This is a critical chapter in Hayek’s 1944 classic, The Road to Serfdom.  The books is a deeply thoughtful examination of why planned economies lead to despotic rule.   In several different parts of the book Hayek explains that the motivation to improve an economy by elitist planning runs counter to a democratic society that respects individual virtues and rights.  Such planning requires an agreement of ends and priorities that conflicts with individual rights. The quest for a planned economy inevitably creates a need for power to enforce common ends that is often reluctantly embraced for the common good. Thus those who valued freedom and democracy start on the “road to serfdom”.

In the pursuit of a common end this path draws on the worst elements of society.  The higher the education and intellect that individuals achieve the more their view become differentiated and the less likely  they are to agree on a single hierarchy of values.  In order to find a high degree of uniformity one must descend into the more common and less educated masses; “the lowest common denominator which unites the largest number of people.”

The “docile and gullible” with no strong convictions will be swayed with a simplistic ready-made system that appeals to this common denominator. The final ingredient is that tendency to focus more on a negative program than any positive task. The “us and them” mentality flourishes in this planned environment.  At its worst it created the virulent anti-Semitism that Hayek was viewing; but its far less virulent exhibition is the class warfare mentality we currently witness.

Perhaps this explains how some of the intellectually vacuous have risen into national leadership positions. But Hayek’s analysis should be fair warning to the many intelligent who think “they” can plan a better economy or a better “health care system” than the market.  The eventual need for raw power to enforce the common ends that such planning requires will betray the very democratic principles many planners hold so dear.

Unfortunately, the relation between the ends and the means remains widely misunderstood.  Many of those who profess the most individualistic objectives support collectivist means without recognizing the contradiction.  It is tempting to believe that social evils arise from the activities of evil men and that if only good men (like ourselves, naturally) wielded power, all would be well.  That view requires emotion and self praise-easy to come by and satisfying as well. To understand why it is that ‘good’ men in positions of power will produce evil, while the ordinary man without power but able to engage in voluntary cooperation with his neighbors will produce good, requires analysis and thought, subordinating the emotions to the rational faculty.

From Milton Friedman’s introduction to the 1994 edition of The Road to Serfdom by F.A. Hayek

.. the desire to organize social life according to a unitary plan itself springs largely from a desire for power. .. in order to achieve their end, collectivists must create power of a magnitude never before known, and …  their success will depend on the extent to which they achieve such power.

This remains true even though many liberal socialists are guided in their endeavors by the tragic illusion that by depriving individuals of the power they possess in an individualist system, and by transferring this power to society, they can thereby extinguish power.  …by uniting in the hands of some single body power formally exercised independently by many, an amount of power is created infinitely greater than any that existed before, so much more far-reaching as almost to be different in kind.  There is, in a competitive society, nobody who can exercise even a fraction of the power which a socialist planning  board would possess, and if nobody can consciously use the power, it is just an abuse of words to assert that it rests with all the capitalists put together.

from The Road to Serfdom by F. A. Hayek

HKO comment:

While it is misleading to defer to the ‘power of capitalists’ as if it came from a single coordinated entity, this is not true of the power of government which often literally does descend from a single government bureaucracy.  This is why power shifted from the private sector to the government sector is power increased, and power much harder to control and correct.

“Too big to fail” is as antithetical to capitalism and economic growth as sugary high fat diet is to good health.

Some free market supporters prefer the phrase “free enterprise” to capitalism, because of the bad name capitalism has developed.  It was a derogatory name used by Karl Marx.  He could be right. The open-mindedness of classical liberalism has certainly been redefined by the distinctly close-mindedness of modern political liberalism.

But whatever term you prefer the modern perception of capitalism is being distorted by recent events.  Crony capitalism is a system where select groups are able to game the political system for advantage rather than compete in the market place. Crony capitalism is to capitalism what national socialism (Nazism)  is to socialism.

There are two critical assumptions to capitalism. The first is that individuals are more capable of making effective choices for themselves than would be made by others. True capitalism is incompatible with a society that has no respect for individual liberty. Big government solutions with bureaucratic micromanagement of consumer choices, whether for health care or automobiles, is antithetical to effective capitalism.

The second essential assumption of capitalism is the preference of allocating capital based on productivity or merit rather than force, political power or class.  Failure is essential to freeing up capital from unproductive use and transferring it to productive use. Our bankruptcy system which allows a rapid discharge of debts is a part of the reallocation of capital that makes capitalism work so well. Our legal system understands the importance of failure to a growth economy.

But few countries and cultures are willing or able to accept the pain of failure that is essential to the good health of a capitalist economy.  The acceptance of the doctrine of “too big to fail” is a blatant rejection of this essential element.  Those that are deemed too important to be subjected to the discipline of the market place, will have an advantage and be able to game the political system that protects them.

It is no secret that America’s tremendous economic growth was fueled by these two essential elements of capitalism. Financial bubbles, a civil war and a history of global conflicts proved to be only minor setbacks.  The current administration’s assault on these two elements, however, can prove more damaging than many of these historical crisis we have endured.

Just as an unhealthy diet is very satisfying now, but potentially deadly later; our unwillingness to accept the pain of business failure today seems to only make the next crisis worse.  Our inability to accept short term pain leads only to greater long term pain.

Ever since Michael Douglas’s character Gordon Gekko in the movie Wall Street declared “Greed is Good” capitalism has been cast in a sinister role that it has yet to overcome.

The movie speech was rumored to be taken from a speech given by Ivan Boesky at a college address. Boesky was indicted for insider trader, served time in jail and paid millions in fines.

Capitalism is not about greed; it is about economic self interest, and this is far more than a semantic distinction. When you take a job paying $10 an hour over the job paying only $8 an hour you are displaying economic self interest, not greed. And when you decide to take the job paying $8 an hour over the job paying $10 an hour because you like the conditions or the work at the lower paying job enough to sacrifice the higher pay you are also acting in your own economic self interest. Economics is about far more than money.

When you decide to take a steady job in a traditional workplace rather than make much more money in drugs and prostitution you are also acting in your economic self interest. It is when your economic self interest disconnects from moral and ethical considerations that it becomes greed.

The ultimate power is the power over your own destiny and environment, but power is most often considered in the control over others. Whereas economic self interest in about control over your own destiny, political self interest is about controlling others.

Capitalism is about people acting in each other’s own self interest and the society benefiting as a result. This works because achieving your self interest requires serving others.

Advanced economic theory also realized that self interest and sharing is not mutually exclusive. In “A Beautiful Mind” John Nash had a Eureka moment courting ladies at the beer hall with his college buddies. He realized that Adam Smith was wrong, or at least incomplete. He developed a theory of equilibrium in competitive game theory. Basically this meant that he realized that your best outcome was not to grab as much as you can for yourself, but that your chance of success was enhanced by assuring at least some success for your competitors. Not only are consumers’ well being enhanced by competition, but the outcome for the competitors themselves is improved.

In order to profit you have to provide a product or service some one else values. Bill Gates, Michael Dell, and Stephen Jobs are very, very wealthy because everyone values Microsoft Windows and Office, iPhones, Macs, and laptops.

Few people complain about the wealth of these techno entrepreneurs because they all provide value we understand. The same can be said of Warren Buffet.

Yet we are outraged at the fortunes made in the financial industry where record amounts of value have been destroyed while CEOs made millions in bonuses. We do not understand derivatives, collateralized debt obligations, and financial models: Apparently neither did the CEO’s and boards of the companies selling these products.

The Wall Street mess was the product of “crony capitalism” which is to capitalism what National Socialism (Nazism) is to socialism. Crony Capitalism is a perversion of the principles of capitalism that includes the freedom “for every man to make himself” to use the phrase of Abraham Lincoln. “Crony capitalism” has its roots in the mercantilist tradition of Alexander Hamilton. During our early years Hamilton saw a need for financial interests and the government to work “closely”. He favored a central bank and such “public private partnerships.”

Hamilton was strongly opposed by Jefferson who favored decentralization and saw the favoritism fostered by mercantilism and the influence such financiers could have over our government as a threat to liberty.

Fannie Mae for example was given special treatment and access to low interest funds available to no other financial institution, and exempted from both SEC and FDIC regulation, Fannie Mae lobbied Congress and plied their special regulators with large campaign contributions. Senator Chris Dodd, head of the Senate Banking Committee and then Senator Barak Obama were the two largest recipients.

But the real damage was not compromising two high profile Senators. Fannie Mae was given special privileges in order to carry out the political will of Congress to make housing affordable for people who shouldn’t buy homes. They created the hunting grounds for the unscrupulous.

Bonuses and bailout funds for Fannie Mae did not elicit near the outrage of AIG and the Wall Street banks. The public still thinks it was the ‘Gordon Gekko’ greed of Wall Street rather than the political greed of K Street.

We still blame the economic self interest instead of the political self interest. Articles decry the old capitalism and herald the new era of state capitalism. The last time we heralded state capitalism was in Italy in the 1920’s and 30’s.

Crony capitalism was not limited to Fannie Mac and Freddie Mac. There has been a revolving door between Wall Street and Washington for decades. As long as the complicated instruments served the political greed, political leaders were willing to ignore prudent financial principles and assume that the overpaid magicians knew what they were doing.

The financial scandals of the 1980’s, the S&L collapse under George H Bush, the collapse of Long Term Capital in 1998, The collapse of the high tech bubble should have been a warning that high salaries and bonuses are not synonymous with competence.

But the solution is not to promote more crony capitalism, also called state capitalism or my favorite term used in the book “Nudge” (Richard Thaler and Cass Sunstein) , ‘Libertarian Paternalism’  (my vote for oxymoron of the year).

By now we should have learned that when business gets in bed with the government, somebody gets screwed.