By Ron Knecht – 20 October 2020
Progressives, liberals and other critics of market capitalism make particular criticisms purporting to show why it’s unfair to workers and consumers, leads to unreasonable inequalities in incomes and wealth, is unsustainable, locks in the poor to generations of poverty, etc.
They are simply wrong, as I’ll show today for the consumer/producer relationship. In later columns, I’ll address the other criticisms. My analyses show capitalism is in fact the greatest economic engine for enriching individuals and societies and fostering fairness, freedom, human flourishing, and wellbeing.
Starting with the relationship between consumers and producers, the capitalists commit the unpardonable sin to the critics of making profits! That is simply predatory and unfair, and the producers should lower their prices until profit is eliminated.
The fundamental fact of which the critics are simply ignorant or from which they hide is that market exchanges on average benefit consumers more than producers. No one forces a shopper to buy a bunch of cilantros. He does it of his own free will because he values that ingredient more than the money it costs him. So, in the exchange with the grocer, each gets more value than he gives.
In technical terms, every voluntary exchange yields a producer surplus – the profit – and a consumer surplus – the consumer’s gain in value of the purchase versus the price he pays.
But more than pedestrian purchases in common equilibrium markets, there are high profits producers make from invention and innovation. That sticks more in the craw of leftists than profits from daily exchange. From John D. Rockefeller and Henry Ford to Bill Gates and Jeff Bezos, aggressive and creative entrepreneurs who disrupted existing production and marketing regimes made huge fortunes. That’s obviously greedy and unfair.
Or maybe not.
Innovation and disruption create wealth, which again is shared between producers and consumers. Consumers buy in part because they can’t get enough of the value created by innovation and disruption. And in fact they get almost all of it.
That may be hard to believe when Bezos and Gates are jointly worth about $250-billion, even after giving away gobs and making a few bad investments. But long ago it became clear to me by considering now ubiquitous products such as word-processing and spreadsheet applications. Just after the Fall of Rome, when I was starting out as a consultant and expert witness, I needed many large, complex spreadsheets.
I had a stable of assistants working by candle-light on butcher or ledger paper with pencils and hand calculators. Because the calculations for each cell typically depended on calculations for previous cells, each spreadsheet had to be done twice, simultaneously by two munchkins to assure their accuracy. Each human computer would work about 15 minutes, and then they’d stop and compare the values they computed. If they agreed, they’d both proceed to the next 15 minutes. If not, they had to backtrack and find and correct any errors before they could again move forward.
This was truly tedious and time-consuming, and the spreadsheets were so large that each one took hours. Plus, the quality and extent of the analysis was limited because I couldn’t run sensitivity cases to see the effect of changing a key value or parameter.
When some brilliant entrepreneurs invented computer-based spreadsheets and subsequent generations of them, the munchkins were relieved of their drudgery and I could create the basic spreadsheet in 45 minutes or less. Accuracy was improved, and I could run endless variations and sensitivity cases so my analyses were robust and definitive.
The cost for each case and turnaround times were greatly reduced. So, the value to me and my clients was huge. Multiplying that value by many billions for the number of people doing similar exercises almost daily, the net consumer value of the spreadsheets for which they paid very modest prices greatly exceeded the hundreds of millions or even billions reaped by application creators.
In fact, in 2005-06 Yale economist William Nordhaus, later a Nobel laureate, did extensive research to quantify the producer and consumer benefits from such innovation. He concluded that, “Innovators were able to capture about 4 percent of the total social surplus (value) from innovation.” Consumers got the other 96 percent. ‘Nuff said.
Ron Knecht, MS, JD & PE(CA), has served Nevadans as state controller, a higher education regent, economist, college teacher and legislator. Contact him at Ron [email protected].