Socialism and risk

Some time ago I ran across a video of Ben Shapiro responding to questions by a professed socialist. The discussion involved a hypothetical pencil factory, and the socialist asserted that the workers should distribute the profits and “own the benefits of their labor.” Shapiro responded that they get the benefits of their labor in the form of wages. The socialist countered that there was a disparity in bargaining power, then made the crucial claim that “without labor, all you have is a factory full of wood, graphite, yellow paint and aluminum.”

This last point is very illuminating. It apparently did not occur to the socialist to ask the question “where did the materials to make pencils come from? Why are they in the factory in the first place?” Nor did he seem aware of the possibility of the workers opening their own pencil factory and becoming owners themselves. This helps illustrate several key points regarding capital, risk, property, government, compensation and what nobody.really refers to a “rents.”

1.) There was risk involved in starting the pencil factory. Whoever undertook to procure a factory, buy the raw materials and hire a work force took risks: that he might not be able to obtain the raw materials at a reasonable price; that someone would open a competing pencil factory across the street; that the demand for pencils might decrease; that his business might be regulated out of profitability, etc. The owner took these risks for the possibility of economic return. He put capital at risk, and if no one were willing to do so, there would be no need for the labor of the factory’s employees. Pension funds, venture capitalists, small business owners seek to profit from the same principle: there is value in reasonable risk-taking, without which there would be essentially no progress. Since progress is concerned with future conditions and the future is unavoidably uncertain, progress involves risk; no risk, no progress. Do not allow people to profit from assuming risk; no progress.

2.) The government plays a role in risk. It can provide incentives for incurring risk, such as allowing deductions for investment losses, or it can coerce people into taking risk, by for example taxing capital that is not invested. The government also plays a role in exacerbating risk (e.g. regime uncertainty) and mitigating it (e.g. protecting property rights.)

3.) The concept of property gives a good illustration of the interaction between capital, investment risk and government. Farmland can either be cultivated or left in its natural state. In order to make farmland productive, resources, including labor, must be expended on it with a degree of uncertainty that such resources will be lost. There will be uncertainty regarding weather, losses due to pests and disease, collapse in market prices, etc. One remote risk is that after the land has been fertilized, planted, irrigated, weeded etc. some one will move onto the land and harvest the crops for his own benefit. We are not usually concerned about this risk because the government protects property rights. The essence of property is the right to exclude others from it. If there were no such concept of property, the person who undertakes to cultivate, plant and tend the land would have considerably less incentive to do so; the concept of private property mitigates certain risks and therefore, as above tends to promote progress. Land owners, secure in their property interest have incentives to advance the capacity of their land to produce, and therefore to develop improved processes, the very essence of progress. The government by protecting property rights mitigates certain risks. The same applies to enforcement of contracts.

4.) Markets are effective mechanisms for matching risk taking with results of such risk taking. Individual market participants are much more efficient at matching economic opportunities with risk tolerances than are government functionaries.

5.) People may be compensated both for their labor, and for their adoption of risk. The notion that risk is an economic entity is illustrated by the existence of insurance, in which people are willing to pay to lessen their risk of particular perils. Appropriating the property of someone who acquires it through accepting risk has no greater legitimacy than appropriating the property of laborers. However, there is in fact wealth that is derived in excess of the risks incurred or labor expended. If the government agreed to make good the losses of a hedge fund, guaranteeing them risk-free investments, but that hedge fund was allowed to keep any profits it made, it might be reasonably argued that something was off-kilter. This is the classic unfairness of socializing risks and privatizing profits. A similar concept seems to affect people’s views of inheritance and windfall taxes, although in the case of the former, there is a philosophical issue regarding the right of decedents to provide for their heirs. In the abstract, at least, it seems to be non-controversial to “distribute” rents, i.e. that wealth that devolves upon a person with little or no labor, exchange for value, effort or risk.