Difference between revisions of "Notes:BC1.EF.The Secret of Enterprise"

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Revision as of 22:42, 23 November 2014


An outline of the ideas in the prologue of Gilder's 2012 edition of Wealth and Poverty[1].

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."


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 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.
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

Why capitalism works


The real sources of wealth cannot be confiscated


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


  1. ↑ Gilder, George. Wealth and Poverty, A New Edition for the Twenty-First Century. Washington, DC. Regnery Publishing. 2012
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