Capitalism does not reward risk

I have been pointing out recently that defenders of laissez-faire capitalism shift between philosophical frameworks when they are arguing, something I call capitalism whack-a-mole. They do this because there are no normative frameworks that justify laissez-faire capitalism and so there is no other way to actually muster an argument in its favor other than opportunistically moving between frameworks. (Click here for an amusing example of this phenomenon.)

In the classic whack-a-mole, defenders of laissez-faire capitalism shift between voluntarist, desert, and utilitarian frameworks.

The voluntarist framework demands that people be free to act as they like with no involuntary restraint imposed from without. Voluntarism is incompatible with property law which is nothing but an involuntary restraint imposed from without.

The desert framework demands that our economic institutions be constructed so as to distribute to each that which they produce. Desert is incompatible with capital income, private enjoyment of the fruits of nature, and wage labor.

The utilitarian framework demands that our economic institutions be constructed so as to maximize overall happiness/well-being/etc. Utilitarianism is incompatible with market distributions because at least some level of taxing and transferring better maximizes overall happiness/well-being/etc. due to the diminishing marginal utility of money.

So, as you can see, each of the frameworks is incompatible with some aspect of laissez-faire capitalism, voluntarism and desert most seriously.

Noah Smith’s Response
Noah Smith had a reaction to my series of posts on this at his blog. The Humean that he is, I gather that Smith agrees with my basic point: none of these frameworks actually motivate those who incorrectly try to use them to justify laissez-faire capitalism. Nonetheless, he raises some specific substantive points that are worth addressing.

First, with respect to the desertist demand that people be compensated according to their personal productivity, Noah Smith modifies that somewhat in a way that he thinks would allow for a pro-capitalist conclusion:

1. “Capitalism should reward either hard work or risk-taking. Thus, both labor and capital income are justified.”

There are a lot of problems with this modification. The easiest problems to see are its omissions. First, it doesn’t deal with the problem that hard work in the form of wage labor is not compensated according to its personal productivity, but rather its marginal value to a firm, which is quite a bit different. Second, it doesn’t deal with the problem of those capturing the value of nature, which is not the fruit of hard work or risk-taking. This principle still is not able to reach a pro-capitalist position then, even if the modification helped some.

But the modification doesn’t help any. Capitalism does not reward risk-taking. This is easily shown. Suppose Noah and I each invest in ways that are identical in all regards with respect to risk. If capitalism rewarded risk-taking, then each of us would get an identical return. But we don’t necessarily. Suppose Noah’s investment leads to him receiving a large return, while mine leads to me receiving nothing and even losing what I put in. In that possible scenario, even though we behaved in a relevantly identical fashion, capitalism distributed us different amounts. Noah was rewarded for risk-taking. I was punished.

Beyond this specific failure, the lottery-like aspect of investment (risk-taking) is diametrically opposed to the core concept of desert. The non-modified desert framework gets at the idea that if you and I put in the same amount of work, we get the same amount of product out of it. I build a house and I get a house out of it. You build a house and you get a house out of it. But this is not the case for investment. We can both do substantively equivalent things — invest in asset class with risk level X — and get totally different stuff out of it. Neither of us is anymore deserving of what we get than the other, just as a lottery winner is not more deserving of the prize than a lottery loser.

Second, with respect to voluntarism, Noah Smith modifies accordingly:

2. “I support conditional voluntarism, not absolute voluntarism. The government should use violence only to protect property rights, and for nothing else. Property rights are defined as blah blah blah…”

The problem with this modification is that it’s totally ad-hoc. I don’t contest that someone could justify their preferred economic institutions by simply saying “my framework is that my preferred economic institutions are good.” The challenge is to justify one’s preferred economic institutions in a general way by appealing to some kind of generally-applicable principles.

Here, the modification of voluntarism says nothing more than “Voluntarism should be respected, except when my preferred economic institutions require that it not be.” But that principle supports literally all economic institutions ever.

I am not saying that you have to be either a full-on voluntarist or not, but at minimum, you have to provide some rationale for why you are making the exceptions that you are. So, in Smith’s case, the question would be: why do you think it is OK to violate voluntarism for the purpose of property rights? Generally speaking, the response to that question will either be some form of “because it’s necessary for utilitarian reasons (e.g. people will starve and be miserable without property)” or “because it’s necessary for desertist reasons (e.g. people won’t be able to keep what they make).” But that’s just a whack-a-mole move and will reopen the position to the same problems discussed above regarding capitalism’s interaction with utility and desert.

Third, with respect to utility, Noah says something that seems to have missed my point entirely:

3. “I am a pure Benthamite, I care about the sum of utilities; I do not care about the poor more than the rich.”

This just does not respond to my point, which is about distributive efficiency. Taxing $1 from the very rich to fund a transfer of $1 (or even less than $1) to the very poor increases the “sum of utilities.” The utility drag caused by the tax is lower than the utility increase caused by the transfer. This is because of the diminishing marginal utility of money.

Again, I don’t think Smith is particularly committed to finding some route to a pro-capitalist conclusion using these frameworks. He doesn’t care because that’s not how he rolls anyways. But it suffices to say the ways in which he tries to get there in his post don’t work.