How Capitalism Will Save Us Page 8

  McMansions are a reflection of the fact that capitalism allows more people to enjoy luxuries once reserved for the rich. Isn’t that good—indeed moral? Over the last thirty years, free markets have made life better for people on all rungs of the social ladder. That doesn’t mean everyone will have the best of taste. The controversy over McMansions is emblematic of the social tensions that typically occur when large numbers of people move up the income ladder, causing discomfort to those both above and below.

  Should there be laws against McMansion building in a free market? We will see in chapter 5 that regulation of the free market often ends up producing unintended consequences. By restricting property sales and development, anti-McMansion laws can discourage prospective home buyers, bringing down property values in an entire neighborhood. Efforts to outlaw such homes have also been criticized for being arbitrary. Exactly how does one define a McMansion, anyway?

  The story of Ira Rennert suggests that not only can McMansions be excessive, but the passions against them can be, too. Since building his monster house, Rennert has faced a bruising bankruptcy of a subsidiary and the loss of millions to Bernard Madoff. Meanwhile people are less angry about his home. A decade later, some of those who once opposed it admit they got carried away. A local newspaper editor, Dan Rattiner, so regretted the brouhaha that he actually published a letter of apology. It turned out that the house was a family residence and not a religious retreat, as Rennert had contended. Rattiner acknowledged that, thanks to a “forest” later planted on Rennert’s property, even the most diligent curiosity seekers today can hardly see the place.

  Love ’em or hate ’em, McMansion building began to slow even before the housing bust. People are increasingly opting for quality amenities instead of sheer space. In other words, the very free market that critics blame for McMansions has begun to encourage higher standards and a cooling of the trend toward monster homes.

  REAL WORLD LESSON

  Prosperity can be socially disruptive as new groups arrive in communities and professions once reserved for established elites.

  Q CAN CAPITALISM BE MORAL WHEN CORPORATIONS RUN BY HIGHLY PAID CEOS LAY OFF THOUSANDS OF PEOPLE, DISRUPTING LIVES AND COMMUNITIES?

  A YES. PAINFUL THOUGH THEY ARE, EMPLOYEE LAYOFFS CAN BE CRITICAL TO A TROUBLED COMPANY’S SURVIVAL, AS WELL AS FUTURE ECONOMIC GROWTH AND JOB CREATION.

  Capitalism could not have seemed more brutal during the 2009 recession, with companies like Caterpillar laying off tens of thousands. “These days mass layoffs are sadly unsurprising,”39 Randy Cohen, ethics columnist of The New York Times Magazine, grimly acknowledged. But are they ethical?

  His view: “They are not, at least until more benign tactics have been exhausted. Caterpillar may not simply pile a bunch of unwanted workers into a van, drive across town, drop them on the doorstep of a flourishing company, ring the doorbell and run away.”40

  Cohen’s belief is shared by many—and it is especially understandable at a time of increased mass layoffs and high unemployment. Layoffs carried out by highly paid executives can be especially difficult for some to accept. University of Arkansas finance professor Craig Rennie found that CEOs who laid off employees between 1993 and 1999 got 13 percent more in total pay than the CEOs of firms that did not have layoffs.41

  Layoffs are immensely disruptive to lives, families, and communities. They seem cruel and unfair. And they are all of these things. However, not to lay off people means a company or industry may not survive—in either the near or the long term. And, sooner or later, there will be fewer jobs.

  We see this playing out today in the collapse and downsizing of the Detroit automakers. Their inability to lay off people is one of the reasons why GM and Chrysler ended up in bankruptcy in 2009—and why a government bailout was necessary to keep them alive.

  One widely acknowledged reason that the U.S. auto industry lost its competitive edge was the burden of billions of dollars of “legacy costs”—including union-pleasing programs that force companies to hang on to unneeded employees. The Wall Street Journal told of the Jobs Bank, a win-dowless room where employees who otherwise would have been laid off are paid six-figure salaries to sit idle. The program cost the auto industry as much as $2 billion annually.

  Traumatic though they may be, layoffs can often be the only way a company can survive in a competitive market. A corporation may have to cut its workforce after revenues decline in bad times. Or else it may need to reallocate resources—shut down one division so it can start a new one that requires a new workforce with different skills. Either way, the cuts protect the vast majority of jobs.

  Of course, not all layoffs succeed in saving companies. Even when they do, that may be cold comfort if you’re unemployed. So what if a layoff helps the guy sitting next to you keep his job? But if CEOs could not respond to economic conditions, you would be less likely to get another job because fewer new ones would be created elsewhere.

  The ability of U.S. companies to respond to a changing market and lay off people is one reason our economy is more flexible, better able to respond to change—and, as a result, a far more robust job creator than the sluggish nations of Western Europe. A study by the International Monetary Fund in 2000 found that “strong systems of job protection,” which make it more difficult to lay off people, tend to decrease a nation’s ability to create new jobs. The United States, with its flexible workforce, was far and away the biggest job creator. Nations with worker-protection laws, such as Germany and France, ranked on the bottom half of the list. Sweden was dead last. IMF researchers observed that America’s level of job creation was especially remarkable, considering the high level of low-skilled immigration to this country.

  [The] United States has truly experienced an employment miracle, creating many more jobs than needed to keep pace with population growth and bringing a dramatic decline in unemployment. Over the last 20 years the country’s ratio of employment to working-age population rose by more than 7 percentage points, despite sizable immigration.42

  Until the 2007–2009 economic slowdown, U.S. unemployment had been lower than in most developed countries.

  Allowing companies to lay off people during a recession can help a company bounce back and enable a downturn to end sooner. History provides numerous examples of corporations that have made major comebacks and hired new people after laying off thousands. One recent example: Boeing, which closed plants and laid off thousands in order to divert resources into the design and production of its 787 Dreamliner. Despite production delays, the plane has been a major financial success, possibly the biggest-selling plane ever, outselling competitor Airbus.

  An even more compelling example is IBM. For decades, Big Blue dominated the mainframe computer market and was enormously profitable. It was immensely powerful—the Microsoft or Google of its day. But in the 1980s the company faltered because of the rise of mini computers and PCs. By 1993, IBM had one foot in the corporate graveyard, having lost $16 billion in three years. A desperate board of directors brought in an outsider, Lou Gerstner, who had formerly turned around American Express credit card operations and RJR Nabisco. Among his moves, Gerstner laid off sixty thousand workers. He fundamentally changed the company. IBM became profitable and innovative. As the company’s fortunes improved, Gerstner was able to add new jobs. By the time he retired in 2002 he had hired sixty-five thousand people. Not only did Lou Gerstner save IBM, but the company had more employees at the end of his tenure than it had at the beginning.

  Ethics columnist Randy Cohen acknowledges the necessity of layoffs in hard times. But he asserts that they shouldn’t be “a panicky response to an economic downturn.”43 A company should try everything else first—cutting stockholder dividends and executive pay, for example.

  Cohen admits that Caterpillar took some of these steps before its own layoffs. Robert Sutton, author and management professor at Stanford School of Engineering, believes Cohen’s criticisms are unrealistic.

  Simply calling layoffs at Ca
terpillar a “panicky response” is sort of like criticizing people for a “panicky response” to [a] Tsunami. I am sure, in hindsight, that executives might have been better prepared, but I think Mr. Cohen does not show quite enough understanding of how hard it is to manage during times of harsh uncertainty.44

  Sutton admits that he once shared Cohen’s view—until he studied the Real World challenges faced by corporate management. He recalls:

  When I first studied declining and dying organizations in Michigan in the early 1980s, I thought that layoffs were misanthropic and any company that did not spread the pain equally was immoral. But as I have seen the difficult and complex set of constraints that executives face in organizations of all kinds and sizes, I have learned to avoid pointing the morality finger at those leaders who do layoffs—there are too many times when it puts the remaining business at risk or when because of immovable constraints (such as union contracts, work rules, or the nature of the work) cost-cutting short of layoffs is not feasible…. Layoffs do massive damage to people, I am not defending them as humane acts, but there are too many times when they are the lesser evil.45

  REAL WORLD LESSON

  Layoffs are moral. The alternative, not laying off people, would mean more companies going under. The result would be fewer jobs, longer downturns, and less prosperity—with longer-lasting pain and suffering.

  Q CAN FREE MARKETS BE MORAL WHEN PEOPLE ARE ALLOWED TO GET RICH BY SELLING PRODUCTS THAT ARE NOT GOOD FOR YOU—SUCH AS TOBACCO?

  A FREE MARKETS ARE MORAL BECAUSE THEY ARE DEMOCRATIC, REFLECTING THE WISHES OF PEOPLE IN SOCIETY. THAT DOES NOT MEAN THAT EVERYTHING THAT EVERYTHING PEOPLE WANT IS GOOD FOR THEM.

  It is a familiar conundrum: Cigarettes are known to increase the risk of cancer. Cigarette packets scream health warnings. Yet people persist in smoking. Cigarette makers generate billions of dollars in profits. Until the 2008 crash, their stocks continuously increased in value. And they performed better than the general market in the downturn. It is the free market at work. But is it right?

  Freemarket critics say no. And yet what would happen if smoking were banned completely? Most likely people would simply continue to smoke, as they have smoked for hundreds of years. And people would most likely still get rich from illegal cigarettes—by selling them on a black market. That’s already happening today in states like New York and Michigan, where high cigarette taxes have created a black market for cheaper tobacco. Smugglers are bringing in cigarettes from lower-tax states, such as North Carolina, or from Indian reservations. Law enforcement officials worry that many Middle Eastern smugglers are channeling ill-gotten gains to fund terrorist activities in other countries.

  Criminals also profited in the 1920s when the United States banned the sale and distribution of alcohol, another addictive and “immoral” substance. People turned to homemade “moonshine” made by bootleggers. It was not only more potent and dangerous, but more expensive. Hard-core drinkers turned to even more destructive substances like opium.

  As Mark Thornton of the Ludwig von Mises Institute has pointed out, banning booze had no effect on the widespread employee absenteeism of the time or on abuse of alcohol. Consumption dropped at first but then rose steadily. Violent crimes such as murder actually increased.46 The expanded black market for booze also helped to bolster organized crime. Prohibition was widely considered to be a failure. Alcohol was legalized again in 1933.

  When it comes to cigarettes, the real moral question is: which is preferable, allowing people to voluntarily buy a product with negative health effects—or imposing a ban that is not likely to work? Instead it would criminalize millions of otherwise honest people, in addition to helping real criminals get richer.

  But what about drugs? Some libertarians say we shouldn’t ban marijuana and other addictive drugs for the same reasons we don’t ban alcohol and cigarettes. Yet society has opted for criminalization because it has judged drugs to be, on the whole, a greater threat to public health and safety. Experiments with looser drug laws have not exactly been successful. Even Holland, which legalized marijuana to great fanfare, is now rethinking its liberal drug laws, shutting down some of its marijuana-selling “coffee shops.”

  REAL WORLD LESSON

  Free markets can sometimes mean making moral trade-offs.

  CHAPTER TWO

  “Isn’t Capitalism Brutal?”

  THE RAP The free market is brutal: Big players with too much power crush smaller competitors. People are laid off without warning or protection. Individuals are vulnerable to ups and downs in remote sectors of the economy that have little apparent connection to their daily existence, suffering untold disruption to their lives and businesses.

  THE REALITY Democratic capitalism can be disruptive and unpredictable. But the process of “creative destruction” is critical to a healthy economy and society. New products and industries render old ones obsolete. Some jobs may be destroyed. But other jobs—more of them—are created. In this way, individuals and resources go where they are most needed by people and businesses, and wealth-producing innovations are developed. Without creative destruction, the economy would stagnate. Living standards would be lower and unemployment would be far higher.

  Wealth is produced not by continuing the old ways of doing things but from change, developing products and services that are cheaper, faster, and better—or that do new things altogether. These innovations offer benefits so powerful that they compel people to abandon the “old”—products, services, business practices, and, sometimes, social customs.

  A thousand years ago in medieval Europe, advances in agriculture, such as the collar harness, the wheelbarrow, and the axle-based horse-drawn wagon, increased farm productivity. Farmers were able to grow more food than they needed and sell their products to others. They moved beyond subsistence to a surplus economy. Medieval monasteries also traded with one another, specializing in certain crops and relying on bookkeeping techniques, becoming prototypes of modern corporations. The wealth they generated helped bring about the rise of city-states, undermining the power of the ruling feudal lords.

  Advances that are today considered progress were seen as destructive by the nobles and aristocrats of that era. We see creation. They saw destruction.

  Industrialization brought similarly disruptive changes in the nineteenth century: the rise of mechanical looms boosted textile production, but they rendered traditional hand weavers obsolete. The result: riots in England. Craftsmen smashed the machines they saw as job killers. One riot was led by Ned Ludd. His opposition was so virulent that his name became synonymous with resistance to all technology. Hence the term Luddite.

  The spread of railroads throughout America and Europe enabled people to travel and transport freight faster. Yet railways also replaced the canals that had been used for commercial transport. Many canal operators went broke, stiffing bondholders. People who made their living from canals had to find new lines of work. Contractors had to switch from digging canal trenches to laying rails and building railroad cars.

  Joseph Schumpeter, the great twentieth-century Austrian economist, recognized the disruptive power of innovation. He understood that advances wrought by entrepreneurs and others are not only beneficial. They also shatter the old order. Schumpeter called this process “creative destruction” and explained that it is essential to a healthy economy.

  Creative destruction can provoke a yearning for a simpler way of life. Industrialization in the nineteenth century raised living standards and made life easier. But it also disrupted the agrarian rhythms of the countryside with smoke-belching factories. People like the writer William Blake called the large textile plants “satanic mills.”

  Like Blake, many people today are upset by the process of change—especially politicians. Ohio congressman Dennis Kucinich calls for protections against foreign competition. New York senator Charles Schumer wants China to revalue its currency to slow exports to the United States. Unfortunately, the instinct of such freemarket opponents is t
o condemn what is changing and attempt to preserve the old order. They don’t see the process of creation simultaneously taking place in the economy.

  Think of where we’d be today if, to preserve jobs, we had to continue using old-fashioned typewriters instead of word processors. Or if we had to use human operators instead of electronic routers to direct our telephone and cell-phone calls. Or if we still had to ship goods via canals—instead of by trucks, rails, and air. Or if we continued using those mammoth old mainframe computers instead of today’s PCs and handhelds. Or, finally, if we still used the telegraph instead of communicating by fax, phone, or e-mail. Some jobs would have been saved. But many more never would have been created. And our general standard of living would have been far lower.

  People who complain about the “brutality” of free markets fail to appreciate that over time, democratic capitalism has resulted in more job creation than destruction. The U.S economy is constantly creating and destroying jobs. Each week in normal times 540,000 jobs are lost while some 580,000 new ones are created.

  Between 1980 and 2007, despite fluctuations, the United States overall gained jobs. Employment rose to 130 million from 91 million, a net gain of nearly 40 million jobs, far more than the rest of the developed world put together. Productivity, measured by output per worker, increased more than 56 percent, despite three recessions during this period.1 Thus, even though there are serious job losses as of this writing in 2009, history shows that the United States will remain a vigorous job-creating machine because we don’t have the job-killing regulations and taxes of Western Europe—at least not yet.

  Many of these new jobs barely existed just a short time ago. For example, no one had ever heard of a “webmaster” in 1990. But in 2002 there were 280,000 of them, in addition to programmers, network operators, and the millions of other jobs created by the Internet in the last two decades.

  Sometimes labor-saving devices end up creating more jobs than they destroy. Take ATMs, which were meant to replace most bank tellers. There are now more bank tellers than there were when ATMs were introduced thirty years ago. Why? The machines handle routine banking transactions, allowing branch personnel to focus on providing customers with specialized services.