Do Capitalists Produce Nothing?
The subprime crisis left many Americans wary of financial markets and capitalist financiers. In his recent speech President Obama blamed Wall Street, and to a lesser extent Main Street, for the 2008 crisis. According to this speech, Washington bears little or no responsibility for the 2008 crisis.
Obama is not alone in blaming Wall Street for the state of the economy. Chris Matthews recently vented his own anger toward financial tycoons and free enterprise. According to Matthews, our system gives the largest rewards to the least productive people: hedge-fund investors. The most successful hedge-fund investors made two to four billion dollars last year.
According to Matthews, these investors create nothing real, "not steel, not cars, not computers, not even movies"; they only make money for themselves. The gains of these investors supposedly come from the working poor and middle class who live paycheck to paycheck. Matthews has misled his audience in this matter.
Some of these hedge-fund investors lost money in 2008, so their long-term gains are not as high as they might seem. However, this fact does not negate Matthews's basic argument about transfers. What does Matthews see as the solution to the alleged problem? He has high hopes for the new financial regulations that Congress will vote on this year.
Is Matthews correct? Should government increase regulation of all financial markets to get back at the most successful hedge-fund investors? Given the assumption that these investors make literally nothing, the correct measure would be to expropriate their unearned income. If Matthews had really thought things through, he would have joined Marx in condemning at least these capitalists. Of course, if Matthews had thought things through, he might have also realized that his assumption that hedge-fund investors produce nothing is never true.
Investors have two functions in modern economies. First, they defer consumption to invest in future production. The only reason that workers are able to produce steel, cars, or anything else is that someone saved and invested in real capital equipment in industry.
Most everybody saves some money in one way or another. However, a disproportionate amount of investment in capital comes from a relatively small number of wealthy persons who refrain from spending their fortunes. Without the capital accumulation achieved in modern capitalism, people would not be living from paycheck to paycheck as workers, but from harvest to harvest as peasants.
Deferring consumption might be regarded by some as easy. Billionaires can live well on only their dividend and interest income. This argument is a non sequitur, as rewards in markets derive from results rather than from efforts. The fact is that most contemporary Americans save and invest a small percentage of their income. We need capitalists to expand their portfolios to finance investment in real capital. To the extent that hedge funds are invested in productive capital, these investors earn their incomes.
Capitalists also perform the more challenging and controversial task of predicting future trends in the economy. The composition of any investor's portfolio is determined by their expectations as to which investments will pay the highest returns. This is a challenging task because market trends are hard to predict. Bill Gates saw the potential for developing Windows software. Henry Ford saw potential in developing automobile assembly lines.
Hedge-fund investors are not so directly involved in developing actual products, and this is perhaps the main source of Matthews's confusion. Stock investing is not a pure monetary transfer. Stock investors earn money by pressuring executives to plan production efficiently. Bond investors also earn money by pressuring executives at leveraged companies. Commodity investors earn money by ensuring the incomes of farmers, miners, and other people who manage the production of "real goods."
Investors do not produce any actual physical product; they make the planning of production more rational. The efforts of "workers who produce real goods" are wasted if production plans are defective. Matthews does not see how successful capitalists can shift production toward goods that consumers want most urgently. Profits derive from the sale of goods that garner the highest revenues from consumers over costs. Few people can predict market trends. Investors can earn or lose billions because their decisions determine whether the work of millions of ordinary people is productive or a waste of time.
The idea that wealthy investors earn their fortunes is controversial, but not because the role of capitalists in a free market is in doubt. Matthews refers to the American economy as a free-enterprise system. Given the tone of his comment, it would seem that he is not completely serious.
David Tepper made four billion dollars investing last year. Tepper bet that the state would bail out many banks and the insurance giant AIG. This was a lucrative investment, but it did come at the expense of a broad segment of American society. The bailouts that enriched Tepper did not actually come at the expense of workers, but from taxpayers. With an income-tax system, taxpayers are workers, but that is not the main point. Matthews framed the hedge-fund issue as a worker-versus-capitalist problem that could be remedied by government regulation.
Matthews seems to half-realize that the government made Tepper richer with its bailouts. Yet he wants to blame Tepper for taking taxpayer-funded bailout money, but not the government for giving this money away in the first place! Worse still, Matthews trusts the institution (the federal government) that handed out taxpayer money to Tepper, among others, in order to provide a solution to the problem that it caused by regulating financial markets.
Matthews might argue that these incomes are unearned, but he is still wrong in his characterization of this activity as unproductive and purely monetary. Bailouts and corporate welfare encourage excessive risk taking and outright waste. To the extent that capitalists like Tepper participate in the subsidization of industry, they are not merely transferring income: they are causing the planning of production to deteriorate.
If Matthews understood the economics of public policy he would see how regulations and bailouts create perverse incentives for management. Investors who lobby for intervention do not just make money. Stock investors make money from capital gains during booms financed by the Federal Reserve, and can also profit by selling short if they anticipate the Fed raising interest rates. Shrewd investors can profit from any type of intervention, but this is not a pure money transfer.
Booms, busts, and bailouts correspond to inefficient production plans. To the extent that capitalists lobby for intervention that distorts markets, they help produce defective production plans. This is not just an income transfer to a few investors but an overall loss of economic efficiency. Hedge-fund investors are already thinking about how they can profit from new regulations, and Matthews is facilitating the process by which they can increase their ill-gotten gains.
Matthews says that we nicely call this system, which gives billions to those who produce nothing, "free enterprise." He could not be more wrong. All capitalists produce something. Capitalists who improve production plans serve the needs of consumers and produce economic progress. This is how the system that we accurately call "free enterprise" actually works. Capitalists who participate in the redistribution of wealth through government policy produce disruptive production plans and economic waste. That is how the system that we accurately call "crony capitalism" works.
The idea that capitalists produce purely monetary transfers is nonsense. All incomes affect production in either a positive or a negative way. Hedge-fund investors either earn fortunes through private speculation or help to disrupt production through state intervention. Of course, we can't simply blame hedge-fund investors for intervention. Media personalities who, like Chris Matthews, advocate intervention are almost certainly more responsible for these problems than are hedge-fund investors.
Obama offered a few positive remarks about financial markets in his speech. Unfortunately, Obama seems to embrace the utterly unrealistic view that regulation of executive salaries and bonuses is necessary for the free operation of financial markets. Worse still, Obama seems unaware of both the role that Federal Reserve Bank regulation of interest rates and the monetary base played in financing the subprime boom and bust, and of the numerous Federal policies that promoted subprime lending.
The biased and confused perspectives taken by Matthews and Obama lead both of them to see federal regulation as the way to prevent future crises, rather than as the primary cause of past crises. The good news is that Matthews merely expresses an uniformed opinion, one that likely has no real consequence. The bad news is that Obama is all too capable of transforming his opinions into real public policies.