Capitalism stifles innovation

Capitalism is defined as an economic system in which a country’s trade, industry, and profits are controlled by private companies, instead of by the people whose time and labor powers those companies.

Where others see doom and gloom, I see a bright future full of innovation and hope. I've been called an irrepressible optimist or worse, but I believe that we live in a time where business has the potential to solve the world's toughest problems. Keep in mind that I'm not writing here to whitewash the problems of business. Capitalism may not be perfect, yet it is the greatest system of social co-operation ever created thus far. Capitalism works because entrepreneurs and managers figure out how customers, employees, suppliers, communities, and people with the money all can cooperate to benefit. Competition is important but it is a second order property that gives people more choice in a free society.

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After the recent global financial crisis, there was a need for new thinking about business. The old model of business of profit maximisation contributed greatly to the crisis. However, there are real tangible signs that this model is changing. With each new generation, people are wondering if this is what business is all about. We have seen Generation Y embrace companies that do good in society and make money too. Technology is forcing companies to become more transparent. Consumers and other stakeholders are more vocal now and cannot be ignored as they were in the past. Many stakeholders, such as suppliers, communities and financiers, are now holding companies to a higher standard than in the past.

Companies associated with the Conscious Capitalism movement already know the new story of business, and they embody it every day. I've been an observer of business for more than three decades, and I can tell things are changing. There has been a tremendous amount of activity and progress during the last 30 years. There have been thousands of new businesses started that have tried to make the world a better place – and most importantly add real value to our daily lives.

Since we are on the cusp of this shift in thinking, I decided to spread the message worldwide through a massive open online course (MOOC) called New Models of Business in Society. I recently finished teaching this course, and it was quite a rewarding experience. The worldwide dialogue is enlightening to say the least. I am learning the most from those who have exposure to multiple cultures. Nothing lets us learn more than seeing a different way to do things in another culture. There are many posts that start with, "In Spain …" or "In Ukraine …" or "In Brazil …"

One student said that the course completely changed her view about capitalism and that proper businesses can be drivers in society. Another student says that they have "awoken" to the idea of Conscious Capitalism. Yet another was honoured to be associated with other like-minded entrepreneurs and business professionals who truly aspire to create a better world.

Some of my students pointed out that there are real benefits to the standard story about business, and this is correct. Business around the world has lifted billions out of poverty. Yet we can make our idea of capitalism even better by applying one of its main principles that is often overlooked: Critique by creating something better. If you think that too many executives just focus on profits and money, then start a business that focuses on a purpose more than profits and relies on the passion of its employees. There are lots of companies like this that have emerged, from Whole Foods Markets, The Container Store, The Motley Fool, to older companies like 3M, Apple and others. Not every company gets everything right, but there are many new companies founded on this principle of "critique by creating" and making the world better.

Some have taken a relentless focus on customers and that is really good; now we need to broaden that focus to other stakeholders who are affected by business. In the words of one executive, "focus on one of the stakeholders. See the interactions. You'll quickly see how making communities better off, for instance can make suppliers, or shareholders, or employees or customers better off."

Many of the students have found purpose in the organisations in which they are involved with. Many of them are from countries that have really suffered in the global financial crisis. Together we have learned about real human stories and the costs associated with them. This is in part the motivation I have to make business better, to ensure that we don't go through this again. Let's leave the old model of business behind and think about what business could become – the potential is unlimited.

Successful companies aren’t usually started this way. Professor Phelps, citing a McKinsey study, suggests that in free-market capitalism, “from 10,000 business ideas, 1,000 firms are founded, 100 receive venture capital, 20 go on to raise capital in an initial public offering, and two become market leaders.” It is easy to doubt, as Professor Phelps does, that the odds are favorable for a Youngstown 3-D printer center.

How you view the innovation institutes, and the topic of capitalism and culture, may depend on your own experience. Many people have never seen the hatching of a successful business idea. That makes it hard to judge the subtle changes that may be occurring in the nation’s culture and in its potential for innovation.

My own business experience has certainly helped shape my thinking. Yale, like many other universities, sensibly allows its professors to spend limited time in business, providing the opportunity for faculty members to gain valuable experience outside of the ivory tower and to offer their technical skill to the business world.

In 1991, I started a business with Karl Case, an economics professor at Wellesley College, and Allan Weiss, a former student of mine at Yale. We called it Case Shiller Weiss, Inc., and it was devoted to an innovation we dreamed up. The idea was a new “repeat sale” home price index — which would track the changes in the value of the same houses over time.

At the time, this was an entirely new line of business. And, at first, that posed a problem: we were spectacularly unsuccessful in raising money. We talked to venture capitalists and their committees, to no avail. They just didn’t seem to get our business plan. We must have appeared odd to them — overly academic, perhaps. One remarked that we’d do better proposing a new shopping center.

But we went ahead with our idea anyway. At first, Allan worked without pay. A friend of Professor Case, Chuck Longfield, contributed some money. And in 1995, I took out a home equity line of credit on my house in New Haven so I could personally lend more money to help keep our business afloat. The experience was stressful, especially when adding it to the burdens of my main job, as a professor. I have much to thank my wife, Virginia, for her tolerance of my overwork and my worrying, and for allowing me to put our family savings at risk.

In the end, our business was successful, and I think a big part of it was that we relied on our own ideas and energy and, to a large extent, our own money. In 2002, we sold the business to Fiserv Inc., then licensed Standard & Poor’s to create what are now known as the S&P/Case-Shiller Home Price Indices. In 2006, the Chicago Mercantile Exchange began trading futures on 11 of our indexes. Fiserv sold the index business to CoreLogic early this year.

In short, our business made its mark without any help from the government.

This little real-life experiment convinces me that committees of experts, even at smart venture capital firms, will often not recognize real innovation. I think that America’s business success through the decades has occurred because we have so many people with specialized knowledge who are willing to put their money, time and resources on the line for ideas that can’t be proved to a committee.

THAT experience may also help explain why I think the new crowdfunding initiative, started by the Jobs Act that the president signed last year, is an exciting step forward. It’s all about finding and mobilizing people who really understand specific, hard-to-prove ideas for important investments.

At the same time, other of my experiences incline me to think that government-appointed committees of experts can help set the stage for an entrepreneurial culture, under certain limited circumstances.

Long before I started any commercial ventures of my own, I received some federal government support — in the form of National Science Foundation research grants, awarded to me decades ago as a young professor. They allowed me to do research, and though it was not directly related to my later business endeavors, the process developed my expertise and reinforced a sense of entrepreneurial opportunity.

These grants were awarded competitively, based on the quality of the proposals, and gave me experience with a system focused on creating opportunities for those who try hard. Later, from 1983 to 1985, I evaluated others’ proposals when I served on the foundation’s panel for economics. Observing the process from the government side convinced me that the foundation really works. Maybe it’s because the panelists are chosen from successful scientists, who serve anonymously out of public spirit.

In any case, as Professor Phelps has argued, direct government involvement in capitalism is a delicate thing. The system’s success depends on subtle cultural factors — and these require careful nurturing.