In Praise of Failure
The stories are now legendary: internet hotshots going from riches to rags in a period of months, infallible stock-pickers with their reputations in tatters, and stock prices of established companies off 75 percent from their highs. The business press is now talking openly about the possibility that the bull market is over. We may be in for a long period of disappointing returns and falling net worth of individual portfolios heavily invested in stocks.
Maybe. In any case, everyone seems to agree that the dot-com shakeup on Wall Street is not all bad news. It has made individual investors more skeptical of internet hype, and venture capitalists more careful about where they put their money. If a web venture is not attracting customers, and its expenses continually outstrip its revenues and ability to raise money, it must reorganize or shut down. Any other option would require wasting resources on business projects that the market has shown to be of marginal worth.
Let's broaden the lesson. When people think of capitalism, they think of wealth and profits. But one of the main features of the market economy is its ability to generate losses and produce business failures. And just as some envy-filled politicians can’t sleep well knowing that profits are distributed unequally, others can’t bear the thought of business failure. In fact, both profit and loss have social and economic merit and should be allowed to take their market-driven course.
Agitation for laws against sudden plant closings were a staple of political rhetoric in the 1980s. We endured 70 years of bellyaching that "family farms" are being out-competed by corporate monoliths and foreign imports. Politicians still roam the land haranguing us about the catastrophic transformation of the industrial Midwest into the "rust belt."
But none of these trends produce disaster, any more than the failure of an internet startup causes social convulsions. The misery is sector-specific and temporary. The market adjusts because the free economy permits people to adjust to change on the upside and downside.
Immense damage can result from the attempt to stave off inevitable losses. Protectionism is the classic example. Businesses losing money attempt to shield themselves from foreign competition by keeping artificially high the prices consumers pay for goods and services. These higher prices are a form of taxation, and the protected industries are receiving the revenue. "Counter-cyclical" fiscal and monetary policies also backfire, the most famous example being the Hoover administration and the New Deal that followed, which, as Murray Rothbard showed in his classic study, actually prolonged America’s Great Depression.
Antitrust is another example. It is a form of regulation that comes to the defense of a marginal firm that is being out-competed by a more profitable firm. This is why nearly all antitrust cases begin with one business accusing another of malfeasance.
Perhaps the best example of industries that have failed is in the public sector. The second half of the life of the Soviet economy can be seen as an elaborate effort to keep failing industries alive. And in the US, the quality and efficiency of public schools have dropped every year for many decades, and yet they are not permitted to go out of business. The same is true for all government "services," which survive only because they aren’t subject to market judgement.
This is one of many reasons why converting Social Security taxes into a stock-market subsidy would be a big error. Anything over which the government claims an interest tends to be protected from losses, and that is particularly true of programs that affect powerful interest groups. SS funds invested in the stock market would be shielded against the kind of declines that have hit dot coms in recent months. This would be a step toward socialism.
And yet with the internationalization of stock and money markets, politicians have found that shielding companies and sectors from losses can produce painful results. Instead of producing profits, the attempt produces economic stagnation that does damage and only puts off the inevitable. International capital flows away from sectors and countries that are hiding behind walls of protection and interventionism.
Now, the left is oddly celebratory about these new trends among dot coms. It's ideological perversity: the left demands socialist profits and capitalist losses. But this is no better than the Business Roundtable's demand for capitalist profits and socialist losses. Both are inconsistent with the capitalist economic framework of freedom and responsibility.
And why do businesses fail? Many reasons. Their owners and managers fail to properly discern market conditions and consumers preferences, or they fail to anticipate changes in resource availability and tastes. Poor internal management can do a company in, and so can aggressive competition from companies who were drawn to a market segment in hopes of sharing in the profits.
One kind of unjust losses are those that are produced by political intervention. Companies saddled with absurd class-action lawsuits alleging "discrimination" end up closing operations that might otherwise have survived. Then there’s the outrageous attempt by the courts to bankrupt the tobacco and firearms sectors. This produces accounting losses, but it is the moral equivalent of burglary or arson.
"Greed is right," said Gordon Gekko in "Wall Street" (1987). "Greed works. Greed clarifies, cuts through and captures the essence of the evolutionary spirit." Fine. But the same can be said of business losses and failures. They are right. They cut through and clarify. And as much as profits, they capture the essence of a healthy market economy.