There is a curious strain of recent conservative thought that laments the workings of the American economic system. The iconic example of the problem is the closing of a factory: it removes the lifeblood of a community and inevitably causes the breakdown of the community and its families. The villain is the factory owner, generally portrayed as a rapacious soul: he lives in comfort and heartlessly tosses hardworking people onto the street. Why? Merely in order to increase profits by moving his capital elsewhere, even, all too often, to another country. For a small, even miniscule, increase in the already large wealth of the greedy capitalist, an entire community is destroyed. Remember: these are conservatives making this argument.
To see a particularly poignant hypothetical example of this, consider Sam Long’s article, “What Are America’s Pensioners Getting from Private Equity?” A teacher making $60,000 a year has part of her retirement savings in a private equity fund. The managers of the fund then engage in all sorts of shenanigans with ominous sounding names, and the next thing you know, the factory in the teacher’s hometown shuts down. Then the teacher is suddenly living in a post-apocalyptic nightmare of falling home prices, rampant crime, and drug abuse. The moral is clear: because the managers of the teacher’s retirement portfolio wanted to get a measly few extra percentage points of return on her retirement account, the teacher’s life became miserable. Don’t let this be you.
Set aside disentangling the financial chicanery Long describes, none of which is necessary to raise the question he is fundamentally asking: is it in the interest of the common good for the owner of a factory to move production elsewhere in order to increase the return on capital? To answer that, let us first think about a question that never seems to have occurred to Long: Why is the teacher making $60,000 a year?
This is not a question about whether teachers are paid too much or too little. The question is more basic: Why is anyone making $60,000 a year? In 1921, the average teacher’s salary was $1,500. In current dollar terms, that is a salary of a little over $20,000. So, why isn’t the most stunning thing in Long’s hypothetical example that teachers’ salaries are three times higher in real terms now than they were one hundred years ago? The increase in pay would be even more dramatic if you go back farther in time.
Is the size of the teacher’s salary related to the story of the closing of the factory? Yes.
The Mystery of Capital
“Once the vast machine of capitalism was firmly in place and its masters were busy creating wealth, the question of how it all came into being lost its urgency.” Hernando de Soto wrote that in The Mystery of Capital, published twenty years ago. The subtitle: Why Capitalism Triumphs in the West and Fails Everywhere Else.
At first glance, de Soto’s book seems to have little to do with the fate of factory towns in the United States. De Soto was concerned with the question: How do poor countries turn into rich countries? He began with an observation: in many poor countries, there are vast tracts of government-owned land that are legally open space. Look on a government map: in certain wide areas there is nothing indicated—no houses, streets, or infrastructure of any kind. But if you go visit those locations, you see a vibrant community—not only streets and houses, but even electricity. What happened?
At some point, squatters moved onto the government’s land and nobody evicted them. Over time, houses and infrastructure were built. (The electricity, for example, is pirated from the cables running down the highways.) Here we have a large group of people who legally own nothing—they are quite poor. But, they have a house in which they live, and everyone around them, other than the government, recognizes their property rights.
In poor countries, de Soto notes, poor people actually own quite a bit of wealth. How much? Figuring that out took quite a bit of work by de Soto and his research associates. The number they arrived at was simply staggering. “By our calculation, the total value of the real estate held but not legally owned by the poor of the Third World and former communist countries is at least $9.3 trillion.” How big is $9.3 trillion?
It is very nearly as much as the total value of all the companies listed on the main stock exchanges of the world’s twenty most developed countries: New York, Tokyo, London, Frankfurt, Toronto, Paris, Milan, the NASDAQ, and a dozen others. It is more than twenty times the total direct investment into all Third World and former communist countries in the ten years after 1989, forty-six times as much as all the World Bank loans of the past three decades, and ninety-three times as much as all development assistance from all advanced countries to the Third World in the same period.
Why does this matter so much? As de Soto notes, that amount of wealth is all dead capital. If the property were legally owned, then people could borrow against it to finance the expansion of business. Suppose you had a small taxi company and wanted to buy a new car and hire your brother-in-law. In places with functional capital markets, you could borrow against your assets—which for many people would be their home—purchase the new car and reap the rewards. But, if you don’t legally own your own house, your capital is locked up. It cannot flow to the most profitable opportunities.
De Soto argues that it would revolutionize poor countries everywhere if they simply legalized the home ownership that already exists on the ground. The problem is that far too many people do not understand the nature of, for example, a house. It is obviously a place in which someone can reside. But if the owner is permitted to use the house only as a place to live, then both the owner and society lose out on realizing the full, invisible potential of the physical house, that is, its ability to generate even more wealth. Poor countries are poor, de Soto argues, because they have prohibited capital from flowing to where it would be most useful, in this case, by not legally recognizing ownership. The result is a needless economic stagnation. People remain poor because the creation of wealth has been stopped at its source.
Another way of asking the question de Soto poses is this: Why don’t teachers in poor countries make $60,000 a year? The answer seems tautologically trivial: Teachers in poor counties have low salaries because they live in a poor country. But this answer ignores the reasons why poor countries are poor.
The new conservatives have not just forgotten the lessons of de Soto; they have also forgotten their Chesterton. In St. Francis of Assisi, Chesterton notes the strange propensity of the modern mind to start at the end of the story.
Men for whom reason begins with the Revival of Learning, men for whom religion begins with the Reformation, can never give a complete account of anything, for they have to start with institutions whose origin they cannot explain, or generally even imagine. . . . We may concede to our contemporaries that in any case it is not a story that ends well. We do not insist that in their version it should begin well. What we complain of is that in their version it does not begin at all. . . . We learn about reformers without knowing what they had to reform, about rebels without a notion of what they rebelled against, of memorials that are not connected with any memory and restorations of things that had apparently never existed before.
These new conservatives are acting exactly like the enlightenment thinkers whom Chesterton chastises. Starting with the existence of a wealthy society, where teachers make $60,000 a year in a small factory town, they ask why the town is no longer vibrant. They forget to wonder why the town existed in the first place. Surely, the impressive thing is that a factory town arose in some vast, uninhabited plain and that the town provided incomes and wealth to many people who worked there—enough wealth to pay teachers $60,000 a year to educate their children.
If these conservatives had peeked backward in time for just a moment, they would have noticed something amazing: that factory whose closing occupies their attention was built when somebody moved their capital into the town and built it. Where did that capital come from? It must have come from somewhere else, and its departure deprived that former location of its use. Similarly, where did the people come from who worked in the original factory? They too left somewhere else and deprived their former hometowns of their labor.
If these conservatives want to be consistent when they complain about the modern economy, then perhaps they should advocate returning all capital to its place of origin. Let us not stop with telling existing factories’ owners that they should not move their capital elsewhere: let us return the capital from the prairies and the mountains back to the coasts, and then ship it back to its countries of origin.
Presumably nobody is actually going to argue for returning all capital to its point of origin. Similarly, we can presumably agree that if a new factory were going to be built, it would be good to use the best available technology to produce better quality products. The matter in question is whether an existing factory’s owner has a moral obligation to continue operating a factory even if a better opportunity comes along. Does the government have the right to prevent the factory owner from moving capital elsewhere if the result would be the demise of the factory town?
It sounds nice to insist that the factory owner should forgo more profitable opportunities in order to keep the workers employed. But, as Joseph Schumpeter noted, what is to stop someone else from coming along and opening a second, new factory that can produce the same (or a better) product at a lower price? Once that new factory has opened, the old factory with the higher costs will close. The effect on the workers at the old factory is exactly the same, whether that factory and its owner leave town altogether, or whether the new factory puts the old one out of business.
Can we rescue the argument by insisting that in some cases the factory owner does have the legal and moral right to move capital to more productive opportunities, but only in extreme cases involving significant technological improvements? Perhaps. If we could predict the future, that might be a possible argument. Are 1970s Japanese cars only slightly better than the cars made in Detroit? Is the iPod a small or large improvement over the Walkman? Is a flat screen HDTV a small or large improvement over those TVs of old? Is Netflix’s mailing out DVDs a major or minor advance over Blockbuster’s retail stores? In every case like this (and you can spend hours thinking of new examples) at the time when the innovation happened, there was no way to tell whether the new product would win out. Somebody had to gamble and move capital into the new production lines. Somebody else could have easily argued that the new product is not enough of an improvement to make it worth laying off so many workers.
The alternative is to recognize that de Soto is right. Factories, like houses, have two aspects. There is the actual, visible building to be sure. But the real magic of generating wealth comes from the invisible potential of the capital inherent in that physical building. Allowing capital to move is exactly what generates the wealth in the first place. Yes, we could freeze capital in its current location; but then we would repeat the economic decline of impoverished countries by locking up that capital’s full, invisible potential. Instead of thinking of ways to prevent capital from moving, why not find ways to make it profitable for a new firm to move into town, hire the unemployed workers, and use the abandoned real estate?
There is something inherently problematic about looking out at the level of existing wealth and saying, “Let us stop here. Now that we have modern medicine and the internet, why should we aspire for more?” When this siren call sounds, it is well worth wondering if these apostles of the status quo also wish their predecessors had won the day. Would we all be happier now living with the amount of wealth from 1920 or 1820? Should we strip away the technological and medical wonders of the day in order to ensure that future generations can also be blacksmiths and candlemakers?