Merit Goods

I am increasingly persuaded that the idea of “merit” goods should have a role in thinking about free markets.

The foundational moral basis for capitalism I have suggested is the willing assent of market participants to a transaction. The ethics of a transaction – a sale, a hiring – arise from mutuality, the interdependence on the parties that each has something of value to the other and that the exchange is freely entered into.

Thus, any factor which closes down the freely accepted terms of agreement – compulsion such as resulting from monopoly or monopsony, rent extraction by governments and other power imbalances, including ignorance and misrepresentation – detracts from the morality of capitalism.

Yet, what if buyers and sellers agree to do something harmful?

What if neither party cares about the negative externalities of a product? Who is to judge their ethics? God only? The state? Parents of naughty children?

The idea of a merit good creates space for freedom in markets. Merit goods and services should be sold and consumed. Unmeritorious goods and services, on the other hand, may be forced off the market or their sales regulated.

There are two recent examples of interaction between markets and unmeritorious goods:

First, the company Purdue Pharma LP is now in financial difficulty for promoting and selling Oxycontin, an opioid. Oxycontin has serious negative externalities which contributed to the opioid crisis and deaths in the U.S. The company’s revenue will drop below $1 billion this year for the first time. Employees are leaving and a potential bankruptcy filing looms.

Secondly, bullets. Bullets can be used to kill and wound people. What merit is there in that? California has passed a law requiring those who want to buy bullets for their guns to undergo a background check before they can make such purchases. Their freedom to buy has been circumscribed given the potential for harm possessed by the product they desire to have.

The law attempts to reduce the harm done by bullets by limiting their sale to those more likely to have “meritorious” intentions in shooting them.

Costs and Benefits of Meritorious Actions

A couple of weeks ago, Heather Gillers reported in the Wall Street Journal that the well-regarded California Public Employees Retirement System (CALPERS) is reconsidering its acclaimed practice of investing for social good following the theory of socially responsible investment.

CALPERS directors are keeping their ownership shares in private companies which run prisons, sell guns or have business links to Turkey (to protest that country’s lack of recognition of the Armenian persecutions 100 years ago) because of the potential for losing needed revenue with which to pay retirees or because of uncertainty about the beneficial effects of such disinvestment.

Underfunded public pension funds across the U.S., short some $4.2 trillion in assets necessary to earn enough money to pay promised pensions, are also thinking about their responsibilities.

On the one hand, they have a conflict between two different standards of merit: one is financial – earning money for beneficiaries and the second idealistic – promoting social good for third parties.

On the other hand, the micro-economic realities of marginal utility curves create their own moral imperatives. When you are flush with money, using some of it for social good does not come at a high cost. But when funds are low, the marginal utility of each additional dollar spent is high. The opportunity cost of not spending it on something else is significant. How, then, should your seeking to do good be balanced against using the dollar prudently to increase your assets?

When is the accumulation of assets for those who depend on them a higher social good?

CALPERS Chief Executive Marcie Frost said “With a targeted return of 7%, we need access to all potential investments across all asset classes. Divesting does the exact opposite – it shrinks the investment universe.”

Just as they teach in Economics 101: you can’t have it all; there is no free lunch; everything comes at a cost; choices must be made.

Elite Expertise?

A recent article in the Atlantic was reassuring to me. It provided confidence that general wisdom – the kind provided by ethics and principles – can be more reliable than professional expertise in guiding our decision-making. Consider Boeing’s reliance on exquisite software to overcome a design problem with the large engines used in its 737 Max8 aircraft.

Philip Tetlock did a study of the reliability of expert predictions. Over 20 years at work, he gathered from experts 82,361 probability estimates about the future.

The experts were, by and large, very bad forecasters.

When they declared an event was impossible, in 15% of the cases, it happened. When they declared an event was certain to happen, in over 25% of the cases, it did not.

Later studies came up with similar results. There is a cost to focusing too narrowly when it comes to thinking about the future.

Importantly, a sub-group of scholars did better in predicting those events that did happen. They were not vested in a single discipline. They integrated conflicting views. They had personalities which made them effective collaborators. They were curious about everything. They viewed teammates as sources of new knowledge, not as rivals to be convinced.

When outcomes differed from what they had expected, these generalists adjusted their thinking, while more narrowly specialized experts barely budged from their established views. The best forecasters viewed their ideas as hypotheses in need of testing.

Harvard – Elitist Egalitarianism?

Recently, Professor Rakesh Khurana, the Dean of Harvard College and a teacher of business and sociology, came out against what he calls “Capitalism.” The system he described in his Class Day speech to 2019 Harvard College graduates is a regressive hierarchy of unjust privilege which channels success to those who were “to the manor born.”

As a graduate of Harvard College, I feel no qualms in contesting his version of reality. After all, in my day at Harvard, we were taught to question and to think for ourselves.

If Dean Khurana is correct, then any thought of a “moral” capitalism is a foolish whim. What is needed for social justice is only enforced equality of money, power, status and, perhaps, happiness. No one deserves to be different, especially if the difference seems to be “better” than the norm. Dean Khurana is not the first to seek leveling in society, culture, politics and the economy. There has been a school in the West advocating regimented sameness for several centuries now.

Such terminal equivalence was the hue and cry of Gracchus Babeuf in the French Revolution. He proclaimed: “Society must be made to operate in such a way that it eradicates once and for all the desire of a man to become richer, or wiser, or more powerful than others.”

The manifesto of his movement – The Conspiracy of Equals – demanded: “Let there no longer be any difference between people than that of age and sex. … Since all have the same faculties and the same needs, let there then be for them but one education, but one nourishment. They are satisfied with one sun and one air for all: why then would the same portion and the same quality of food not suffice for each of them? … Open your eyes and your hearts to the fullness of happiness: recognize and proclaim with us the REPUBLIC OF EQUALS.

The Japanese have a saying: “The nail which sticks up is pounded down.”

In this vein of social analysis, Dean Khurana proposed to “interrogate” in his remarks what it means to deserve something, whether being at Harvard or being successful in life. The “capitalist ethos,” according to Mr. Khurana, tells us that “We deserve to win because of our skill, our hard work and our contributions.” In Monopoly, the board game which Mr. Khurana called synonymous with the capitalist system, it’s the roll of the dice that determines “whether we land on Park Place or land in jail.”

Monopoly is like real life, he concluded, which is often determined by factors beyond our control—above all by “those privileges sociologists call ‘structural inequities.’”

When I was at Harvard, the “life is only a game” theory was used by Professor Timothy Leary as justification for taking LSD and dropping out into chemically induced blissfulness.

Dean Khurana proposed we should stop thinking in terms of individual effort, merit and moral character. He said it’s time to stop using words like “deserve” and “deserving” because they don’t account for the “systemic inequities” that play such large roles in our accomplishments. Harvard, he announced, has made progress in “acknowledging and naming the privilege” that makes the language of “deserving” so “insidious.”

Khurana also urged listeners to junk the myth of the self-made person. He told his audience to focus instead on recognizing the “increasingly dynastic transmission of political, social and economic privilege governing” life in the U.S. and to work toward a sustainable, equitable society.

So, asking people to try, to learn, to work, to stretch themselves when in discomfort, to put up with others, to listen to the better angels of their natures, to be responsible and thus energize their minds, hearts and souls to do better is “insidious?” Hogwash.

Aristotle proposed that each of us individually should set before ourselves the goal or end in life of “eudemonia” – or happy flourishing. No one, no dean of a college, no social order, can give this state to us. It is up to us to give it to ourselves. That is why a concept such as “virtue,” which is personal, only comes into play as a guide to living well.

In the Greek, “eudemonia” breaks down into two ideas – “eu” or good and “daimon” or spirit. The observation about eudemonia is that we need a spirit guiding us which knows the good when that spirit is personal to us and not a collective mission imposed on us for the good of others, using us as a means for their ends.

Khurana then accused capitalism of fostering a “zero-sum” mentality. In what reality is he living? I know that as a tenured professor, he can’t be fired and his salary is secure. He lives off rent extraction secured by Harvard’s reputation in the marketplace for higher education. That reputation gives Harvard structured power and Mr. Khurana is a beneficiary of that power. Under the law of the land according to his contract of employment, he has a “zero-sum” position vis-à-vis the rest of us.

But why is he in such a prestigious position, authorized to instruct students on the “correct” way of thinking about capitalism and life? Does he, himself, deserve to be Dean of Harvard College? Apparently, some at Harvard think so.

How in a market reality, though, can a seller impose upon a buyer the purchase of a good or service? Both need to benefit according to their respective utility curves from the exchange. Economics and growth depend on mutuality, on interdependency, as Adam Smith realized. Harvard profits because students and their parents believe it provides utility leading towards success in life and pay the tuition charged.

What if Dean Khurana were to be paid by piecework, a cash fee from each student who decided to attend one of his classes? Would he not then quickly come to see some reciprocity of benefit, some ethical force at work in capitalism?

Will sellers try to cheat? Will buyers seek to push the offered price down or buy the same good elsewhere for a lower price? Will owners try to hire workers at a lower wage with fewer benefits? Will workers take advantage of employers when possible? Are people, as a rule, prone to ignoring their moral sense and abusing power? Yes.

Lord Acton was not the only one to observe this when he affirmed that “Power tends to corrupt and absolute power corrupts absolutely.” That is why we have legislated constitutional restraints on political leaders and protect private property from exploitation from others by the rules of law and the maxims of equity.

The only way to realize Khurana’s heaven on earth of absolute equality is to give some power over others to make them the same in mind, heart, soul, will, intelligence, aesthetic preferences, effort and money. Those with the power will not find the concept of “deserving” to be insidious at all. They will specify what it means to be deserving and then the rest of us must obey their tastes. That would be the structured inequality needed to ensure structured equality. Seems incoherent to me.

The idea of enforced equality ended up with Pol Pot and his Khmer Rouge followers. Seeking Babeuf’s utopia, as championed by French educated Khmer Rouge leader Khieu Sampan, everyone in Cambodia who was not “hammered” to death one way or another was pounded down under the Khmer Rouge revolutionary regime, even their own cadres who fell out of line.

Uber – An Example of Private Market Capitalism at its Best?

Uber’s Path of Destruction – American Affairs Journal

According to today’s Wall Street Journal, share prices of Uber and Lyft stock have not recovered to the level of their offering prices.

One reason may be that some more perspicacious valuations of the companies are in the minds of some investors.

The commentary here on Uber’s business model provides insight into how to value the company’s financial prospects.

The reality of Uber may prove the wisdom of the old sayings “If wishes were horses, beggars would ride” and “If to do were as easy as to know what were good to do, chapels had been churches and poor men’s cottages princes’ palaces.”

There is something in the human heart which is prone to speculation; not the prospect of reward only, but hubris of besting fortune or just “irrational exuberance.” Financial markets, as John Maynard Keynes told us in the 1930’s, in large part, feed the need of betting on outcomes for the wise and the foolish alike.

Can the West find the Middle Path?

As I reported to you a few days ago, last week, I spoke at the 2019 annual meeting of the Fondazione Centesimus Annus Pro Pontifice at the Vatican. My assignment was to consider “The West” and “The East” in relation to the call of Pope Francis in his Laudato Si’ encyclical for an “integrated” ecology of time and space in our world today, inclusive of the environment and humanity’s various strivings forward.

To attempt this consideration, I superficially postulated one essence for “The West” and another for “The East” and sought to contrast them. For “The West,” I highlighted “rationality” as the axial principle of its endeavors and for “The East,” I took the flexibility of the Doctrine of the Mean, the Tao Te Jing and the Yi Jing texts from China, along with the middle way of Buddhism and the naturalism of Shinto in Japan. “The East,” I postulated, rested its understandings on following a mean, a middle way among more extreme and rigid alternatives, while “The West” found comfort in absolutes discovered by rationality, as in mathematics, geometry, calculus, science and syllogistic logic. Descartes told us that “cogito ergo sum” – “I am because I think.” For “The West,” reality was forced into compartmentalized concepts devised by the human mind, while for “The East,” the human mind adjusted itself more flexibly to reality.

My point was to suggest that the left-brain formalism of “The West” should be counter-balanced by the intuitive, right-brain perceptions of “The East.”

I added that the time to do this was now, as “The West” has become post-modern after Nietzsche, who intuited that rationality did not lead to truth but to many truths, all socially-constructed, a permanent condition of nihilism in which the peoples of the U.S., U.K. and E.U. now twist and turn looking for meaning and solace.

A friend, Adrian Pabst, from the U.K. and Reader in Politics at the University of Kent, a leading thinker in the “blue labour” movement and co-author of The Politics of Virtue: Post-Liberalism and the Human Future, came up to me and said I had got Nietzsche wrong. It was better, he suggested, to understand Nietzsche as calling for mediation between rationality and intuition, rather than choosing one exclusively over the other.

“A good point,” I replied.

Then, I caught myself thinking: “What is the Western basis for mediation among big ideas, equivalent to Yin/Yang analysis in China or the Noble Eightfold Way in Buddhism? I sensed we in “The West” don’t have a particularly strong philosophical and cultural tradition of mediation. Aristotle proposed one in his Nichomean Ethics but we seem over the centuries to have preferred winners and losers, rather than compromisers.

So, I looked up on the internet the root words for “mediate.” What I found I want to report to you.

First, “mediate” goes back to the Latin for middle – “medi.” It also comes from a root “medere” – “to cut in half.”

Then, I found a commentary from the Center for Hellenic Studies at Harvard University which linked the root “med” to “govern,” ” think,” “care for,” “measure.”

These words imply arrangement of disparate pieces into some relationship or order, of accepting reality and responding to it.

“Med” is also linked to moderation and to the Greek “medeor” (Latin “medeo”) – to care for, or medical, medicine.

Imagine: to “mediate” might be analogized to providing care for something ill and unhealthy, making it better and more sustainable.

Well-being would be associated with moderation, not extremes and absolutes. The Greek poet Hesiod had advised us: ”Observe due measure; moderation is best in all things.”

In ancient Greek, Zeus was called the “Medeon” – the “moderator.” A “medeon,” one who knows the middle, could restore order and well-being. Such a mediator was chief by virtue of a skill, not by virtue of position or the law.

And the root “med” supports the word “meditate” – to reflect on what is.

Thus, perhaps, if we in “The West” would do more “mediation,” we could more quickly come to nourishing and sustaining balance and equilibrium in our approach to civilization.

I have suggested here and there that the function of CSR in capitalism is to mediate for a firm with all its stakeholders. Corporate social responsibility is, therefore, a process of continual mediation and business leaders should study mediation skills.

Mediation should start with discernment – approach what is with open-mindedness and humility. A company should always be aware of the situations of its stakeholders.

We have a short paper for enhancing our facility for reflection, which might be of interest to you. You can read it here.

Vatican Conference on Responsible Economics

Last Friday and Saturday, I attended the annual conference at the Vatican of the Fondazione Centesimus Annus Pro Pontifice, of which I am a member and I also serve on its Advisory Council with our Chairman emeritus Lord Daniel Brennan. The Fondazione was established by Saint John Paul II as a lay organization reporting to the Pope for the advocacy of Catholic Social Teachings in business and finance. Our topic for consideration was the encyclical Laudato Si’ of Pope Francis.

In speaking to us on Saturday morning, Pope Francis importantly said:

“At the same time, however, a number of challenges and issues still remain. For example, progress on the achievement of the Sustainable Development Goals has in some cases been slow and even non-existent, or, sadly, has regressed. Improper use of natural resources and models of development that are not inclusive and sustainable continue to have negative effects on poverty, social growth and social equality (cf. Laudato Si’, 43, 48). Laudato Si’ is not a “green” encyclical: it is a social encyclical. Don’t forget this. Moreover, the common good is placed in jeopardy by attitudes of unbridled individualism, consumption and wastefulness. All this makes it difficult to promote economic, environmental and social solidarity and sustainability within a more humane economy which considers not only the satisfaction of immediate desires but also the welfare of future generations. Faced with the enormity of such challenges, it would be easy to lose heart, giving in to uncertainty and anxiety. Yet, human beings, while capable of the worst, are also capable of rising above themselves, choosing again what is good, and making a new start” (ibid., 205).

On a personal note, when teaching in Bangkok these past several years, I have been working with Ven. Anil Sakya, a descendant of Ananda, the cousin and first disciple of the Buddha. Ven. Anil has proposed understandings of the Buddha’s first sermon which consider the Dharma as a guide to sustainability in our modern terms of living wisely. Ven. Anil and I are editing a book of essays on this convergence of moral thought.

I thought it helpful to have him invited to this year’s annual meeting of the Fondazione to exchange views with experts on similar understandings coming from Catholic Social Teachings.

I was, accordingly, very pleased that he was invited. Here is a picture of Ven. Anil meeting Pope Francis:

Would that mutuality and reciprocity among all faiths, wisdom traditions and political philosophies were so congenial.

Three Recent Developments of Interest

With respect to our Principles for Business, I noticed three recent developments of interest at three major global corporations:

1) In its first quarter since putting its shares on the public market, Uber has lost $1 billion. How do you value such a company?

2) The U.S. Department of Justice has taken preliminary steps towards reviewing the business model of Google for being too large in violation of anti-trust laws. We raised such a concern over a year ago in one of our commentaries.

3) The fatal flaws in the software used to correct the angle of ascent in Boeing’s 737 Max 8 aircraft arose from lack of communications and sharing of information among units in Boeing’s bureaucracy. We have noted the “friction” – a notion borrowed from Clausewitz – which inevitably arises in large bureaucracies and often leads to failures of corporate social responsibility, BP and General Motors being notorious previous examples.

Values Make History

This week is the 75th anniversary of the Allied landing in Normandy, France and the 30th anniversary of the repression of the Tiananmen manifestation in China. Both events teach us the same lesson: at the root of human behavior are values.

Yes, interests also drive our actions but interests are values too. What we prefer is of value to us. More importantly, when national politics and war are concerned, the value of legitimacy takes on special importance: is it legitimate for us to follow our interest, to defend it against others, to enjoy it?

On what grounds are our interests so deserving that we can seek them even at the expense of others? That is a question of right and wrong, the ethics of living in community with others. What is right is legitimate. Legitimacy reveals what is within our right to do. Legitimacy is about core values.

For the Allies in World War II, the German Reich was an aggressor and military action against it was legitimate, so legitimate that the great expense in blood and treasure necessary to defeat that German government and its army was easily accepted as very worthwhile.

In the case of aggressive war, international law is accepted by nations as the test of legitimacy. What international law will sanction is legitimate and cannot be opposed with force. Aggressive war was outlawed by the 1928 Kellogg-Briand Pact.

The bloodshed in Tiananmen Square in 1989 came as a result of political conflict among Chinese over the legitimacy of the state. Protestors and the Chinese Communist Party leaders did not agree on the terms of legitimacy for a government in China. The Party believed its values should govern Chinese; the protestors wanted the Chinese state to be legitimated by some open political process and not imposed by the Party alone. It was a conflict of values.

The question we are left with is: what right does violence have in creating legitimacy for values?

The Greek historian Thucydides recorded an Athenian perspective on this: “The strong do what they will; the weak what they must.”

I align with the Allies of World War II and those gathered in Tiananmen Square: legitimacy imposed by violence has no claim to our allegiance. We must insist, even to the point of violence, on the rule of law and ethics as the basis for state power.

In my legal history course, we read the exhortation of Henry de Bracton in his commentaries on English law of 1235: “Not under man but under God and the law.”

What is a Company Really Worth to Society?

Stock market prices are often taken as the gospel truth, until they are not. Today’s price of any stock – bought through a stock exchange, over-the-counter or in a private sale – bears no necessary correlation to the stock’s price tomorrow or two weeks from now.

So why have we built a mighty fortress of global finance on possible falsehoods? The first asset bubble and crash of stock valuations was the tulip mania of 1637, right at the start of capitalism in its birthplace in Holland. Our market valuations are no more “true” today, nearly 400 years later.

Just ask those who bought the stock of Uber or Lyft when those companies listed their shares for public trading. The initial offering price immediately dropped as the market followed the preferences of buyers.

The May 28th edition of the Wall Street Journal carried a story that the price volatility of stocks has become such that judiciously picking individual stocks will bring more profit than “throwing money into index-tracking funds.” Stock pickers make their own valuations of shares company by company, competing to be more perspicacious about future prices than other market buyers and sellers.

After the collapse of credit markets in 2008, I was educated in price theory by Suppiah Dhanabalan, then Chairman of DBS Bank in Singapore. Reflecting on the bubble and collapse of prices on securities tied to American sub-prime mortgages, Dhana said “prices are only nominal.”

Nominal – in name only; in appearance but not in essence.

So, to some extent, the essence of financial markets is speculation on appearances, on what others think is the “right” price. And as we have seen since 1637, people have different ideas about what the “right” price of a stock should be. The fact that a market reflects one price today has no bearing on what people will think the “right” price of that security will be in the future.

Consider: what is the right price for a share of Tesla stock?

On May 24th, Tesla stock closed at $190.63, down 42% for 2019, a loss of $30 billion in market value. Tesla’s shares now have a negative return over the past 5 years. Two analysts predicted the stock would fall lower, to $36 per share.

The reality of Tesla is that it has spent $10 billion since 2011 on running its operations and has only made a profit in 4 quarters. It has funded its going concern costs with infusions of capital from trusting investors. What will happen to its share price when investors no longer believe that the company will be profitable someday?

Consider Uber. The company raised $8.6 billion between December 2015 and October 2018 at an average cost to investors of $48.77 a share. Uber shares now trade about $40 a share.

Other companies which went public but now see their stock trading at prices lower than what investors paid in private placements before the public listings are Snap, Dropbox and business software maker Cloudera.

Lyft’s stock price is higher than what early investors paid in private offerings but it is down 19% from its March 2019 public offering.

Why the gap between hope and reality?

With Uber and Lyft, “There is no profitability within sight even with binoculars and that’s been a tough pill for investors to swallow,” said Daniel Ives with Wedbush Securities. “It’s a totally different ballgame trying to get public investors around the valuations,” he added.

Uber lost $3.7 billion in the 12 months through March.

Since 2014, startups Tencent Music, Meituan Dianping, iQIYI, Sea, Pinduoduo, Uber, Snap, WeWork, Lyft, Spotify, Pinterest and Dropbox have cumulatively lost nearly $47 billion.

In the San Francisco Bay Area, there are 88 startups each valued at more than $1 billion.

The Economist magazine looked at the financials of 10 such highly priced startups, finding that while their sales have doubled since 2017, operating margins average a minus 30%. So, the more they sell, the more they lose.

How do you put a “true” value on such companies?

If we can’t accurately price a company, how then can it be managed for optimal advantage to its owners, customers, employees and society?