Unleash the Innovators and Entrepreneurs

The solution to market failures is market solutions, carried out by innovators. A reader requests my views on "capitalism," which I set out as answers to his questions and comments.

In the following, I answer comments and questions from a friend and reader, Benjamin. I will rarely be able to do this, but I wanted to this time. In any case, Benjamin invited me to share my thoughts about “capitalism,” despite the term, which makes me bristle. Anyway, I’ve put Benjamin’s lightly-edited questions and comments in blockquote italics.

I generally agree that capitalism and technological progress benefit everyone, at least so far—and that the free market and entrepreneurship have been good for development. You’ve spoken about the positive incentives and outcomes of capitalism, but what about the perverse incentives and externalities of the commons?

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First, the term capitalism. It’s such a fraught term coined by Marx, I think. It focuses the mind on capital and who holds it. But capital is useless unless it’s deployed and deployed well. I quite like Dierdre McCloskey’s term innovism because it focuses the mind on what prosocial changes can be made when more people enjoy the opportunity to have a go at serving people better. I tend to refer to “entrepreneurial markets,” mainly as entrepreneurs are real people, and markets are aggregates of those people constantly testing experiments in production and trade.

But the other problem with the term “capitalism” is that it’s hard to know what people mean by it. What do you mean by capitalism? Do you mean a system that protects bloated monopolies or crony cartels propped up by politicians or powerful bureaucrats using tariffs, subsidies, and (yes) regulations? Or do you mean a system in which free people—fully responsible for tort injuries against others or others’ property—may justly acquire resources and capital goods, then attract people and apply knowledge in such a way as to serve people? Will they always have to succeed in an environment where they have to do it better, faster, cheaper, and with more waste elimination than a competitor—staying solvent—all while reckoning with undistorted price signals and the rigors of seeking profit while avoiding loss?

I think many critics of what I call entrepreneurial markets rely on the ambiguity of the term capitalism, which causes people to talk past each other.

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I’m curious to hear your response to criticisms of capitalism, for example, perverse incentives to maximize short-term ROI despite externalities, such as damage to the environment, future generations, etc.

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When discussing systems, we sometimes want to talk about ideal systems, even as we live in unideal systems. For example, as I explained above, I think entrepreneurial markets should exist in a more robust common-law system, particularly with jurists applying the law of torts. That implies that entrepreneurial activity should not injure others. But if it does, the injuring party should cease and desist and pay damages.

Yet most of our statute laws and regulations enable large incumbents to comply with said laws and regs, which allows them to evade responsibility or liability—all while restricting upstarts. In such cases, we comply with federal regulations, which sometimes means we can legally dump into the river or the sky. In a loose, crony capitalist statutory regime, like the US, corporations get away with this stuff all the time.

They use the regulations to maintain their incumbency.

When people and property are strictly protected under the common law, plaintiffs only have to meet a preponderance of evidence standard to prove injury. In such a system, it’s far more difficult for cronies to extract rents, externalize costs, or injure others. Alas, that’s not exactly the system we live in. You might call that “capitalism,” but I call that “crapitalism,” which is not my preferred system.

Still, we have to ask: Compared to what?

While the system I advocate is no Utopia, it has a relatively better prospect of keeping entrepreneurship honest. And nearly all of its features have been successfully tried somewhere and at some time—so it’s not theoretical. Still, if you’re referring to the crony-infested system we live in now, I suppose I would prefer that to Communist China or Bureaucratic Europe—but our system is not that different from either of these. Again, we must ask: Compared to what? Any alternative system you or I might wish to try, however different each is, will be nigh impossible to realize due to the entrenched interests that keep the system from evolving in prosocial ways.

The paradox is the only way to find out if a given system works better is to be able to have more experiments in governance, which means a freer market in governance!

I’ll return to the question of short-term versus long-term incentives after addressing this next point.

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Other perverse incentives could be fiduciary responsibility to share holders to maximize profit over everything else.

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Some will argue with me, but I think the status quo legal, tax, and regulatory structure creates short-term incentives for most public companies. Many entrepreneurs want to create long-term value but don’t always appreciate that when they “go public,” they subordinate themselves to quarterly results, by law.

Is this pattern “capitalism”?

Here again, we turn to questions of more idealized forms, though millions of people with 401Ks would argue they are okay with this distortion—tradeoffs being what they are. Still, we can imagine some solutions that could be implemented today:

• Long-term performance shares for executives—Is it possible to tie more executive compensation to long-term metrics?

• Staggered reporting—Could a move from quarterly to semi-annual or annual financial reporting reduce short-term pressures?

• Loyalty-driven financial instruments—Could companies issue stocks that confer increasing voting rights or dividends the longer they’re held?

• Encourage alternative business models—Could relaxing limits of creating novel corporate structures change how companies are financed?

Remember that many status quo problems are not features of a highly evolved market but of government regulation, conceived as a means of “improving capitalism.” Quarterly reporting, for example, is an SEC regulation in the US.

So, my instinct is always to liberalize and adjudicate frictions before regulating. It’s too easy for people to get stuck in patterns that are artifacts of statute or the products of regulatory cronyism. This is how Molloch gets entrenched.

Otherwise, to the extent possible, Criticize by Creating.

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What about manufactured and manipulated markets and consumers, for example planned obsolescence? Or cutting quality and workers compensation programs to minimize costs and maximize profits

First, you answer your own question when you say,

[I]n a competitive landscape, there’s a kind of arms race … in that quality can only be cut so much before consumers choose a competitor’s product instead).

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I don’t think planned obsolescence is a thing. (Galbraith was full of shit.) There are products of specific quality categories, which usually align with certain price points. I own a Honda because I expect 150,000+ miles out of it. After all, Honda proves time and again that their products last. Do you want a $200 mixer that lasts 20 years? Or a $20 mixer that lasts five years? There is a cornucopia of options, even under imperfect “capitalism.”

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The worst perverse incentives I find with capitalism is that impact on the environment and future generations is hardly ever priced in.

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Yes, under a lot of this “capitalism,” I agree—though internalizing externalities is a nut we’ll have to figure out through experimental, not technocratic, means. Many externalities relate to the absence of good rules rather than the need for more regs.

Consider the difference between cattle and ocean fish. When do you hear anyone worry that cows are being overexploited? In one case, we have private ownership of cattle. But we have “common” property in ocean fish. Private ownership creates long-term incentives to conserve. Common property, owned by everyone and thus no one, creates incentives to overconsume—a destructive race to exploit. So, under entrepreneurial markets, my “capitalism,” the institutions (rulesets) matter. I acknowledge it’s not always easy to assign private property to commons, but there are pragmatic workarounds to be sure.

Yet despite perverse incentives to overfish, the price system still prompts entrepreneurial experimentation. Behold:

This particular local experiment might not work. But another might. That’s why the answer to “market failures” is almost always to unleash the entrepreneurs.

Now, we should return to questions about a more robust tort regime, but instead, I’ll leave you with some > excellent stuff < by my old friend and now-fellow South Carolinian, Bruce Yandle (along with Roger Meiners).

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Many businesses rely on labor where workers aren’t paid an actual living wage (Amazon etc), for if they did most businesses wouldn’t be nearly as profitable—or at least CEO, board of directors, shareholders, and stock prices would need to take a hit.

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I must admit that talk of living wages or raising the minimum wage makes me want to bang my head against my desk. As there are several reasons why, I bullet them:

• What is a “living wage” exactly? There are different wage rates around different regions of the country. The very idea of a national minimum wage is outlandish, and to the extent that we might agree about what it takes for a given person to live, the same can be said about “living wages.”

• Compared to what? So, do you think you can suspend the law of labor supply and demand? It’s a law that political paladins or activists cannot wish away. If you raise the costs of hiring employees, companies will simply hire fewer of them—and/or they will automate. Or they will go out of business. The effect is more unemployed people, not fewer.

• Earned Income Tax Credit (EITC). A least-bad option for political paladins might be to raise the Earned Income Tax Credit, which is like a UBI that already exists, only one that targets poor people. So if we could agree about what a “living wage” is, officials might be able to provide some income support less distorting to the labor market—i. e., that doesn’t result in layoffs or business closures. (That said, we must not create income traps and ever-deepening public debt.)

• The greater pathology. Inflation is a bigger problem, which is—again—not a part of any market entrepreneurship I care to see exist. If poorer people’s currencies didn’t lose purchasing power, what they did bring in would gain in purchasing power over time. This would encourage savings and only consumption necessary for “living,” which in many cases might not include destructive products such as cigarettes, liquor, Ding Dongs, and Playstations. I understand that for many people, these are cheap means of amusement or enjoyment in an otherwise bleak existence. But I think a more deflationary currency option would encourage thrift and upward mobility. (God, I sound like an old man.)

In any case, poverty issues are tough to solve through largesse or algorithm. Poverty issues are just tough.

But understand that before the Great Society programs—aka the War on Poverty—about 15 percent of people lived at or below the poverty line. Since the War on Poverty, that figure stands at about 15 percent, despite $25 trillion.

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Is it possible for businesses to operate in truly net neutral and or net positive regenerative ways considering all inputs and outputs of the business under free-market capitalism?

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I don’t know. But I don’t think anyone does, either.

Instead, we see much of what the inimitable Alexander Bard calls “Pillar Saints” and “Boy Pharaohs.” Simply put, Pillar Saints love the mind but hate the body. Boy Pharaohs love the body but hate the mind. My gauche American interpretation of this is mere thinkers and mere doers:

Pillar Saints—Ponder and fret but do nothing of substance.
Boy Pharaohs—Do something without reflecting.

There are too many goddamn Pillar Saints driving the conversation about the environment and Climate Change. There are too many Boy Pharaohs using the former’s placards and hysteria to reward cronies or gain political power, only to wield the bludgeon of state power in counterproductive ways.

A pox on both.

But this is the thing about entrepreneurial markets: It includes entrepreneurs. And entrepreneurs are a special breed. They are out there tinkering and figuring out how to solve problems ceaselessly. So as Pillar Saints get on YouTube endlessly to hold forth in loving-but-verbose sanctimony about sustainability, or regenerative living, or Molloch, entrepreneurs—even social entrepreneurs—are figuring shit out.

Entrepreneurs thrive in institutions where they can more easily have a go.

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There does appear to be a late-stage capitalism phenomenon where all products across all competitors start to get shittier and shittier while still in competition with one another. The consumer just learns to accept worse products. Surely I’m not the only one that feels like many of the things I bought 10 years ago were of higher build quality than today.

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I will pass over the term “late-stage capitalism” because I think it’s either content-free or ideologically loaded.

Otherwise, regarding quality, we mostly covered this above. If you buy cheap Chinese junk on Amazon, you will get cheap Chinese junk—though it’ll seem like you’re paying more for it thanks to the Federal Reserve money printing. In any case, I don’t think we can deepen the conversation by only talking about our feelings. I would invite readers to resist appealing to much of anything without evidence. Otherwise, it’s a postmodern game of “my truth” versus “your truth.”

For example, reflecting on all my favorite products, I have the opposite experience. That doesn’t mean that prices haven’t gone up due to inflation, nor does it mean I’m correct about quality across the board. Indeed, I noticed the quality of Austin restaurants going down before I left—staffed as they are by workers who get rewarded for their apathy because the city is so crowded. But overall, my Ninja coffee maker still kicks ass. My Honda still hums like a sewing machine. And my smartphone improves with every release, even though I paid less for it this time.

Better.
Faster.
Cheaper.

Anyway, anecdotes don’t prove or disprove anything, much less for an imperfect system that takes both exogenous and endogenous shocks and manages to trundle on increasing human well-being and environmental health on net.

Don’t forget that twenty years ago, there was no such thing as a smartphone.

I leave you, Dear Benjamin, with Strong’s Law of

Michael Strong's Entrepreneurial Solutions

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Strong’s Law
Ceteris paribus, properly structured free enterprise always results, over time, in higher quality, lower cost, and more customized products and services.

Strong’s Corollary.
This theorem applies just as forcefully to the entrepreneurial supply of law, governance, community, housing, education, health care, happiness, and well-being as it does to technology. Our world suffers because we have not allowed entrepreneurial initiative to fully address humanity’s most important issues.