Principled Perspectives

I don’t believe that just because someone is a billionaire, that he or she has anything particularly worthwhile to say on politics, or art, or science or really anything outside his direct experience. Even that may be the result of luck, or be more down to luck than he will admit. Having said all that, this chapter by Ray Dalio is, I believe, worth a read. Dalio is one of the 0.001%. He is not a malcontent, writing a screed of bile from his mother’s basement. He is definitely not Owen Jones or Polly Toynbee. But he is very pessimistic about how the current political/economic cycle will pan out. I wouldn’t like to try to summarize his thesis in a glib sentence or two, but he certainly compares today’s western society to that of Ancient Rome as the barbarians were massing at the gate.

The problem with any prediction is getting the time right, spotting the catalyst that will shift the world into its new equilibrium. This pandemic has imposed massive costs on those in society who are least set up to bear them. Unless this is remedied, we’ll continue to see grumbling unrest. If is remedied, we might see a “market instability” and a second Global Financial Crisis. Neither option is remotely appealing.

Investing takeaway: buy gunmakers.

People understand unemployment all too well

Sarah O’Connor has written an excellent piece in the FT explaining why people are very skeptical when they hear that “They’ve never had it so good.” Well, they are not literally told that, but they are told that unemployment is extremely low by historical standards. Their instinct is that this is simply not true. The main reason is that non-economists don’t understand that the homeless drunk is not actually unemployed: because he’s not actively seeking employment. Nor is the discouraged youth who spends his days playing video games in his bedroom.

Anyway, we need a better measure. Politicians have repeatedly changed the definition of unemployment, and the nature of the job market has changed out of all recognition. In America in the 1930s nobody on the government’s payroll was counted as employed. With the UK govt. now spending 60% of GDP, if we used this figure today we’d practically all be counted.

Friedman and the responsibility of the firm

It is fifty years since Milton Friedman said that the proper role of the firm was to maximize shareholder returns. Everyone disagrees now, but Friedman’s case holds up if firms are in a fully competitive environment where they are all price takers, and where they all take a moral stance not to break the law, and where ‘contracts are complete’ or equivalently where they supply well-defined and commodity-like goods and services.

Friedman would have understood all this, and would have been thinking of firms like US Steel and General Motors, not firms like Amazon and Goldman Sachs. We now are in a world where firms can set the rules and exploit loopholes in double taxation agreements and generally act as price setters. Competition authorities have largely thrown in the towel. I don’t think I’d like to be a badly paid lawyer in the Competition and Markets Authority taking on Facebook.

Friedman’s original article is here. It is very powerfully argued, much more so than the articles which now, fifty years later seek to dismiss his logic. Friedman argues that it makes no sense for a company to decide to make contributions to charity. Of course, a company is really just a contractual arrangement between creditors to share risk in a particular way: it has no ability to make a decision as a legal entity separate from its component parts. In theory, a company is a democracy. If a majority of shareholders wish a company to make a contribution to charity, it’s hard to see why it should not (assuming that its memorandum of association permits it to do so, but this itself is not immutable and subject to change at the will of shareholders). The reality, though, is that decision making is wholly delegated to the directors, who largely transfer it to the CEO, in exchange for suitable benefits, the most important of which is money.

The modern theory is that a company rewards all “stakeholders” “fairly.” Rather than all residual income, after paying market prices for all factor inputs, going to shareholders, it is diverted to all the stakeholders: suppliers, employees, community, maybe even bondholders, for all I know. This sounds lovely, until one asks on what basis this income is to be split. We know that when CEO’s get to divide up the pie, they pay a minimum to just those they absolutely need to keep them in their job, and pay the rest to themselves. If you doubt me, take a look at Elon Musk, who stands to make over $140 billion via his performance bonus, almost certainly more than the company will ever make in profits. (The company has never made a GAAP profit, so it’s not even possible to give a multiple.)

Friedman wrote That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. I some how doubt that he’d consider a company that committed 154 violations of securities codes, pay $34 billion in fines and settlements would qualify (guess which!).

The reason we have so much of this behaviour is that abuses of this kind go unpunished, agencies of enforcement are systematically de-funded and the stockmarket rewards unethical behaviour. Or, as Kuppy says “fraud is alpha.”

To say that stakeholder capitalism is the solution to market abuses of established firms is to argue that criminals should be encouraged to go to church more. It’s probably not a bad idea, but it’s hopelessly naive.