Property Rights & Adam Smith

Week 2

Five Mysteries of Capital

Hernando de Soto

Hernando de Soto Interview

Part 1.http://www.youtube.com/watch?v=tYe7lbT-I8A&feature=related

Part 2http://www.youtube.com/watch?v=sgcAMCy2zyI

The Mystery of the Missing Information

Charitable organizations have so emphasized the miseries and helplessness of the world's poor that no one has properly documented their capacity for accumulating assets. Over the past five years, I and a hundred colleagues from six different nations have closed our books and opened our eyes—and gone out into the streets and countrysides of four continents to count how much the poorest sectors of society have saved. The quantity is enormous. But most of it is dead capital.

The Mystery of Capital

This is the key mystery and the centerpiece of this book. Capital is a subject that has fascinated thinkers for the past three centuries. Marx said that you needed to go beyond physics to touch "the hen that lays the golden eggs"; Adam Smith felt you had to create "a sort of waggon-way through the air" to reach that same hen. But no one has told us where the hen hides. What is capital, how is it produced, and how is it related to money?

The Mystery of Political Awareness

If there is so much dead capital in the world, and in the hands of so many poor people, why haven't governments tried to tap into this potential wealth? Simply because the evidence they needed has only become available in the past forty years as billions of people throughout the world have moved from life organized on a small scale to life on a large scale. This migration to the cities has rapidly divided labor and spawned in poorer countries a huge industrial-commercial revolution—one that, incredibly, has been virtually ignored.

The Missing Lessons of U.S. History

What is going on in the Third World and the former communist countries has happened before, in Europe and North America. Unfortunately, we have been so mesmerized by the failure of so many nations to make the transition to capitalism that we have forgotten how the successful capitalist nations actually did it. For years I visited technocrats and politicians in advanced nations, from Alaska to Tokyo, but they had no answers. It was a mystery. I finally found the answer in their history books, the most pertinent example being that of U.S. history.

The Mystery of Legal Failure: Why Property Law Does Not Work

Outside the West

Since the nineteenth century, nations have been copying the laws of the West to give their citizens the institutional framework to produce wealth. They continue to copy such laws today, and obviously it doesn't work. Most citizens still cannot use the law to convert their savings into capital. Why this is so and what is needed to make the law work remains a mystery.

Hernando de Soto

• What does he think poor countries should do?

• What is the connection between property rights and capital formation?

• What are the criticisms of his approach?

Question of culture …

One of the things that always scares me is that secret little argument, not even intellectual argument, that little prejudice that is not only in the minds of Westerners, but is also in the minds of elites of developing countries and people that take decisions, that the reason the capitalist system doesn't work is because culturally we're not ready for it, whatever the word "culture" means. It may even have racist implications. What we're saying is well, maybe it's true. Maybe the capitalist system does work much better with Protestants and whites. Maybe.

Experiment …

But before that, let's take away all these enormous legal obstacles that poor people have to face. Let's take away all the ignorance around law and let's put good law into place and then we'll just see whether it works or it doesn't. We're absolutely convinced it does work because people are actively [conducting] enterprise all over the world. The thing is, they can't make long-term contracts, and because they can't make contracts, they can't obtain credit, and they have no way of constituting a company that can issue shares, therefore they have nothing to sell against investment. That's the reason it doesn't work. I don't think it's cultural at all.

Limited Liability

What role does it play in capital formation?

What is the downside of limited liability?

Are corporations socialist institutions?

Gordon Gekko: Greed is Good?

http://www.youtube.com/watch?v=tqOUlBXrzik&feature=related

Role of limited liability.

Is this what Adam Smith meant?

Adam Smith (1723-1790)

Professor of Moral Philosophy at the University of Glasgow.

The Invisible Hand “ Every individual is continually exerting himself to

find out the most advantageous employment for whatever capital [income] he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to society. ...He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was not part of his intention.”

– Adam Smith, The Wealth of Nations (1776)

Invisible hand quotation from the Theory of Moral Sentiments

The rich consume little more than the poor, and in spite of their natural selfishness and rapacity, … though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants.

Along the same lines …

The capitalist engine is first and last an engine of mass production which unavoidably also means production for the masses. . . . It is the cheap cloth, the cheap cotton and rayon fabric, boots, motorcars and so on that are the typical achievements of capitalist production, and not as a rule improvements that would mean much to the rich man. Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within reach of factory girls.

J.A. Schumpeter, Capitalism, Socialism & Democracy

Das Adam Smith Problem

Theory of Moral Sentiments (1759)

How is moral behavior possible, if we are motivated by self-interest.

How do we reconcile two conflicting tendencies:

self-seeking vs fellow feeling

Bill Gates on “Das Adam Smith Problem”

http://www.istartedsomething.com/20080127/bill-gates-davos-world-economic-forum-2008-video/10:30

This week's Economist had a section on corporate responsibility, and it put the problem very nicely. It said it's the interaction between a company's principles and its commercial competence that shape the kind of business it will be.

The challenge here is to design a system where market incentives, including profits and recognition, drive those principles to do more for the poor.

I like to call this idea creative capitalism, an approach where governments, businesses, and nonprofits work together to stretch the reach of market forces so that more people can make a profit, or gain recognition, doing work that eases the world's inequities.

Some people might object to this kind of market-based social change, arguing that if we combine sentiment with self-interest, we will not expand the reach of the market, but reduce it. Yet Adam Smith, the very father of capitalism and the author of “Wealth of Nations,” who believed strongly in the value of self-interest for society, opened his first book with the following lines:

"How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunes of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it."

Creative capitalism takes this interest in the fortunes of others and ties it to our interest in our own fortunes in ways that help advance both. This hybrid engine of self-interest and concern for others can serve a much wider circle of people than can be reached by self-interest or caring alone.

Division of Labor

Pin factory example.

“The man whose whole life is spent performing a few simple operations generally becomes as stupid and ignorant as it is possible for a creature to become.”

Smith’s Recipe for Development

Prosperity requires little else … but peace, easy taxes, and a tolerable administration of justice.

Theme of the Wealth of Nations (1776)

The beneficial invisible hand.

The dangers of the visible hand of ruling elites, leading to mercantilism,

monopolies, tariffs, & special favors granted to business by government.

Corn Laws

Tariffs on grain imported from abroad.

Cui bono?

Public Choice Theory

Applying economic principles to the political process. Start with the assumption that public servants are self-seeking and rational.

Rent seeking instead of profit maximizing.

Pork barrel.

Logrolling.

THE IRON TRIANGLE

• The House and Senate agriculture committees form the first leg of this triangle. Lawmakers who serve on the committees tend to come from farm districts and are staunch defenders of agriculture. This allegiance to agriculture can make it difficult for other interests to be heard as the committees hold hearings and draft legislation on matters reaching far beyond crops and meat production.

• The second leg of the triangle is the farm lobby. The sugar industry and other farm-subsidy interests -- peanut, tobacco, wheat, and so on -- act as a lobbying bloc to preserve all agricultural price-support programs. They are also big campaign contributors.

• The third leg of the triangle is USDA, a massive, sprawling department with a budget of roughly $60 billion a year and more than 100,000 employees. Critics have charged that the huge bureaucracy that administers farm programs exists to perpetuate itself.

• http://www.opensecrets.org/pubs/cashingin_sugar/sugar02.html

Smith on Corporations

With an immense capital divided among an immense number of proprietors, it was naturally to be expected, therefore, that folly, negligence, and profusion should prevail in the whole management of their affairs.