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The suicidal impulse of the business community.

Corporations often promote policies adverse to their own best interests. In the political arena, business has a short time horizon that differs from its approach in long-term corporate planning. Examples are given of business attitudes toward protectionist tariffs, and regulatory policy, fixed exchange rates, corporate contributions, and budget and trade deficits. Corporations, acting in a climate that considers government action a cure for all problems, are contributing to the destruction of a free market economy rather than shoring up its foundations.

AS BUSINESS ECONOMISTS, you straddle two fields: economics and business. Those two fields are not synonymous by any manner of means, as Adam Smith, whose name has been given to this series of lectures, clearly recognized. Adam Smith is correctly and properly regarded as the father of modern economics and particularly of the idea that a free, private market society is capable of combining material prosperity with human freedom. Although that idea has been expressed by others before and since, Adam Smith's two great books, The Theory of Moral Sentiments and The Wealth of Nations, are the classical works on that theme.

One of Adam Smith's most often quoted statements is, "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public." Another of his comments is, I believe, even more relevant to the doctrine that has come to be called "the social responsibility of business." It is brief, pithy and definite: "I have never known much good done by those who profess to trade for the public good." That sentence follows immediately after his famous remark about the "invisible hand."

As a disciple of Adam Smith, who believes that the pursuit of self-interest can be in the national interest, I'm not going to bash business for pursuing its self-interest. A corporate executive who goes to Washington seeking a tariff for his company's product is pursuing his stockholders' self-interest, and I cannot blame him for doing so. As an employee of the stockholders, he has a fiduciary responsibility to promote their interest. If he's made a valid, accurate judgment that a tariff will be in the self-interest of his enterprise, he is justified in lobbying for such a tariff. If he is a principled free trader, his proper recourse is to resign and seek a job where his principles do not conflict with his fiduciary interests. So I don't blame corporate executives who lobby for tariffs. I blame the rest of us for being such fools as to let them exploit us. We're to blame, not them. We're the ones who enact the tariffs.


My complaint about the business community is very different. It was recently expressed in a book by Paul Weaver called The Suicidal Corporation. That book, published a year or so ago, is devoted "to the corporation's war against its own best interest," and that's exactly what I intend to discuss. I am going to argue that corporations, and especially large corporations, seeking to pursue through political means what they regard as their own interests, do not do a good job of evaluating their interest. The policies they pursue and promote are very often adverse to their own interests. That's what I mean by my title, The Suicidal Impulse of the Business Community.

The activities involved are not only those of individual corporations and, although less often, of individual businessmen, but equally of their trade associations, which supposedly represent the interest of a broader group and not of individual enterprises within that group. I'm not going to try to demonstrate this on an a priori basis. I'm just going to cite some examples that I regard as fairly typical. My general conclusion from observing the way businessmen behave is that they are schizophrenic with respect to time. Corporate officials who consider expanding their own enterprises -- putting up a new factory, making new investments in developing trade -- tend to look a long time ahead. They plan for 5, 10, 15, or 20 years and take into account the long-run consequences of their behavior. However, when they come into the political arena, the only two groups that are more shortsighted than the business community are Wall Street and Washington. On Wall Street, it's a matter of two hours. In Washington, it's a matter of at most two years between congressional elections, and that's an overstatement. The business community is just about as short-sighted. They tend to look at the short-term impact of what they promote and not at the long-term impact.

I have no satisfactory explanation for why the business community behaves in this suicidal fashion. What I'm stating is an empirical observation that is in need of an explanation. Before I finish, I'll try to suggest some tentative explanations, but I have little confidence that they are satisfactory. Let us proceed to some examples.


I mentioned tariffs. The business community has long promoted protectionism. Yet, I challenge you to name any industry in the United States that over a long period has benefitted from protection. The industry in the United States that has the longest record of protectionism is probably the steel industry. Already in 1791, Alexander Hamilton recommended protection of infant industries, of which the iron and steel industry became one of the earliest to receive protection. His famous Report on Manufactures is a brilliant example of sophistry. Hamilton praises Adam Smith to the sky, but argues that his principles do not apply to the United States: the United States is different and it needs protection -- a pattern of special pleading that has since been repeated ad nauseam. The steel industry, to judge from the continued protection it receives, is apparently still an infant industry. Has the steel industry benefitted from protection? Some decades ago, the steel industry asserted that it was being overwhelmed by a flood of foreign imports and asked for additional protection. They received it, at first in the form of a "target price," and then in the form of import quotas. The main effect was higher wages for their workers, higher costs for the industry, and a continued influx of foreign steel. The firms that benefitted from the tariffs, and are saving the industry, are small mini-mills which in the main have not sought protection. More important, perhaps one can understand U.S. Steel seeking protection. But what about the backing it received from the National Association of Manufacturers? Their members include many users of steel, such as the automobile manufacturers, the manufacturers of home appliances, the machine tool industry, and so on and on. There's little doubt that the restrictions on steel imports harmed the users of steel to a far greater extent than they benefitted the steel producers. Why has NAM typically promoted protectionism? The Chamber of Commerce has occasionally shown more sense, but it is far from guiltless.

Tax Legislation

Let me cite some other examples. Consider tax legislation. In the 1930s, Franklin Delano Roosevelt persuaded Congress to impose a tax on undistributed profits. The business community launched a major campaign against the tax, and even though that was the Roosevelt New Deal era, they were successful in getting it repealed. Yet, if they had supported the undistributed profits tax at that time, I believe that the corporate income tax would long since have eliminated. What was the undistributed profits tax? It said, if a corporation retains income instead of distributing it to shareholders as dividends, the shareholders avoid paying individual income tax on that undistributed income. That's a major tax loophole. The solution adopted was to impose a tax on undistributed income.

In my opinion, the response of the business community should have been to agree that undistributed income did constitute a loophole but that the right solution was to tax the shareholders, not the corporation. That could be achieved by requiring corporations to attribute undistributed income to individual shareholders and requiring the shareholders to report such income on their individual income tax returns along with dividends. That would eliminate the problem of evasion. It would also make it clear that there is no excuse for double taxation -- once to the corporation and once to the individual -- as occurred then and occurs now with dividends. Such an approach would have enabled the business community to convert the agitation about undistributed income into a vehicle for getting rid of the corporate income tax.

Let me come to a more recent episode. Before the 1981 reforms, the business community was lobbying for specially favorable treatment for depreciation and investment, including an investment credit. I talked to a number of leading business leaders urging them that that was a bad tactic, that they could do much better for themselves, and for the country as a whole, by lobbying for comprehensive indexation of the tax system against inflation, both the corporate tax and the individual tax. They would end up better off and, in addition, they would not be lobbying just for own special interest; they could be part of a much broader coalition. The ordinary taxpayer has little interest in accelerated depreciation or an investment credit; but the ordinary taxpayer is and was very much interested in abolishing "tax creep" and being protected against inflation. I believe you will agree that subsequent experience does not, to say the least, contradict my judgment that the alternative I recommended would have benefitted the business community more than the pursuit of special treatment. However, I was unable to pursuade any of the businessmen I talked to.

The current attitude of the business community on the capital gains tax is not very different. Again, it seems to me, their self-interest would be far more effectively promoted by indexation of the base for capital gains, the base of depreciation allowances, interest paid, and so on, than a temporary cut in the capital gains rate. Yet that is not the position spokesmen for industry have taken. I'm not saying that a capital gains tax is good thing; it isn't. Fundamentally, I'm in favor of a tax on consumption and not a tax on income at all. From that point of view, I'd like to get rid of the capital gains tax. But the capital gains tax is here, and the failure to index the base is a far more serious defect than taxing gains at the same rate as other income. Moreover, it is consistent with the 1986 tax reform, remedying a defect in that reform, rather than appearing to be a departure from it.

Commercial Banking

Consider a very different and more specific example, the commercial banking industry. At the end of World War II, the commercial banking industry probably accounted for well over two-thirds of all commercial and other credit. It's doubtful today that it accounts for as much as a third. What caused the decline? There is no question that it was the banking industry's insistence, first, on regulation Q; and, second, on fixed exchange rates. Those two elements played a major role in the decline of the commercial banking industry. Money market funds would not exist today if there had been no regulation Q. Regulation Q limited the interest rates that banks could pay. Once inflation started accelerating, market interest rates were driven up, regulation Q interest rates were no longer competitive, and money market mutuals were invented to enable ordinary citizens to share in high interest rates. Given regulation Q, that was a desirable social change. From a broader point of view, it was a waste. Why create a new industry just because there is an arbitrary limit on an interest rate? Had there been no regulation Q, the banks would have done what the mutual market industry does now and that activity would have been part of the banking industry.

Similarly, fixed exchange rates had similar adverse effects on the banking industry. One result of fixed exchange rates was that President Johnson imposed restrictions on foreign lending by American banks, a form of exchange control. By all that's logical, it seems to me the world financial center should be in New York, not in London. It's in London primarily because of the banking industry's support of regulation Q and fixed exchange rates. So far as the leaders of the banking industry are concerned, the only exception was Walter Wriston, who was in favor all along of abolishing regulation Q and floating the exchange rate, long before these changes became discussed, and who predicted the adverse consequences of postponing changes that he regarded as inevitable.

Some two decades ago, I recall testifying before a congressional committee on the issue of exchange rates in a session in which another witness was David Rockefeller. Incidentally, his advisor was Paul Volcker, whom I met on this occasion for the first time. David Rockefeller testified in favor of fixed exchange rates, in direct opposition to Walter Wriston. Ideas do have consequences, to parrot the title of Richard Weaver's book. Consider the present status of Citibank on the one hand and Chase on the other.

Thrift Institutions

The savings and loan industry is another example but almost too easy a shot. The savings and loan industry was destroyed by two factors: (1) the inflation of the 1970s along with regulation Q; (2) federal deposit insurance. Deposit insurance alone would not have destroyed it. After all, deposit insurance was enacted in the middle thirties and there were negligible failures of either banks or S&L's for more than thirty years after that. Why? Because so long as S&L's and banks have a major equity position, their owners have an interest in avoiding failure. Deposit insurance insured depositors but not stockholders. The accelerating inflation of the 1970s, along with regulations limiting what savings and loans and banks could do and what interest rates they could pay, destroyed the net worth of many institutions. If all of an institution's liabilities are insured and it has no net worth, there's no reason for its managers to worry about taking risks. It's heads the institution wins and tails the taxpayers lose. That was the fundamental source of the problem. But consider the more recent period after the industry was already in difficulty, what did the associations of savings and loans lobby for in Washington? They lobbied for weaker regulation, for delay in closing down institutions, all of which simply made the situation worse.

Corporate Contributions

Another easy shot consists of corporate contribution under the guise of social responsibility. Many studies of such contributions all show the same thing.(1) The oil companies contribute to conservation groups that are opposed to exploration for oil and that are engaged full time in bashing the oil industry. The nuclear industry contributes to antinuclear organizations that are engaged in bashing the nuclear industry. Most corporations contribute to universities and business schools, whose faculties are often dominated by fervent opponents of free enterprise and supporters of socialism. It would be a nice exercise, and I hope someone will undertake it, to determine the political affiliations of the corporate officials in charge of allocating corporate contributions -- in the public affairs section or the government relations section or some other section in charge of corporate contributions. It boggles the imagination to understand why corporate executives believe it is in the interest of their shareholders to finance activities directed to destroying the foundations of a free market society. Yet there is no doubt that they act as if they did.

Trade and Budget Deficits

Finally, consider the attitude that the business community has taken in recent years to budget and trade deficits. The budget deficits over that period have been a boom to the business community. They have been the only thing that has kept Congress from spending more money and wasting more of the taxpayer's substance. I'm not in favor of deficits. On the contrary, I've been an active sponsor of a balanced-budget/tax-limitation amendment. But without such as constitutional amendment, is there any doubt that any increases in taxes over the past five years would not have reduced the deficit, except perhaps momentarily, but would have simply increased government spending? Nobody can tell me that the Democrats who scream about the budget deficit, from Tip O'Neil before to the present group, are born-again budget-balancers. They have historically been big spenders and they still are. They want more taxes not to balance the budget, but so that they can spend more. For every problem, they have a standard response: "We should be spending more on this, that or the other thing" -- whether it's drugs, child care, or whatever -- "but we need more taxed to do it." What has been the reaction of the business community? In this respect, I guess Wall Street is worse than any of the rest. They've been screaming, "We need higher taxes to be responsible," as if responsibility involved bigger government.

Again, the same is true of trade deficits. The trade deficit is a sign of American strength because its counterpart is a capital inflow. The japanese and other foreigners, as well as domestic residents, are investing in the United States because they can get a higher return here than they can elsewhere. Is that a sign of our weakness and their strength or is it the other way around? We have been able to have a higher level of investment than we otherwise could have had because of the capital inflow. But what is the position of the business community? "We must end the trade deficit. We must end the fiscal deficit." Talk about shortsighted policies.


I trust I've given you enough examples to show that my complaint is not without some basis. Let me turn to the question of why. I don't really have a satisfactory answer. One reason was stated more than a century ago by General Francis A. Walker. He was an honest-to-God military general who enlisted as a young man in the Civil War, had a brilliant war record, rose in the ranks, was wounded and captured, and after the war was over, was granted what was called the brevet rank of general as recognition of his services. He was also probably the most famous American economist of the nineteenth century. He was director of two censuses, gaining a worldwide reputation for his success in improving their accuracy and coverage, he was a professor at Yale, and the president of MIT, and also a very good economist. In one of his books he wrote, "Few are presumptuous enough to dispute with the chemist or mechanician upon points connected with the studies and labors of his life; but almost any man who can read and write feels at liberty to form and maintain opinions of his own upon trade and money. . . . The economic literature of every succeeding year embraces works conceived in the true scientific spirit, and works exhibiting the most vulgar ignorance of history and the most flagrant contempt for the conditions of economic investigation. It is much as if astrology were being pursued side by side with astronomy, or alchemy with chemistry."(2)

I believe that is part of the reason for the suicidal impulse of the business community. The source for many if not most economic fallacies is that what's true for an individual is almost always the opposite of what's true for the country as a whole. If you as an individual go to the market to buy strawberries, the price of strawberries is fixed and you can buy as many as you want. But suppose everybody suddenly decides to buy more strawberries. There are no more strawberries to buy than before. The quantity is fixed for the time being and the price is variable. Similarly, each one of us thinks we can hold as many pieces of paper of those things called money as we want to. But there's a fixed total of money that's been created by the Federal Reserve System. And so you have a game of musical chairs. If I acquire more cash or deposits, it's at the expense of somebody else. In case after case, the same phenomenon arises. But most businessmen do not hesitate to generalize from the particular to the general, satisfying fully the description of General Walker.

Joseph Schumpeter, in his brilliant and penetrating book, Capitalism, Socialism and Democracy, gives a very different, and more subtle, explanation of why "the capitalist order tends to destroy itself." He sums up his reasons in four points, one of which is particularly pertinent to my present topic: "the scheme of values of capitalist society, though casually related to economic success, is losing its hold not only upon the public mind but also upon the |capitalist' stratum itself."(3) To put this point in different words, none of us is able to free himself from the general climate of opinion in which he operates (to cite a trivial example, that climate requires me to hesitate before letting "himself" stand for "himself or herself"). In the United States, and indeed around the world, that general climate of opinion treats government action as the all-purpose cure for every problem.

I have recently been expressing this in what I call a welfare-state syllogism based on three propositions that are clearly part of the conventional wisdom. Major premise: socialism is a failure. Everybody agrees with that proposition about Russia, China, the United Kingdom. Minor premise: private enterprise capitalism is the only system that has been able to combine prosperity with human freedom. Again, there is wide agreement with that proposition. Conclusion: the U.S. needs more socialism! The conclusion is a clear logical fallacy yet I am sure that you will agree that it is conventional wisdom. Whatever problem you talk about -- child care, drugs, health, oil spills, earthquakes, schooling, productivity, volatility in the stock market -- the only solution generally regarded as possible is more government intervention, throwing more money at it, passing more laws, more regulations. Like the rest of us, the business community in general has been exposed all their lives to that climate of opinion. They are graduates of colleges and business schools in which the crucial -- and implicitly beneficent -- role of government is taken for granted. They are busy running the businesses that they own or that employ them. You cannot expect them to be philosophers and independent thinkers in the social area as well. Though there are some notable exceptions, most of them simply accept the common view. As a result, when any problem arises, their immediate answer is, "Let's go to the government and get it solved." I believed that is probably a major part of the explanation for the suicidal impulses of the business community. But I am far from confident that it is the whole answer.

You people are in a first-hand position to observe the phenomenon I have been discussing. I hope some of you will be induced to investigate it further. It is of the utmost importance for the future of our free society to understand what is happening and why it is happening. Perhaps then, something effective can be done to prevent the business community from fouling its own nest. Even better, perhaps it would be possible to harness the undoubted influence of the business community to shoring up the foundations of a free market economy instead of contributing to their destruction.


(1)See in particular the publications of the Capital Research Center (1612 K Street, N.W., Suite 704, Washington, D. C. 20006). (2)Francis A. Walker, Political Economy (New York: Henry Holt & Co., 1887), pp. 29-30. (3)4th ed. (London: Allen & Unwin, Ltd., 1952), p. 410.

Milton Friedman is a Senior Fellow, The Hoover Institution, Stanford, CA.
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Title Annotation:Adam Smith Address
Author:Friedman, Milton
Publication:Business Economics
Date:Jan 1, 1990
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