Objectivism & Politics, Part 35

Politics of Human Nature 19: Businessmen and the state. In the last post, I examined how economic interests can bias even businessmen against laissez-faire. In this post, I will examine another side of this issue illustrated by Rand’s tendency to rigidly divide businessmen into two classes: (1) competent businessmen who, like the heroes of Atlas Shrugged, make “their fortunes by their own personal ability”; and (2) incompetent businessmen who need government help to compete with their betters. Rand’s conviction appears to be that “It is only with the help of government regulations that a man of less ability can destroy his better competition"—and he is the only type of man who runs to government for economic help.

Is that really true? No, not at all. There is a third class of businessmen: (3) competent businessmen who use government as a source of additional capital. This class includes even those businessmen Rand singles out for praise for making their fortunes by their own personal ability, James Jerome Hill, Commodore Vanderbilt, Andrew Carnegie, and J.P. Morgan. Yet each of these men either took government funds or lobbied for funds or supported measures which involved transfers of money to the business class. Early in his career Hill took advantage of several government land grants. For instance, he attempted to reacquire a grant forfeited by a railroad company he had taken over. This grant had already been settled by farmers who, alarmed at the prospect of eviction, appealed to Congress. The dispute was resolved by merely giving Hill valuable timber lands in Montana and Idaho.

Vanderbilt's dealings with government were very complex. Local government in New York City was extraordinarily corrupt, and so bribery was a necessary part of doing business in that city—so in one sense you could argue that Vanderbilt had no choice but to engage in bribery. Yet it would be a mistake to argue, as Rand did, that Vanderbilt engaged in political chicanery merely for defensive reasons, to protect his legitimate interests. Vanderbilt, for instance, persuaded the city to pay him $4,000,000 to replace a dangerous section of his railroad with a tunnel. There are, in addition to this, many other government financed favors done for Vanderbilt of a more ambiguous nature, such as building streets that benefited Vanderbilt’s business interests.

Andrew Carnegie admitted "the single most important event" in prompting him to enter the steel business was the $28-per-ton tariff on imported steel, passed by Congress in 1870. J.P. Morgan, for his stead, rejected the notion of a pure free market, believing it would lead to “ruinous competition.” Morgan began his career selling faulty rifles to the army; and while his subsequent dealings with the government seem to have at least honored the letter of the law, it would be naive to conclude he achieved a Roark-like level of integrity in his affairs with the state.

Rand’s belief that only men of less ability go to the government for economic help is not supported by the facts. Regardless of their ability, entrepreneurs are always looking for ways to get their hands on capital. Their function is to “lead” the means of production into new channels—hardly a trivial task. Economic development did not arise due to capital accumulation or to increases in the quantity of labor. As Schumpeter explained more than a century ago: “The slow and continuous increase in time of the national supply of productive means and of savings is obviously an important factor in explaining the course of economic history through the centuries, but it is completely overshadowed by the fact that development consists primarily in employing existing resources in a different way, in doing new things with them, irrespective of whether those resources increase or not.” [Theory of Economic Development, 68]

So it’s not necessarily how an entrepreneur gets ahold of the necessary resources: it’s what he does with it once he gets control of it that counts. If he makes good decisions with his capital, it will create new products, new jobs, increase productivity, and lead to what is broadly described as economic “development.” In this, we see both the splendor and moral ambiguity at the heart of capitalism. An entrepreneur, a capitalist, a businessmen can enrich himself and help raise society’s general standard of living by resorting to methods that are not entirely honorable. As a zealous advocate of “capitalism,” Rand could not admit the seamier sides of free enterprise. To admit such a thing would hurt the cause. Moreover, Rand tended to resent the very notion of ambiguity, particularly of the moral variety. So she created her rigid division between the heroic entrepreneurs who never soiled themselves with the spoils of the state and the Wesley Mouches who required the state to keep their businesses from going under.

The willingness of even competent entrepreneurs to use the state as a means of raising capital and fending off "ruinous competition" adds yet another obstacle to finding support for laissez-faire. If Rand's vision of Capitalism were correct, we would expect to find the most zealous advocates of laissez-faire among prosperous businessmen. Is that what we find in reality? Not exactly. While most businessmen advocate free enterprise, the majority of them don't exactly embrace the "laissez-faire" version of free enterprise propagandized by Rand and her disciples. Nor should this be in the least surprising: for it is not always clear that laissez-faire is in the interest of the business class. The state is too rich a source of business and capital to be shunned altogether by the intrepid entrepreneur.

Objectivism & Politics, Part 31

Politics of Human Nature 15: Sociology of the Intellectual. In the essay “For the New Intellectual,” we find Rand insisting that “the need for intellectual leadership was never as great as now.” Where is this “intellectual” leadership to come from? Rand imagines a “New Intellectual” who “will be the man who lives up to the exact meaning of his title: a man who is guided by his intellect.” The “New Intellectual,” Rand promises, will end “the rule of Attila and the Witch Doctor.” How will intellectuals do this? According to Rand, they have to do a number of things, such as: (1) Adopt a philosophy of “reason”; (2) reunite and become a champion of businessmen; (3) understand the nature and the function of the free market; (4) discover the theory and the actual history of capitalism; (5) prove and accept two principles: a.”that emotions are not tools of cognition”; and b. “that no man has the right to initiate the use of physical force against others.” [FNI, 59-64]

Now anyone who understands human motivation will recognize immediately that Rand’s views about the power of intellectuals are little more than wishful thinking. For the purposes of this post, however, I’m not interested in analyzing that side of Rand’s view. I would prefer, instead, to focus on Rand’s assumption that any significant number of intellectuals can be expected to do the things Rand wants them to do. Those of us who understand the “sociology of the intellectual,” as Joseph Schumpeter described it, regard intellectuals as one of the very last groups in society which we would wish to trust our fortunes to. "Beware intellectuals," warned historian Paul Johnson in his incendiary exposé, Intellectuals (Harper Perennial, 1990). "Not only should they be kept well away from the levers of power, they should also be objects of particular suspicion when they seek to offer collective advice."

Let us now examine the “sociology of the intellectual,” as limned by Joseph Schumpeter:

Intellectuals are in fact people who wield the power of the spoken and the written word, and one of the touches that distinguish them from other people who do the same is the absence of direct responsibility for practical affairs. This touch in general accounts for another—the absence of first-hand knowledge of them which only actual experience can give. The critical attitude, arising no less from the intellectual’s situation as an onlooker—in most cases also as an outsider—than from the fact that his main chance of asserting himself lies in his actual or potential nuisance value, should add a third touch.

Note particularly Schumpeter’s remark about “absence of direct responsibility.” When discussing intellectuals, this is critical in several senses. As I have stated in previous posts (for example, here), there are some domains of knowledge that can only be mastered by intensive experience. Intellectuals often have little, if any, appreciation for this fact. They often think they can attain mastery in a subject merely through reading or rationalistic speculation (i.e., “reason”), when, as a matter of fact, nothing less than experience will do. And since most intellectuals lack the requisite experience, they are not in a position, nor are they in the least qualified, to judge on matters relating to politics, social policy, and economics.

But there is another potentially serious problem: what happens when society produces too many intellectuals? What happens to all the intellectuals who cannot earn a living through their intellectual skills? As Schumpeter explains:

The man who has gone through a college or university easily becomes psychically unemployable in manual occupations without necessarily acquiring employability in, say, professional work. His failure to do so may be due either to lack of natural ability—perfectly compatible with passing academic tests—or to inadequate teaching; and both cases will, absolutely and relatively, occur more frequently as ever larger numbers are drafted into higher education and as the required amount of teaching increase irrespective of how many teachers and scholars nature chooses to turn out. The results of neglecting this and acting on the theory that schools, colleges, and universities are just a matter of money, are too obvious to insist upon….

All those who are unemployable or unsatisfactorily employed or unemployable drift into the vocations in which standards are least definite or in which aptitudes and acquirements of a different order count. They swell the host of intellectuals in the strict sense of the term whose numbers hence increase disproportionately. They enter it in a thoroughly discontented frame of mind. Discontent breeds resentment. And it often rationalizes itself into social criticism which as we have seen before is in any case the intellectual spectator’s typical attitude toward men, classes, and institutions… Well, here we have numbers; a well-defined group situation of proletarian hue; and a group interest shaping a group attitude that will much more realistically account for hostility to the capitalist order than could the theory—itself a rationalization in the psychological sense—according to which the intellectual’s righteous indignation about the wrongs of capitalism simply represents the logical inference from outrageous facts and which is no better than the theory of lovers that their feelings represent nothing but the logical inference from the virtues of the beloved. [Capitalism, Socialism, and Democracy, 147-153]

There are other considerations that also have to be broached. If you examine the works of intellectuals through history, the results are not always terribly edifying. Indeed, the more an individual devotes himself exclusively to an intellectual life, the greater the chances that he will champion ideas based on irresponsible speculation and wishful thinking. Plato, one of the earliest men to devote himself almost exclusively to intellectual pursuits, is typical in this respect. We also see something along these lines in the Pythagorean cult, in the mania for abstruse theology among the Christians, in the pre-Kantian rationalist philosophers (particularly Leibniz and Wolff), in the idealist and Hegelian philosophers, and in the deconstructionists. Whole forests have been destroyed to promulgate views contrary to good sense and the facts of life.

Rand wished to place the lion’s share of the blame for all this rationalistic wishful thinking on Plato and Kant. Yet even if it were true that Plato and Kant are the primary culprits, we would still have to ask ourselves why so many intellectuals are attracted to rationalistic, wishful thinking. Could it be that the very type of individual most attracted to an intellectual life is, generally speaking, also the type of individual most alienated towards reality? Or could it be that the intellectual life tends to attract weak people, who look at a life of irresponsible speculation as a convenient escape from the rigors of a more active existence? Realism about the world requires strength; yet strength cannot be acquired merely by thinking. Strength is not, as the logic of Objectivism implies, a product of an individual’s premise. Changing a person’s premises will not transform the coward into a hero. The life of the mind may prove a poor and shoddy breeding ground for developing strong individuals. Perhaps only the exceptional individual can develop both strength and intellect, so that the number of strong, reality-orientated intellectuals will be too small to count in any significant way. If so, then Rand’s hopes for a new intellectual appear doomed from the start. The intellectual, by his lack of experience and practical responsibilty, by his unemployability and rationalized resentment, and by his tendency toward weakness and wishful thinking, will tend, by the very nature of his vocation, to entertain an intractable bias against capitalism; and no amount of arguments or premises can alter this fact.

Objectivism & Politics, Part 22

Politics of Human Nature 7: Psychology and social type of the businessman. Ayn Rand imagines a polity where entrepreneurs and capitalists are free to do as they like. But where is this freedom supposed to come from? Who is going to defend it? Can merchants and industrialists, capitalists and entrepreneurs be counted on to defend their freedom from threats, both foreign and domestic?

Not according to Joseph Schumpeter. In order to defend freedom, one must be able to lead men in battle. But this is precisely where the typical entrepreneur-businessman, dominated, as he is, by Pareto’s combination instinct, tends to fall short.

There is surely no trace of any mystic glamour about [the industrialist and the merchant] which is what counts in ruling men, [wrote Schumpeter in Capitalism, Socialism, and Democracy.] The stock exchange is a poor substitute for the Holy Grail. We have seen that the industrialist and merchant, as far as they are entrepreneurs, also fill a function of leadership. But economic leadership of this type does not readily expand, like the medieval lord’s military leadership, into the leadership of nations. On the contrary, the ledger and the cost calculation absorb and confine.

I have called the bourgeois [i.e, the businessman] rationalist and unheroic. He can only use rationalist and unheroic means to defend his position or to bend a nation to his will. [In other words, the businessman is not good at using or applying force, so he must use his wits, just as Pareto warned.] He can impress by what people may expect from his economic performance, he can argue his case, he can promise to pay out money or threaten to withhold it, he can hire the treacherous services of a condottiere or politician or journalist. But that is all and all of it is greatly overrated as to its political value. Nor are his experiences and habits of life of the kind that develop personal fascination. A genius in the business office may be, and often is, utterly unable outside of it to say boo to a goose—both in the drawing room and on the platform. Knowing this he wants to be left alone and leave politics alone.

Again exceptions will occur to the reader. But again they do not amount to much…. The inference is obvious: ...the bourgeois class is ill equipped to face the problems, both domestic and international, that have normally to be faced by a country of any importance…. [W]ithout protection by some non-bourgeois group, the bourgeoisie is politically helpless and unable not only to lead its nation but even to take care of its particular class interest. Which amounts to saying that it needs a master. [137-138]

Now Schumpeter wrote these words in the late thirties, when capitalism was clearly on the defensive. Many defenders of capitalism were frustrated with the inability (or unwillingness) of businessmen to defend capitalism against attacks from both the fascist right and the socialist/communist left. Rand herself seems to have at least had an inkling of some of the issues raised by Schumpeter; for we find her, in Atlas Shrugged, going out of her way to cast the businessmen in the role of a quasi-Nietzschean superhero, with the dollar sign replacing the Holy Grail; and we also find her formulating a theory to explain why businessmen failed to adequately defend themselves: the “sanction of the victim,” wherein the victim (i.e., the businessman) accepts the morality of his enemies (i.e., altruism) and hence deprives himself of the moral high ground.

Is Rand’s explanation plausible? Not really. There are, it should be clear, far more plausible explanations for why businessmen fail to defend themselves. In the first place, where individuals have some choice in their vocation, this very choice serves as a selective or screening process, since individuals tend to choose vocations that best fit their innate talents. So those who combine intelligence with the ability to delay gratification and the willingness to put in long hours of work will not only feel themselves drawn to a career business, but, even more importantly, such individuals will be more likely to succeed in such an endeavor. And given the extensive division of labor in an advanced industrial society, the tendency is toward specialization in the development of one’s abilities and talents, so that individuals who devote most of their time to business activity (as they often must to succeed), end up developing only those skills useful in business at the expense of skills that might be useful in other endeavors, such as skills of political or military leadership. Hence the processes of societal selection under capitalism produce a class that is not particularly adept at defending its own interests.

Nor is it merely the man of force and violence, the marauder and plunderer, that poses a threat to the productive classes. There is another type of individual who arises in advanced civilizations who also can cause serious problems to a free, market-orientated social order. This individual goes by a number of names: socialist, humanitarian, progressive, idealist, social democrat, altruist. Rand was particularly concerned with defending the businessmen from this specific social type. In the next series of posts, I will examine the extent Rand’s analysis of the humanitarian syndrome accords with the facts.

Objectivism & Economics, Part 16

Dishonesty, cheating, and theft. A recent study by the Josephson Institute found that 30% of today’s teenagers admit to having shop lifted in the last two year; that 42% said they lie for monetary gain; that 83% confessed to lying to a parent about a significant issue; and 64% admit to cheating in school over the past year. This sort of behavior is not, unfortunately, confined to teenagers, but afflicts all of society. In 2004, U.S. companies lost $4.7 billion to shop lifting and employee theft.

Corporate fraud remains a huge problem, despite the burdens imposed by the Sarbanes-Oxley regulations. Private equity firms, for example, aggressively buy up companies on the pretext of making these enterprises more efficient, yet statistics demonstrate that far more looting goes on than “value creation.” Subprime lending often was spearheaded by predatory mortgage brokers who made big promises to unsophisticated borrows only to charge immense fees and high interest rates further on down the road. Many of the financial instruments spawned by hedge funds have the whiff of fraud about them. Bad debt is mixed with good debt to create collateralized mortgage obligations (CMOs) which are then sold with triple A ratings, the good debt being used to conceal the bad debt. Then we have all the big news items in the corporate world: Enron, WorldCom, Madoff, etc. It doesn’t make for a particularly edifying spectacle.

Various explanations are given for the rise of dishonesty, cheating, and theft in America. Some blame it on secularization; some on the “greed” and “over-competiveness” of free enterprise; some on the decadence and demoralization caused by living in a wealthy society; some on the failure to discipline and instill self-control in young people. What do orthodox Objectivists blame it on? Consider Alex Epstein’s and Yaron Brook’s take on corporate scandals:

The common explanation that "greed" is to blame makes no sense--the abuses in companies like Enron and WorldCom were not exercises in self-interest, but in self-destruction. The shareholders of these companies lost huge amounts of money thanks to corporate mismanagement--mismanagement reflected by plummeting stock prices long before any scandals broke. Why did they tolerate incompetence for so long?
The reason lies in existing regulations that prevent shareholders from acting in their own interest. Anti-hostile-takeover legislation (passed in 1968 and reinforced by a myriad of state regulations) has made it difficult and costly for shareholders to replace incompetent management, thus allowing bad managers to get rich while driving companies into the ground, à la Enron. Arcane regulations passed in the 1930s limit the ability of the most knowledgeable shareholders to be involved in the board and therefore in decision-making. For example, financial entities, such as pension funds, insurance companies and mutual funds that own large stock positions in corporations, are either prohibited or strongly discouraged by law from board participation. Bankers who possess the financial resources and knowledge to take large positions in companies and promote rational corporate governance (as J. P. Morgan did at the turn of the century) are not allowed to do so.

As would be expected, Epstein and Brook blame government regulation. Is there any merit in their claim? No, not much. Several problems immediately come to mind. Note the dates of the regulations mentioned: the 1930s and 1968. Forty years ago in one instance, over seventy in the other. If these regulations are the prime culprits behind the rise of corporate fraud in recent years, why didn’t they lead to more fraud when they originally passed?

Be that as it may, it is unlikely that government regulations play a major role in shareholder power. The corporation, by dividing ownership into bits and pieces, creates institutional incentives that effectively empower management at the expense of ownership. As Schumpeter put it:

The capitalist process, by substituting a mere parcel of shares for the walls of and the machines in a factory, takes the life out of the idea of property. It loosens the grip that once was so strong—the grip in the sense of the legal right and the sense that the holder of the title loses the will to fight, economically, physically, politically, for “his” factory and his control over it, to die if necessary on its steps.

If you are simply one owner among hundreds, you’re not likely to go any great lengths to defend your “interests.” Indeed, you probably won’t even know about the incompetence of management until it’s too late. After all, that is normally what corporate fraud is all about: to conceal incompetence in management by “cooking” the books.

Brook and Epstein also complain of “complex and contradictory rules” which “encourage bad accounting.” But is that really what happened with Arthur Anderson and other accounting firms that are guilty of fraudulent accounting? Not according to insiders.

One reason for [the failure of accounting] is the well-known problem of conflict of interest [writes Richard Bookstaber, the well known hedge fund manager]. Accountants have a financial incentive to be on the company’s good side so they can keep their mandate. This conflict was the main reason for the erosion in the quality of financial reports over the course of the 1990s.

Brook and Epstein insist that “Rational managers have an incentive to provide accurate information to shareholders--it establishes their credibility and reputation and allows them to raise capital when needed.” This observation, however, misses the point. The problem is that, in contemporary financial markets, the risks are so great and the rewards so immense that it is possible for a manager to make huge amount of money at first only to lose huge amounts later on. Corporate fraud often arises from trading strategies that make huge amounts of money in the short run only to lose huge amounts in the long run. If a brokerage firm that has reputation for making enormous profits hides recent losses, how is anyone to know that the managers are incompetent? Their record seems to state otherwise; and until the fraud is exposed, they will continue to be seen as brilliant. It’s only after the fraud is exposed and investors have lost billions of dollars that the market punishes the fraud. Yet by then it’s too late.

Brook and Epstein conclude:

In an unfettered free market the desire for profit is satisfied by honest, long-range, rational behavior: by innovating, by hiring the best employees, by selling quality products and by providing accurate information to the owners of the corporation--shareholders. As for short-range managers, the markets will not tolerate them. As for the real swindlers, existing laws against force and fraud are sufficient to protect us.

The issue is not whether markets tolerate “short-range managers.” Markets do in fact tolerate such managers in the short-run—but that gives the managers plenty of time to inflict serious damage on financial markets. And when these same “markets” punish such short-term strategies, the greatest victims are never the managers, but the shareholders and investors. In the end, we have to reject the notion that markets, by themselves, will make people honest. Whatever the cause of the epidemic of cheating, dishonesty, and thievery that afflicts our society, such behavior places capitalism at risk. To paraphrase Edmund Burke: It is ordained in the eternal constitution of things, that men of dishonest minds cannot be free. Their mendacity forges their fetters.

Objectivism & Economics, Part 15

Schumpeter’s challenge. The economist Joseph Schumpeter created quite a stir in the forties when he warned that “the capitalist order tends to destroy itself.” Schumpeter issued this warning despite his belief in what he described as “the impressive economic and the still more impressive cultural achievement of the capitalist order and at the immense promise held out by both.” Capitalism would destroy itself because it would undermine its own “protecting strata” and “institutional framework.” One of the reasons he gave for this pessimistic assessment seems rather prescient in relation to the current economic crisis:

Capitalist activity, being essentially “rational,” tends to spread rational habits of mind and to destroy those loyalties and those habits of super- and subordination that are nevertheless essential for the efficient working of the institutionalized leadership of the producing plant: no social system can work which is based exclusively upon a network of free contracts between (legally) equal contracting parties and in which everyone is supposed to be guided by nothing except his own (short-run) utilitarian ends.

In one sentence Schumpeter has put his finger on the greatest flaw of capitalist order. Contrary to what Rand and her followers believe, “rational” self-interest is not an entirely benign psychological force. Rand’s faith in self-interest (and it is only a faith) is not warranted by the facts. In the first place, it is absurd to regard human desires and sentiments as rational. A desire or sentiment can only be criticized in reference to an opposing desire or sentiment. As Spinoza famously put it: “an emotion cannot be destroyed nor controlled except by a contrary and stronger emotion.” Consequently, rationality, as an ideal, can only apply to the means by which desires and sentiments are satisfied. Yet this is not all. Even if there were (per impossible) such a thing as a “rational end,” it is very doubtful that very many human beings would be interested in pursuing it. If we make history and experience our guide in such matters—and whatever guide could possibly lead us to the truth besides history and experience?—then we are forced to conclude that the majority of human beings are largely non-rational in their conduct and are probably not even capable of being rational about any issue in the least complex (as rational methods of analysis tend to break down when applied to complex situations). When Schumpeter talks about “rational” habits of mind, he is not writing in the Randian sense of the word. He means something more along the lines of rationalism—i.e., the belief that no doctrine is true unless it can be proved “verbally,” through clever patter and other exercises of blatant sophistry. As a consequence of this sort of perfervid rationalism, individuals no longer believe in “higher” values or “lofty” moral ideas. Short-term self-interest and “immediate gratification” become the main desideratum, with sophistry being brought in to give the whole thing a window dressing of moral justification.

We see this played out in the financial sector. The birth of complex financial instruments based on computer generated formulas has allowed finance capitalism to mask what ultimately amounts to a vast ponzi scheme which yields huge profits in the short-run but ends in bankruptcy and dishonor. This sort of finance capitalism fits into what is known as the “Minsky cycle”:

Firms participating in the early stages of the cycle typically are not leveraged; Minsky called them hedged firms because their cash receipts cover their cash outlays. The success of the first movers draws in additional players. Speculative firms then engage in leverage to the point where they must borrow to meet some of their interest payments—usually borrowing in short-term markets to finance higher-yielding long-term positions. None of this is irrational behavior; market players are chasing short-term gains, and some of them are getting very rich.

The final stages of the Minsky cycle arrive with a proliferation of Ponzi firms, which must borrow to meet all their interest payments, so their debt burden continuously increases. At some point, a disruptive event occurs, … and markets abruptly reprice—the further along in the cycle, the more violent the repricing. [Charles Morris, The Trillion Dollar Meltdown, p. 133-4]

In other words, what we find in the world of high finance is a system which, by giving individuals the hope of huge rewards in the short-run, encourages them to behave in a ways that are destructive in the long-run. It takes strength of character to resist such huge short-run gains. Unfortunately, the very success of capitalism tends to create a prosperous society that weakens the moral fibre of individuals. Add to this situation the tendency of individuals—particularly intelligent individuals—to cloak their real motives under a thick shroud of ingenious rationalizations (e.g., “portfolio theory,” the “efficient market hypothesis,” “laissez-faire” ideology, etc.), and we have all the elements required to create market failure leading to widespread and socially harmful externalities, as can be readily corroborated by examining the 2008-2009 financial crisis.

Objectivism & Economics, Part 12

Objectivism and Austrian Economics: entrepreneurship. Richard Salsman is on record for criticizing von Mises’ “(absurd) theory of the essentially-passive, arbitrage-chiseling entrepreneur (and ‘the consumer is king’).” Now this issue has been a bone of contention between Austrain economists and Objectivists for several years. Nearly eight years ago, Mark Skousen, a prominent exponent of free market ideology and Austrian economics, penned a mildly critical attack of Rand’s view of entrepreneurship and what he describes as Rand’s “strange, distorted view of the money-making process.”

[Rand’s hero from her novel The Fountainhead, Howard] Roark denies a basic tenet of sound economics--the principle of consumer sovereignty... [T]he goal of all rational entrepreneurship must be to satisfy the needs of consumers, not to ignore them! Discovering and fulfilling the needs of customers is the essence of market capitalism... In short, Howard Roark's [view of the customer] is irrational and contradicts a basic premise of Rand's Objectivist philosophy. For Roark, A is not A. He wants A to be B--his B, not his customer's A. Thus, Ayn Rand's ideal man misconceives the very nature and logic of capitalism--to fulfill the needs of customers and thereby advance the general welfare. As Ludwig von Mises writes in his book, The Anti-Capitalist Mentality, "The profit system makes those men prosper who have succeeded in filling the wants of the people in the best possible and cheapest way. Wealth can be acquired only by serving the consumers." (1972:2) Apparently Howard Roark doesn't believe in consumer sovereignty. As he states in his final court defense, "An architect needs clients, but he does not subordinate his work to their wishes." (1994:714) Really?

So who is right about this issue? Is Salsman and Rand right that the entrepreneur should never "subordinate" his work to the wishes of his clients? Or is Skousen and Mises correct in their emphasis on consumer sovereignty?

Although Rand and Salsman are clearly guilty of exaggerating and over-stating the case, their view comes a tad closer to the truth than the Skousen-Mises position which over-emphasizes consumer sovereignty. Although few if any entrepreneurs would succeed if they were as inflexible and uncompromising as Howard Roark, it is entrepreneurial leadership and not consumer sovereignty that is critical in advancing a capitalist economy. As economist Joseph Schumpeter explained in his classic The Theory of Economic Development:

[Although] we must always start from the satisfaction of wants, since they are the end of all production, and the given economic situation at any time must be understood from this aspect, yet innovations in the economic system do not as a rule take place in such a way that first new wants arise spontaneously in consumers and then the productive apparatus swings round through their pressure. We do not deny the presence of this nexus. It is, however, the producer [i.e., the entrepreneur] who as a rule initiates economic change, and consumers are educated by him if necessary; they are, as it were, taught to want new things, or things which differ in some respect or other from those which they have been in the habit of using.

Of course, in educating consumers, the entrepreneur does not have unlimited scope. It would be virtually impossible for any entrepreneur to educate consumers to prefer candles to light bulbs or black bread to meat. Consumer “wants” (rather than “sovereignty,” which overstates the case) remain critical. And so Skousen is right on target when he writes:

[The Fountainhead's] thesis is entirely unrealistic in the everyday world of commercial building. Occasionally a client values more the notoriety of living in a home built by a signature designer than getting what he really wants, but not many. Almost all of Rand's scenarios are extreme and idealistic, a strategy that works to sell novels, but does violence to all sense of reality. Normally architects work closely with the client and make numerous changes in order to fit the client's needs.

Objectivism & Economics, Part 4

Market failure: Greenspan’s testimony Alan Greenspan’s curious testimony before a House panel on Thursday brings forth a curious admission from the former Rand acolyte. According to an AP report:

Greenspan called the banking and housing chaos a "once-in-a-century credit tsunami" that led to a breakdown in how the free market system functions. Accused of contributing to the meltdown, but denying that it was his fault, Greenspan told a House panel the crisis left him -- an unabashed free-market advocate -- in a "state of shocked disbelief."

The longtime Fed chief acknowledged under questioning that he had made a "mistake" in believing that banks in operating in their self-interest would be sufficient to protect their shareholders and the equity in their institutions. Greenspan called it "a flaw in the model that I perceived is the critical functioning structure that defines how the world works." ...

Committee Chairman Henry Waxman, D-Calif., suggested that Greenspan contributed to "irresponsible lending practices" by rejecting appeals that the Fed intervene to regulate a surging subprime mortgage industry. "The list of regulatory mistakes and misjudgments is long," Waxman said of oversight by the Fed and other federal regulators. "My question for you is simple," Waxman told Greenspan. "Were you wrong?"

"Well, partially," Greenspan said. But [Greenspan] went on to assign the blame on soaring mortgage foreclosures on overeager investors who did not properly take into account the threats that would be posed once home prices stopped surging upward. He said what had been "a critical pillar to market competition and free markets did break down. And I think that, as I said, shocked me. I still do not fully understand why it happened."

After reading this, Objectivists can take consolation in the fact that Greenspan no longer considers himself one of their number—and perhaps never did. Yet his vision of the free market is not so very different from Rand’s. Self-interest, Greenspan believed, would be sufficient to motivate banks to act in such as to protect their shareholders’ equity. Apparantly not so—much to Greenspan’s confusion and dismay!

Greenspan would have done well to have heeded Joseph Schumpeter’s insight about the sociological flaws of a free market based on “self-interest.” “[N]o social system can work which is based exclusively upon a network of free contracts between (legally) equal contracting parties and in which everyone is supposed to be guided by nothing except his own (short-run) utilitarian ends,” Schumpeter warned.