Sunday, October 26, 2008

Bureaucratizing Wall Street

I heard a radio morning show in which the DJ's and their callers were outraged over a Wall Street firm that received bailout money from the US government, then sent its executives to a posh spa for a retreat that cost tens of thousands of dollars. Everyone was outraged over this irresponsible behavior. To the people on this show, here was evidence of the fundamental cause behind the financial crisis: corporate greed. The fat cats only care about themselves and that's why America is in trouble.

My reaction is different. Let's say you give a man $10, and he spends it irresponsibly. He buys cheap wine and cigarettes and spends the night in foggy dissipation. It seems to me you can reach one of two conclusions:

1. I should not give this man any more money.

2. In the future I must watch this man carefully to make sure he spends the money I give him well.

Private individuals should choose #1. Once you give someone money, it is his property. You have no power to force him to do what you want with the money. If you continue to give money to someone who wastes it, whose fault is that?

The government always chooses #2. Unlike private individuals, the government has the power to force people to act as it wishes. Not only will it watch how Wall Street spends the money the government "invests," but it will pass laws dictating what can and cannot be done with the money. With the money will come regulation.

As Ludwig von Mises explains in his brilliant little book, Bureaucracy, government has to use regulation because it is not driven by the pursuit of profit.

In the private sector, everyone pursues one goal: make a profit. A chain store does not need a bookshelf full of regulations directing store managers on how to pursue profit. Within a few simple rules such as employee uniforms and corporate image, the individual store manager is left alone to solve the problem of making a profit.

In the public sector, however, functions such as police, courts and military are not motivated by the pursuit of profit. Thus the government must write books of regulations telling employees in detail what they must do in every situation.

To the extent to which government subsidizes the financial sector, that sector becomes a government agency. Its function becomes part private and part state. Wall Street firms that take government money will have two purposes: to make a profit and to do what the government wants.

Supposedly, the government is spending a trillion dollars to keep firms from going bankrupt. In theory all this money should go toward the pursuit of profit. But watch how this government involvement grows in the coming years. The government is not driven by the pursuit of profit, but by other concerns, such as altruism, collectivism and the public good -- not to mention giving money to pressure groups in order to buy votes. Government will force Wall Street to cater to its concerns, not just to pursue a profit.

Look for a big push in the coming years to turn corporations into mini-welfare states. This trend goes back to the 1940's, when employers sought to get around confiscatory income taxes by giving employees "free" health insurance. Tying insurance to work was a disastrous unintended consequence of high taxes.

Making corporations do welfare state functions is the fascist way to socialism. Mises, writing in 1944 when the Nazis still existed, describes the totalitarian end of turning entrepreneurs into bureaucrats:

The Nazis have succeeded in entirely eliminating the profit motive from the conduct of business. In Nazi Germany there is no longer any question of free enterprise. There are no more entrepreneurs. The former entrepreneurs have been reduced to the status of Betriebsführer (shop manager). They are not free in their operation; they are bound to obey unconditionally the orders issued by the Central Board of Production Management, the Reichswirtschaftsministerium, and its subordinate district and branch offices. The government not only determines the prices and interest rates to be paid and to be asked, the height of wages and salaries, the amount to be produced and the methods to be applied in production; it allots a definite income to every shop manager, thus virtually transforming him into a salaried civil servant. This system has, but for the use of some terms, nothing in common with capitalism and a market economy. It is simply socialism of the German pattern, Zwangswirtschaft. It differs from the Russian pattern of socialism, the system of outright nationalization of all plants, only in technical matters. And it is, of course, like the Russian system, a mode of social organization that is purely authoritarian.

It's hard to imagine America getting this bad, but according to Mises it's just a matter of time before interventionism ends in totalitarian control of the economy. Intervention leads to crisis, which leads to further intervention, which leads to further crisis, which leads to... you get the idea.

"Socialism of the German pattern" has an added, irresistible benefit to politicians: they evade responsibility. They dictate to corporations what welfare state programs they must enact, but when things go wrong, the politicians blame the greedy corporations. As long as the corporations are driven in part by the profit motive, they are immoral to altruists. With each new crisis, the capitalists, "blinded by greed," will always be blamed, as noble altruists such as Hillary Clinton and John McCain preen about how they just want to help the little guy.

But there will be other unintended consequences of forcing entrepreneurs to behave like bureaucrats -- so many that it would take a book to be comprehensive. To look at just one more, Mises writes,

To say to the entrepreneur of an enterprise with limited profit chances, “Behave as the conscientious bureaucrats do,” is tantamount to telling him to shun any reform. Nobody can be at the same time a correct bureaucrat and an innovator. Progress is precisely that which the rules and regulations did not foresee; it is necessarily outside the field of bureaucratic activities.

The virtue of the profit system is that it puts on improvements a premium high enough to act as an incentive to take high risks. If this premium is removed or seriously curtailed, there cannot be any question of progress.

The more capitalists are forced to follow regulations, the less progress and innovation we will have.

This trillion dollar bailout of Wall Street will prove to be more costly than just the money involved. The financiers should have declined the money, saying, "No thanks -- we can't afford it." The greatest cost will be our liberty.


Benpercent said...

Absolutely excellent analogy. I will remember this for conversations.

John said...

"The financiers should have declined the money, saying, 'No thanks -- we can't afford it.'"

I'd just like to mention in passing that there were some banks that _did_ refuse the money.

In true authoritarian fashion, they weren't given a whole lot of choice in the matter. It was, in effect, "you take our (The tax-payers) money and thus submit to our changes, or else."

Galileo Blogs said...

I agree on the profundity of Mises' little book, "Bureaucracy." It is far more than an exposition of the principles that distinguish the operation of bureaucratic from entrepreneurial firms. It is a powerful argument against regulation, which bureaucratizes entrepreneurial firms.

The new regulations affecting Wall Street will have serious repercussions, as they have in all other hyper-regulated segments of the economy. Think utilities, insurance, and medicine.

Apollo said...

How can you make the legitimate functions of the governemnt(police, courts, military, executive,legislative, judicial branches) effient?

Galileo Blogs said...


You can't make these functions efficient by free market standards. Because government must provide these services, and because they must do so as legal monopolies, they can only be managed according to bureaucratic principles. They can be as efficient as a bureaucracy can be and no more.

mike18xx said...

GB, I reject the premise that a government "must provide th(o)se services".

Myrhaf said...

The more free an economy is, the more bureaucracies can use the market as a guideline to help them be efficient. They can look on the internet and see that toilet seats run $49.95, and maybe they should not pay the $600 per toilet seat in the latest defense contract. But if some politician is intent on buying the votes of everyone who works in the toilet seat factory in his district, he will probably insist on paying $600.

The important thing is to get the government out of the economy and expand the market sector. This is the only way to minimize government waste.

Anonymous said...

The notion that government spending derived from taxes can be rational and responsible, when that money is procured through theft and extortion, is absurd.

It's easy to spend other people's money, especially when you've got a loyal police force and legal system between yourself and your victim.


Elisheva Hannah Levin said...

This is an excellent essay, Myrhaf.
It explains in a sensible way why what has happened did happened, and it makes clear to us what is coming.