March 21, 2012

Some thoughts spurred by Goldman Sachs...

The bridge-burning op-ed by Goldman Sachs employee Greg Smith has spurred a great deal of commentary. But this blog post in particular piqued my interest. Some choice quotes:

"This is not how capitalism is supposed to work. This is not "creative destruction" -- Schumpeter's vision of entrepreneurs disrupting inefficient systems and profiting from making them better -- this is simply the enrichment of a few smart, lucky men at the expense of everyone else.
Theoretically, investment banks help allocate capital towards its most efficient use. They help governments and companies raise money, they help with mergers and acquisitions, and they create securities which should distribute risks or at least give clients more choices about the risks they take. But in reality, up to 80% of M&A; destroys value, opaque securities have created endemic risks in our society, and there are astounding conflicts of interests between clients and investment bankers -- the very same bank that is floating your company's shares has a long term relationship with the hedge funds who are purchasing the stock. Who is the bank really serving?
It's not clear what has caused this system or how to get out of it. It's not just because corporate boards want to use the "top tier" firms to avoid potential litigation: the Big Four audit firms have an oligopoly which they don't seem to be abusing to the same degree. Has capitalism changed somehow? Has America simply stopped creating real wealth in other areas of society so the only thing to do now is to constantly shuffle it around in Manhattan?

I have three things to say:

(1) Regarding "this is not how capitalism is supposed to work" that instead of "Schumpeter's vision of entrepreneurs disrupting inefficient systems and profiting from making them better", were left with "the enrichment of a few smart, lucky men at the expense of everyone else". Maybe it's not how capitalism is supposed to work in some idealized sense, but it's pretty evident that this is how it does work. The main economic allocator in capitalism, markets, are competitive realms, so while one can compete on honest grounds to profit, it's also possible (and arguably easier and far more common) to compete on _dis_honest grounds to profit (the elaboration of which sounds like the topic of its own blog post). Given that context, the rational response is to behave like a monster, seeking everything for oneself and nothing for anyone else, undercutting your opponents before they undercut you. And the most honed institutional form of that kill-or-be-killed ethos is the limited-liability corporation, like Goldman Sachs.

(2) "It's not clear what has caused this system". On the contrary, I think it is clear -- the result of selective pressures stemming from the sacrosanct status of markets. As mentioned above, markets tend to select those institutions like corporations that thrive in competitive realms. But the "winners" from that competitive realm can't behave nicely in internal operations, lest they get undercut by opponents in the market who don't behave like that. That's why markets also select for not only for psychopaths as institutions but those people who exhibit psychopathic behavior who also thrive in competitive realms. And when profit streams done by legitimate means dry up, those institutions (and the people in them) take on more extreme measures in order to get their profit fix.

(3) "It's not clear how to get out of it." I actually agree with part of this statement, but just one part. I think we know what the "it" in "how to get out of it" is -- get rid of markets and replace them with a more sane allocation system (I recommend the participatory planning system of participatory economics) -- so I disagree in that sense. But I would agree somewhat in that we don't know the full details of the how part -- what tactics to deploy in what combination to achieve "it". I have recommended various specific tactics, but they are all predicated on the idea of building awareness in one capacity or another and ultimately convincing enough minds so that we reach what recent research has found to be a minimum 10% threshold to achieving critical mass for an idea to take hold in a society. It could be a magic bullet, but it could (and likely would) also be a variety of approaches working separately or in tandem to help build that threshold.