September 28, 2018 Reading Time: 6 minutes

In the movie Wall Street, Gordon Gekko delivers an iconic speech:

Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures, the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge, has marked the upward surge of mankind.

But few defenders of free markets, not even the oft-maligned Ayn Rand, can be read as defending greed. In fact, if greed or selfishness is understood as exploiting others, then greed is impossible in a system of voluntary exchange.

It is more accurate to say that some form of self-interest is always lurking in the background, contingent on the rules and norms of a society. Human institutions can usefully be arranged to make the clash of self-interest a benefit, rather than a harm, to a society. And that is just what market exchange can do, under a limited set of circumstances: markets can make human interaction mutually beneficial even if those same humans could be greedy in an authoritarian system.

What, then, of profits and the income disparities associated with market processes? Is not profit the animating spirit of capitalism? No. Capitalism is consumer sovereignty. Full stop. Profits, and income inequality, are signals, byproducts of the attempts by entrepreneurs to serve consumers. As in any other context, the idea that the world would be better if the level of byproducts were reduced to zero is quite mistaken. Pollution, for example, is a sign that something is being produced. Profits, in fact, are a sign that we need even more of the things being produced.

In an earlier post, I argued that the price system creates enormous value for the consumer because many products are available for much less than the consumer would be willing to pay. That benefit of markets is widely recognized, and even some of those who are worried about inequality would admit that the front end, the price-and-production side of markets, is indispensable.

But what about the back end, the distribution side? John Stuart Mill (1848, Principles of Political Economy) certainly thought otherwise. As he famously put it, there is a crystal-clear distinction between production decisions and distribution decisions:

The laws and conditions of the Production of wealth partake of the character of physical truths. There is nothing optional or arbitrary in them. Whatever mankind produce, must be produced in the modes, and under the conditions, imposed by the constitution of external things, and by the inherent properties of their own bodily and mental structure….

It is not so with the Distribution of wealth. That is a matter of human institution solely. The things once there, mankind, individually or collectively, can do with them as they like. They can place them at the disposal of whomsoever they please, and on whatever terms. Further, in the social state, in every state except total solitude, any disposal whatever of them can only take place by the consent of society, or rather of those who dispose of its active force. Even what a person has produced by his individual toil, unaided by any one, he cannot keep, unless by the permission of society. Not only can society take it from him, but individuals could and would take it from him, if society only remained passive; if it did not either interfere en masse, or employ and pay people for the purpose of preventing him from being disturbed in the possession.

In other words, the so-called free market distribution is just as arbitrary as any other distribution the state might select. The state not only can but must choose the best distribution from the perspective of the society as a whole.

The problem with this formulation is the idea that we can assume production and distribution are separable. “The things once there”? Seriously? And economists get mocked for their facile assumptions? There is no reason to assume that “the things” will be there, unless prices and profits can perform their directive functions. In fact, as Venezuela has recently learned to its great harm, without the lure and signal, the things are not there.

In a larger sense, the things won’t even be “things.” Innovations are just ideas that no one ever thought about until some entrepreneur came up with them. Potential profits are a signal to entrepreneurs. And entrepreneurs serve consumers. Greed won’t help, because the task of the entrepreneur is to imagine what the consumer wants even though the consumer doesn’t know it yet.

The idea of entrepreneurship appears to derive from the French verb entreprendre, meaning “to undertake.” One of the first clear statements using the modern meaning comes from J.B. Say:

An entrepreneur is an economic agent who unites all means of production — land of one, the labour of another and the capital of yet another and thus produces a product. By selling the product in the market he pays rent of land, wages to labour, interest on capital and what remains is his profit. He shifts economic resources out of an area of lower and into an area of higher productivity and greater yield.

But entrepreneurship is more than just buying low and selling high. Israel Kirzner gives what I think is the best description of the relation between profit, value, and entrepreneurship:

Let us consider the theorem which Jevons correctly called “a general law of the utmost importance in economics,” which asserts that “in the same open market, at any one moment, there cannot be two prices for the same kind of article.” … Now the existence of such a tendency [toward a single price] requires some explanation. If the imperfection of knowledge (responsible for the initial multiplicity of prices) reflected the lack of some “resource” (as where means of communication are absent between different parts of a market), then it is difficult, without additional justification, to see how we can postulate universally a process of spontaneous discovery.…

We understand, that is, that the initial imperfection in knowledge is to be attributed, not to lack of some needed resource, but to fail to notice opportunities ready at hand. The multiplicity of prices represented opportunities for pure entrepreneurial profit; that such multiplicity existed, means that many market participants (those who sold at the lower prices and those who bought at the higher prices) simply overlooked these opportunities. Since these opportunities were left unexploited, not because of unavailable needed resources, but because they were simply not noticed, we understand that, as time passes, the lure of available pure profits can be counted upon to alert at least some market participants to the existence of these opportunities. (New Directions in Austrian Economics; emphasis added)

Kirzner defined entrepreneurship as awareness, the constant searching for profit opportunities. But Kirzner conceived of errors much more broadly than the above passage would suggest. Rather than simply correcting errors in the price system and causing the convergence of prices of a single existing commodity, entrepreneurs imagine alternative futures, possible ways of organizing production, and new products that consumers may well not even be aware that they could have, much less want.

Steve Jobs, of Apple, famously observed in 1989 that entrepreneurs could not rely on static conceptions of demand: “You can’t just ask customers what they want and then try to give that to them. By the time you get it built, they’ll want something new.”

A decade later, Jobs went further: “But in the end, for something this complicated, it’s really hard to design products by focus groups. A lot of times, people don’t know what they want until you show it to them.” This view, if it is correct, suggests how entrepreneurship may be destructive, at least from the perspective of those other firms and enterprises still trying to make what people used to want. If an entrepreneur shows folks what they really want but don’t know they want … boom!

The Sony Walkman was an extremely popular (and profitable) device that allowed people to move around or even exercise while listening to the radio or to cassette tapes. At one point, the Walkman captured more than 50 percent of the mobile-music market. But then MP3 players were invented. MP3 is short for MPEG-3, an abbreviation for Motion Picture Expert Group codings. Codings are means of reducing the amount of information (bits of stored digital information) to encode a song without losing quality.

The first patents for MP3 encodings were issued in the United States in the late 1980s and the early 1990s. The first commercially viable MP3 players went on sale in the late 1990s, and by 1999 they were relatively common in stores. The first iPods from Apple were released in January 2001; by the end of 2002, 600,000 had been sold at prices exceeding $400 (in 2002 dollars).

So even though people didn’t know that MP3 was how they wanted to buy, store, and carry their music, it turned out to be so. The most successful MP3 player, for more than a decade, has been the iPod, made by Apple. Steve Jobs and the Apple engineers imagined a different arrangement of productive resources.

None of the resources needed to be invented, and none of the digital processes for storing the music were especially difficult or innovative. But the package, the iPod, was something new. It was a thing that wasn’t there, and then it was there, and people wanted it. Perhaps Steve Jobs did it for glory, but his company did it for profits, and profits made it possible.

Michael Munger

Michael Munger

Michael Munger is a Professor of Political Science, Economics, and Public Policy at Duke University and Senior Fellow of the American Institute for Economic Research.

His degrees are from Davidson College, Washingon University in St. Louis, and Washington University.

Munger’s research interests include regulation, political institutions, and political economy.

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