I recently watched the movie “Margin Call”, a movie set in a similar vein as the Wall Street movies but one that (better) deals with the recent financial crisis from the point of view of the people (investment banks) directly involved. This quote by one of the leading characters near the end of the movie, John Tuld, resonated with me the most:
We just react. And we make a lot money if we get it right. And we get left by the side of the road if we get it wrong. And there have always been and there always will be the same percentage of winners and losers. Happy foxes and sad sacks. Fat cats and starving dogs in this world. Yeah, there may be more of us today than there's ever been. But the percentages-they stay exactly the same.
How very Schumpeterian of him! After all, “Capitalist reality is first and last a process of change”; if you fail, i.e., if you do not consistently make other people happy by providing them with goods or services at acceptable prices then you will quickly be “left by the side of the road”, replaced by a “happy fox” who is better equipped to solve the endless coordination problems in the economy – someone for whom you will likely have to work in exchange for a consistent, less-risky wage according to your marginal productivity.
To get to the point of this article, let us compare John Tuld to Gordon Gecko’s speech in “Wall Street”:
The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind.
To the contrary, greed for greed’s sake alone is not good; greed has been indirectly responsible for most of the worst atrocities that have been committed throughout the history of mankind. But we are all greedy; it is hardwired into our nature. The question then becomes not “how do we stop greed” (sadly trying to change human nature is something people in the political system seem determined to keep attempting) but “how can we control greed”? And the answer is the same as it has always been: we can control greed only by allowing Adam Smith’s self-interested individuals to operate within the correct institutional setting; that is, within an institutional setting of private property, freedom to contract and voluntary consent that encourages social cooperation rather than predation. Milton Friedman succinctly summarised how this process works within the correct institutional setting:
The key insight of Adam Smith's Wealth of Nations is misleadingly simple: if an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it. Most economic fallacies derive from the neglect of this simple insight, from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.
It is when you remove these constraints – as we have done with certain industries (hint: the financial sector) – that that very greed and self-interest that can be so beneficial to society is instead channelled towards unproductive, zero-sum uses such as political rent-seeking. As Max Weber said, there is “…orientation to the profit possibilities in continuous buying and selling on the market with free exchange”, as well as orientation to profit opportunities that are the result of “…domination by force…by political authorities”.
There is nothing wrong with greedy, self-interested individuals seeking a profit. But there is a problem when this profit is not created by satisfying the needs of fellow human beings through non-coercive means but is instead achieved through rent-seeking in the political sphere. Profit derived from rent-seeking, transfer payments, coercion or fraud are not what capitalism is about; they come about when the returns for greedy individuals is greater in seeking regulation, lobbying and buying politicians than the returns that they could earn by (unintentionally) satisfying their fellow man through the market process. The rewards to individuals in sectors of the economy where the profits are privatised while losses are largely socialised and where their very existence is owed almost entirely to artificial means created through state intervention are not examples of “market failure” but are examples of “government failure”. What is not needed is more government to solve a problem created by the government; what is needed is more capitalism to channel individual self-interest into socially cooperative and productive activities – profit that expands the pie, not profit (rent-seeking) that takes from it. Differentiating between the two is a critical distinction to make, less tragic policy errors be committed.