Capitalism, wealth disparity, and the end of Western Civilization as we know it … what would Adam Smith do?

Thanks to my good pal Keith (Check out his cool Travel blog about the Tuvaluan Island of Nanumea  ) I’m directed once again to the capitalist controversies.

A letter to capitalists from Adam Smith

By David Rubenstein

To: Capitalists of the World

From: Adam Smith

What has become of my beloved capitalism? Countries teeter, protests rage, unemployed multiply, deficits abound the virtues of capitalism are questioned. Based on a few hundred years of observation, I have some fresh thoughts on how to sustain this system for a few hundred years more, or at least do better in 2012 than it did in 2011.  

….  CONTINUED at FT – free registration required.


My (Joe’s) take on that article:

I like the first part – the setup – by far the most.

In my opinion Adam Smith would be fine with the ups and downs and wealth disparities as long as the poor keep getting richer – which is in simple terms what is happening now, esp. when one does not (absurdly) remove Chinese and Indians from the equation.

The disparity controversies  remind me of the OWS ranting against the big system, and I remain somewhat unmoved by that until I can find better data about money flows.  There may be some merit for the case that wealth is flowing “too disproportionately” to the wealthy, but we need a LOT more than simply observing disproportion, which is the cornerstone of smart markets.   Without it you tend to get a race to the bottom, where the lack of incentive  makes it hard to get folks to work “harder” than others.   Simplification?  Yes of course, but if we are ever going to improve the disparity issues we need the American left to recognize how brilliantly the American system has worked over a long history to *improve* things using the architecture of entrepreneurial incentive, combined with a very progressive federal and state taxation system where those with the most pick up most of the tab for those who don’t have as much.
Obviously about 99 % of us would like to see the extra wealth flow to US more than the 1 percenters who are reaping more than what some would call a “fair share”, but …
Let’s try to figure this out by simplifying:  Let’s say if you have a single very clever woman who builds a company that eventually consists of 101 people, the founder (who took risk, mortgaged her  house in process, and developed a brilliant idea into a business) and 100 other folks who were hired after the company was a success, all 100 of now make a living wage of $50,000 per year plus benefits.   Let’s also reasonably assume that the founder remains clever, and her departure would hurt the company to the tune of many millions in profits.
Question:  What is a “fair amount” for the founder to make in this example?    0 because she loves her work and she has no boss ?   50,000 because everybody else makes that?   100% of the extra profit she account for?   Very few would argue for any of these.  Obviously she should make MORE than the others, and LESS than the total extra profit.
Really, the only smart issue on the big economics table is HOW MUCH MORE?
VERY IMPORTANTLY note this.   Assume she’s been making 50k, same as the wage of her workers.  Then, after a great year that she single handedly engineers that give the company an extra 5 million in profits – profit from accounts that are likely to continue into the future –  she raises her pay to 500k  (a 900% raise) and doubles all her worker’s pay to 100k (100% raise).    How do we interpret that action?
OWS is incensed – the new wealth was distributed VERY disproportionately.  She got 900% the raise she gave her workers.
I, on the other hand, think she’s great and would love to work for her.   That’s GREAT pay when you have so little risk, and she’s the architect of the innovations.    Both in fairness terms and in pragmatic terms I want her to get more.   I want SOME of that extra profit, after all, I’m part of the company, but the architects of the wealth creation “should” be disproportionately compensated.
There are exceptions to this simplification, such as CEOs that preside over lowered valuations yet make big money, but in simple terms this is pretty much how things work, and we change that at our enormous peril, because you can bet dollars to yuan that China will choose that model over the OWS more socialistically inspired model.
Key questions are this:  HOW do we optimally distribute and redistribute (tax)  “new wealth”?   and “old wealth”, such as inheritance money?

2 thoughts on “Capitalism, wealth disparity, and the end of Western Civilization as we know it … what would Adam Smith do?

  1. I guess the main gripe is not with self made successful individuals who have vision. They are the ones who can see an opportunity and seize it and who develop their personal skills and talents to be able to take advantage and develop those opportunities. If in doing that, they create worthwhile employment opportunities for hundreds and may be thousands of ‘ordinary’ folk that is a laudable achievement for which one cannot doubt anyone of sensible mind would deny those ‘creators’ their just rewards. After all, is it not the case that most of us are cut out to be just the employed rather than be the employer?

    The main source of discontent is with those who are awarding themselves disproportionate remuneration packages when measured against the contributions they make, thus lining their pockets whist at the same time taking little or no personal risk. In short they are gambling with the money of others and not their own.

    One has to cite the most obvious and recent examples of those at the top of the financial services sector who, for years, have claimed they can demand and justify their excessive rewards because they are highly talented and have special skills and experience which renders them to be far superior to mere ordinary mortals. The reality is that they have created self-perpetuating cosy clubs, the members of which award themselves and the friends a continuously revolving merry-go-round of highly lucrative executive positions whilst at the same time agreeing amongst themselves what their rewards should be.

    “After all, if I don’t receive the remuneration package I demand, I will go elsewhere and ‘you’ will lose out on not receiving the benefits of ‘my’ wonderful talents.”

    Oh yeh! These ‘highly talented’ people have literally gambled away what are literally the fortunes of simple ordinary folk who who have been naive enough to accept the cheating and lying rhetoric and placed their explicit faith and trust in these despicable people from whom has been a persistent evacuation from their mouths of what has been proved to be mere verbal diarrhoea. These people are not creators, they are manipulative, devious charlatans and their wonderful talents have finally brought the world to the brink of economic disaster. Certainly, there are some folk who are still doing very nicely thank you, but there are massive numbers who have been ruined and reduced to lives of poverty by the greed, avarice and cheating of what is a mere handful of individuals who carve up the commercial world to sustain their own personal egos.

    Argue as much as you will, there cannot be any justifiable morality in being able to cream off tens and even hundreds of millions each year for simply manipulating a pile of promissory notes across a desk or on a computer screen. These people are not ‘creators’, they are manipulators and although they usually cannot perpetuate their falsehoods without building empires of employees around them, when the going gets tough they have absolutely not scruples about cutting the legs off their employees whilst still walking aways with even bigger rewards for their ‘efficiency measures’!

    I am no advocate of extremes of socialism, but there has to be some way in between that of such obscene excess and that abject poverty. One can argue that those who placed themselves in positions of massive personal debt whilst they had decent jobs should have managed their personal affairs more astutely and should have had an appreciation of the potential for personal financial disaster if they ever find themselves out of work. One has to remember, however, that ’employees’ are rarely in a position to influence the successes and/or failures of their places of work and if things do go wrong they are rarely the cause, but always the victims.

    The money lending machine is big, and powerful, and devious, and dishonest and those at the top are perpetuators of that dishonesty because as long as they can keep on selling money they can reap massive personal rewards. There is no genuine thought of how that money may be repaid by the borrowers. It is all for ‘today’ and the limit of their ‘vision’ is the end of the next fiscal year at best, or as short as the next bonus payout.

    As a final note, we would all do well to read ‘The Complete Works of Thomas Paine’, (including his ‘Age of Reason!) the 18c writer who greatly influenced the creation of the Constitution of the USA. His main targets were the parasitic monarchy, aristocracy and all of the useless courtesan hangers-on. However, if one replaces those titles with financial sector CEO’s, Boards of Directors, Non-Executive Directors and ‘management consultants’, Thomas Paine is a relevant today as he was in 1790.

    • Great comment Rodney! Totally agree that we need to find much better ways to engineer those systems where reward does not come with risk, as in your example where the relationships of boards and CEOs leads to compensation that is out of whack with performance. But again my concern with critics is that they are throwing out babies with bathwater. China and India undertand clearly that capitalism is the most effective path to prosperity.

      Too many Americans challenge that notion because they do not understand the connections between their own well-being and the capitalist model, which in general terms remains the best prosperity mechanism ever devised. The usual response to that is “sure, it’s great for rich and hard on the poor”, but the poor in countries like the USA live at standards far higher than the poor in non-capitalistic countries.

      I actually agree with socialists/communists in that we should measure the success of an economy best by how it treats the poor and disadvantaged rather than how it treats the wealthy or by total wealth. However I think it’s unfortunate that so many “progressive” thinkers generally ignore the state of affairs in the many non-capitalistic countries where alternative policies have failed to create much prosperity for anybody.

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