he created a business around it.

Q. One of the issues that one comes across is that of the environment that is still pretty much focused on short-term goals like share price and profitability. On the other hand, organizations are trying to breed this new culture of inclusive capitalism. As a company, you want to make that transition, but you still need to deal with the short-term pressures. Are there any lessons from the experience of companies that have already made the transition?
A. Unilever is a very good (example). Unilever has outperformed its competitors in terms of its stock price. Whole Foods is very definite about its social responsibility. I’m on the board of Estee Lauder, one of our products is Mac. Mac is very involved in the AIDS problems. I think our shareholders reward us for this. Certainly we are not there yet. You still need profitable growth, but you also need sustainability. So I think educating shareholders and empowering shareholders to ask the questions (will make a difference). We have something in America called “say on pay” to give shareholders the right to understand or to approve or disapprove the compensation packages for management teams. That’s a step to right direction.
 Shareholder activism I believe will lead to more than just quarterly results.
 
About Lady Lynn Forester de Rothschild:
Lady Lynn Forester de Rothschild is a former corporate lawyer and telecom entrepreneur. She is the CEO of E.L. Rothschild, an investment company she founded with her husband Sir Evelyn de Rothschild. E.L. Rothschild has investments in media (The Economist Group, UK), information technology, agriculture (FieldFresh Foods, India), weather forecasting and real estate. Lady de Rothschild is a director of the Estee Lauder Companies as well as The Economist Newspaper Limited. Recently Lady de Rothschild became Co-Chair of the Henry Jackson Initiative for Inclusive Capitalism (HJI), a non-profit working towards building a more inclusive capitalist system. Among other things, HJI proposes that companies should invest in training, nurture small and medium-sized enterprises, and fix corporate governance.

[This article has been reproduced with permission from CKGSB Knowledge, the online research journal of the Cheung Kong Graduate School of Business (CKGSB), China's leading independent business school. For more articles on China business strategy, please visit CKGSB Knowledge.]