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Risk, Returns, and Rich People

Are our rich people not rich enough?

By Petrarch  |  May 9, 2012

A few weeks ago, we reviewed a semi-obscure book by a couple of highly successful stock-pickers which argued that the basic concept of employment is nothing more nor less than insurance against bad business decisions: the capitalist who owns the company takes the risk that his decisions won't make a profit, whereas his employees, by accepting a wage with no participation in the potential upside, purchase insurance against the risk that their personal activities won't lead to an economically viable business success.  The business may go bust, but they'll have pocketed their wages either way.

Independent small businessmen are familiar with this concept: if the local stationery store doesn't sell enough pens, then the storekeeper will be on short rations for a while until business picks up.  If the weather is bad this year and the crops don't grow, the farmer will have a tight year.  Both of them, though, reap all the benefits when things go well.  A steady wage won't go up much, but nor will it go down except in the case of business collapse or layoffs; it's more reliable and secure, all else being equal.

The trouble is, our government's actions of late have decreased the probability of business success, making people who have the capital more reluctant to take the risk of investing in anything or hiring anybody.  We've all seen articles complaining about trillions in cash stockpiled by corporations; the Left likes to whine that they aren't performing their social requirement of hiring people with all that money.

But if they aren't confident that the new workers will contribute anything profitable - and with unknowable but likely massive Obamian increases in regulatory costs, how could they be? - it would be illogical for them to invest in anything beyond the most clear and immediately profitable activities, probably restricted to what they're already doing that's working.  Hence no new jobs, and teeming masses of discouraged would-be workers who don't think they'll ever find anything remunerative to do.

Put another way: the appetite for risk is too low and nobody's buying it, so workers are stuck with that risk when they'd rather not be and wind up unemployed.

Then what's for dinner tomorrow?

Discouraging the Intrepid

The New York Times sheds more light on the causes of this imbalance in a fascinating interview with the sort of Really Rich Guy whom the Left, and the Times, generally loves to hate.  Apparently the reporter was honest enough to imagine that Rich Guys might, just might, have an argument as to why what they were doing was really good for everybody and that it could be interesting to hear what that might be, if only to poke holes in it.  So he found one wealthy person who was brave enough or stupid enough to try to explain it to him.

Edward Conard is precisely the sort of individual who the Occupy crowd would like to string up from the nearest lamppost.  He does nothing visibly useful: he doesn't run factories employing hordes of unionized middle-class workers, nor has he invented new and useful technologies like Steve Jobs.  Yet he's a member of the 0.1%, with hundreds of millions of dollars stashed away in his worldwide coffers.

He made this money working with Mitt Romney, buying and selling troubled companies.  He is proud of his wealth.  What's more, he's proud of the fact that he is rich and you aren't.

To be precise, he argues that the massive inequality we see complained about is not just not bad, it's a sign of health that our capitalist system is working.  We need even more inequality, he says, and only by even richer rich people will we be able to increase the wealth of the ordinary sort.

How can this be?  It's a fact that the vast majority of new ventures fail.  It's also a fact, observable all throughout history and in all walks of life, that great success virtually always comes only from taking great risks.  Most of the rags-to-riches heroes of American industry and commerce, from Henry Ford to Col. Sanders, had a time in life when they risked their very last dollar on what seemed like a crazy venture but which catapulted them to fame and fortune.

As we've discussed before, most people don't have the cojones for that kind of all-or-nothing risk and thus have no chance at joining the ranks of the plutocrats, but traditionally middle-class folks were able to take on at least some outside risk - by investing, or starting a small side business.  Individually these mini-enterprises don't do much, but collectively they have always been the heart and soul of American employment and economic growth.  In today's environment, though, middle-class jobs themselves are no longer as secure and are much harder to find, so normal people are less likely to take chances elsewhere.

According to Mr. Conard, this is devastatingly bad for America and grossly wasteful of American talent:

Society benefits if the successful risk takers get a lot of money. For proof, he looks to the market. At a nearby table we saw three young people with plaid shirts and floppy hair. For all we know, they may have been plotting the next generation’s Twitter, but Conard felt sure they were merely lounging on the sidelines. “What are they doing, sitting here, having a coffee at 2:30?” he asked. “I’m sure those guys are college-educated.” Conard, who occasionally flashed a mean streak during our talks, started calling the group “art-history majors,” his derisive term for pretty much anyone who was lucky enough to be born with the talent and opportunity to join the risk-taking, innovation-hunting mechanism but who chose instead a less competitive life. In Conard’s mind, this includes, surprisingly, people like lawyers, who opt for stable professions that don’t maximize their wealth-creating potential. He said the only way to persuade these “art-history majors” to join the fiercely competitive economic mechanism is to tempt them with extraordinary payoffs.

“It’s not like the current payoff is motivating everybody to take risks,” he said. “We need twice as many people. When I look around, I see a world of unrealized opportunities for improvements, an abundance of talented people able to take the risks necessary to make improvements but a shortage of people and investors willing to take those risks. That doesn’t indicate to me that risk takers, as a whole, are overpaid. Quite the opposite.” The wealth concentrated at the top should be twice as large, he said. That way, the art-history majors would feel compelled to try to join them.

We can't help feeling that he's right!  Earlier this year, a major Scragged series explored the concept of "jobs" that are, in economic terms, not jobs at all - they are non-productive or actually destructive of wealth, and the more people doing them the poorer we all get.  Mr. Conard is making what amounts to the same argument, but in a more capitalist-specific way.


This graph, which regular Scragged readers will find familiar, demonstrates his point.  The Chinese economic miracle is unmistakable:

Deng's numbers speak for themselves!

Chairman Mao was utterly convinced that Communism was the only viable economic system.  If his cadres caught you starting a business, they'd chop your head off.  That was an even more effective job-killing measure than Mr. Obama's ill-advised regulations.  Mao actually achieved the "fairness" which Mr. Obama talks about so much - everybody except the highest government officials was equal, but at a very low economic level.

When Deng Xiaoping took over after Mao died, he unleashed Chinese "animal spirits."  Growth in inequality was far more spectacular than overall economic growth.  The Chinese Miracle took about 300 million Chinese to the 1st world.  A billion illiterate peasants were left behind in the gutter.

China's inland peasants haven't gained nearly as much as the more fortunate citizens along the coast.  They are, however, better off than they were.  The coastal elites are a thousand times better off, so the inequality score is off the charts just as Mr. Conard expects.

The bottom line?  Inequality has increased, but the lowest level is higher than it was.  That ought to make people happy, but it doesn't.  All too many jealous sorts would prefer to have nothing so long as everyone has nothing, rather than have something when others have more.

Strangling the Golden Geese

Equality in poverty may sound like a just solution, but anyone who's ever experienced real poverty - an impossibility in the United States where genuine poverty ended well over a century ago - knows that poverty is wretched or miserable whether you're equal or not.  The question for all societies is, how can the masses of people who will never be billionaires still have the opportunity for a decent life?

Mr. Conard's answer is: make sure that the rewards of success are so lavish and well-publicised that everyone with the slightest ability even to hope for them will have a go - and in so doing, will lift everyone up at least a bit.

Follow the logic:

 - Economic history proves that, across an entire economy, the more risk-taking you have the wealthier the society as a whole becomes.  Most risk-takers fail, but some succeed; the massive rewards given to those lucky few inspire others to try and we all benefit from the innovations.  Only a couple of people become the Google Guys but we all benefit from the invention of Google.

 - When there is less risk-taking, there is less innovation, so society as a whole doesn't get as wealthy as it otherwise would.  This hurts everyone.

 - Right now, Americans are so fearful for a number of reasons that there's very little innovation or risk-taking going on.  Our economy has stalled.  There are few new jobs being created and little being invented, and we're all the poorer for it.

 - Seeing this, many intelligent, well-educated people who in better times might found a business or join a startup, instead opt for low-risk but economically useless professions like lawyer or government bureaucrat.  All those extra costs create a vicious cycle of making business success even harder and less likely, thus discouraging the next generation from giving it a try, and so on down until you reach societal and economic sclerosis as in continental Europe.

We well know by personal experience that there's a lot of truth in this analysis: investors won't try new job-creating ventures if they think the government will steal all the profits in taxes or, worse, destroy them through random regulations.  The fact that Mr. Conard is himself hugely rich strongly suggests that he, unlike our President, actually does know a thing or two about how our economy works.

A crystal-clear explanation of what's at stake comes from, of all places, France, where center-right President Nicolas Sarkozy just lost the presidency to openly socialist François Hollande:

In the course of their bare-knuckle “debate” last week, Mr Hollande said to Mr Sarkozy, “I protect the children of the Republic, you protect the most privileged”, thereby encapsulating the sentimental moral blackmail of modern center-leftism. And Mr Sarkozy retorted, “You want fewer rich people. I want fewer poor people,” which pretty much sums up the view of center-rightism that only free markets can produce prosperity for the mass of the population.

Sarkozy hit the nail on the head for us here in America: Barack Obama and his Democrats want fewer rich people, as they've shouted to the skies time and again.  They want more poor people because poor people vote for higher taxes and more government power.

Mitt Romney, we hope and pray, wants fewer poor people - not because he kills or starves them off as Democrat hacks would have it, but because he encourages them to get in the game and not be poor anymore.  The French voters have decided to go the route Mr. Obama wants us to take.

Which road would you rather see America take?