Welcome to the Terminal Value Podcast
Feb. 15, 2021

#23 The Future of Capitalism with Mike Munger

#23 The Future of Capitalism with Mike Munger

Doug and Mike talk about the current dynamics of capitalism in reference to his book: 'Is capitalism sustainable?'

The core conflict Doug and Mike discuss is the fundamental conflict between public policy and private enterprise whereby there is an adverse incentive for business leaders to take advantage of government programs that are not broadly beneficial, but produce narrow benefits.

The core conflict is that if these managers do not participate, their board of directors have every incentive to replace them with other managers who will.

Doug's business specializes in partnering with companies and non-profits to create value and capture cost savings without layoffs to fund growth and strengthen financial results. 

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Welcome to the terminal value Podcast where each episode provides in depth insight about the long term value of companies and ideas in our current world. Your host for this podcast is Doug Utberg, the founder and principal consultant for Business of Life, LLC.

Doug: Okay Welcome to terminal value podcast. I have Michael Munger on the line here. This is actually a little bit of a moment for me. Because I have actually been a long time listener to the econ talk podcast. Where Mike has been a regular and recurring guests and one of my favorite guests of course. I think one of the first episodes I listened to was with Milton Friedman and well you know it's hard to compete with Milton Friedman. But Mike here is a world-class okie dokie guy and he has written actually a number of books. But the one that I wanted to talk about today just as a part of the conversation is his book is capitalism sustainable. Because I’d like to talk about really what the future of capitalism looks like. And Mike I’d love to get your thoughts or just kind of tee up the conversation. But just what I’m seeing is that you know I think what people call capitalism really isn't capitalism. People think of capitalism as what we have in America and that is not the furthest thing from capitalism because you know for a work trip recently, I went to China and Shanghai. Let me tell you that is very far from what we have in America. But still it's what we have now is very not a free market. There are any number of things that are very tightly controlled and not allowed to freely float, largely just because of people's political fears. And so  what I would love to get your input on is how does this project forward into the future? And is there a way that we can get to that vision of greater prosperity and opportunity for everybody. That capitalism pretends but has a very hard time delivering on due to the externalities and inevitable inequalities. So I’ve talked enough, please share your thoughts.

Michael: We make a distinction to begin with between markets and capitalism. So markets is a system of allocation and production that uses prices as signals about the relative value of resources. And one of the things that's complicated about large societies is that they have to have institutions to reconcile all of the conflicting plans and purposes of individuals. So I think I want to open a restaurant, you think you want to open a factory. We both want the same piece of land to do it, who should get it now? We could have a political process and vote on it, we could have some bureaucratic process. But in a market system then whoever will pay the most for it, must be about to create the largest value for society. So if I can use it for a restaurant and I expect the profits to come to that restaurant. Allow me to pay more for the property. Then you are going to make a cement factory and it’s not really going to produce that much profit. So profit is a price, it is a signal about the relative value of the activity to society. Because it says something about the consumer surplus that's being created. Which is the value to the people that buy it. I think something we often miss is that entrepreneurs actually capture only a small amount of the value that they create.  I get profits but everybody who buys this product and all of my suppliers all of these contracts are voluntary. So I go and I buy labor. I go and I buy steel. I buy electricity, buy plastic and each person I contract with is made better off. And then I sell it in a competitive market to consumers and they're better off. So I’m creating value all over the map and then profit is the signal that there's actually even some revenue left over after I do. That it's amazing! It is an amazing decentralized system that old people used to call cybernetics. Because you're creating wisdom out of no one knows whether this is a good product or not. Nobody knows if this is a good. So the system is wiser than any individual element. The magical part about markets is that we're creating value, we're creating the highest value for all of the resources all down the line. That's great! Now you started to say something I interrupted I’m sorry oh.

Doug: I was just going to say the I think the and I’m of course very sympathetic to that point of view. Because I think that you know involuntary transactions nobody should ever enter into any transactions unless it's mutually beneficial. However, in the current environment that happens all the time. So the question is going to be  A.) Why and then. B.) How do you get back to a mutually beneficial exchange type of idea? Because the other thing I’d just like to bump what you were saying a little bit, is that because the thing that the profit motive actually does really well that a lot of people don't appreciate is that it provides signals about what types of businesses are good and bad for people to be in. And they don't have to know a lot about the internals of their business, they just know if they're losing money they need to do things either do things differently or get out of that business. And if you're making money that says you must be at least be doing something right because you're generating a profit after paying all the costs.  But anyway enough for me talking.


Michael: Well without you, you have emphasized some important aspects. So that's a market system and you could argue that in the United states we don't even really have a market system because a market system requires that prices be unfettered and unregulated in order to give the accurate signals about the relative values of resources. So If we have things like rent controls, then what that is saying is that in a large city, we don't value new housing very much. And so it's no surprise at all to learn that New York and San Francisco, the two American cities who have the most rent control are those where the shortage of affordable housing is the greatest. Because they're not allowing markets to signal to entrepreneurs, you know we really need more housing and the only way that you can get more housing is if people will build it. But, we have these rent controls and we have a bunch of restrictions on building new houses. So it is true that markets are also restricted. Okay, full stop that's what markets are. China is a market system. It's really interesting that China is largely a market system. They have some regulation of price. What China is not is the other thing, which is a capitalist system. Capitalism is something that can only exist in a market system but it's something else. Capitalism is a system of distribution based on returns to property of a particular sort called equity or stock, that is the joint ownership of large amounts of value that we call corporations or companies. A way to raise capital is to sell things that are literally called shares. Their stock that allow me to have a stake in the future profitability of this company and we can only raise enough capital to be able to invest enough. If we can find private investors who say you know I’m going to risk my money on this. Now, you can have markets without capitalism and china is a good example of that. And in fact if you look at Deng Xiaoping in 1973 said “you know we're losing of the international arms race, we're becoming weaker, we're going to have to institute markets.” It wasn't because he was a free market guy far from it but he recognized the essential feature of increasing the productivity. And the amount of value that goes to citizens that comes from using the price signaling mechanism, particularly in such a large society as China. So being able to give accurate decentralized signals that coordinate all of these conflicting plans and purposes it's a genius move. And so China and India they're moving right along together. Xiaoping says in 1973 let's have markets and China has been a remarkable success story ever since. The amount of poverty in china has fallen from 80 percent to below 10 percent. If you use constant international standards, China is one of the great market success stories in the history of the world. Now capitalism is a hard thing to sustain because we have a lot of questions about capitalism as a system of distribution. So here's the fly in the ointment for the story that I told before. So I have an entrepreneur and they've sold stock in their company. Now they have a lot of stockholders and those stockholders are interested in profits and as far as the stockholders are concerned their definition of profits is not the one that I gave before. The signal that the activity is socially valuable, what they're interested in is increasing the amount of revenues that are left over after costs are paid. Now one way I can do that is to make cheaper and better products and hire engineers, hire sales people and provide better service. But there's another way that I can do that particularly in democratic society, I can hire lobbyists and lawyers and I can pay US senators to say “You know it seems like you're really having a difficult time why don't we give you money or you're having a difficult time why don't you protect why don't we protect you from those rotten awful competitors because it'll be possible for you to make a lot more profits now.” So the question is at some point mature businesses almost always come to the point where it is more profitable. And I’m making air quotes which I realize is great podcast. But I’m making air quotes when I say.

 Doug:  We're going to video stream this one too, so the people who are watching on YouTube will get to see the air quotes.

Michael: In that case I’m making profits in the sense that I’m getting to keep a lot more of the excessive revenues that I’m earning, as a result of government protection. But then the whole story Doug that I told is gone. None of the social value is being created. What I’m doing is selling stuff to the state and I’m paying bribes. Those bribes could be legal in the form that their campaign contribution they could be I invest in your district, I put a plant there's no economic reason for me to have a manufacturing plant in your district except that you're the chair of a key committee and you're going to ensure that I get protection from competitors and subsidies. If I make a loss you will make it up. So the result is that there is a really bad tendency in capitalism towards a perverse form of capitalism called cronyism. So here's the thing that about five years ago I realized so for example I have always been a critic  of socialism and I teach at Duke University. So I know a lot of people who are not critics of socialism, they are worshipers.

Doug: Yeah. I live in Oregon and I and I went to undergrad of Portland State. I am very familiar with the idea of socialism.

Mike: Well fair enough and socialism is a really good way because it means that the government cares about the people. I don't see any evidence of that but that's what people say. So I say look at Venezuela, Venezuela that's socialism and they say oh no that's not real socialism that's that something went wrong there real socialism that works really well. Well I'm doing the same thing when I look at the U.S system where we've got things like Solyndra, we've got companies that are investing in state protection I say oh that's not capitalism that's cronyism. But Doug what if capitalism becomes cronyism in a democracy if it inevitably becomes cronyism in a democracy because it is more profitable to get state protection than it is to produce better cheaper products then my claims about capitalism are not sustainable and that means that many of the criticisms of the left are perfectly valid. Now I think for the wrong reasons they imagine socialism be better. It's not clear that's true, but it is actually true and this is disturbing capitalism has an inherent tendency towards cronyism and let me give two quick quick reasons why because;

Doug: That is extremely valid. 

Mike: Well but and it's within the context of capitalism too. So suppose that I'm the CEO of a large corporation and I have been trained in economics and I know that engaging in what economists call rent seeking is legal but morally wrong. So it is wrong for me to invest in state protection because that's not creating value and so I say I'm not going to do it and my stockholders say well uh actually we think you will. And there's a competitive market for managers and if you do not start a big lobbying operation to increase our returns you're going to be on the street and we're going to hire another manager who will. So the competitive market for managers means that they can find somebody else. Now, that's not outside of capitalism the competitive market for managers is an internal competitive process that will replace people who say it is immoral. I understand it's legal but it's immoral you're going to get CEO’s all of whom are going to engage in that kind of rent seat but suppose we can go one step further and say that stockholders say “you know, he's right. This is wrong.” Well I'm a corporate raider and I look at your company and I see that your stock price is probably 10 to 12 percent undervalued compared to what it could be if we would engage in lobbying. And so I go to a bank and I say look there's this company that's 12 percent undervalued. I can show you why if you loan me 20 million dollars I can pay you back tomorrow. So we issue a 10:10 10-year offer. We buy up the stock, we fire the management and the stockholders are happy to sell I mean they have may have this moral view but you give me a 12 premium. I'll sell the stock, I fire the managers and now the stock price rises because we are behaving rationally. We're behaving badly in the sense that we're harming the society we live in but we are exploiting the fact that lobbying is legal but immoral. So competitive market for managers and the market for mergers and acquisitions are inherent in capitalism there's nothing outside there's nothing perverse there's nothing about the state that says that has to happen.


[Sponsorship Part]

Doug: Hey there everybody, I'm just taking a quick break here to tell you about the sponsor for this episode. So this episode of the podcast is actually sponsored by podcorn. Now for those of you who don't know, podcorn is actually a podcasting sponsorship platform so if you go over to podcorn.com what you will see is you'll see opportunities for either brands to sponsor podcast episodes or for podcasters to promote brands in exchange of course for sponsorship revenues this is actually really great platform for a couple of reasons:

  1. What it does is it really makes it possible to monetize your podcast in a pretty frictionless way the platform is very easy to use and;
  2. It  really helps niche brands to be able to reach audiences that are a lot harder to target by mass media and a lot of times will be really expensive so it's really a win-win all the way around.

So if you've ever had any interest at all in podcasting definitely check out podcorn.com. I hope you have a wonderful day and we'll get you back to the show now. 

[Back to the show]

Mike: So Karl Marx would say “It's an inherent contradiction of capitalism.” And I actually think he has a point. Marx was wrong about the way a socialist society would work. But Marx makes a pretty good point about the way a capitalist society works to the extent that it can find government to be helpful. Many regulations benefit the regulated industry more than it benefits consumers.

Doug: Pretty much all regulations benefit the regulated industry more than they benefit consumers.

Mike: My final point on this is suppose you think that's not true. Suppose you think that regulation starts out benefiting consumers. Before long the government realizes that there's a lot more money in corporations than there are in taxpayers. So what we can do is basically have a protection record. So I have a friend John Allison, who was the head of BB&T bank. A large regional bank in North Carolina. And in about 2006 they had realized that mortgage-backed securities were a bad bet. And so they had completely unwound their position. They had divested themselves of all the mortgage-backed securities. So 2008, 2009 come around and his bank BB&T they're doing fine they don't need a bailout. So they get a visit from the securities and exchange commission in the treasury department because this is 2009 and their story was you know this wasn't really the bank's fault this was a pathology of capitalism we're going to use the toxic asset relief program and take money from taxpayers and give it to large corporations that made stupid risky investments. It's pretty hard to explain if it was just stupid risky investment but if it's a pathology of capitalism okay we understand it. And John said look we didn't have any toxic assets so we don't need a relief program. Take your tarp and go and they came back with a more senior official who looked around and said “you know it would be really a shame if something was to happen here you know like a fire maybe an audit who knows how these things get started.” 

Doug: Just for the sake of the younger listeners. Mike was just doing an impression of Marlon Brando and the godfather..

Mike: I'm trying to do a..

Doug: proverbial offering interviews.

Mike: It's a protection racket. So they show up and say either you take toxic asset relief program funds, or we are going to audit you and we're going to ruin your company and so he ended up saying “okay I'm fine. Give me money. I don't need it but, okay.”

Doug: Go find it you can pay a hundred cents on the dollar for my garbage go ahead.

Mike: The state wants companies to be croniest. And if they try to refuse the state has guns, the state has auditors, the state can force...