Aligning Private Interests with the Public Good

Robert McGarvey
October 13, 2020

Getting the economy back to pre-COVID normal is neither possible, nor is it desirable.

The capitalist system that existed before the lockdown had a number of structural flaws. These deficiencies include stagnating economies, rising inequality, climate degradation as well as insupportable levels of debt, both public and private.

At Rethinking Capital we are reconsidering basic assumptions in ways that will address some of these fatal flaws. What we have discovered - quite by accident - is that accounting is the key to making a more responsible capitalist system.
Accounting? Isn’t that the most boring thing in the world?

The answer is yes, and no. Accounting is all about backroom measurement and financial reporting. So, yes, it is not the most exciting occupation. In addition, accountants take a professional pride in ignoring the great changes that are taking place in society - pretending they do not exist.

For instance, accountants still operate with an ‘industrial-era’ view of economic value, which means that - to accountants - the only things of true value are industrial plant, equipment and machinery. They ignore the exploding value of data, relational capital assets, algorithms and other forms of intangible value.

But, on the positive side, accountants are guardians of ‘double entry bookkeeping’ a measurement system that has been described as the Most Important Invention in the history of civilization.

At this point you may be asking yourself, WHAT?

Yes, major decision-making at the policy level, in corporate board rooms and in operations up and down the economy are influenced by a simple question: is an expenditure to be written off (lowering quarterly profits) or is it an asset, a resource that should be ‘stored’, capitalised on the balance sheet?

Getting ‘double entry’ right by designing the accounting system to identify a host of new assets could magically align private interests with the public good.

For example, let’s examine the double entry logic behind Ford‘s classic Pinto blunder back in the 1970s.

Sadly, like a lot of smaller cars of that era, the original Ford Pinto had been designed with a defective fuel system, which caused it to explode if involved in the wrong kind of rear end collision.

Ford realised it had a problem and had access to a new design that would have decreased this risk. But flaws in their accounting practices led them to the wrong conclusion. The logical pathway went something like this:

The cost-benefit analysis Ford undertook contrasted the new Pinto redesign, which would cost $137 million, against the $49.5 million that executives estimated that it would have to pay to deal with the subsequent deaths, injuries, and car damages.

By this accounting logic, NOT implementing the design changes resulted in $87.5 million difference in profits, even though implementing the changes would have saved their customers from horrible, fiery deaths.

But, if we were to include intangibles like auto designs as assets on the balance sheet, this revision would have made the ‘right’ choice obvious.

If design and related costs had been capitalised (with profits increased proportionately) and design improvements effectively eliminating the $49.5 million in contingent liabilities, the net gain to the company for doing the ‘right’ thing and saving lives would have been a positive by millions of dollars.

Flaws like this in accounting are compounded through their adverse impact on business decision-making, leading to a pointless misalignment of public and private interests.

Regrettably, flawed accounting also materially contributes to 21st century environmental damage. For instance, doing the ‘right’ thing for carbon emissions reduction or circular planning means spending money on new equipment, design changes and experimental innovation. The present system describes these costs as expenses, essentially creating a profit penalty.

However, if spending to reduce carbon emissions were building design assets or corporate ‘reputation’ assets, then these costs would not reduce corporate profits; they would be capitalised, strengthening the balance sheet and increasing shareholder equity.

Modernising accounting could impact the entire financial and business landscape translating unnecessary cost ‘penalties’ into capitalised assets, leading to more socially responsible business outcomes at all levels.

The net result would be a better capitalism, with much closer alignment between private corporate interests and societal goals, like saving the planet.

Robert McGarvey

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