In “Wall Street,” Gordon Gecko delivers an iconic speech:

Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures, the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge, has marked the upward surge of mankind.

But few defenders of free markets have actually claimed greed is good.  Perhaps Ayn Rand or Mandeville can be read that way, but even then one has to be careful.

It is more accurate to say that greed is simply a fact.  Given this fact, human institutions can usefully be arranged to make the clash of self-interest a benefit, rather than a harm, to the society.  And that is just what market exchange can do, under a limited set of circumstances:  Markets can make human interaction mutually beneficial, even if those humans are sometimes greedy.

The best consequentialist arguments (there are others) for free markets is based on individual liberty and consumer sovereignty.  That is, an individual left to his or her own devices has better information and clearer incentives to act.  A system based on consumer sovereignty ensures that consumers direct the production decisions of entrepreneurs, though consumers themselves need expend no effort in performing this directive function.

What, then, of profits and the income disparities associated with market processes?  Is not the pursuit of profit the goal of capitalism?  Absolutely not, and to say that is to fundamentally misread the argument for capitalism.  Capitalism is that system that best ensures consumer sovereignty.  Full stop.  Profits, and income inequality, are waste products, byproducts of the attempts by entrepreneurs to serve consumers.  And like by-products in any other context, the idea that the world would be better if the level of external effects were reduced to zero is quite mistaken.  Pollution is a sign that something is being produced.  So also with profits, provided that the profits are not result of state-protected rents.  Would the world be better off without profits?  Would the world be better off without friction?  Neither of these questions make any sense.  But actions that reduce friction, such as using oil in motors, make our lives better.  Allowing free markets makes profits smaller, while at the same time making consumers sovereign.

(More after the jump)

Consumer Sovereignty

Would the capitalist system continue to produce whatever value we care about if the accumulation of profits were to be curtailed?

It seems tempting to think the answer is “yes.”  John Stuart Mill (1848, Principles) certainly thought so (Jerry Gaus always gets mad at me when I quote this passage, because elsewhere Mill is much more circumspect.  Jerry:  Bite me–I’m quoting it out of context again).  As he famously put it, there is a crystal clear distinction between production decisions and distribution decisions.

The laws and conditions of the Production of wealth partake of the character of physical truths. There is nothing optional or arbitrary in them. Whatever mankind produce, must be produced in the modes, and under the conditions, imposed by the constitution of external things, and by the inherent properties of their own bodily and mental structure….

It is not so with the Distribution of wealth. That is a matter of human institution solely. The things once there, mankind, individually or collectively, can do with them as they like. They can place them at the disposal of whomsoever they please, and on whatever terms. Further, in the social state, in every state except total solitude, any disposal whatever of them can only take place by the consent of society, or rather of those who dispose of its active force. Even what a person has produced by his individual toil, unaided by any one, he cannot keep, unless by the permission of society. Not only can society take it from him, but individuals could and would take it from him, if society only remained passive; if it did not either interfere en masse, or employ and pay people for the purpose of preventing him from being disturbed in the possession.  (p. 199)

In other words, perhaps something like a capitalist system is necessary for efficient production of goods and services.  But it is perfectly plausible to insist that decisions about distribution of the increased prosperity that results are well within the boundaries of state competence.  In fact, Mill makes a radical claim:  The distribution of property that results from leaving market processes to work without interference is still contingent on state action.  Therefore, that so-called “free-market” distribution is just as arbitrary as any other distribution the state might select.  The state not only can but must choose the best distribution from the perspective of the society as a whole.

This separation of economic production and distribution is quite similar to the separation envisioned later by Rawls.

These principles [Liberty and Difference] presuppose that the social structure can be divided into two more or less distinct parts, the first principle applying to the one, the second to the other. They distinguish between those aspects of the social system that define and secure the equal liberties of citizenship and those that specify and establish social and economic inequalities. The basic liberties of citizens are, roughly speaking, political liberty (the right to vote and to be eligible for public office) together with freedom of speech and assembly; liberty of conscience and freedom of thought; freedom of the person along with the right to hold (personal) property; and freedom from arbitrary arrest and seizure as defined by the concept of the rule of law. These liberties are all required to be equal by the first principle, since citizens of a just society are to have the same basic rights.

The second principle applies, in the first approximation, to the distribution of income and wealth and to the design of organizations that make use of differences in authority and responsibility, or chains of command. While the distribution of wealth and income need not be equal, it must be to everyone’s advantage, and at the same time, positions of authority and offices of command must be accessible to all. One applies the second principle by holding positions open, and then, subject to this constraint, arranges social and economic inequalities so that everyone benefits. (Rawls, 1971:  61)

Rawls envisions a sphere where government action is primarily focused on protecting liberty, and another where government action should focus on effecting a just distribution of income.  In the first instance, liberties are assumed to exist, and the job of government is to protect justice.  In the second instance, the distribution of wealth is assumed to be flawed, and the job of government is to effect justice.

The problem with this formulation– explicit the (selected) quote from Mill, and implicit in Rawls–is a question-begging premise:  “The things once there, mankind, individually or collectively, can do with them as they like.”

The things once there?  Seriously?  And economists get mocked for their facile question-begging assumptions!  (“Assume a can opener”).  We have no basis for assuming that “the things” will be there, unless prices and profits can perform their directive functions.  Without the promise of profit, the things are not there.  In fact, the things are not even “things” yet, but rather ideas that no one has ever thought about until some entrepreneur imagines them.

The idea of entrepreneurship appears to derive from the French verb entreprendre, meaning “to undertake.”  One of the first clear statements using the modern meaning was J.B. Say:

An entrepreneur is an economic agent who unites all means of production- land of one, the labour of another and the capital of yet another and thus produces a product. By selling the product in the market he pays rent of land, wages to labour, interest on capital and what remains is his profit. He shifts economic resources out of an area of lower and into an area of higher productivity and greater yield.

But this notion of simply buying low and selling high ignores the most important aspect of entrepreneurship:  imagining an alternative future.  As Joseph Schumpeter put it:

The introduction [of new products] is achieved by founding new businesses, whether for production or for employment or for both.  What have the individuals under consideration contributed to this?  Only the will and the action; not the concrete goods, for they bought these—either from others or from themselves; not the purchasing power with which they bought, for they  borrowed this—from others or, if we also take account of acquisition in earlier periods, from themselves.  And what have they done?  They have not accumulated any kind of good, they have created no original means of production, but have employed existing means of production differently, and more appropriately, more advantageously.  They have “carried out new combinations.”  They are entrepreneurs.  And their profit, the surplus, to which no liability corresponds, is an entrepreneurial profit. (Schumpeter, 1934; 132)

Elsewhere, Schumpeter famously described entrepreneurs as more destructive:   “Entrepreneurs are innovators who use a process of shattering the status quo of the existing products and services, to set up new products, new services.”  This was echoed, at a more popular level, by Peter Drucker:  “An entrepreneur searches for change, responds to it and exploits opportunities. Innovation is a specific tool of an entrepreneur hence an effective entrepreneur converts a source into a resource.”

The particular theory of entrepreneurship most useful for present purposes, one that combines the idea of different prices and innovations in imagination, is Israel Kirzner.  Kirzner gives a classic description of the relation between profit, value, and entrepreneurship:

Let us consider the theorem which Jevons correctly called “a general law of the utmost importance in economics,” which asserts that “in the same open market, at any one moment, there cannot be two prices for the same kind of article.” …Now the existence of such a tendency [toward a single price] requires some explanation. If the imperfection of knowledge (responsible for the initial multiplicity of prices) reflected the lack of some “resource” (as where means of communication are absent between different parts of a market), then it is difficult, without additional justification, to see how we can postulate universally a process of spontaneous discovery

We understand, that is, that the initial imperfection in knowledge is to be attributed, not to lack of some needed resource, but to fail to notice opportunities ready at hand. The multiplicity of prices represented opportunities for pure entrepreneurial profit; that such multiplicity existed, means that many market participants (those who sold at the lower prices and those who bought at the higher prices) simply overlooked these opportunities. Since these opportunities were left unexploited, not because of unavailable needed resources, but because they were simply not noticed, we understand that, as time passes, the lure of available pure profits can be counted upon to alert at least some market participants to the existence of these opportunities.  (Kirzner, 1978; emphasis added)

Kirzner defined entrepreneurship as “awareness,” the constant searching for profit opportunities.  But Kirzner conceived of errors much more broadly than the above passage would suggest.  Rather than simply “correcting” errors in the price system, and causing the convergence of prices of a single existing commodity, entrepreneurs imagine alternative futures, new products, and possible ways of organizing production that consumers may well not even be aware that they could have, much less want.

Steve Jobs, of Apple Computer, famously observed that entrepreneurs could not rely on static conceptions of “demand”:  “You can’t just ask customers what they want and then try to give that to them. By the time you get it built, they’ll want something new.” (Inc., 1989).

            A decade later, Jobs went further:   “But in the end, for something this complicated, it’s really hard to design products by focus groups. A lot of times, people don’t know what they want until you show it to them.” (Business Week, 1998).  This view, if it is correct, suggests how entrepreneurship may be destructive, at least from the perspective of those other firms and enterprises still trying to make what people used to want.  If an entrepreneur shows folks what they really wanted but didn’t know they wanted….boom!

The Sony “Walkman” was an extremely popular (and profitable) device that allowed people to move around or even exercise while listening to the radio or to cassette tapes.  At one point the Walkman captured more than 50% of the “mobile music” market. But then MP3 players were invented.  MP3 is short for MPEG 3, an abbreviation for “Motion Picture Expter Group” codings.  Codings are means of reducing the amount of information (bits of stored digital information) to encode a song without losing quality.  The first patents for MP3 encodings were issued n the U.S. in the late 1980s and the early 1990s.  The first commercially viable MP3 players went on sale in the late 1990’s, and by 1999 they were relatively common in stores.  The first iPods from Apple were released in January 2001; by the end of 2002, 600,000 had been sold, at prices exceeding $400 in nominal terms.

And so, even though people didn’t know that MP3 was how they wanted to buy, store, and carry their music, it turned out to be so.  The most successful MP3 player, for more than a decade, has been the iPod made by Apple.  Steve Jobs, and the Apple engineers, imagined a different arrangement of productive resources.  None of the resources needed to be invented, and none of the digital processes for storing the music were especially difficult or innovative.  But the package, the iPod and other product like it, was something new.  It was a thing that wasn’t there, and then it was there, and people wanted it.  Perhaps Steve Jobs did it for glory, but his company did it for profits, and profits made it possible.

And what about the Walkman?  Sony lost billions of dollars, and was unable to offer a competitive product for much of the period when MP3 players were being sold to people who were buying one for the first time.  Sony laid off at least 10,000 workers, and closed two large production facilities, causing at least 100,000 people to suffer significant economic harm.  If Steve Jobs caused that much harm, how could entrepreneurship be a virtue?  Remember, the harm was actually intentional; it wasn’t an accident.  Apple had specifically targeted Walkman, the then-dominant product, as the consumer electronic device they wanted the iPod to replace.  And they did it.

Profits as a Way of Ensuring “the Things” GET There

Creating profits is not the objective of market economies; indeed, competitive markets–markets not fettered by state regulations on entry and price–drive profits downward.  Now, it could be argued that, since many companies consistently make profits year after year, this competitive force is weak.

The problem with this viewpoint is that it takes an odd benchmark, an imaginary world of perfect competition where “the things” are already there, as a description of how actual markets work.  Profits, large or shrinking, are a means to an end.  The pursuit of investment in high profit ventures directs resources toward those activities that consumers value most.

This point is very important, and for some reason most critics of markets are greatly confused by it, perhaps willfully.  Profits, and greed, are not inherently good.  Rather, given the right context, the greed-driven pursuit of selfishness can be useful to consumers, as more, better, and cheaper products are produced.  In a simple economy, profits would likely be quite limited, because choices are few and information is easily obtained.

But given the dynamic and constantly changing nature of a modern economy, choices are many and the consequences of those choices are hard to foresee.  In a complex economy, both benefits to consumers (the primary objective) and profits (a byproduct of consumer sovereignty) are likely to be produced in great abundance.

As I said, it is easy to become confused about this.  There are three core confusions I want to address in this section.

  • First, it is a mistake to assume that the amount of wealth, and the quality and variety of consumer goods, is a fixed pie that can be redistributed according to a conception of justice.  The way the pie is expected to be cut sharply affects the size of the pie.
  • Second, the people who make profits do not deserve them, in any important moral sense.  The only reason we would allow people to keep profits is if the consequence of using a system that produces profits does more social good than harm.
  • Finally, I will argue that allowing the pursuit of profits improves the welfare of the least well off better than any alternative.  What that means is that anyone sympathetic to the general goals of Difference Principle (though not Rawls statement of the realized form of that principle) should choose the institution of markets, though with the kind of welfare safety net that Hayek describes.  Markets uniquely satisfy the Liberty Principle, provided that the continuous politically motivated redistribution process can be avoided.

It is useful to give a brief summary of the examples of institutions I have selected (and the selections are entirely arbitrary, as I’m sure is obvious to the reader.  In fact, the selections are all satirical, not illustrations of what “real” institutions might look like at all).

  • Egalitarian Socialism:  State ownership of the means of production, equal incomes for all citizens.  Collective action and other incentive problems prevent GDP from growing very large.
  • Pure Laissez-Faire Anarcho-Capitalism:  Winner takes all, bare-knuckled markets.  No government, and security is provided privately.  The very poor cannot afford either to feed or defend themselves, and don’t live very long.  But average income is much higher than under pure state socialism, so there is a 60% chance a selected citizen will be better off, at least monetarily.
  • Capitalism with Redistribution:  Tax rates for higher income levels are confiscatory, so that incentives for great wealth are attenuated.  But even the bottom 20% are better off than under socialism, and much better off than being dead under pure anarcho-capitalism.
  • Capitalism with Social Safety Net/Welfare:  The bottom 20% are slightly worse off than under socialism, and the next 20% can expect $20,000, the same as under capitalism with redistribution.  But every other level of income class is much better off.  The very wealthy would be better off under anarcho-capitalism, but the chances of being in some other income category make capitalism with social welfare an attractive alternative.

Table 1:  An Arbitrary Example of Incomes Under Alternative Institutional Choices

Egalitarian Socialism

Pure Laissez-Faire Anarcho-Capitalism

Capitalism with Redistribution

Capitalism with Social Safety Net/ Welfare

Bottom 20%

$10,000

subsistence or less

$15,000

$8,000

Next 20%

$10,000

$10,000

$20,000

$20,000

Middle 20%

$10,000

$20,000

$30,000

$50,000

Upper 20%

$10,000

$30,000

$50,000

$100,000

Top 20%

$10,000

$1,000,000

$100,000

$500,000

GDP:

$50,000

$1,060,000

$215,000

$678,000

Expected Income

$10,000

$212,000

$43,000

$140,000

 

A decision rule that said “maximize GDP” would select Anarcho-Capitalism, but such a rule is quite foreign to the Rawlsian project.  On the other hand, it is by no means clear that the institution implied by maximin (in this case, Capitalism with Redistribution) would actually be selected in the Original Position, given the attractiveness of Capitalism with Social Welfare.  GDP and average income are much higher, and a person with even moderate risk aversion might well select Capitalism with Social Welfare because the expected payoffs in all income categories but one are greater than or equal to Capitalism with Redistribution.

Rawls claimed that it was self-evident, as an empirical matter, that people would choose according to the maximin principle in the Original Position.  But this is an additional empirical premise to his argument, and not a key part of the logic he uses.  The fact is that a considerable literature in experimental psychology and political economy has grown up around this question.  If one looks at this literature (See, for example, Herne and Suojanen 2004; Oleson 2001; de la Cruz-Dona and Martina 2000; Jackson and Hill 1995; Frohlich and Oppenheimer 1992; Bond and Park 1991; Lissowski, Tyska, and Okrasa 1991; Frohlich and Oppenheimer 1990; Frohlich, Oppenheimer, and Eavey 1987), there is essentially no evidence in favor of Rawls’ empirical claim.  Probably the fairest assessment is that reached in the review article by Konow (2003, Journal of Economic Literature), where the problem is acknowledged but the difficulties are pointed out also.

The experimental evidence on Rawlsian justice seems to constitute a near-categorical rejection of its crucial premise.  Nevertheless, legitimate questions can be raised about the efficacy of the experimental design. Passing through the laboratory door is not necessarily equivalent to passing through a veil of ignorance, and previously formed knowledge and expectations might taint subjects’ reasoning. (P. 1196).

The most useful thing at this point is likely to be an acceptance of Rawls’s claim about extreme risk-aversion, though perhaps not quite as far as his maximin principle.

A Simple Experiment As An Example

To illustrate the problem of temporal priority, and the original position, I performed some classroom experiments, along with my Duke colleague Alex Rosenberg.  We gave each student one “scratch off” lottery ticket, from the North Carolina Education Lottery.  We asked that the students not scratch off the cover until we decided how we might divide the winnings.

The students were presented with two choices:  Each person keep his or her own ticket, and accept the profits, recognizing they were due to chance alone, or pool all the winnings and divide them evenly.  After discussing this for a few minutes, we had the vote.  Having done this now in several classes, I can say for sure the result is always the same: a large majority favor keeping whatever their ticket gives them.

Students then were asked to scratch off their tickets.  We asked for a show of hands, on how many winners there were.  Then we asked for amounts.  In one class, one young woman had won $200.  Summing this and the rest of the winnings, the total for that class was about $235, in a class of 40.

After a moment of silence, one of the students asked, “Can we vote again?”  I nodded, and vote again we did.  Of the 40 students present that day, 38 voted for equal sharing, after they knew they had lost.  Of course, as I noted above, almost all of these students had voted that each should keep his or her own winnings, before the values of the lottery were revealed.  The only two votes for each to keep her own tickets after they were scratched off were the young woman who had won big, and a woman sitting beside her (perhaps a friend, or an aspiring friend?)

Following the second vote, I invoked professorial privilege as Leviathan to protect the original property rights we had agreed on, and the students all laughed.  All of them left, and the young woman who had won later cashed in her ticket and kept the money.  (I’m not sure if her ally got any, of course!)

There are two lessons here.  First, it is by no means obvious that being behind the veil of ignorance will result in an equal sharing rule.  People might well choose to go with what they get, out of optimism or a sense of being special.  One could argue that the stakes were not high here, and losing didn’t mean that you die.  On the other hand, the probabilities here are quite low.  In the “institutions” lottery described earlier, your probability of out-performing equal division was 60%.  Here, the probability was about 25%, at best, and your chances at a significant prize are negligible.  Yet given the chance a large majority voted to go with their own endowment.

I did an extension in class, to test more directly the proposition that expectations about the distribution of the pie affect the size of the pie.  In one class, I had lottery tickets for sale, $1 each.  Students could buy as many as they wanted, with the distribution condition in two different classes (with random assignment) being either “all share” or “each keep.”  In the “all share” condition almost no one bought lottery tickets.  In the “each keep” condition more than three quarters of the students bought at least one.

As it turned out, none of the few tickets in the “all share” class had any winnings at all.  The “each keep” condition had a few winners of small amounts, but only two students made more than the cost of the tickets they had purchased.

Nonetheless, the point is clear.  If it is true that ability is a lottery, then I still have a choice about how much effort I am going to devote to producing products and services that other people need or want.  If I expect the rewards of my effort to be evenly distributed, I am likely to work less hard and less long than if I am allowed to keep some or all of the profits.  Again, my abilities may be due to chance.  But my willingness to devote effort to producing goods for the public is contingent on earning extra for myself.  And if that “extra” improves the lot of the least well off, the income difference must be approved by the Rawlsian observer.

The difference between my lottery example—where “effort” produces no public goods except for winnings—and the real world of profits and markets is that profits result from making things other people want to buy.  I may not “deserve” those profits any more than a lottery winner deserves her winnings.  But that does not mean that choosing a system where wealth is partly determined by chance is ruled out in the original condition.  In fact, since markets serve both the liberty principle and the difference principle, only markets can ultimately accomplish the goals Rawls sets out.

People Who Make Profits May Not “Deserve” Them:

Somerset Maugham wrote a famous short story, “The Verger.”  In the story, the church verger, Mr. Foreman has been working as a verger at the church for more than 15 years, and been a servant in some capacity since he was a child.  He works hard, and well, but the new vicar is shocked to learn that the verger cannot read or write.  The vicar demands that Mr. Foreman become literate, or leave the church’s employ.

Mr. Foreman doubts he can learn, and is sacked.  He wanders, looking for a cigarette.  But there is no tobacconist anywhere on all the long street of shops.  Mr. Foreman opens a shop, and makes considerable profits.  Before long, he opens another, and then several more, in every case using the simple strategy of finding an area that has many shops but no tobacconist.  Nothing could be more obvious, but no one else seems to have thought of this.

After amassing a considerable fortune, Mr. Foreman is told by an executive at his bank that he should invest in something with a greater return than a bank account.  Mr. Foreman demurs, saying he is not confident he can manage other investments, since he cannot read or write.  The banker is amazed, and notes that it is truly remarkable that an illiterate man could have become so very wealthy.  The banker muses about how things would be different, if only Mr. Foreman could read and write.

“‘I can tell you that sir,’ said Mr. Foreman, a little smile on his still aristocratic features. ‘I’d be verger of St. Peter’s, Neville Square.’”

This parable illustrates the three points I am trying to make in this section quite well.  First, the overall level of economic activity is increased by opening the new shops (for tobacco haters, just pretend it was a hardware store).  The demand for tobacco products was in this era routine, and local.  Mr. Foreman was increasing the size of the pie by seeking profits.  Second, Mr. Foreman is quite unremarkable.  He invented nothing, and brought no new products into the country.  All he did was improve the lot of the working class (the third point) in all of the neighborhoods where he opened his shops.  People were able to buy a product they wanted, at a lower price (counting travel) than had been possible before.

Mises (1952, p. 121) himself is quite honest about this feature of the profit and loss system.

The entrepreneurs are neither perfect nor good in any metaphysical sense. They owe their position exclusively to the fact that they are better fit for the performance of the functions incumbent upon them than other people are. They earn profit not because they are clever in performing their tasks, but because they are more clever or less clumsy than other people are. … If the grumbler knew better, why did he not himself fill the gap and seize the opportunity to earn profits? It is easy indeed to display foresight after the event. In retrospect all fools become wise.

But Allowing People To Make and Keep Profits Helps the Least Well Off: 

            The fascinating thing about this argument is that it turns the standard Rawlsian argument on its head.  Rawls objects to the differences in wealth produced by profits because the things that produce profits seem random.  He was right in a sense, because our illiterate verger, like other entrepreneurs, was “neither perfect nor good.”  In truth, it is difficult to make any argument that claims the entrepreneur deserves the extra wealth.  He was just lucky to have noticed something that would improve the welfare of many people. 

But it is for that reason that we must tolerate profits and disparities in income.  Profits can only accrue to entrepreneurship if resources are misallocated; profits are the result of improvements in the allocation of resources.  Mr. Foreman noticed that he could improve the welfare of the city’s citizens by opening shops in areas that were underserved.  In doing so, he improved the lot of all consumers, including those who are least well off, precisely the group whose welfare Rawls claims can be invoked as a justification for differences in income.

Well, that’s what profits are, by definition: increases in income differences that reward successful efforts (not efforts; successful efforts) to serve consumers better.  By putting consumers in charge and using systems of markets where profits and losses attach themselves to decisions on how consumers might best be served, it is true that the society creates an unequal distribution of income.  Further, it is also true that the recipients of these profit bonuses do not deserve the extra income, in any sense save one.  But that one sense, the increased benefits to the least well off in the society, is precisely the one that Rawls privileges as justifications for differences in wealth.

Of course, one might object we can’t let consumers decide what they want, especially those who are least well off.  Rather than letting ignorant consumers decide what they want, we should perhaps have some board of experts decide what the poorest consumers should want.  But that would be a wrong reading.  Rawls is very serious about claiming that the only condition on choice required to produce fairness is ignorance of one’s position in the realized society.  He wants to endow even the poorest citizens with the liberty to make their own choices; all he requires is that the differences in wealth in that realized society have the consequence of improving the lot of the least well off.

So who is to decide if the least well off are in fact better off?  Rawls discusses two principles one might use:  (1) Paternalism, or the imperative to choose for others as we believe they would choose for themselves if they were of age, competent, and reasonable.  (2)  Liberty, or (following Mill) the claim that one activity is better than another if it is preferred by those who are capable of both and who have experienced each of them under circumstances of liberty.  (Rawls, 1971:  209-210).

In the absence of robust markets, liberty would not be available as a principle because there would be far fewer choices and little experience of the consequences of choices.  That is fine for the paternalist, of course, because if poor people choose many of their choices will be bad.  Drug use, gambling, no saving, borrowing from loan sharks, and other awful things will happen if we let people make their own choices.  To be fair, the paternalist would claim that these are not really “choices” at all, in a free-standing euvoluntary sense, because several of the restrictions for ensuring that choices are euvoluntary are not met.  The heroin addict or crack prostitute are not making a euvoluntary choice, because their addiction robs them of volition and the capacity to choose reasonably.

Rawls is careful here (Rawls, 1971:  210-211).  He argues that we cannot opt for paternalism, for many of the reasons that Mill himself argues.  This kind of paternalism is simply a brand of utilitarianism, where the welfare of all, or the welfare of the state, is easily traded off against harms to a few.  In fact, Rawls makes a statement that comes quite close to certain elements of Hayek:  “The suppression of liberty is always likely to be irrational.  Even if the general capacities of mankind were known (as they are not), each person has still to find himself, and for this freedom is a prerequisite.”  (p. 210).  He returns to the themes of liberty and autonomy for the least well off later, in restating the difference principle and how we might judge if it is satisfied.

[P]aternalistic intervention must be justified by the evident failure or absence of reason and will; and it must be guided by the principles of justice and what is known about the subject’s more permanent aims and preferences, or by the account of primary goods. These restrictions on the initiation and direction of paternalistic measures follow from the assumptions of the original position. The parties want to guarantee the integrity of their person and their final ends and beliefs whatever these are. Paternalistic principles are a protection against our own irrationality, and must not be interpreted to license assaults on one’s convictions and character by any means so long as these offer the prospect of securing consent later on. More generally, methods of education must likewise honor these constraints (Rawls, 1971:  250)

 

To close a loop that I hope has already become obvious to the reader, I read Rawls as allowing, even encouraging, all transactions that are euvoluntary.  Even among exchanges that are not euvoluntary, the test for whether the transaction should be allowed is the one that Rawls proposes, allowing for rewording to make it consistent with the problem we are examining here.  I might pose it as an answer to a question (we’ll see if I can get my Aquinas on, here):

Question:  In a “justice as fairness” world, what transactions would be permitted?

Answer 1:  All euvoluntary transactions would be allowed, because by definition they make both parties to the exchange better off.

Answer 2:  Even exchanges that are not euvoluntary would be allowed if the violation of the conditions of euvoluntaryness is the “disparity in BATNAs” condition.  The reason is that denying the least well off access to market transactions preserves their unacceptably abject position.

Answer 3:  If allowing profits, and guaranteeing profits as property, makes the least well off better off, the accidental by-product of arbitrary or undeserved extra profits for entrepreneurs may be permitted.  In fact, it may be required if the real concern is for the greatest net improvement in the welfare of the least well off.  More simply, just the fact of the existence of a newly created rich class cannot by itself justify confiscation, if that confiscation would harm the incentives for consumer sovereignty that benefit the poor.  In Nozickian terms, though the newly wealthy may not deserve their affluence, they are entitled to it, because that’s what makes consumers better off.

“Answer 3” is the most difficult and controversial of these answers.  The reason is that it requires a complex judgment about the consequences of attempts at redistribution.   The claim rests on the idea that profits are an accidental consequence of the fundamental social good, viz., placing consumers in charge of directing resources to their highest valued use.  If that claim is accepted, then any attempt to redistribute profit, while achieving an increase in fundamental ex post fairness of the income distribution, will have very bad consequences for the least well off, who were helped most by the improved efficiency of resource use.  The “resource use” I have in mind, of course, is employment.  Employment is higher in a society with fully employed resources, and profits are necessary (as for the Verger) to encourage entrepreneurs to focus on improving employment.

More simply, employment is better than state-sponsored “welfare” payment based on intrusive and restrictive criteria for eligibility.  In terms of income, self-esteem, and the fully realized self, autonomy makes people happier and better off.  Attempts to redistribute profits are worse, for the least well off (though, again, it may make the society more equal!), compared to accepting morally arbitrary differences in wealth that dramatically improve the welfare of the least well off.

Loren Lomasky proposed, perhaps tongue-in-cheek (who can tell, with Loren?) that one could in fact read “twin” Rawls as an argument for markets.  Lomasky says:  “It is not paradoxical hyperbole to maintain that the prospects of the poor are enhanced by disallowing all special pleading in legislatures and regulatory bodies on behalf of the poor.  Impartial enforcement of a regime of strong property rights and binding contracts almost certainly will better serve them.”  (Lomasky, 2005: 191-2).

The observation is a common one, and I’m not sure why Rawls and other political theorists ignore the fundamental public choice insight that self-interest pervades government action just as much as market action.  And in the case of government, one has no alternative.  As Frederic Bastiat recognized this in his usual trenchant way:  It is by no means obvious that an attempt to redistribute, even if motivated by right reasons, either can (as a matter of economic physics) or will (as a matter of political incentives) have anything like the result Rawls intends.

When under the pretext of fraternity, the legal code imposes mutual sacrifices on the citizens, human nature is not thereby abrogated. Everyone will then direct his efforts toward contributing little to, and taking much from, the common fund of sacrifices. Now, is it the most unfortunate who gains from this struggle? Certainly not, but rather the most influential and calculating. (Frederic Bastiat, Justice and fraternity, in Journal des Économistes, 15 June 1848, page 324)

Next:  What’s The Point?

In the fifth and final installment of the LM, I will try to take some of the many threads I have taken up, and weave them into something a little more coherent.  But I can foreshadow here what that conclusion will be:  Hayekian socialism.  I use the phrase ironically, of course.  Hayek is often called a “socialist” for conceding that a social safety net not only can be, but should be, provided by advanced capitalist societies.  But what he advocated was certainly not socialism, because he rightly insisted on private ownership of the means of production.  And even his “safety net” arguments were careful to distinguish between income maintenance (which is actually impossible, and has very damaging effects) and a basic safety net that achieved in effect a kind of social insurance.

So, in my final essay, I will argue for two kinds of “insurance” as core state activities:  Basic Income for employment insurance and old age pensions, and Single Payer health insurance.  So, my “real” libertarian friends, get ready to set your flames to “extra crispy.”

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  • Les Kyle Nearhood

    DR. Munger, this is fantastic, and much to digest. Thank you for the effort.

  • j r

    Capitalism is that system that best ensures consumer sovereignty. Full stop.

    Yes. And that is why it is best to remember that people who oppose capitalism really oppose consumer sovereignty. Their focus on equality and the rich is classic misdirection. Anti-capitalists don’t hate the rich. They are often rich themselves. They hate the idea that capitalism will empower the hoi polloi, leading to the cultural supremacy of prole tastes. That’s why greed becomes one of the cardinal sins; it’s associated with the rabble.

    Also, I always find it funny when people try to reference Gordon Gecko as some sort of capitalist poster child. What Gordon Gecko is, is a an old-fashioned, mustache-twirling movie villain. Instead of tying a damsel to the train tracks he ties Blue Star’s over-funded pension.

    Oliver Stone knows lots about movie making, but not a whole lot about finance and economics. And that’s part of the enduring appeal of Wall Street. It’s a movie that you mostly watch to see people flaunting the artifacts of 1980s conspicuous consumption, like Gecko’s comically large cell phone or his fancy blood pressure monitor that can now be bought at any corner drug store for under 50 bucks.

    One of my favorite scenes is when Charlie Sheen hits it big and has that yuppie cooking session with Daryl Hannah. “Look, they’re making sushi and defrosting that fancy Haagen Daz ice cream in their microwave over.” The real economic lesson of Wall Street is that a good number of those things that movie used to signal tremendous wealth can now be purchased at any Walmart.

    • famadeo

      “Their focus on equality and the rich is classic misdirection. Anti-capitalists don’t hate the rich. They are often rich themselves. They hate the idea that capitalism will empower the hoi polloi, leading to the cultural supremacy of prole tastes. That’s why greed becomes one of the cardinal sins; it’s associated with the rabble.”

      Good God. The density of assumptions here gives me a headache. I don’t know where you’re identifying opposition to capitalism, but even if what you describe is indeed the case, boiling it down to just that constitutes the most pathetic attempt at a straw-man I’ve ever wittnessed.

      • j r

        You read a comment on the internet and it gave you a headache? You should check that out; it might be a medical problem.

        Question: is there an argument buried somewhere in your comment or is just the usual sort of internet snark and hyperbole?

        • famadeo

          If you pay attention you’ll noticed the term *Straw-man*. That’s all what you say ammounts to.

          • j r

            So that’s a no, got it.

          • famadeo

            You clearly don’t. Your original argument is falalcious. I’m pointing it out.

          • j r

            You’re not pointing anything out. You’re making an assertion that is not backed up by any actual argument. And you’ve replied twice and not offered any arguments in those posts either. Either say something meaningful or stop responding.

          • famadeo

            “You’re making an assertion that is not backed up by any actual argument.”

            No, my friend, that’s you. You’re boiling down all opposition to capitalism to fear of prole culture hegemony. A straw-man at worst and question-begging at best. Either way, it’s a logiacl fallacy.

            Exactly what type of evidence are you looking for? The fact that centuries of political sentiments expressed in either movements or literatutre have absolutely nothing to do with you characterization? Are you honestly unaware of *any* of such manifestations? You can’t blame me for suspecting you’re being coy.

  • Luke

    A quibble – “capitalist” is not the same as “free market”. Plenty of entrepreneurial free market profit seekers don’t have capitalist investors.

    • Michael Munger

      Luke: You are right, of course, but if we try to make that objection it sounds like a hair-splitting semantic defense. I have just given up and embraced “capitalism” as a description. Yes, that concedes a lot, but this way I am more likely to get people to focus on the main differences. Still, you are clearly right!

  • Guest

    Luke: You are right, of course, but if we try to make that objection it sounds like a hair-splitting semantic defense. I have just given up and embraced “capitalism” as a description. Yes, that concedes a lot, but this way I am more likely to get people to focus on the main differences. Still, you are clearly right!

  • Kevin Vallier

    I love that you tell Jerry Gaus to “bite me” on a point he’s right to harangue you about! Here’s my totally awesome and definitive argument in Utilitas on Mill’s production-distribution distinction, which just isn’t that worth freaking out about if you understand what’s really going on: http://www.kevinvallier.com/wp-content/uploads/2010/10/Kevin-Vallier-Production-Distribution-and-J.S.-Mill1.pdf

    Now, beg for forgiveness for lumping in Mill with Rawls, as Sam Freeman does.

    (I loved the post. But … bite Mill.)

    • Michael Munger

      Kevin, I never said Jerry was wrong! He’s right, and so are you! But you can bite me, too!

      • jdkolassa

        Aw man, why can’t philosophy be more like this? Why don’t we have Departments of Mungerosophy at colleges?

  • Les Kyle Nearhood

    I always thought of a social safety net as a necessary evil. The historical fact is that every democracy has voted one for itself. This is the political reality. So the trick is to try and restrain it as much as possible so that it does not become the bankrupting monster we have in most modern nations.

    • jdkolassa

      *cough* Negative Income Tax *cough*

  • martinbrock

    There are two lessons here. First, it is by no means obvious that being behind the veil of ignorance will result in an equal sharing rule.

    Your second vote asked the wrong question. Rather than asking students if they wanted to share the winnings that were already known, you should have handed each student a new lottery ticket and voted on a division of winnings from the new tickets. In this scenario, I predict a different outcome.

  • Counsellor

    This is not necessarily a challenge to Dr. Munger’s premise; it is another consideration.

    “Capitalism” has been, and is being, used as label for a number of differing **resulting conditions** observed as far back as the 12th century in Western Civilization.

    As a label, “Capitalism” is *not*an “ism” in the same sense as Political
    Positivism, Socialism, Historicism (and its excrescences of “Marxisms”),
    Communism, Fascism, Totalitarianism, and various Collectivisms.

    All of those other isms can be defined in their concepts or systems, all having
    specific objectives. The label “Capitalism” does not describe a “system.”

    Capitalism can be described, but not defined because it has no
    objectives, ***it is not a system.*** In its various forms it has been, and is,
    *** a resulting condition;***
    as feudal capitalism, mercantile or commercial capitalism,
    industrial capitalism, financial capitalism, and today’s managerial capitalism.

    The “Capitalism” label is applied to those conditions resulting from the emergence, exercise and interactions of individuality.
    That was the nature of the actual perception of Adam Smith
    as he inquired into his previous observations in “A Theory of Moral Sentiments”
    (dealing with individuality and the regard of individuals for one another and
    for themselves) as the essential part of the *nature* of, and probable
    **causes** of, the Wealth of Nations.

    Historians and scholars have conjectured from their research
    that individuality has had periods of the emergence and recession, recorded as
    far back as the 12th century in northern Italy, and similarly reflected
    (particularly as shown by land transactions) in English records of the
    approximate era.

    In social conversations, one may hear it said that capitalism
    has the objective of “profits” or “greed.” But those of course are the
    objectives of individuals; and individual objectives are moderated by the
    interactions with the objectives of other individuals – which produces the
    resultant condition designated as capitalism.

    Capitalism has taken on its varieties and cultural differences
    in various societies in accordance with the degrees of freedom of interactions
    of individuality and open access to the formation of facilities for cooperation
    or for mitigation of conflicts.

    We may now be witnessing one of those periods of the recession
    of individuality (in Western Civilization). A plausible argument can be made
    that the trends of subordination of individual interests and direct individual
    interactions to interactions of aggregations of interests is evidence of the recession of individuality and its expressions.

    A current epithet for Capitalism, “Cronyism,” is a form of aggregation of interests. As a resulting condition from the increases in trends toward interactions amongst aggregated interests rather than interactions amongst individuals exercising individuality, the characteristics of those results we label as capitalism are affected. However, those effects are not necessarily the result of specific objectives of the individuals.

    Capitalism is not a system; it is a resultant condition.

  • J-Lib

    I absolutely deny that greed is “good” — even though market freedom may indeed mitigate its negative effects. I still believe it is a net drag, not a source of lift. 

    Any one who needs greed to inspire creation and innovation either a) is not actually creative, b) is in the wrong line of work , or c) perhaps needs to adjust his value system. Creativity comes from spirit and love, not from greed. Ask any artist, or any truly inspired individual who excels at what he does. A non- greed-based society that was based instead on affording people to pursue their highest aspirations would be much more productive IMO, in the right ways.

    As for the wealth distribution business, much could be said.
    yes, it has always been apparent to me that “profits” in a true just (i.e., equally free) market would be small.
    After all, to the extent the market is trading (which term covers domestic and foreign)  well, trade is a trade; the very definition implies as equal an exchange as possible.

    The increased profits (wages and interest) due to harder and smarter work, invention, and even sharp bargaining, are dwarfed by the rents grabbed by wielding state-granted privileges. Speaking of “profits” : that is an accounting term that merely connotes what is left to a firm after expenses. It is not a political-economic term that accurately and usefully describes the derivation of the earnings  or whether they are justly earned — which ought to be of utmost concern. It does not help to illuminate what is actually going on in the flow of wealth in a macroeconomy. The classical terms wages, interest (*capital yield) and rent do the job of actually distinguishing types of income. 

     
    “.  Pollution is a sign that something is being produced”

    Well, not quite — not in the sense of large-scale, industrial-quantity, xenobiotic pollution of our industrial age, which actually poisons life and destroys ecology rather than promoting it. Also there’s a differnce between even organic waste products in their proper place (animal waste in soil)and not in their proper place (animal waste in drinking water).

    JS Mill has it backwards in the cited passage. Wealth belongs to he producer as a matter of morality and of fact — EXCEPT as it is appropriated by others, such as a state, a landlord, or other collector of tolls.

    Whatever collective security arrangement society adds,merely an extension of what individuals already do for themselves. 

    Rawls, like Mill, misses it. If protecting liberty is construed as protecting equal access to natural opportunity, then  just distribution of wealth is assured since the law then 1) ensures opportunity to produce wealth and 2) secures it to the producer, once produced. Thereafter , if anything, the state need do nothing but perhaps resolve disputes and, where necessary, assume functions that would involve natual monopoly (roads etc) solely as defense against the greater evil of privatized monopoly.

    Again, Henry George (sr.) makes some of the best arguments on how liberty and justice intersect at the point of access to natural opportunity — i.e. land — as well as in abolition of the usual suspects, taxes on production and exchange, privileges, and other monopolies we all love to hate.

  • J-Lib

    Can’t believe how long this has gotten. Unfortunately, time does not allow greater brevity. 

    I have a problem with ”entrepreneurship.” as it happens, earlier today before reading this I was harshly interrogating  my old college econ test. One of my targets is “entrepreneurship” as a separate “resource” (like”profit,” “resource” and “entrepreneurship” are both fuzzwords that do little useful work as scientific terms, and blur crucial distinctions). The notion that “entrepreneurship” is something distinct from “labor” is bunk. What real entrepreneur does not labor — long and hard? Labor can be mental or physical, and involve management or execution. 

    Furthermore, as all capital is produced by labor, factors of production really can be boiled down to land and labor. (Time as distinct factor? No, time comes out of labor’s hide as well.) So, ultimately either labor gets all that it produces, or the nonlaboring owner of land or other privilege designated by the state, gets to appropriate it.

    “An entrepreneur is an economic agent who unites all means of production”

     Every worker of whatever kind  (when not impeded from doing so), unites the factors of production every day to produce a product. Not a useful distinction.
    Schumpeter was at great pains to make an artificial distinction between physical and mental labor. Such a distinction is more ideological or class-based than economic. Swinging a hammer is more physical than mental, but still one has to use one’s mind. Trading futures is more mental than physical but one still has to push buttons, pick up the phone, use one’s voice…. It is all just labor.

    ” By selling the product in the market he pays rent of land….”

    That’s the problem Who created land, that the laborer should have to pay them before he may work???

    see this image.

    “ What have the individuals under consideration contributed to this?  Only the will and the action; not the concrete goods, for they bought these—either from others or from themselves”

    “Bought them … From themselves”? I.e., they labored to produce them.

    Or, If they bought them from some one else, they presumably labored for something which they traded for the goods. Practically, that is the same as laboring to make the goods.
    If they traded a service for the goods, they had to consume concrete goods (food, shelter, tools) in order to provide the service. So any way you slice it for political-economic purposes, dissecting mental from physical labor, or goods from services, is misleading.  It’s all laborer laboring — and, in the process, using capital — which all labor does practically all the time — and land, which all labor does absolutely all the time.

    Again, the real question mark is land: where is the laborer to labor, and does he first have to buy a ticket from some one  in order to do so? (and then, is the state standing in his way, taxing his production etc)

     ” They have not accumulated any kind of good, they have created no original means of production, but have employed existing means of production differently, and more appropriately, more advantageously.”

    Schumpeter was at great pains to make an artificial distinction between physical and mental labor; and then again to artificially divide between oridinary and “entrepreneurial” mental labor (the latter being worthy of greater profit, allegedly)  Such a distinction is more ideological or class-based than economic. Swinging a hammer is more physical than mental, but still one has to use one’s mind. Trading futures is more mental than physical but one still has to push buttons, pick up the phone, use one’s voice…. Inventing a product requires making a sketch, jotting notes, etc. It is all just labor.

    Any old laborer may innovate any given day, while much of what even Schumpeter’s/ heroic idealized entrepreneur has to do is simple old boring grunt work. Again, the distinction is specious and takes us away from the fact labor is labor, sometimes “innovative” and other times not. Except to the extent we are rentiers, we are all laborpreneurs, every one of us.

    “ And their profit, the surplus, to which no liability corresponds, is an entrepreneurial profit.”

    Let’s hope so, but since “profit” says little about provenance, in the current system, more or less of “profit” may be rent of this or that kind; while real wages and interest — the actual right of the laborpreneur — are suppressed and stolen.  

    Entrepreneur as the Creative Destroyer suits a particular political or ideological or historical narrative, or perhaps the quirks of some particular temperaments, but  is of little economic value.  

    • J-Lib

      Ugh, sorry for the redundancies redundancies. Too late at night.

  • J-Lib

    Hayekian socialism — how about first, defining the term? As I complain in a previous comment, too many terms we use to do too much heavy lifting, are vague and malleable to suit various agendas. Who’s not a “socialist”? We are all social creatures (some more, some less); moreover we all share at least some cmmon goods– does even the crankiest an-cap want no common anything? By the same token, who’s not a capitalist? Humans can hardly live without using capital. Socialist states, too, are great users of capital. The question is not whether a society will be socialist or capitalist (or individualist).The question is what it will socialize and what it will leave to the individual. (And perhaps the lesser question: will the “social” involve a coercive component or rely totally on voluntarism?)

    Hayek IMO ceases to give us good guidance when he recommends socializing services which are inherently individual — such as health care. He appears to have made such concessions to New Dealism because of his rejection of Georgism, on which he had cut his teeth). George’s placement of things in their proper spheres (i.e. nature and natural monopolies and true public infrastructure as economic commons; everything else as presumptively individual goods best administered by the market) created much more clarity.

    Health is inherently an intensely individual possession and responsibility. Even where we talk about communicable diseases, these ultimately live or die based on the individual’s immune response. (Beware collectivist “germ theory” with its exaggerated focus on the microbe rather than the host!) besides, our health crisis is largely a lifestyle-caused crisis. It must be addressed by individuals within a free-market framework. A free market, in turn, must be based on the level playing field of equal access to nature’s free gifts.

    The only way to avoid “single payer” becoming “single decider” becoming effective “single provider” is to not to even venture down the road. Instead, we need 300-million-payer, with every one free to choose and to educate himself, care for his own health and that of his household, and help his neighbor. Or are health goods exempt from the economic laws that apply to all other goods?
    Why would policies that would destroy any other industry, presumed to benefit health care?
    Let’s not mistake distributive justice for managerial paternalism!

    Place free market upon flat level surface. It will work — no assembly required.
    It fails to work today because of privilege, and that alone.

    Finally. wrt social insurance, as I said in the last Basic Income thread (writing as JayLib) is relevant. A BI should not be a “government grant.” such is unnecessary. First, secure to labor the full value of its product and the same to capital. How? Turn off the Law of Rent, that’s how. Collect natural Rent for public needs in lieu of taxes. Land is thus forced to give up free-lunching at Labor and Capital’s expense. Wages and interest benefit, and real prosperity begins to show itself. We can then afford the public infrastructure and truly essential public services (and purchase the nonessentials or non-public goods, such as health, individually).

    Meanwhile, our public capital earns a return too — and any surplus can be either reinvested in the “company,” distributed as a Citizens Dividend, and/or as homestead-type exemptions, above which the land rental payment kicks in.

    • J-Lib

      Did not mean to imply that the return earned by our public capital is in addition to Rent. The return to public capital is in fact, included in Rent.

  • http://frankhecker.com/ Frank Hecker

    I’ve really enjoyed this series, and am looking forward to the final installment. I do have one quibble with one statement in this post (and beg pardon for the delay in commenting): “Employment is higher in a society with fully employed resources, and profits are necessary … to encourage entrepreneurs to focus on improving employment.” The first part of this seems almost (but not quite) a tautology, but it’s the second part I want to focus on, especially given that it’s followed by a discussion of the benefits of people being employed:

    I agree that any given entrepreneur is motivated by profit to ensure that anyone whom the entrepreneur employs is in fact usefully employed. But I don’t see that as implying that an entrepreneur is motivated to actually employ anyone in the first place. In fact, if anything an entrepreneur is motivated to employ the absolute least number of people needed to support the business, to work to reduce that number over time, and if human labor is still required then to have that labor provided voluntarily at no cost to the entrepreneur. That’s basically the business model of Google and related Internet businesses: employ a small smart core of workers, embody their intelligence in software-based algorithms, combine with increasingly cheaper physical capital, and leverage the unpaid activities of consumers (e.g., searching for information and clicking on links) to drive the algorithms and make them better.

    There’s certainly a larger dynamic in which entrepreneurial activities can open up new markets and thus create new possibilities for people to be usefully employed. However this part of the essay as written seems to be implying in essence that profits motivate entrepreneurs to be “job creators”, when in fact they seem more motivated to be “job destroyers” (at least in the direct sense).

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