The Worse Outlaw World
A thought experiment on the trade-offs
Consider this extreme tradeoff: Outlawing excessive profit versus outlawing bankrupting losses.
If you outlaw making a profit above some arbitrary threshold, you will create an environment in which people and firms will create two sets of books.1 They will deceive by hiding how good things really are. Insiders will be content but burdened with this artificial cost. Outsiders (onlookers) will be content in that they don’t know how “unequal” things really are.
If you outlaw losing money below some arbitrary threshold, you get something much worse. You get a deception where we lose all the most helpful market signals—those that tell us where to stop burning up resources. The eventual equilibrium is toward a different kind of deception where we paper over losses through bailouts and resets. We would have to hide the problems by kicking cans down the road (and creatively always finding new roads).
The fraud that is perpetrated in the later world is much worse than the first. Rather than just hiding the benefits that are being fruitfully generated as in the first case, we would be pretending things were better than what they really were in a way that would compound.
In the case of outlawed gains there would be constant witch hunts for those abusing the system. Yet these would not be like traditional witch hunts because the witches would actually exist. Upon these discoveries, the frustration people would naturally feel especially the most resentful among us would be palpable. They would be quite unruly and frustrated as a result.
Yet that is preferable to the seemingly more pleasant world where we pretend everything is fine and yet we’re all getting poorer together. That is the world where excessive losses are prohibited. In that world everything is fine until it isn’t. Sure, we would have lots of resentment and frustration especially, again, from the most resentful among us. Yet it is all worse because in this case the ones getting the most support would be those risking the most and occasionally losing.
Those big risks cannot be wished away. When they succeed, there are profits galore . . . for them. But when they fail, we share the burden because crippling losses are outlawed.
In reality we do not live in either of these extreme worlds. However, we do attempt to get some of both. We periodically attack profit thereby creating a world of deception as well as weaponized envy. We also generally look to build safety nets around, well, everything. None of this is free.
Punishing profit yields us less profit through disincentives as well as the cost of disguise.
Underwriting losses yields us idleness and excessive risk taking.
Tens of millions of people explicitly subsidized modestly to maintain a low standard of living comes at a cost—lots of people who find little need to take responsibility for their own lives and be productive.2
Tens of thousands of people implicitly subsidized tremendously to take risks with huge upsides (for them) and dramatic downsides (socialized) comes at a cost—people who find little need to balance risk and return.
Reality isn’t optional as Thomas Sowell always reminded us. Things that work should be allowed and encouraged to work. Things that don’t should not be.
If you outlaw profits, only outlaws will make profits.
This is made worse when benefits abruptly end at certain thresholds of income earned (so-called benefit cliffs) whereby the implicit tax on work can be as high as 100%.