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.

That people should wish to be relieved of the bitter choice which hard facts often impose upon them is not surprising.  But few want to be relieved through having the choice made for them by others.  People just wish that the choice should not be necessary at all. And they are only too ready to believe that the choice is not really necessary, that it is imposed upon them merely by the particular economic system under which we live.  What they resent is, in truth, that there is an economic problem.

In is their wishful belief that there is really no longer an economic problem people have been confirmed by irresponsible talk about “potential  plenty” – which, if it were a fact, would indeed mean that there is no economic problem which makes the choice inevitable.  But although this snare has served socialism propaganda under various names as long as socialism has existed, it is still as palpably untrue as it was  when it was first used over a hundred years ago. In all this time not one of the many people who have used it has produced a workable plan of how production can be increased so as to abolish even in western Europe what we regard as poverty- not to speak of the world as a whole.

From The Road to Serfdom by F.A. Hayek.  Originally written  in 1944.

HKO comment-

The fallacy of the government believing it has a better solution is that they would have us believe that a hard choice does not have to be made.  We want to fight wars on the cheap and promise benefits without paying for them.  The leader we need will speak clearly of the decisions, directly of the costs involved and be willing to stand up to the special interests that are committed only to ignoring the hard choices ahead.

That people should wish to be relieved of the bitter choice which hard facts often impose upon them is not surprising. But few want to be relieved through having the choice made for them by others. People just wish that the choice should not be necessary at all. And they are only too ready to believe that the choice is not really necessary, that it is imposed upon them merely by the particular economic system under which we live.  What they resent is, in truth, that there is an economic problem.

In their wishful belief that there is really no longer an economic problem people have been confirmed by irresponsible talk about “potential plenty”- which, if it were fact, would indeed mean that there is no economic problem which makes the choice inevitable. But although the snare has served socialist propaganda under various names as long as socialism has existed, it is still as palpably untrue as it was when it was first used over a hundred years ago. In all this time not one of the many people who have used it has produced  a workable plan of how production could be increased so as to abolish even in western Europe what we regard as poverty… Yet it is this false hope as much as anything which drives us along the road to planning.

from The Road to Serfdom by F. A. Hayek, first published in 1944

HKO comments-

A wonderful observation: what we have been deluded to believe is a solution is nothing more that pretending the problem does not exist. This quest for both guns and butter, low unemployment and low inflation, high production and wealth generation AND robust government programs is just the hubris to think that we can assume away economic choices and problems with newer versions of programs than have proven to be failures throughout history.

The president ran on clear ideals of a fairer and more just society,  ultimately meaning redistribution of income. He saw the gaps between the rich and the poor widening.  He has been demonized by his opposition for being socialist, communist , corporatists, and fascist. Such pejoratives cloud the issues even if in elements of policy they may be true.

The gap between rich and poor is subject to clarification. If you measure the difference between the top 20% and the bottom 20% as a group the disparity is widening, but this ignores both the social mobility happening between the groups and  the cultural changes that affect the result.  Few in the bottom group remain there,  most of them rise into the middle class.  And  many in the top groups drop into lower groups as businesses fail and the values of financial assets drop. Bernie Madoff has done more to equalize income than the intentional policies that attempt to flatten income distribution.

The rise of capitalism upset the social order of European aristocracy because it achieved redistribution in a radically new way.  Capital was deployed based on merit, productivity, and innovation rather than power and status. Capitalism proved to be the most just, unbiased, efficient, and productive form of redistribution ever attempted.

The free flow of capital helped Samuel Mayer, born in poverty, create the movie industry; Scottish born Andrew Carnegie create the steel industry; and Russian born Sergie Brin create Google.  Each of these and thousands of others like them created millions of jobs and benefits because capital was allowed to seek its productive use.

But capitalism is brutal when you are on the losing end of the reallocation of capital. Just as the aristocrats of Europe tried to fight this “creative destruction”, we have a new aristocracy that seeks political power to help keep them from losing their economic power.

We hear that social justice is necessary to preserve our capitalist system.  Even George Bush commented during the crisis “We must destroy free market capitalism to save it.”  FDR uttered similar comments after the Great Depression.

Under some examination the free market did not fall of the cliff,  it was driven off, less by reckless deregulation than by specific regulations that precipitated and aggravated the crisis. Markets, like human nature, are driven to excesses, but they are also driven to correction.  Government intervention is often like a weak chemotherapy  that is used even though it is ineffective because it causes less discomfort.

In our effort to redistribute in the name of social justice rather than productivity, we risk serious damage to the machine that creates the wealth to distribute. It is a fine balance to extract enough to bribe the less productive to let the more productive enjoy the fruits of their success, without burdening them with such costs that they can no longer produce. The more radical and drastic the change the more likely this destructive outcome is to be.

The wealthy are driven by more than money. They measure risk as hazard plus outrage. They can quickly cease production if their capital is treated poorly.  The can move capital to different industries and to different countries. As the other developing countries are developing their own consumer base this becomes an easier option.

High taxes and more misguided regulation on capital will make the income discrepancies larger and eliminate the social mobility that neuters  these differences.  Reducing the allocation of capital to its most productive, though occasionally painful, use also reduces the creation of capital and the economic growth that raises everyone’s living standards, even if it doesn’t do it equally.

We would all be much better off with a growing economy even with its occasional bubbles than with a stagnant economy with a ‘fairer’ distribution decided by political power.

Do not confuse capitalism with the crony capitalism of Wall Street and the corporatist bailout of Washington.  Crony capitalism is to capitalism what national socialism is to socialism.

We cannot have success without failure, not just in the philosophical sense but in the real sense that without failure capital cannot be reallocated to more productive use. Exchanging the productive re-allocation of capitalism for political based redistribution will only make us all poorer.

It is probable that we habitually overestimate the extent to which inequality of incomes is mainly caused by income derived from property, and therefore the extent to which the major inequalities would be abolished by abolishing income from property. What little information we have about the distribution of incomes in Soviet Russia does not suggest  that the inequalities are substantially smaller there than in a capitalistic society. Max Eastman in The End of Socialism in Russia …. gives some information from official Russian sources  which suggests that the difference between the highest and lowest salaries  paid in Russia is of the same order (about 50 to 1) as in the United States; and Leon Trotsky…. estimated as late as 1939 that the “upper 11 or 12 per cent of the Soviet population now receives approximately 50 per cent of the national income. This differentiation is sharper than in the United States, where the upper 10 per cent of the population receives approximately 35% of the national income.”

HKO comment:

This footnote in Hayek’s The Road to Serfdom, published in 1944, reminds us that socialism is just the substitution of political self interest for economic self interest and does nothing to truly address inequalities of wealth. Higher wealth today is more likely to come from better education, intellectual capital, working longer hours, and taking more risk. This is even more true today when fortunes are made on ideas such as Apple, Facebook, and Microsoft than on real property such as real estate and natural resources.  In fact the real estate collapse has even widened that gap. The bigger threat is that the motive to equalize wealth will squelch the risk capital that has funded our huge successes.