We all know the Samuel Goldwyn quote, “the harder I work the luckier I get”; as a personal maxim it has some considerable advantages over, “what will be, will be.” Capitalism revolves around the idea that control amasses to those who have done well. To some extent that ensures that the economy is governed by the competent. However it would be irresponsible and delusional to deny that the effects of personal effort are overlaid on a canvas of stochastic dumb luck. Serendipity is the backdrop to many a success and many losers are potential future winners. If we want our economy to best provide for all of us and make best use of every ones‘ talents, then we need to face up to this randomness.
Ole Peters has posted a fantastic video lecture about the nature of chance (bear with him past the grasshopper stuff). He describes a simple game where a coin flip decides whether the player gains 50% or loses 40%. Clearly winning gains more than losing loses BUT a subsequent win does not make up for a preceding loss and a subsequent loss loses more than was gained by a preceding win (1.5×0.6=0.9<1); that is the “magic” of compounding. This simple set up means that a large enough population of players will, in aggregate, steadily gain from playing the game but all of the winnings will randomly accrue to an ever smaller minority of players whilst almost everyone loses almost everything. Ole Peters points out that from an individual’s perspective playing such a game appears highly unattractive. A critical point to emphasize is that it is just as unattractive for a winner to continue with the game as it is for anyone else. A winning or losing streak does not influence the future. A rational winner would choose to stop and keep the winnings. If wins and losses are pooled and rebalanced across many players, then the game becomes universally attractive.
Perhaps this simple game has more similarity to real life than we care to admit. Starting an enterprise entails financial risks and from an individual’s perspective the financially prudent course of action is typically to hold back. However, if we do that, nothing gets done and we are all poorer. Perhaps much of the regulatory and legal framework of our financial system is an attempt to entice participation in the perils of enterprise risk so as to add to the overall greater good of society. Whatever lies behind how our financial system has come to be the way it is; I think it has lost its way. Limited liability and bankruptcy laws protect owners from the full financial consequences of bankruptcy. Winnings are kept but losses can be transferred to creditors. Ultimately the state subsidises credit provision to socialise losses whilst leaving profits with owners. This would all be very well if the only sort of risk being subsidised were true enterprise risk from potentially productive endeavours. We all need people to be making valiant attempts to create the next technological breakthrough or provide services in a more effective manner or whatever. The problem is that blindly subsidising financial credit and risk also encourages concoction of synthetic financial risk through use of financial leverage*.
The incredibly complicated to manage and idiosyncratic world of creative innovation or micro-enterprise is not an easy zone to park a vast fortune into. A vast fortune can however prosper very well in circumstances where enterprise risk is avoided and instead exposure is taken to the stochastic fluctuations of global asset and commodity prices. Then economies of scale favour the biggest players –it becomes more affordable to have market beating ultra-low-latency trading systems and to employ the best of the best to develop and operate them. Wealth deployed in that way however is not providing for the future; it is merely gathering money from other people in a zero sum redistribution towards the richest. Unfortunately leveraged speculation also exacerbates price volatility and that can have tragic real world consequences such as the starvation that occurred from the 2009 spike in grain prices.
In principle financial intermediation might be hoped to distribute risk and so create a situation where enterprise risk is readily taken on. The problem is that true enterprise risk is massively dependent on the details of what is being done. That is something that can only be assessed and managed by those intimately involved in each specific project. It is utterly unsuited for pooling across the whole economy. Large corporations have a tendency to only engage in cutting edge developments after it becomes clear that the most risky, initial stages are in the bag. When broader pools of funding for investment are available, it is all too often the case that genuine attempts at innovation become displaced by those cynically attempting to tap into a gravy train. There are plenty of ghastly anecdotes from the 1990’s tech bubble. One scientist told me about how a financier in the 1990’s tried to persuade him to start a biotech company. The financier was triumphantly boasting that none of the many companies he had started had any prospect of commercial viability and all investors had been conned. Even within large companies, it is very hard to keep cutting edge innovation on an effective focussed footing. All too often projects flounder in a way that wouldn’t happen if those involved all saw the project as theirs rather than the companies.
The mainstream view seems to be that innovation would best be fostered by facilitating concentration of wealth. I wonder whether the opposite might not be true. A universal citizens’ dividend could provide a necessary small measure of financial freedom that would help anyone who fancied to have a go at developing some innovation perhaps together with other like-minded people. The history of the 19th century industrial revolution is full of examples of very small groups of individuals tinkering away and making ground-breaking technological advances. Jean-Pierre Garnier then head of GSK has stated that, “The basic philosophy for modern R&D should be to morph big into small in recognition of the fact that critical mass in fundamental research is the size of one human brain.” To my mind that is an argument for ensuring that much financial power is also at the scale of each and every human. The key thing is that people having a go at developing an innovation whilst being partly supported by a citizens’ dividend would have a lot of skin in the game. Their time and money would be theirs and so they would be so much less likely to simply “go through the motions” in the way they might if they were simply following orders.
I also think the same principle applies to provision of everyday goods and services and not just to cutting edge innovations. In some circumstances it may be most efficient to supply say groceries through a huge supermarket chain but there are also certain efficiencies in having a dispersed small scale system. Currently, holders of outdoor market stalls selling food may be displaced by a supermarket not because they are less efficient or convenient but simply because a supermarket chain is more suitable for accommodating large scale impersonal financial investment. It might be argued that bank lending provides finance to small scale enterprises such as market stalls. However as Ole Peters so clearly demonstrates in his lecture, an enterprise financed in that way becomes dramatically more risky. The repayments are fixed but the revenue stream is subject to the variances of real life. That is why in the UK and USA the (relatively predictable and secured) purchase of pre-existing housing stock accounts for 80% of bank lending and banks are so wary of business lending. An asset tax and citizens’ dividend system might cause the economy to be conducted at whatever scale was most effective rather than having the current bias towards ever greater scale (this pdf describes such a possible economic arrangement).
*This subject is explored in further detail in the section “A zero interest rate policy does not reduce the financial overhead” on page 18 of this pdf.
Related material on the web:
Opaque and stinky logorrhea- Interfluidity and the many many links therein
Cutting Edge Capital Raising for Small Business – katovich (I added this link 11May 2013)
VC for the people -Interfluidity (link added 17April2014)