Fred Smith

Post image for The “Cooperative” Enterprise Institute?

Having spent much of my professional life at the Competitive Enterprise Institute, I found Paul Rubin’s recent Wall Street Journal piece “How to Roll Back the Demonizing of Markets” intriguing. Just as CEI has since its inception, Rubin argues that markets are cooperative, rather than competitive institutions. A business will compete with a few rivals, true. But to stay in business, it must cooperate with thousands of customers, employees, shareholders, suppliers and neighbors.

The popular mind tends to associate capitalism with competition, but there is actually far more cooperation. As CEI’s “I, Pencil” movie shows, these cooperative links extend outward from the company to engage millions throughout the world.

Rubin’s point is important. Competition does focus on the win/loss nature of creative destruction. But throughout that competitive contest, both sides are seeking to cooperate with their customers (each seeking to demonstrate their superiority in such cooperation), with their workers, suppliers, and shareholders. In a sense, companies compete with each other to be the better cooperator.

Rubin is discussing what we all know, but rarely take to heart: words matter. Market defenders have been too passive — too willing to adopt the anti-market rhetoric that has dominated discussions about markets since the days of the Muckrakers. Those of us who believe capitalism to be a virtuous institution must develop a positive rhetoric and an array of “I, Pencil”-style positive narratives.

CEI won’t be changing its name, but we and others should focus more on rhetoric. No one cares what you know until they know that you care. Capitalism is more “caring” than any other known institutional system. We must find ways of making its concern more apparent.

Jeffrey Sachs, the harbinger of bad policy, has written his first post-election column in the Financial Times, “Obama has four years to transform America’s Economy” (FT, Nov 12, page 11, subscription required). No surprises here; his advice is to speed up the destruction of our residual free market economy. He concedes that macro-Keynesianism has proven “outdated and outmoded,” but nevertheless calls for moves to a micromanaged economy.

Here he departs from his predecessor John Kenneth Galbraith, who recognized the inability of centralized planners to micromanage a dispersed entrepreneurial economy, and thus favored the consolidation of business into mega-firms that could (perhaps) be directed politically. Sachs retains part of that tradition (“the US needs massive overhauls of its key economic sectors”), but recognizes that a focus on “aggregate demand” policies is inadequate. The president, he argues, must become “the conductor of deep-seated structural changes.”

If President Obama follows his advice, we may expect a much more interventionist government. The role of capitalism is to plant our always scarce seed corn in the most fertile, most economically productive, sectors. The role of politics is to place it where it will yield the greatest short-term political gains, such as more funds to clean energy (and, of course, a carbon tax).

Don’t expect any moves to liberalize the entrepreneurial creativity that means America will soon outproduce Saudi Arabia in oil production, that has greatly weakened the blackmail potential of Gazprom and of Arab governments — and, of course, nothing that would have encouraged the low-cost energy realities that the private sector has made possible.

In brief, whatever the election might have achieved, rest assured that Jeffrey Sachs is still Jeffrey Sachs.

Post image for Remembering Elinor Ostrom

Among the individuals with whom I wish I could have greater opportunities to exchange ideas is Elinor Ostrom. She passed away today, and now I must pursue that conversation indirectly — via her writings, her colleagues, and my recollections of those few conversations I did have the opportunity to enjoy.

Her work — for which she received the Nobel Prize in Economics – dealt with the way in which cultural enclaves often evolved institutional and technological solutions to resource management. And, not surprisingly, ideologues of various sorts claimed her work validated their world view.

Communitarians saw her work as “proving” that the classical liberal institutional view of private property, based on a formal rule of law, was not essential to ensure efficient allocation of resources. All one needed, they claimed, was to return to the common property world of yesteryear. Conservative agrarians also found much support from her research for their perspective. And, indeed, her work could be read that way – but it didn’t have to be.

Classical liberals, myself included, viewed her work far differently — as  evidence that the core institutions of a liberal world had developed (in embryonic form) much earlier than first thought. They were not imposed from above, but rather evolved as man began the long path toward modernity.

Moreover, some of her work did touch upon modern property rights — illustrating how commons could evolve into properties that could be restricted by use, by time, and in other ways that moved toward the formal property rights of today, ultimately meeting my friend Rick Stroup’s 3-D definition of property — definable, defensible, and divestible.

CEI’s Center for Private Conservation benefited greatly from some her insights. Once, she and Vincent, her husband, visited CEI and gave an impromptu seminar.

One question that I wished I’d pursued further with her concerns the transition from tribal common property management regimes to the modern private property regimes of today. Under what conditions do such transitions occur? What leads groups to accept a shift of this sort and what advantages (and penalties) does it create?

My own thoughts are that culturally enforced resource management rules can often be very creative and efficient — still, they rely on the culture being closed to outside transactions with others not sharing these cultural values. In a global mobile society, this suggests such closed systems are not likely to survive. However, unless the conditions for the transition to the modern formal rules have arrived, the situation can actually worsen. Fisheries, tropical forests, wildlife — all illustrate how the Tragedy of the Commons re-emerges when the old order collapses without anything to take its place.

Thus, CEI’s interest in pursuing the question: How can one assist isolated tribal enclaves to join an open world economy — when that shift is wise? The question is relevant in many areas of policy: how to better allocate the electromagnetic spectrum, offshore fisheries,  surface waters, and myriad other areas where property rights remain somewhere between the cultural controls Ostrom explored and those favored by classical liberals.

The right to trade a resource that is often restricted to one class of users (agricultural uses of water, for example) might be extended to urban or industrial users, but that liberalization threatens existing  arrangements and requires some trust that the new rules will be at least as effective. The very slow evolution of such liberalized trading policies suggests how little we understand social change. Ostrom had much to say about all this, and left us a rich legacy on which to ponder.

Business spends around the world almost $1 trillion annually, seeking to sell its goods and services. These communiqués are focused almost exclusively on influencing the choices that consumers make. Logical, of course, since failure to sell one’s products in the private world means bankruptcy. But, in today’s world, sustainable profitability requires also that businesses find ways of reducing costly political predation (excessive regulation, government support of competitors, high taxes, direct governmental agency competition). And business does spend a minor fraction of its overall communication budgets on political advertising.  Unfortunately, these ads tend toward rent-seeking — increasing the overall burden of government on others — not on reducing the firm or sector’s vulnerability to such predation.

A recent example was a full-page ad by the National Association of Realtors in Politico [PDF] calling for a number of expanded housing subsidies. Now realtors have suffered to varying degrees by past housing promotion policies. The FHA, Fannie and Freddie and a wide array of other special provisions pushed far too much capital into this capital investment sector, rather than allowing capital to flow where it would yield the greatest societal returns. Moreover, the failure of housing markets to clear, for the excess supply to quickly be absorbed at discounted prices (via foreclosures, bankruptcies, lowering sale price, etc) have been slowed by political efforts to delay these adjustments. Thus, one can sympathize with realtors, home owners and others but be saddened by this latest attempt to delay the recovery of the housing markets.

Wouldn’t the housing market be far more stable, far more efficient, if current regulatory and other government interventions disappeared? Wouldn’t realtors be better — once the transition pains were overcome – in that more entrepreneurial world? Perhaps, but clearly that is the path not taken by the National Association of Realtors or other business groups today. Their more entrepreneurial members suffer, too many incompetents remain cluttering the field, and their comparable advantage in wealth creation suffers while their rent-seeking skills expand.  Gradually, realtors (like health or flood insurers) can be expected to be little more than state employees. Sad.

From time to time, I think of this question.  Consider free speech — almost every liberal views that as the one part of the Constitution they’d keep. Indeed, they once defended the rights of Nazis (Nazis!) to march in Skokie, Illinois! Now they find it all too easy to support selective speech restrictions: “harmful” speech, campaign finance laws, campaigns to eliminate the “false balance” of the media (re global warming and other PC-controversies).

Free speech now is restricted to intellectuals — academics, the media (if they don’t fall into “false balance”), liberal politicians. But economic interests must be treated differently — they have undue influence and threaten true, democratic “free speech.” Business and business friendly voices have been targeted repeatedly — and campaign laws are but one example. Research papers funded (even with independence guarantees) must carry the equivalent of  a scarlet dollar sign. Experts from the business world are denied a voice on government advisory committees. Activist shareholder groups file shareholder resolutions seeking to force firms to cancel any support of business-friendly policy group voices. The First Amendment they support is only to allow the Chattering Class to chatter in much quieter rooms.

Another statist argument that illustrates this inconsistency is their view on “cooperation.” They seem to view the market as anti-cooperative — only the state, they seem to believe, allows cooperation. Free markets are certainly competitive — indeed the very essence of free market capitalism is Schumpeter’s creative destruction. But, firms certainly do all in their power to cooperate with their customers, their suppliers, their shareholders, their employees, those living in their neighborhood. Such cooperation is essential to sustainable profitability.

Moreover, firms often seek to cooperate even with their fiercest competitors. A firm, after all (a la Coase) is best viewed as that assemblage of tasks that are best performed at roughly the same scale — within the same entity. Typically there will be some tasks — cooperative R&D, resolving intellectual property rights disputes, technology advertising — that is better performed at the supra-firm level (that is via joint ventures). Yet, statists see all such cooperative ventures only through the antitrust regulatory lens. Often they are banned as “anti-competitive!”

Statists fail to understand that the essence of capitalism is cooperation – voluntary exchange. Firms, of course, compete to persuade customers to come to them rather than others, but they do so by making their offers more attractive, more cooperative. Nicer stores, lower prices, more agreeable clerks — all to encourage more cooperation. Yet, all that is depicted as nature savage in tooth and claw! How silly. Individuals compete for mates. Do we really think that is “vicious competition?”

European and American political and private institutions have made many non-sustainable retirement promises over the last 50 years. These promises cannot be kept and that reality is forcing reform. One primary reform is a shift from defined benefit to defined contribution plans. Critics argue that would shift risks from the company or agency to the individual. But is this true?

While an individual may fail to set aside enough savings for retirement or invest poorly, that is also true for a firm or government entity. The firm or agency may have the resources to make up for a shortfall — but they may not. When firms and — increasingly — political jurisdictions go broke, they leave workers badly shortchanged. In the private sector, the federal Pension Benefit Guarantee Corporation caps benefit payouts for pensions it takes over. And around the country, financially strapped state and local governments are enacting reforms to lower their pension liabilities. In a still-struggling economy where bankruptcies are likely to increase, defined contribution plan that are independent of the resources of a larger entity may often be the less risky option.

Note that in Europe, to avoid crippling taxes during high-tax periods, part of workers’ compensation would be in kind, often in the form of a car or even an apartment. While these were nice perks, their being provided by the employer meant that to lose one’s job meant losjng not just income, but also access to critical necessities of life. The European nations that have better weathered the Great Recession are those that have liberalized their labor markets. Those reforms allowed workers in those countries to receive higher pay and gain these resources more securely themselves. Isn’t the same principle at work in the retirement area?

George Will warns that America’s system of competitive federalism is threatened by our own “Greeces.” (“In Illinois the bills are coming due,” April 27). Europe has been brought to its knees by the moral hazard from guaranteeing the debt of imprudent entities. Could a default in Illinois create a similar collapse here? Not in the same way.

States are allowed fiscal autonomy and are expected to suffer the consequences of their own fiscal imprudence. Direct federal bailouts are unlikely, but they are not the real threat.  The risk Illinois raises for America is that the Federal Reserve may decide that states are “too big to fail” and move to ensure that failing states can continue to borrow and carry on their non-sustainable fiscal and regulatory policies.

That is what happened in Europe, as the European Central Bank (ECB) rushed to ensure that Greece could continue spending. The ECB is outside of normal political controls. Finding ways to restrain the Fed may be the primary challenge of the next administration.

Robert Samuelson’s column (April 8, 2012) discussing President Franklin Roosevelt’s reservations about the longer term implications of Social Security should not be surprising. In 1932, FDR ran as the more market-oriented candidate against interventionist Herbert Hoover. FDR was also reluctant to sign legislation creating the Federal Deposit Insurance Corporation legislation, stating in 1932: “It would lead to laxity in bank management and carelessness on the part of both banker and depositor. I believe that it would be an impossible drain on the Federal Treasury to make good any such guarantee.”

Today, that moral hazard problem has metastasized into a government safety that extends to massive corporations and large institutions — crop insurance for farmers, stimulus and bailout funds for corporations, pension guarantees, and so on.

Now that system is collapsing. It will not be easy to move from a politicized economy to market discipline, but the fact that corporate America has largely moved from defined benefit to defined contribution pension plans illustrates the robustness of the market to adjust. Hopefully, those such as Paul Ryan who recognize this fact will gain the audience within Congress and the administration to achieve the reforms that will be necessary.

CSR: Business’s Shampoo?

by Fred Smith on February 28, 2012

in Economy

To the Editor, Financial Times:

Gillian Tett notes the vogue among CEOs for “corporate social responsibility” (When Making Shampoo Becomes a Service to Society). CSR is a response to those demanding business assume responsibility for ending pollution, poverty, income disparities, discrimination, and the other ills of the world. As Tett notes, charging business with CSR is a back-handed complement.  The critics have more confidence in business’s abilities than they do in governments’.  But, should business accept this assignment? Will the CSR shampoo really wash those attacks right out of business’s hair? Market tests say no.

The marketing notion that the customer is always right — useful in enhancing brand reputation — has mistakenly been transmuted to politics — our critics are always right. CSR has been around for decades yet attitudes toward business have not improved.

CEOs might examine the approach of the American Plastics Council. In the early 1990s, plastics were blamed for threatening the environment and human health. APC responded with the “Plastics Make It Possible” campaign, marketing the myriad societal benefits of plastics. Rather than apologize for what they do, CEOs should seek to clarify that capitalism and its products and services are not only good for “me” but for “all of us.”

Fred Smith, President
Competitive Enterprise Institute

Michael Greve’s recently released, The Upside-Down Constitution, traces the evolution of federalism in of our Constitution. He persuasively documents the transition from competitive federalism (a Constitution that protected the citizenry from exploitation by government at all levels) to today’s cartel federalism (one that empowers governments at all levels to exploit the citizenry).

One of several factors that encouraged this upheaval was the Progressive notion that competition encouraged a “race to the bottom”: relentless pressures to maximize profits would force businesses to employ abusive practices (such as child labor). An interesting argument that we still hear often today. It remains the basis for national and international regulation in fields ranging from global warming to religious freedom to human rights: Economic freedom leads to loss of egalitarian justice; political rules encourage a fairer world. But is it true?

Greve provides data on the extent of child labor in the period 1880 to 1930 (p. 188). In the early Industrial Revolution, child labor constituted 6.4 percent of the work force, a figure that began to fall by the turn of the century, reaching 1.4 percent in 1930. He notes it was not until 1938 (by which time child labor had largely disappeared) that federal regulations were enacted. Rising wealth allowed families to forgo putting their children to work (as did the shift away from agricultural employment) and that wealth also led to some prohibitory state rules.

In a world where states must compete for citizens, values other than profits are advanced. There is no race to the bottom. If anything, there is a race to (not the top; utopian ideals are not the stuff of reality) ever higher rungs on the ladder of human progress.