The Social Function of Accounts

Reforming Accountancy to Serve Mankind

John Flower

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781317240501
• Edition: 1
• Topic: Business
• Subtopic: Accounting
• Index: Business

Accountancy as presently practised is tied to the paradigm of modern financial capitalism with its reliance on market solutions and the maximization of the firm's profits, which are the fundamental causes of most these problems.

The Social Function of Accounts argues that accountancy, as currently organized and practised, is failing society, both in Britain and in the world as a whole. Examining the current problems afflicting the world: financial crises and instability, global warming, degradation of the environment, growing inequality, this book asks the question - what contribution does accountancy make to the solution of these problems? The book argues that the accountancy profession does not serve the public interest, notwithstanding its claim to this effect.

The Social Function of Accounts argues that the moral responsibility of the accountant is analysed with reference to the principal theories of ethics continuing that the individual accountant has a moral responsibility to consider the impact of his actions on other people and on society as a whole. This responsibility is then analysed in a series of chapters dealing with four specific aspects of the matter: Distributive Justice, Sustainability, Financial reporting & the Accountancy Profession.

Concluding with a call for the accountancy profession to adopt a new ethic of service to the public The Social Function of Accounts redraws the boundaries of current accounting literature and will be vital reading for academics, researchers and policy makers in accounting and related disciplines.

1
Capitalism in Crisis

The themes of this book are that the present economic system, based on capitalism, is failing mankind, that it should be reformed and that accountancy, my profession, can make a significant contribution to its reform. In this opening chapter, I analyse capitalism’s current failings, which I consider to be so serious as to merit the label ‘crisis’. The analysis relates principally to the position in Britain and the USA, with occasional references to the other parts of the world.

1. Capitalism’s Successes

Although I consider that capitalism in Europe and America is currently in crisis, I do not deny that, in earlier periods, it was a force for good. This case is well put by Edmund Phelps in his book Mass Flourishing.¹ Phelps bases much of his argument on historical analysis, particularly on movements in real wages. He cites recent research which indicates that, in England, there was no significant increase in output per worker between 1500 and 1800, but that output per head started to increase rapidly around 1820. Two British researchers claim that ‘after prolonged stagnation, real wages … nearly doubled between 1820 and 1850’.² A similar increase occurred at around the same time in the USA, followed in the 1830s by Belgium and France and in the 1850s by Germany. These increases in output per head were extraordinarily rapid and quite unprecedented. They were dubbed by Walt Rostow, the economic historian who first drew attention to them, as ‘take-offs’—take-offs from flat economic performance to sustained economic growth.³ Phelps sings a hymn of praise to the results of this take-off: ‘To countries where it came … [it] brought immense material benefits. In raising wage rates, it provided increased numbers the dignity of self-support, it liberated them to get out into society, and it opened up city life as an alternative to rural ways. In raising incomes, it improved living standards in very basic ways, reducing risks of early death through disease’.⁴

There is no doubt that the early nineteenth century witnessed a significant increase in output in certain countries. But there is continued controversy as to the causes of this increase. Phelps attributes the increase in output to the business environment in Britain and the USA, the two countries that led the charge. In both countries, a businessman who had an idea for a new product or process had the opportunity, the means and the freedom to put it into practice. In effect, three indispensable elements of a successful capitalist economy came together: a set of enterprising and determined businessmen with ideas that they sought to implement; a stable state with an independent and effective judicial system which greatly increased the chances that contracts would be honoured; and a financial system which provided finance for the new ventures, at least in the quantities demanded by the relatively small enterprises of the period. Phelps rejects two other putative causes: increases in basic scientific knowledge and practical inventions, such as Hargreave’s spinning jenny and Watts’s steam engine. Personally, I do not fully agree with Phelps on this point, as I consider that both increased scientific knowledge and inventions were important factors. But I accept that, without the contribution of enterprising capitalists, their impact would have been far less. In my view, entrepreneurial capitalism was a necessary but not a sufficient condition for the take-offs in the early nineteenth century.

There can be no doubt that capitalism as practised in the period of take-off was an extremely powerful force, both in stimulating industrial output and in destroying antiquated social structures. Even Karl Marx was extremely impressed with capitalism’s energy and creative power. In the late twentieth century, a vivid demonstration of capitalism’s productive power was provided by China, when the ruling Communist party decided to allow businessmen to set up and operate their own enterprises and to benefit personally from their success. The Chinese leader was reported to have said that he had nothing against a successful businessman becoming ‘filthy rich’. There followed an extraordinary increase in national output from which the Chinese people have undoubtedly benefited. Clearly, the recent growth in China’s GDP can be attributed, almost entirely, to the working of the capitalist system as analysed by Phelps, in particular the freedom given to businessmen to set up enterprises to put into practice their plans to enrich themselves. A similar case can be made for the role of capitalism in promoting the recent growth in national output in India and in other, smaller Asian countries, such as South Korea, Taiwan and Singapore.

2. The Rise of Neo-Liberalism

There can be no doubt that capitalism was, on balance, a positive force in Europe and North America in the nineteenth century, and that this is still largely the case in China and India today. But, in recent years, in certain developed countries (most notably Britain and the USA), the character of capitalism has changed, with the increasing acceptance of a radical new philosophy: neo-liberalism.

2.1. The Intellectual Origins of Neo-Liberalism

Neo-liberalism was first developed over 50 years ago, by a small group of philosophers and economists; prominent among the group were Friedrich Hayek and Milton Friedman. Both won Nobel Prizes and both wrote books,⁵ which set out very clearly and cogently the principles of neo-liberalism. These principles may be summarised as follows:

1. The freedom of the individual is paramount, with, in the words of Milton Friedman (2002, p. 5), ‘freedom as the ultimate goal and the individual as the ultimate entity in the society’.
2. The economy should be based on transactions between free individuals. Provided the transaction is voluntary, both parties benefit, for no party is obliged to agree to a transaction from which he does not benefit.
3. Transactions between individuals should be conducted on a free market, where prices are determined by the interaction of supply and demand. Market participants (both producers and consumers) should be motivated solely by their own self-interest, and, guided by Adam Smith’s ‘invisible hand’, they will achieve the best result for mankind.
4. The owners and managers of firms⁶ should seek to maximize the firm’s profit. The firm makes a profit from its operations when the revenue that it receives from the sale of its output is greater than its outlay on its input resources. But, at the same time, the firm has increased the total market value of goods and services in the economy, in that it has converted a set of resources with a certain market value into a set of finished goods and services with a higher market value.
5. Competition between market participants assures that resources are allocated in a way that best serves mankind’s needs. Competition also ensures that no individual is subject to domination by others. Friedman (2002, p. 15) argues that ‘the consumer is protected from coercion by the seller because of the presence of other sellers with whom he can deal. The seller is protected from coercion by the consumer because of other consumers to whom he can sell. The employee is protected from coercion by the employer because of other employers for whom he can work, and so on’. Competition also assures that market participants (both capitalists and workers) receive their just rewards: the capitalist’s profit represents the increase in the value of society’s goods and services created by his actions; the worker’s wages represent (in the jargon of economists) the marginal value product of his labour—that is, the increase in the firm’s output of goods and services attributable to his effort.
6. The principal economic role of the government is to ensure that the free market operates smoothly. The government should set up and maintain a legal system, consisting of legislators who define the law, judges who apply the law in specific cases and the police who enforce the law. An effective legal system is a necessary condition for the operation of a free market in that (i) it protects the freedom of the individual and enables him to play his allotted role in the market (whether as businessman, worker or consumer) free from the threat of violent coercion from others, (ii) it assures that contracts are honoured and (iii) it defines and enforces property rights. All three points are essential for the proper functioning of the capitalist economy. Businessmen must be able to operate without fear of violence; they must be able to rely on the promises of people with whom they deal (especially with incomplete contracts—promises to do something in the future), and they must have the confidence that they will be able to enjoy the fruits of their labours (that their property rights will be respected). Neo-liberals accept that a state with these limited functions (often termed ‘the night-watchman state’) is absolutely necessary for the economy to flourish.
7. Some neo-liberals consider that it is appropriate to extend the government’s function to include action to improve the functioning of the free market—for example, by curbing monopolies. But, in general, neo-liberals are opposed to the government assuming further functions in relation to the economy, for example, in setting prices or undertaking specific economic activities through state bodies, such as nationalized industries. They argue that such government actions interfere with the functioning of the market, leading to inefficiency. One thing on which all neo-liberals agree is that taxation is a bad thing, because it deprives the individual of his property; it should therefore be kept to a minimum by limiting the role of government to its basic functions. Neo-liberals deny that the government should play an active role in the economy. In economic matters, the only justification for the government to restrict the freedom of the individual is to improve the operation of the free market. Hence, government action to protect the environment or to increase demand in a recession is illegitimate.

A fundamental principle of neo-liberalism is that the firm’s managers, in reaching decisions concerning the firm’s operations, should be motivated solely by the imperative to maximize the firm’s profits. The firm should have no other objective; in particular, it should not attempt to ‘do good’ by promoting the welfare of anyone other than the firm’s owner—the owner is the personification of the firm. Milton Friedman (2002) made this very clear in the following passage: ‘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, engage in open competition, without deception or fraud’. Milton Friedman offered two arguments in support of his proposition. Firstly, that any interference in the functioning of the free market would lead to inefficiency and a fall in the value of output, from which everyone would suffer; secondly, that the managers of firms are not morally entitled to use the resources entrusted to them by the owners for any purpose other than for the owners’ benefit.

2.2. Neo-Liberalism in Practice

With the elections in 1979 of Margaret Thatcher in Britain and Ronald Reagan in the USA, the governments of both countries enacted economic policies based on neo-liberal policies. These included:

• Measures to improve the functioning of free markets, notably by limiting the power of trade unions. In both Britain and the USA, the governments used the power of the state to defeat strikes by militant trade unions—the coal-miners in Britain and the air-traffic controllers in the USA.
• Scrapping many government regulations that limited the freedom of action of businessmen, with particular emphasis on lifting restraints on the financial sector. In Britain, the Thatcher government deregulated foreign currency transactions and oversaw the ‘Big Bang’—the wholesale removal of restrictions on the trading of securities on the London Stock Exchange in October 1983.
• Curtailing the role of the government in the economy, for example, by privatising nationalized industries and by cutting the level of state aid and subsidies to industry.
• Reducing the level of taxation, particularly on higher incomes and on business profits.

The basic principle followed by both governments was that the growth of the economy should be encouraged by stimulating the enterprise of businessmen; this was to be achieved by removing restraints on their actions and allowing them to retain a greater share of their profits.

2.3. The Case for Neo-Liberalism

Neo-Liberalism’s advocates use two arguments to justify their position:

• That the freedom of the individual to undertake economic activity is of fundamental impor...