President Trump’s inauguration featured a conspicuous display of billionaires. Elon Musk, Jeff Bezos, Mark Zuckerberg, Sergey Brin, Sam Altman, and a host of others, whose wealth collectively tops $1.35 trillion, attended the day’s festivities. Trump’s association with them did not end that day. He appointed thirteen billionaires to high office. I don’t even know thirteen billionaires! The ostentatious display of wealth and entrepreneurial talent feeds the conservative narrative that the Republican Party is pro-business and that business leaders are uniquely qualified to manage the economy. This belief is wrong.
At the heart of economics is a counterintuitive proposition first articulated by Adam Smith, which defines it as an academic discipline: that everyone, by pursuing their interests, ultimately results in the public good. Vilfredo Pareto refined this proposition, convincingly arguing that competitive markets yield an equilibrium, a stable point of production and consumption, in which no one can be made better off without making another worse off. There are strings attached. Markets must be complete, have perfect information, and have no externalities. I illustrate the implications of the theorem using a circular flow diagram, explaining that pro-market policies trump pro-business policies because they generate higher income, or, alternatively, higher-valued output. In short, pro-market policies yield a higher level of societal well-being for market participants. Economists are pro-market, not pro-business.1 Policy makers would do well to pay heed to this intuition.
The circular flow diagram assumes two types of economic
agents: households and firms (represented by the red ovals). Households own all
the resources, which economists generally categorize as land, labor, capital,
and entrepreneurship. Firms combine these resources into outputs categorized as
goods and services. Agents trade resources in the market for resources (represented
by the lower blue rectangle), and goods and services in the market for goods
and services (represented by the upper blue rectangle). The circular flow
diagram has two types of flows from economic agents to markets. The flow of
tangible objects, resources, goods, and services is represented by the orange
arrows, which move in a counterclockwise direction. The second flow is
financial. It records the payments for resources, goods, and services,
represented by green arrows moving clockwise.
Households take resources to market, illustrated by orange
arrow 1A. Firms take the resources from the market, illustrated by orange arrow
1B. The financial flow moves in the opposite direction. Firms pay households
for resources in the resource market; green arrow 2B shows the financial flow from
the firm to the market, and green arrow 2A shows the financial flow households take
from the market to the household. Each type of resource receives payment. Land
receives rent, labor receives wages, capital receives interest, and
entrepreneurship, which combines all the resources into goods and services,
receives profit. Household income, the sum of rent, wages, interest, and
profits, equals exactly the expenses of firms for the resource.
Having described the nature of the two flows between
economic agents in one market, I can be more succinct in describing the flows
between agents in the other market. Firms produce goods and services for markets
where households buy them. The orange arrows 1C and 1D illustrate the physical
flows, while the green arrows 2D and 2C represent the financial flows.
The flow of resources, goods, and services to markets and
the financial exchanges for them may seem routine and dull. It is anything but.
They are tumultuous. Joseph Schumpeter described them as the “perennial gale of
creative destruction.” Entrepreneurs want more than the profits earned in competitive
markets where they are unable to influence price. Their exertions create
winners and losers. Robots and AI continue to replace workers, who then struggle
to find remunerative employment. Burgeoning trade with China shuttered
factories in the Midwest but created jobs in technology centers near great universities,
such as those in Seattle, Silicon Valley, Boston, and Austin. Does anybody miss
Ma Bell? An antitrust settlement hamstrung her, and smartphones finished the job.
Market competition hampers the ethically challenged, but they
still manage to plague markets. Enron employed fraudulent accounting practices
to conceal debt and inflate profits. WorldCom’s CEO, Bernard Ebbers, inflated
profits by nearly $3.8 billion through capitalizing operating expenses. An
internal audit by Cynthia Cooper discovered and revealed fraud. Burdened by high
debt, the company filed for bankruptcy. BP’s Deepwater Horizon drilling well would
have given the company access to 50 million barrels of oil valued at $5 billion.
Shortly before the well went online, it failed a critical safety test. The company
covered up the failure, leading to an explosion that caused the largest oil spill
in U.S. history.
According to the First Welfare Theorem, total payments are
maximized when markets are so competitive that entrepreneurs must accept the
prices set by markets. When entrepreneurs set prices, they extract rents,
wages, and interest from the other factors of production. Income falls. Having
a government that does not keep an eye on entrepreneurs, and two as often as
they can, is bad enough. Giving entrepreneurs the reins of government is like
giving them the key to the candy store. Most entrepreneurs are honest, but they
tend to see all problems through the eyes of an entrepreneur. Entrepreneurs do
not need to run the government themselves. They can elect pro-business
politicians who share the same predilection to maximize profits at the expense
of other sources of income. The first welfare theorem compels economists to be
pro-market, rather than pro-business. Voters should demand that the government
at all levels be pro-market.
1. See the "About ProMarket" at ProMarket - ProMarket.
Posts
