Source of evil

My blog received a big boost in traffic this week because, according to commenter Stephen (with minor corrections):

Founder of Crossfit had a talk in which he used rent-seeking as a reference and why that was bad for crossfit and against his business model which he likened to “Striving to excellence instead of striving to make money is a better way to run a business”

He then posted a link to a blog post I wrote in 2011 to distinguish rent-seeking (or as one of the excellent regular commenters here, Mike M, put it, “privilege seeking”) from capitalism. So, I’d like to thank the Founder of CrossFit, thank all who visited Our Dinner Table and thank to all who left a comment to advance the discussion — even those who disagreed with me.

I’m guessing he posted a link for rent-seeking because, as I point out in that blog post, so few people understand what rent-seeking is and the term itself is not intuitive.

Privilege seeking is a more intuitive term. Seeking privileges at the expense of others is about as spot on description as I’ve heard, so far.

Rent-seeking is using government to reduce consumer choices for the benefit of a special interest.

In my 2011 post, I used the sugar tariff as an example of rent-seeking. It works like this: Government adds a tariff to sugar imports, which results in a higher price paid for sugar products in the U.S. by consumers. The higher price benefits domestic sugar farmers who get to charge more since their foreign competitors’ sugar prices includes the tariff.

The objective of my previous post was to highlight that to the extent the tariff allows domestic sugar farmers to charge more, those profits are not earned through capitalism. But, too often folks see that as capitalism. In their eyes, profit and capitalism are almost interchangeable.

I’d like to commend the founder of CrossFit for shunning rent-seeking (it’d be great if he could hook me up with a set of pipe/monkey bars and maybe a small climbing wall for my basement ). That means his strategy is to attract and retain customers by making their lives better, rather than using government to restrict their alternatives.

As it turns out, I happened to also listen to a Harvard Business Review podcast this week with guest John Mackey, Founder and CEO of Whole Foods Market. He has a new book titled, Conscious Capitalism.

capitalism is actually beautiful (Photo credit: wallstalking.org)

In the podcast, Mackey describes his journey from spouting progressive to appreciative capitalist — and it sounds a lot like mine, except I haven’t founded any big companies, yet.

He discovered that how he viewed businesses when he was young — as greedy, singularly focused money-makers — wasn’t all true. He learned that businesses (usually) succeeded by providing something customers value, which is a tremendous overlooked (or perhaps taken for granted) benefit for society. It may be fun to hate on capitalism, but by gosh, don’t take away my iPhone, sort of thing.

But, I think Mackey misses something BIG. While I applaud Mackey and the Founder of CrossFit for eschewing rent-seeking and favoring customer value creation, i.e. for being capitalists, not all businessmen are capitalists.

One thing almost all business people have in common with the rest of us is that they are human. And one thing nearly all economists know about humans is they respond to incentives (though they differ in their beliefs by how much).

So, it follows that business people respond to incentives. They make more money when their companies do well. One way to guide their companies to success is through good-ol’ capitalism — providing the customer with products they value enough to buy.

But, another way for business people to make money is through rent-seeking. Whether it’s a sugar tariff that allows you to charge more or a state giving special tax breaks for auto plants to ‘attract jobs’, as government at all levels have gained more power, the value of rent-seeking has increased along with it. As Harry Browne put it:

Government is good at one thing: It knows how to break your legs, hand you a crutch, and say, “See, if it weren’t for the government, you wouldn’t be able to walk.”

You can blame greedy business people who are unlike John Mackey and the CrossFit founder for seeking profits without creating customer value, but you’d be blaming the wrong people. The right people to blame would be us, for letting government out of its cage to sell the power we give it to the highest bidder to do things like transfer $40/year of our money to rich, rent-seeking sugar farmers so they can continue to buy that power…with our money.

Think about that for a second, $40 isn’t much (which is why we’re not picketing in the streets about it). But, wouldn’t you rather use that $40 to buy something you value rather than give it to the sugar farmer so he can use it to keep getting it from you?

That’s a double-whammy. Whammy one: You lose your chance to buy something with that $40 that makes your life better. That value never materializes in society. Whammy two: Some of that money goes to do nothing more than to convince politicians to continue getting it. If you understand that, it shouldn’t be hard to see that shrinking government can help the economy.

What is profit?

I’m looking forward to listening to the latest EconTalk podcast, where an organic farmer talks about profit and how she finds her teenage workers not quite ready to earn their keep. Her theory, similar to mine, is that kids have led a life up to the point of getting their first job where things are done for their benefit, rather than them having to make themselves useful to others.

EconTalk host, Russ Roberts, posted her interesting comments about this here. It’s worth repeating:

we hire some high school kids. And they are lovely people. But usually it’s one of their first jobs, like maybe they’ve mowed the lawn for their neighbor or maybe they did some babysitting. But by and large we’re their first job. So, everything else that’s happened in their life has happened for their benefit. They’ve gone to summer camp–that was for their benefit. They’ve gone to school–that was for their benefit. We as parents certainly do everything we can to benefit our children. And then they come to me and–yeah, there are a lot of programs that go on in the summer. And that’s not what this is. This is: You are going to work, and at the end of the week I’m going to give you money; and I expect that because you are here, I will make more money. And that’s a concept that I’ve had to explain to them. And it comes in really hard. And I have to say: Why would I have you here if I wasn’t going to end up with more money? Why on earth would I have you show up every day? And they kind of start to get that this should be a mutually beneficial arrangement, not just that I shouldn’t come out even because I think of–capitalism as me making money for the aggravation of having you here. And then we get the college kids; they’ve kind of gotten that kind of concept a little better. But then I’ll say: What do you want to do when you are done with college? And they’ll say: Oh, I want to work for a non-profit. And that one makes me angry. First, it’s like, well, non-profit, that could be a hospital, that could be a–like you haven’t thought about this any more–that could be a land trust, it could be anything. ‘Non-profit’ is huge. You don’t have any more direction than that you want to work for a non-profit? But also, they are telling me that profit is bad. So, I say: Well, look around at all this stuff you see, the tractors, the greenhouses, the walk-in cooler–like all this stuff. Ralph and I could have taken that money and even if we put it in the bank in a savings account we’d have earned like a percent or something, even now. But we’ve done this, and we’re risking that–it may not work out; we may not make any money from this; we may not get back the money we put in. Don’t we deserve a little more than what we could get in a bank by doing something safe? And they say: Oh, well yeah, of course you do. And I say: Well, that’s profit. And that’s all that profit is. And: Ohhhh. And then the light dawns. But they come with no idea about how capitalism works, even though capitalism is the economic system of our country.

I’d go a step further on profit.

I think it is unfortunate that we tend to only think of profit as a financial term. This causes us to see differently the actions undertaken by profit-seeking companies from the actions we undertake ourselves to conduct our daily lives. Those evil companies seek profit. How noble I am to give my time to charity.

But, a more general definition of profit is to derive benefit. What percent of your actions do you take to derive benefit?

Why did you show up to work? Probably for the same reason companies distribute their products, to earn money.

Why don’t you devote all of your time to charity? Probably because you need to have a shelter, you need food and clothes and you want quite a few other things. Companies, too, do not give all of their output to charity because they would soon have nothing left to give.

Why did you build the patio and fire-place in your backyard, instead of giving that money to charity? You did this for the same reason companies build lounges for workers and sell their products in pleasant surroundings.

Why did you replace your aging vehicle, instead of giving that money to charity? For the same reason companies replace their aging equipment.

How are the actions you take to derive benefit different from the actions companies take to derive benefit?

There are only two key differences that I see. First, companies more carefully record the money unit benefits of their actions because they have folks who hold them accountable, the owners. Second, they are trying to accrue those benefits for someone else, the owners instead of themselves, unless they happen work for an employee-owned company.

Profit is nothing more than a derived benefit. We profit a great deal from others, that’s why we are willing to pay them. Without that profit, we’d be living the short and lean lifestyle of a hunter-gatherer.

“Innovationism”

In a post about styrofoam, Don Boudreaux points out Diedre McCloskey’s better name for capitalism, innovationism. I couldn’t agree more. The word capitalism sterilizes what’s really happening. Innovationism captures it much better.

Bono 4 Capitalism

Amazing timing.

I had a conversation about the band, U2′s, lead singer, Bono, with a co-worker. I quipped that I thought it was funny how Bono made so much money from commerce while being so critical of commerce.

Then I read this post at The Pretense of Knowledge, about the reformed Bono, who now recognizes that commerce and capitalism is key for lifting folks from poverty and creating prosperity.

Not only that, it’s as if he heard me poking fun at him. From the article:

The Irish singer and co-founder of ONE, a campaigning group that fights poverty and disease in Africa, said it had been “a humbling thing for me” to realize the importance of capitalism and entrepreneurialism in philanthropy, particularly as someone who “got into this as a righteous anger activist with all the cliches.”

I think this is good news and bad news.

It’s good news that a popular entertainer gets it now. Maybe someone will listen to him. It’s also good news that someone like Bono admitted to changing his mind. We don’t see enough of that.

It’s bad news that it took him so gosh darned long to figure it out. That’s a key reason folks the world over try to restrain capitalism — they don’t understand it, even when it provides them with so much prosperity.

“Life Would Be So Much Better Without Capitalism!”

Thanks to Cafe Hayek for pointing me to this well done video from the Fund for American Studies:

 

All the good stuff we get from capitalism and don’t even notice is a them I like to explore often. The video does a nice job of illustrating it.We take for granted something as mundane as having 24-hour pharmacies nearby chock full of stuff to help many ailments that can be ours for a relatively small price. Have you considered that billions of people in the world now and before us would love to have.

In the video, an anti-capitalism protester who enjoys plentiful gadgets, food and overall decent standard of living (due to capitalism), is knocked out by a sign waver at the demonstration and gets to explore a world without capitalism while out cold, aided by a little dude with wings to help explain why everything is so dreadful there.

I love this line:

Anti-capitalist: My X-Box is gone?

Little winged guy: Yeh. In this world, that greedy Bill Gates works at a bowling ball factory in Akron.

Join the discussion.

No skin in the game

This is from the February 23, Harvard Business Review Ideacast with Mihir Desai. The topic was CEO pay and this part of the discussion was about whether capitalism was failing (emphasis mine).

I actually think capitalism is wonderful. I actually think shareholder capitalism is a wonderful thing. I don’t have a problem with that. What I see is a significant deviation from it. Which is, again, I see managers and investment managers doing remarkably well, and shareholders doing fairly poorly if one looks at the last 15 years. That’s not shareholder capitalism. That’s capture of capitalism by managers and investment managers. That, I think, is not sustainable. That, I think, is destructive to the long-term health of shareholder capitalism.

I think this well-said. Many people often mistake distorted capitalism for capitalism.

But, the question is how can this happen in capitalism? As I like to say, the problem usually lies in the feedbacks. Desai contends that stock-performance based compensation for investment managers creates several distortions in incentives, yet the “you get paid when I get paid” logic is so alluring that it has become the generally accepted way to pay investment managers.

Desai hits on a few of these distortions, but I believe the key distortion is in the risk-taking. Investment managers share in the upside, but don’t lose their pants on the down side. The have no true skin in the game. The managers might not get paid on the downside and they may lose their contract on the downside, but they don’t actually lose their own money. So, they have more incentive to take more risk than they would if they were betting with their own money.

The next question is why hasn’t capitalism sorted out this problem? My answer is that few people know it exists.

So, here is one example where having no skin in the game has caused our financial markets to become more fragile.

Why did you buy that?

Art Carden writes that Entrepreneurs Serve Public Better Than Politicians (H/T: Speedmaster at The Pretense of Knowledge).

I agree. I agree.

While on a trip to Vegas, Carden found a profit opportunity. Two nearby Starbucks were selling coffee at different prices. The higher priced Starbucks was busier (sounds like they got their pricing right). Carden bought two cups of coffee at the cheaper (and less busy Starbucks), brought them to the line at the busier and more expensive Starbucks and sold them for a profit to people standing in line.

As Carden sums it up:

The 97 cents I earned was my reward for taking a risk on my hunch that two cups of coffee would be more valuable downstairs than upstairs.

According to Deirdre McCloskey, this is the key to the wealth of the modern world. That we live in a world in which buying low and selling high is at least tolerated encourages economic growth. The great irony of this is that merchants tend to be scorned or otherwise not trusted. But who is the real public servant: the politician deciding he will take more of your money by force so that he can accomplish his goals, or the merchant who decides he wants more of your money and offers you a hot cup of tasty coffee in return?

I have one beef with the column. To make his great point that business folks do more to serve their fellow-man than politicians, he brushed over a key point on value creation.

Most people think of business people as McCloskey put it, someone who buys low and sells high.

That’s too simple.

Why were the folks in line at the more expensive Starbucks willing to pay Carden more than he paid for the coffee?

The answer to that is why business people can “sell high”, if they’re lucky. That is the value creation process.

And the beauty of that process is that it’s sometimes hard to pinpoint the reasons we’re willing to pay what we pay for things.

Perhaps Carden’s buyers were in a hurry, he had what they wanted, so he saved them time. Maybe Carden looks like a trustworthy fellow, had a big smile on his face and his buyers got some value out of his charm. Or maybe, they saw him speak the day before, and thought that he was up to something clever, so they thought they’d play along.

If the reason they bought Carden’s coffee had anything to do with saving time, then Carden had solved what economist Friederich Hayek called the knowledge problem. Carden had knowledge of the particular circumstances of time and place. He knew of a nearby Starbucks with lower prices and shorter lines.

This is knowledge that most of the folks waiting in line at the other Starbucks did not have or did not value enough to act on.

Two people valued it and bought out Carden’s inventory.

Carden took a risk. He could have wound up with no takers, in which case he would have two grande cups of coffee to drink.

Since Carden wasn’t sure whether anyone would buy from him, he didn’t invest much.  He exhibited prudence, as I wrote about in the previous post, by limiting his risk to two cups of coffee.

Business people experiment all the time. They usually don’t know what people will value any more than you or I. They are following their hunches, observing and trying things to find something people value.

It doesn’t always work. Most business owners have experienced failures. They bought two cups of coffee and couldn’t find buyers.

The businesses we trade with every day are the few experiments that worked. For each one, there were likely dozens or maybe even hundreds that failed.

Further, once a business has established its success, we tend to take its success as a given and forget the failures and risk the business owners took to find the success. We have a tendency to question their profits rather than praise the value they bring us.

We forget that even Carden’s customers profited. Most likely, they gained time that was valuable to them.

“Losses encourage prudence”

George Mason economist and EconTalk podcast host Russ Roberts has said:

Capitalism is a profit and loss system. Profits encourage risk-taking. Losses encourage prudence.

It follows, then, that if you remove losses, you wind up with risk-taking and less prudence.

This removal of losses, and therefore prudence, is a key driver in things like the real estate and mortgage bubble that we are still trying to recover from.

The Wall Street Journal provided a perfect example in this article about a real estate development around a new downtown events arena in Kansas City, Missouri. The city government signed up as partner with a private developer. The city pledged taxes that would be generated from the area to pay off $295 million in bonds issued to help finance the $850 million construction.

Now, with the entertainment center generating about one-third of the original forecast in tax dollars, the city has to cover the bond repayment from its other funds.

Do you believe the private developer would have invested the full $850 million if the City hadn’t agreed to fund $295 million of the construction? Do you think the investors would have been a little more prudent in their investment? Maybe they would have still invested, but perhaps on a smaller scale.

(Thanks to a friend for sending the article to me)

Unintended Consequences Matter

I linked to Aaron McKenzie’s disentanglement of self-interest and greed here.

In this post, Arnold Kling recommends reading an essay called Capitalism and the Jewish Intellectuals.  In it, he writes, the authors believe intellectuals are hostile to capitalism because of this entanglement of self-interest and greed.  They interpret “incentives matter” as “greed drives capitalism.”

So, they recommend a way to get intellectuals over that hump.  Kling poses their recommendation in the form of a Q&A:

Q: How would you break down that hostility to capitalism?

A: By de-emphasizing “Incentives matter” and instead emphasizing that “unintended consequences matter.” That is the message of Adam Smith. It is the message of Hayek. Once we embed people in complex economic and political systems, selfish intentions can turn out well (because of competition), and good intentions can turn out badly (because of imperfect knowledge).

Though, based on Aaron’s advice, I would reword part of the answer to:

…self-interested intentions can turn out well (because of competition)

People do not know what capitalism is

Even though the video has made its rounds on other blogs, I had to post it here because I think it’s really good.  I credit Speedmaster at The Pretense of Knowledge for directing me to it.

It’s called Top 3 Common Myths of Capitalism from Jeff Miron of Harvard.

Myth 1: Being pro-capitalism is the same as being pro-business.

Miron says:

The point of capitalism is to make sure that businesses have to be compete vigorously against each other.  That benefits consumers.

It’s not good for the businesses, per se, because they have to work really hard.  Many businesses understand this and they hate capitalism.  They’re constantly trying to get government erect various rules, restrictions, regulations that help them, but they are not in the interest of the consumers [though they will say otherwise].

I believe one cause of this myth is that many people don’t fundamentally know what capitalism is.

Just this morning I heard radio DJs criticizing capitalism.  Yet, they were really criticizing disingenuous commercialization.  On that I agree with them.  That bugs me too.  Other things bug me.  Whiny millionaire football players, cheesy car salesmen and endless customer service touch tone menus are not my faves.  But these aren’t capitalism either.

These have emerged from capitalism.  So have many other things.  Things that I like and love and have made my life better than my ancestors and even better than my younger days.  On net, we all come out far ahead.

And, I know that I can turn the channel when it shows whiny football players, I can find a professional car salesmen and I’ve noticed those phone menus getting better.

I also noticed that those DJs didn’t criticize their advertisers.

Another cause of Myth 1 is that few people differentiate between profits earned by capitalism, through competition, and those earned by rent-seeking or politics.

We need to get better at asking if the profit came from providing valuable products that people voluntarily buy or rent-seeking or politics?

For example, sugar tariffs increase the price consumers pay for sugar and results in a higher profit for domestic sugar companies.  Those higher profits are passed to domestic sugar companies directly from consumers.  Those sugar companies should thank their friends in government.  They do.

Without the tariff, sugar and things made of sugar, would cost less and we would spend our savings on something else that could make our lives even better and create more jobs.  That’s rent-seeking.  It’s anti-capitalist and anti-consumer.  But is viewed by most folks as capitalism itself.

Myth 2:  Capitalism results in an unfair distribution of income.

Miron explains that capitalism rewards people based on what they contribute and produce and admits that a downside to capitalism…

…is that some people have very little skill.  They are not able to earn very much, left on their own.  Some reasonable people support anti-poverty spending, but that’s completely different than interfering with capitalism–regulating prices, limiting quantities, etc — those make the economy less productive, give us a smaller pie and makes it harder for us to operate programs that help those who are less fortunate.

I’d add that the anti-poverty spending does not have to be (nor is it an enumerated power) conducted by the Federal government.

Myth 3:  Capitalism was responsible for the recent financial crisis and recession.

Miron explains that we didn’t have unbridled capitalism in housing prior to the meltdown.

We had enormous government interventions — subsidized risk, encouraged over investment in housing.  If one is going to draw a conclusion, it seems to suggest much more clearly that interfering with capitalism generates financial crises…

…because what happened was a result of the market distortions created by government interference.

This goes back to causes of Myth 1, primarily that people do not know what capitalism is.  People see private, for-profit companies operating in the housing and mortgage industry and stop there assuming that’s capitalism.

They don’t understand that those private companies — and private individuals — were responding to incentives distorted by government.

Consider Speedmaster’s example.  If we believe owning a Porsche cause folks to become well-off (which it doesn’t), then government will do things (distort incentives) to make it easier for people to buy Porshes.

Government can tell banks to not worry about lending on Porsches, because if anything happens, the government will help out.  Government sends subsidies to Porsche to encourage them to produce more cars (though they don’t have the capacity to keep up with demand caused by the incentives distorted by government).

Porsche prices rise from the increasing demand.  People buy more because it seems like, even if you can’t afford one, you can sell it two or three months later for a profit.  Why buy just one?  Buy two, maybe three.

It’s not hard to imagine what happens next.  First, few will have achieved success by simply becoming a Porsche owners.  The original thinking was flawed.

Second, prices rise well beyond normal, capitalism-driven, prices for awhile as everybody gets one or two.

Then they look around and wonder, who’s going to buy my Porsche?  Everyone seems to have one of their own now (which also makes it uncool).  They realize they can’t afford to keep it (plus it’s suddenly uncool), so they panic and rush to sell it before anyone else realizes what’s going on.  Supply skyrockets relative to demand.  Prices collapse.  Everyone says this was capitalism’s last hurrah and governments pays off loans with taxpayers money and becomes the proud owner of millions of Porsches.