Notes:BC1.EF.The Secret of Enterprise

2014/11/22 User:Jeff

An outline of the ideas in the prologue of Gilder's 2012 edition of Wealth and Poverty.

Wealth and Poverty was first published in 1981.

Supply Side vs. Incentive-Reward views of Capitalism

In 1981 "socialism was dead" but few stepped up to hail capitalism as triumphant. Most seemed to view capitalism as faute de mieux that was saved by charities and regulations and the New Deal. But capitalism is

"the supreme expression of human creativity and freedom, an economy of mind overcoming the constraints of material power."

"a dynamic force of constant creation, pushing human enterprise down spirals of declining costs and greater abundance"

Supply side vs. incentive-reward.

In the supply side model, taxes are "the price of earning and investing income - that yielded increasing revenues as the rates were reduced." A controversial idea.

• Some accept the behavioral model of stimulus and response, in which lower rates are the stimulus of reward for more work and risk taking which yield more taxes.

Gilder writes that a successful economy is driven more by the "unimpeded flow of information. . . Increasing revenues come not from a mere scheme of carrots and sticks but from the development and application of productive knowledge."

• Greed vs. information and knowledge

The acceptance of stimulus-response encourages the idea that capitalism is a greed based system.

On the contrary - greed "prompts capitalists to seek government guarantees and subsidies that denature and stultify the works of entrepreneurs. Greed . . leads as by an invisible hand to an ever growing welfare state - to socialism."

It is the expansion of information and knowledge that generates growth and progress.

It is a competitive pursuit of knowledge. (CW emphasis)

• Capitalism is not a zero-sum dog-eat-dog game.

The winners teach the losers how to win through the spread of information.

The success of some is not at the expense of others. Free economies "climb spirals of mutual gain and learning."

Capitalism's moral center is a golden rule of enterprise: The good fortune of others is also your own.

"Not only does capitalism excel all other systems in the creation of wealth and transcendence of poverty, it also favors and empowers a moral order."

But much of the world indicts capitalism as a zero-sum game in which any gains by the rich come at the expense of the poor - that they are somehow extracted from the poor.

"Zero-sum inequality and exploitation continue to preoccupy the media. Congress remains enthralled with static accounting rules that assume tax-rate reductions will not alter economic behavior. In this model, the only way to expand tax receipts is to raise rates on the "rich."

• Altruism: capitalism favors altruism, an orientation toward the needs of others (a slight warping of the meaning of the word which also means selflessness)

Quotes Richard Posner, a professor of law and economics at the University of Chicago. "Because the individual cannot prosper in a market economy without understanding and appealing to the needs and wants of others, and because the cultivation of altruism promotes the effective operation of markets, the market economy . . . also fosters empathy and benevolence, yet without destroying individuality."

• writer's input

Capitalism can be thought of as a marriage between altruism and self interest - a very powerful combination.

Critics of capitalism lay historical flaws of humanity at capitalism's feet. such as:

displacing American Indians

displacing Palestinians

environmental devastation

colonization and hegemonic evisceration of the entire Third World

but these have nothing to do with capitalism. They have nothing to do with the competitive pursuit of knowledge.

The budget is not the big problem

The ranks of supply siders have thinned. A number of erstwhile allies now insist that they never claimed that lower tax rates lead to higher revenues. The mantra of the day is to starve the out-of-control government by controlling the budget and deficit.

• The focus on the budget is "misguided":

"Shrink the budget" is now the conservative mandate for prosperity. "Keep what you earn" is the moral foundation. The focus is on the downside of deficits as the deterrent to abundance and creativity.

Still, no one has the political will to shrink the budget except to cut defense. They seek a balanced budget amendment as the fix.

But revenue to fund progressive-liberal goals can be extracted in ways less obvious than taxes - with mandates and regulations - that are even more demoralizing to enterprise. These can take the form of mandating private spending or offering a tax rebate - example, the mandate to suppress CO2.

This focus sees budgetary issues as acute in the future

which "implies that liberal policies are not already infecting our economy with a multiple sclerosis of tax and regulatory curbs, destroying jobs and families with webs of rules and pettifoggery, price controls, skewed social policies, and litigation. A budgetary focus obscures the continuing devastation of vast expanses of our environment with archaic windmills, ethanol farms, and subsidized Druidical sun-henges. It downplays the continuing degratdation of schools by agitprop campaigns and Ponzi schemes of self-esteem. It diverts attention from the stultification of our health care systems by misconceived insurance fragmented through fifty states and denatured by coverage of every human frailty and daily need (rendering it not insurance at all but merely government overreach)."

"Most of all, the budgetary preoccupation obscures the ongoing assault on the families of the poor, ensnaring them in a welfare state for women and children and a police state for two generations of black boys. Some seventy programs annually dispense close to $900 billion mostly to single-parent families totally incapable of raising boys."

The Crash of 2008

• The crash of 2008 caused many to raise the issues and concerns of capitalist economics and democratic politics

Gilders former influence Richard Posner was the most formidable critic. writing The Failure of Capitalism (2009) and The Crisis of Capitalist Democracy (2011) which called the financial problem a new Depression.

There were some interesting questions concerning the events.

US bankers took $2 trillion from taxpayers over 6 years "while massively misallocating the world's liquid capital."

Posner described it thus:

as "the result of normal business activity in a laissez-faire economic regime" and as "an event consistent with the normal operation of economic markets."

He absolves the government - "were there no government regulation of the economy, there probably would still have been a depression" - but acknowledging that low interest rates did increase the demand for housing.

Posner diminishes the impact of Fed policy and points to the private excesses of "aggressive marketing of mortgages, a widespread appetite for risk, a highly competitive, largely deregulated finance industry, and debt securitization."

He maintains that the authentic capitalists of Wall Street were forced to follow the actions of deregulated rivals and that consumers similarly followed capitalist rationality by accepting attractive mortgages at a time of rising housing prices.

According to Posner, it all made perfect capitalist sense.

It was not the greed of bankers or consumers or of regulators. It was the flawed logic of capitalism itself.

Mathematicians, quants, and computer nerds developed sophisticated hedging algorithms, diversification schemes, and insurance techniques that were supposed to reduce tisk to near zero. This transformed finance, neutralizing each risk by a hedge, and every downside with insurance.

And standing behind the assets and promoting subprime lending were guarantees from government bodies such as Fannie Mae and Freddie Mac and insured bank deposits via the FDIC.

"Posner is right that, assuming close to zero risk, bankers would be entirely rational to maximize their borrowing; the banks with the most leverage would then win the largest returns. And the bankers certainly did believe they had reduced risk to something very like zero.

"The fundamental assumption of modern finance in the early years of the new millennium was that the best way to address the perils of a volatile world was not by confronting those perils and analyzing how to ameliorate them, but by hedges and insurance."

There are two ways to reduce uncertainty - replace uncertainty with information, creating productive knowledge, or alternately - turn uncertainty into a measured probablility and purchase insurance.

Modern finance opted for insurance. "Buttressed by government guarantees, the banks persuaded themselves they had solved the actuarial problem and fully understood the probabilityes and believed they could havest the difference between the cost of the insurance and the yield of investments without risk.

"In such a world...the winning investors would be the boldest borrowers, making the biggest bets.

For Posner, the explosion of leverage made capitalist sense which could only call for more aggressive regulation.

The incentives obscured knowledge and hobbled capitalism

Posner is shocked by the disastrous outcome of the apparently rational behavior to the defined incentives. The flaw is that the defined incentives had no basis in capitalism.

Posner felt betrayed by the collapse of ordered markets at the core of his legal philosophy.

According to Gilbert "devoid of entrepreneurial surprise, such a rational world is irrelevant to real capitalist economies.

"entrepreneurs resolve uncertainty not by reducing it to statistical probabilities but by replacing uncertainty with information" - which is what the people behind "the Big Short" did. (these were the only capitalists in sight)

The problem is not to align incentives with some fashionable public good. It is to align knowledge with power - to allocate power so that people who provide new knowledge can grow the economy. (not, for example, giving the power to regulators who look at the past, create nothing new, regulate as if nothing will change, and do not understand the businesses they regulate)

Business investments provide both a financial yield and a yield of new knowledge. It is capitalism that joins these two.

"Capitalist economies grow because they award wealth to its creators, who have already proven that they can increase it."

Knowledge is gained because business plans are "falsifiable" (can be shown to be right or wrong). Businesses are subject to bankruptcy. Investment outcomes can be negative or positive.

But business plans can be shielded from consequences of error by political protections or government subsidies or bureaucratic mandates - in which case knowledge is destroyed. (Crony capitalism) The power of politicized companies grows and solidifies, but their knowledge degenerates into fatuous ideology and public relations. Thus BP postures as green, GE diverts assets from productive manufacturing to windmills and defective light bulbs. Harvard University, Archer Daniels Midland, Fannie Mae, Goldman Sachs distort price and opportunity signals and stunt the real enterprises in their shadow.

A key point of competitive capitalism: Entrepreneurial enterprise subsists on unforced profits of enterprise; politicized companies subsist on rents and tolls and privileges at the Treasury, the Federal Reserve, and the White House.

Big banks were incentivized to insure the risk of their assets rather than avoid the risk

and it blew up in their faces.

• Gilbert: "From no other realm of the American economy has the entrepreneur been so thoroughly banished as from the domain of the great banks and their funders and protectors in government."

Contrast those who bet on the subprime schemes and those who bet against them and tried to expose the risk.

betting for: "were most of the world's central banks, the World Bank, the IMF, Fannie Mae and Freddie Mac, Citigroup, Merrill Lynch, Deutche Bank, and Bank of America."

All had access to government funding and safety nets and all were backed by the global financial regulators, the universities, charities, and politicians, such as Barney Frank and Chris Dodd who were to later come up with the pile of new financial institution regulations known as Dodd-Frank.

The central banking Group of Ten who develop the rules for national banks mandated the purchase of the sovereign bonds and subprime mortgage securities that were central to the crisis. The risk of such holdings was obscure. This same group opposed owning individual mortgages for which risk information was readily available and easily assessed. The effect was to separate knowledge from power.

These were the regulators that Posner wants to rely on, but it is such regulation that chases knowledge out of the system.

voting against were a small group of hedge fund operators (Michael Lewis talks about them in his book The Big Short).

The hedge funds were operated by people that had most of their own money at stake. They were skeptical about the soundness of the mortgage bonds (which were rated AAA) which caused them to actually looked into the quality of the assets underlying the derivative assets that caused the problem. The knowledge they gained lead them to bet against them. They knew their bet was safe.

Those betting for the scheme had huge amounts of capital to place on their bets in relation to those betting against them, so the situation went out of control. Don't you wish you could have placed a bet in hind sight.

The real meaning of the one percent

The regulatory system

On March 3, 2009 testifying before the Senate budget committee, Ben Bernanke, Chairman of the Federal Reserve Board, identified a "huge gap in the regulatory system". "There was no oversight of the financial products division." He was referring to AIG.

New York State Attorney General Elliott Spitzer had chased Maurice "Hank" Greenberg, who had built AIG into the largest financial and insurance conglomerate, from the company. This was supposed to be a big step forward in oversight.

over the next 3 years AIG financial products division wrote $2.7 trillion of credit default swaps - a form of insurance mandated by regulators to offset the risk of subprime mortgage based securities

The problem was not an absence of regulators or that they were inadequately empowered. The problem was that, like most regulators, they lacked relevant information. The understood the politics, but hand no command of the intricacies of the businesses within their purviews or any stake in their operations.

So Bernanke was right - just not in the way he thought - there was a big gap.

Why capitalism works

• Regulation is an effort to replace knowledge with power.

"The government cannot be sure what complex corporations like AIG are doing. It does not know how to make AIG better at what it does, how to improve its efficiency and effectiveness as a global insurance company. So it imposes an array of rules that have the effect of distracting the company from its corporate purposes and toward government purposes, making AIG less like an entrepreneurial corporation and more like a government bureaucracy.

"The rules from outside AIG attempt to substitute for actual knowledge residing within the company about its operations and markets. The vital knowledge in Greenberg's head became particularly unavailable."

• The reality is that throughout that period or systemic collapse examiners, overseers, regulators inspectors, and compliance officers swarmed over every large institution, pronouncing them sound - right up to the moment that they announced their need for billions of bailout funds to prevent catastrophe.

The completeness of regulatory coverage was no remedy for the lack of knowledge. The regulators could never match the knowledge about the future of the regulated companies of the entrepreneurs of the companies themselves.

Regulations are rules based on past experience. Regulators are political appointees. Entrepreneurs take their cues form the subtle signals on the crest of creation

The lesson of the crash is that a hundred regulators and all of the encyclopedic rules could not replace one Hank Greenberg who was thrown out by the regulators before AIG ever wrote a single credit default swap contract on a single bogus AAA bond.

"That hundred-regulators-to-one-entrepreneur mismatch is the real meaning of the 'one percent' - the tiny minority that gives capitalism its name."

• The difference between people is not what they own but rather what they know.

"Wealth is only valuable if it is combined with information. If it is combined with ignorance or greed it quickly dissolves, like the fortunes of lottery winners or Vegas jackpot millionaires."

• Many examples of wealth inequality:

Can it be fair that

Mark Zuckerberg is worth $17B while a social worker makes $40K a year?

Why should Bill Gates be worth $50B while Dan Bricklin, the inventor of the pioneering VisiCalc spreadsheet that launched the PC into business applications be reduced to working his tiny consultancy?

Why should Buffett be able to parlay his assets into a fortune that makes him close to the world's richest man while some work two jobs to make ends meet?

Some advocates of capitalism justify such inequalities by the larger results - capitalism doesn't make moral sense - just practical sense in terms of wealth. It justifies the 'greed'.

"Far from being greedy, America's leading entrepreneurs cannot revel in their wealth because most of it is not liquid. It has been given to others in the form of investments. It is embodied in a vast web of enterprise that retains its worth only through constant work and sacrifice."

The reason capitalism works is that the creators of wealth are granted the right and burden of reinvesting it.

An economy grows only if its profits are joined with entrepreneurial knowledge. Wealth increases only if the people who create it control it.

You join the one percent by learning the gritty and relentless details of live that allow the creation of great wealth.

• Entrepreneurial knowledge has little to do with certified expertise of advanced degrees or the learning of establishment schools.

Many spurn the focused learning commanded by the one percent. Wealth often comes from doing what others consider boring or insufferably hard.

the intricacies of building codes

the mechanics of butchering sheep or frying and freezing potatoes

the mazes of high-yield bonds and low collateral companies,

the way petroleum leases work

"Most people consider themselves above learning the gritty and relentless details of life that allow the creation of great wealth. They leave it to the experts. The one percent do not.

This can't be planned and creates a lot of surprises. Which is offensive to levelers and planners because it yields much new wealth in ways that can't be planned. It defies every econometric model and socialist scheme.

"It makes no sense to most professors, who attain their positions by the systematic acquisition of credentials pleasing to the establishment above them."

Leading entrepreneurs did not ascend a hierarchy. They created a new one. They did not climb to the top, they became the pinnacle.

The real sources of wealth cannot be confiscated

• "As long as Larry Page and Sergey Brin are in charge of Google, it will probably grow in value. Put a government bureaucrat in charge and it will loose half its value before sundown."

Even "professional management" will retard the growth of value relative to having the owners in control. At Google, it only Page and Brin who would see their wealth dissipate if they focused less on customers than on their own consumption.

Even if it wished, the government cannot capture the wealth of the 1%.

As Marxist despots and tribal socialists from Cuba to Greece have discovered, governments can neither create wealth nor effectively redistribute it. They can only expropriate it and watch it dissipate.

Wealth is not a stock of goods or a natural resource that can be divided. It is a flow of ideans and information. It is "a form of change" tat "never can be stationary."

Capitalism is a noosphere, a mindscape, as empty in proportion to the nuggets at its nucleus as the solar system in proportion to the size of the sun.

volatile and shifting ideas, not heavy and entrenched establishments constitute the source of wealth. There is no tax system or planner who can capture the fleeting ideas of the wealth generators.

One can buy the buildings and patents of an enterprise, but you can't reproduce the leadership. Capturing the worth of a company is more difficult than purchasing it.

"The wealth of America is not an inventory of goods; it is an organic living entity, a fragile pulsing fabric of ideas, expectations, loyalties, moral commitments, and visions."

Whatever the state of inequality of incomes, it is dwarfed by the inequality of contributions to human advancement.

Robert Heinlein wrote, "Throughout history, poverty is the normal condition of man. Advances that permit this norm to be exceeded - here and there, now and then - are the work of an extremely small minority, frequently despised, often condemned and almost always opposed by all right thinking people. Whenever this tiny minority is kept from creating, or (as sometimes happens) is driven out of society, the people slip back into abject poverty. this is known as 'bad luck.'"

President Obama in Iowa: "We had reversed the recession, avoided depression, got the economy moving again, but over the last six months we've had a run of bad luck."

What countries will best compete for the real sources of wealth?

"American economists are simply fatuous in their belief that the United States can continue to lead the world and prosper while maintaining some of the highest corporate and personal tax rates on the planet and attempting to regulate everything that breathes."

"According to a 1983 study by Keith Marsden of the World Bank, as updated by Polyconomics in 1992, government spending rises three time faster in countries with low or declining tax rates than in countries with hight or rising tax rates. The low tax countries can increase their government spending three times faster because they grow six times faster. Thus government spending declines as a share of GDP while tripling in absolute amounts.:

the US maintains more civil freedoms than China and Russia, but pursues tax and regulatory policies intensely hostile to enterprise. Today, skilled immigration moves from the US to China and India rather than the other way.

Hong Kong has maintained a top tax rate will under 20% since 1947 and has been among the world's fastest growing economies, with one of the world's fastest growing populations. It has also maintained close to the fastest rate of growth of government spending.

This also can be linked to the article on economic freedom.

"In Europe too tax rates are becoming more competitive. Beginning with the Baltic countries in 1994 and 1995, some twenty countries have adopted low flat tax rates over the last two decades. Virtually every flat tax country experienced rapid growth and most attracted massive foreign investment, while the US for the first time since the Carter administration is suffering net capital flight."

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