Solutions Rooted in Sentiment always Exacerbate Bad Scenarios
As the story goes, America’s problems are rooted in its adoption of Capitalism as rubric for conduct of economic activities. In presence of stated assertion, there is arrival at the implication, which patently is false, that Capitalist Countries which care about income inequality, but yet are about as rich as America — Norway, Denmark, Finland, Netherlands, Sweden — do not exist.
If countries that combine Capitalism with regulation of Income Inequality are about as rich as America, and richer than most other countries, with ethical building of wealth as essence of Capitalism, can it be asserted that such countries are not fully Capitalist?
Perhaps, more importantly, we arrive at the following normative question, namely:
“Does Financial Economics Theory itself predict a Capitalism that differs from one which cares about Income Inequality?”
The Answer? No, financial economics theory does not predict only shareholders matter. Evidence and Explanation to follow.
Why you should trust my answer?
I will provide Evidence.
Why you should trust my evidence?
I am ranked in the top 10% of authors who conduct research in Finance, Economics, Innovation, Entrepreneurship, and Business in general on the most reputable research dissemination platform, the ‘Social Science Research Network (SSRN)’, which is owned by the most reputable name in academic publishing, Elsevier. Here is the link to my SSRN Author Page.
With 72 publicly available research papers and counting, already, with respect to aggregate output, I rank in the top 1% of all researchers in the field of Business. Lastly, I have myself conducted extensive research on rationality of capitalism. While researchers tend, at times to come up with different answers to the same question, when it comes to essence of capitalism, interestingly, inclusive of my research outcomes, all researchers who model essence of capitalism agree as to true essence of capitalism.
I have reputation at stake. The cost of being seen to be misleading far outweighs any benefits I can derive from this post.
Stiglitz (1972), Jensen and Long (1972), Leland (1974), Baron (1979), and Obrimah (2019) all agree that shareholders’ aggregate returns on investments ought to be arrived at only subsequent to determination of fair wages for labor and all other factors of capital (all references available in Obrimah (2019), which is referenced at end of this post). While some minimum return on capital always must be established, the premium that accrues to shareholders over and above that minimum ought to be a residual that is arrived at subsequent to determination of fair returns for labor and other factors of production.
Importantly, all of the cited studies agree that with shareholders investing funds at some time t, and expecting to generate long-run returns at some future time, t+n, that shareholders are guaranteed a positive return at time t+n only if they accept that the premium they earn on their capital is arrived at as a residual, as opposed to if they were to make a ‘take-it-or-leave-it’ demand.
Based on the evidence, Capitalism ought to care about minimum wages. Minimum wages for full time workers are required, by theory of Capitalism to be Living Wages.
Shareholder Value, in reality, embeds Living Wage Compensation for Labor.
For illustration, suppose the cost at which investors raise capital is deemed to be 8.00%. Suppose a decent economic return on the cost of capital is 4.00%. Combined, we arrive at a ‘minimum required return on capital’ to shareholders of 12.00%.
How it ought to be based on theory of Finance
Suppose at end of the financial year, a firm generates a pre-dividend, pre-labor -bonus performance of 18.00 percent. With 2.00% of returns allocated to bonuses for labor, investors end up with, in aggregate, a return of 16%, a return that embeds two-thirds of the return premium that was generated by labor. A return that also incorporates a doubling of the cost of capital, with outcome, investors earn a 100% return on their cost of capital. Is there any business in context of which a 100% return is deemed a meager return?
How it currently is practiced or implemented — Hedonistic Capitalism
Suppose, however, that investors pre-specify a return of 18.00% as a ‘take-it-or-leave-it’ demand on management of companies. In this scenario, labor is unable to earn a bonus. Suppose instead, pre-specification of a return of 20.00%. Then we have that the only way management is able to keep their jobs is to reduce compensation that accrues to labor, with outcome there is arrival at wages that are less of living wages.
You perhaps then sense the difference between America’s hedonistic, non-conforming version of Capitalism, and the Capitalism that is formally and theoretically motivated by scientific outcomes of research in financial economics.
In presence of America’s practice of a hedonistic Capitalism — such that persons who have to work so society can continue to function in context of a lockdown have to agitate for some additional compensation, as opposed to such compensation being freely offered — many persons in society have concluded that the problem with America is Capitalism.
The problem with consideration of Capitalism as America’s problem?
Just because a teenager chooses to soak his or her laptop in water in a bathtub, such that the laptop stops working, does not imply laptops do not work.
If America allows some people’s political agenda induce a knee jerk reaction that pushes the country into either of Socialism or Communism, the country will be the worse for it.
None of socialist countries, such as Spain, Italy, or France are as rich as either of America or the Nordic Countries — Norway, Denmark, Finland etc.
For arrival at economic prosperity, China had to augment communism in the political space with a moderated capitalism within its markets.
The Verdict? Based on the evidence, there is not any form of market theory that is working better than Capitalism that cares about minimum wages and income inequality, and that guarantees basic necessities of life for every resident and citizen.
Socialism seems America’s ‘sentimental’ solution to its current quandary, a solution that avoids dealing with the real heart of its problems. In this respect, when he asserts that America seems unwilling to take on the rich in order to create a lasting solution to America’s problems, Bernie Sanders is right. For concreteness, ask yourself this question:
Absent direct efforts to the effect, how exactly does Socialism imply arrival at minimum wages that are living wages when all it does is produce free college education that, simultaneously, in presence of the inflation that it fuels, and absence of college loans to pay off, ultimately, will result in deterioration to standards of living?
Can it really be argued that the rich ought to be more willing to agree to living wages for labor in context of Socialism, that is, lower returns on capital, as opposed to Capitalism? If the wealth of a country decreases — as must be projected in context of Socialism — labor may, perhaps, get a larger share of the smaller pie, yet relative to its prior state, may not be better off in the long-run.
When it comes to the real issues at stake, the political theory of government turns out to be irrelevant. Only efforts at tackling of economic challenges help make things better.
One of my research papers, Obrimah (2020) provides formal theoretical proof of irrelevance of Socialism to progress in economic development, that is, progress in welfare of individual agents living within a society.
Everyone knows in their hearts that Joe Biden will not take on the establishment. His manifesto already says as much.
But then, if at least he does not make things worse, and does not play faction politics, perhaps America can have another stab at formenting of true change in another four years. In this respect, note that ‘affordable health care for all’ is neither of a capitalist nor socialist agenda. Only in America people consign a basic right of human existence to context of political squabbling. Affordable health care for all is a human right, not a political agenda.
As the United Kingdom has discovered, if your economy is designed to function on incentives for innovation, free college education turns out to be inimical to objective of incentivization of economic agents to be innovative.
I have proposed a capitalist solution to the antecedent problem of college debt in a preceding Medium post, a solution that, if it makes him or her ‘happy’, has power to free up a kid with US$120,000 in college debt to work for a non-profit, or while working towards some artistic breakthrough in music, painting, writing etc., bartend without ever having to worry about his or her college debt.
Nordic Countries, such as Norway, Denmark, Finland do not run economies that are dependent on innovativeness of individual agents. In the enumerated countries, the State is arbiter of pursuit of innovation and fits its economic agents into such roles. In presence of such a structure, and the fact that incomes are regulated, with outcome everyone fit for a specific profession earns about the same wage, enumerated countries are able to pursue free college education.
Neither of America nor the United Kingdom have any such structure for pursuit of innovation. In America, an MBA from Harvard can make US$120,000 per year. An MBA from some lower tier university, perhaps no more than US$80,000 per year.
Does a Socialist America plan to strip Harvard of the premiums that currently accrue to its reputation? And does it have an alternate mechanism in mind for assessing quality of tertiary institutions?
Socialism seems America’s sentimental darling, the solution that places a band aid on the real issues at stake. Sentimental solutions always only make things worse.
Obrimah, O.A. 2019. Unexpected, Yet True, Value Maximization Is a Rational Behavioral, as Opposed to Rational Expectations Valuation Rubric. SSRN (Elsevier) Online Journal: http://dx.doi.org/10.2139/ssrn.3484299.
Obrimah, O.A. 2020. Income Inequality and Per Capita Income: Equilibrium of Interactions (March 12, 2020). Available at SSRN(Elsevier) Online Journal: http://dx.doi.org/10.2139/ssrn.3551909.