America’s wealth is not an inventory of goods; it is an organic entity, a fragile pulsing fabric of ideas, expectations, loyalties, moral commitments, visions. To vivisect it for redistribution is to kill it. As President Mitterrand’s French technocrats discovered in the 1980s, and President Obama’s quixotic ecocrats are discovering today, government managers of complex systems of wealth soon find they are administering an industrial corpse, a socialized Solyndra.
All riches must finally fall into the gap between thoughts and things. Governed by mind but caught in matter, assets must afford an income stream that is expected to continue. The expectation may shift as swiftly as thought, but things, alas, are all too solid and slow to change. The kaleidoscope of shifting valuations, flashing gains and losses as it is turned in the hands of time, in the grip of “news,” distributes and redistributes the wealth of the world far more quickly and surely than any scheme of the state.
The belief that wealth consists not chiefly in ideas, attitudes, moral codes, and mental disciplines but in definable static things that can be seized and redistributed — that is the materialist superstition. It stultified the works of Marx and other prophets of violence and envy. It betrays every person who seeks to redistribute wealth by coercion. It balks every socialist revolutionary who imagines that by seizing the so-called means of production he can capture the crucial capital of an economy. It baffles nearly every conglomerateur who believes he can safely enter new industries by buying rather than by learning them. It confounds every bureaucrat of science who imagines he can buy or steal the fruits of research and development.
Even if it wished to, the government could not capture America’s wealth from its 1 percent of the 1 percent. As Marxist despots and tribal socialists from Cuba to Greece have discovered to their huge disappointment, governments can neither create wealth nor effectively redistribute it. They can only expropriate and watch it dissipate. If we continue to harass, overtax, and oppressively regulate entrepreneurs, our liberal politicians will be shocked and horrified to discover how swiftly the physical tokens of the means of production dissolve into so much corroded wire, abandoned batteries, scrap metal, and wasteland rot.
Capitalism is the supreme expression of human creativity and freedom, an economy of mind overcoming the constraints of material power. It is not simply a practical success, a “worst of all systems except for the rest of them,” a faute de mieux compromise redeemed by charities and regulators and proverbially “saved by the New Deal.” It is dynamic, a force that pushes human enterprise down spirals of declining costs and greater abundance. The cost of capturing technology is mastery of the underlying science. The means of production of entrepreneurs are not land, labor, or capital but minds and hearts. Enduring are only the contributions of mind and morality.
All progress comes from the creative minority. Under capitalism, wealth is less a stock of goods than a flow of ideas, the defining characteristic of which is surprise. Creativity is the foundation of wealth. As Princeton economist Albert Hirschman has put it, “creativity always comes as a surprise to us.” If it were not surprising, we could plan it, and socialism would work. Joseph Schumpeter propounded the basic rule when he declared capitalism “a form of change” that “never can be stationary.” The landscape of capitalism may seem solid and settled and something that can be captured; but capitalism is really a noosphere, a mindscape, as empty in proportion to the nuggets at its nucleus as the expanse of the solar system in relation to the sun.
Entrepreneurship is the launching of surprises. The process of wealth creation is offensive to levelers and planners because it yields mountains of new wealth in ways that could not possibly be planned. But unpredictability is fundamental to free human enterprise. It defies every econometric model and socialist scheme. It makes no sense to most professors, who attain their positions by the systematic acquisition of credentials pleasing to the establishment above them. Creativity cannot be planned because it is defined by information measured as surprise. Leading entrepreneurs — from Sam Walton to Larry Page to Mark Zuckerberg — did not ascend a hierarchy; they created a new one. They did not climb to the top of anything; they were pushed to the top by their own success. They did not capture the pinnacle; they became it.
In the Schumpeterian mindscape of capitalism, entrepreneurial owners are less captors than captives of their wealth. If they try to take it or exploit it, it will tend to evaporate. Bill Gates, for example, already a paper decibillionaire, commented during his entrepreneurial heyday that he was “tied to the mast” of Microsoft.
If Gates had tried to leave or substantially cash out at any time during the early decades, the company would have plummeted in value more rapidly than he could have harvested the funds. When the founders of Bain and Company attempted to cash out in 1991, taking $200 million with them, Mitt Romney was faced with the likely bankruptcy of the firm. He had to confront a Goldman Sachs effort to close it down. As the once-lucrative company collapsed, Romney cut the share of his departing partners in half in order to save his company and his reputation in business. David Rockefeller devoted a lifetime of 60-hour weeks to his own enterprises. Younger members of the family wanted to get at the wealth and forced the sale of Rockefeller Center to Mitsubishi. But they will discover that they can keep the wealth only to the extent that they serve it, and thereby serve others, rather than themselves.
Most of America’s leading entrepreneurs are bound to the masts of their fortunes. They are allowed to keep their wealth only as long as they invest it in others. In a real sense, they can keep only what they give away. It has been given to others in the form of investments. It is embodied in a vast web of enterprises that retains its worth only through constant work and sacrifice. Capitalism is a system that begins not with taking but with giving.
For this reason, wealth is nearly as difficult to maintain as it is to create. Owners are besieged on all sides by aspiring spenders — debauchers of wealth and purveyors of poverty in the name of charity, idealism, envy, or social change. Bureaucrats, politicians, bishops, raiders, robbers, short-sellers, and business writers all think they can invest money better than its owners. In fact, of all the people on the face of the globe, it is usually only the legal owners of businesses who know enough about the sources of their wealth to maintain it. It is usually they who have the clearest interest in building wealth for others rather than spending it on themselves.
Nevertheless, even while dismissing the charge that the “rich” indulge in a carnival of greed, we have not fully explained the reasons for their great wealth, much less justified it. Some apologists will say that Mark Zuckerberg’s Facebook billions, for example, are a reward for his brilliant entrepreneurship and software coding, while penury is just the outcome of alcoholism and improvidence. The saintly social worker and even the president of the United States, for that matter, earn modest salaries by comparison, and they are neither improvident nor necessarily less brilliant than Mark.
But that whole line of argumentation is beside the point. The distributions of capitalism make sense, but not because of the virtue or greed of entrepreneurs, nor as inevitable by-products of the invisible hand. The reason capitalism works is that the creators of wealth are granted the right and the burden of reinvesting it. They join the knowledge acquired in building wealth with the power to perpetuate and expand it.
Entrepreneurial knowledge has little to do with certified expertise, advanced degrees, or the learning of establishment schools. The fashionably educated and cultivated spurn the kind of fanatically focused learning commanded by the innovators. Wealth all too often comes from doing what other people consider insufferably boring or unendurably hard.
The treacherous intricacies of software languages or garbage routes, the mechanics of frying and freezing potatoes, the mazes of high-yield bonds and low-collateral companies, the murky lore of petroleum leases or housing deeds or Far Eastern electronics supplies, the multiple scientific disciplines entailed by fracking for natural gas or contriving the ultimate search engine — all are considered tedious and trivial by the established powers.
Most people consider themselves above the gritty and relentless details of life that allow the creation of great wealth. They leave it to the experts. But in general you join the 1 percent of the 1 percent not by leaving it to the experts but by creating new expertise, not by knowing what the experts know but by learning what they think is beneath them.
The competitive pursuit of knowledge is not a dog-eat-dog Darwinian struggle. In capitalism, the winners do not eat the losers but teach them how to win through the spread of information. Far from being a zero-sum game, where the success of some comes at the expense of others, free economies climb spirals of mutual gain and learning. Far from being a system of greed, capitalism depends on a golden rule of enterprise: The good fortune of others is also your own. Applied to both domestic and international trade and commerce, this golden rule is the moral center of the system. Not only does capitalism excel all other systems in the creation of wealth and transcendence of poverty, it also favors and empowers a moral order.
Richard Posner, now an eminent judge, was one of my inspirational sources for the idea that capitalism is inherently favorable to altruism. “The market economy,” he wrote, “fosters empathy and benevolence, yet without destroying individuality,” because for an individual to prosper in a market economy he must understand and appeal to the needs and wants of others. As a result of my seizing the verboten flag of “altruism” from his hands and waving it at the head of the supply-side parade, Ayn Rand devoted much of her last public lecture to a case against my ideas. I hugely admired Rand, who flung her moral defense of capitalism in the face of Soviet terror and socialist intellectual tyranny. But toward Christian altruism she indulged an implacable hostility, stemming in part from her simplistic atheism and in part from her disdain for the leveler babble of sanctimonious clerics.
Most of the world, then as now, was engaged in one of its periodic revulsions against capitalist “greed” and waste. Lester Thurow of MIT was proclaiming a “zero-sum society,” where henceforth any gains for the rich must be extracted from the poor and middle classes. William Sloane Coffin, the formidable Yale chaplain, was inveighing against capitalist orgies of greed and environmental devastation. Howard Zinn and Noam Chomsky were denouncing Western capitalism for displacing American Indians and condemning Israelis for displacing Palestinians (rather than praising the settlers in both countries for reclaiming and redeeming wastelands and hugely enlarging the populations they could support). Edward Said was conducting his Columbia classes (fatefully introducing the works of Frantz Fanon to future president Barack Obama) on Western psychological colonization and hegemonic evisceration of the entire Third World.
Here we go again, in the New Millennium. The themes of exploitation and zero-sum equality continue to preoccupy the media. Congress remains enthralled with static accounting rules that assume tax-rate reductions will not alter economic behavior. In this model, the only way to expand tax receipts is to raise rates on the “rich.”
For their part, some conservative leaders imply that our national crisis is merely some budgeting blunder remediable through a balanced-budget amendment to the Constitution. The focus on budgetary issues that will become acute a decade or so from now implies that liberal policies are not already infecting our economy with a multiple sclerosis of tax and regulatory curbs, destroying jobs and families with webs of rules and pettifoggery, skewed social policies, and litigation. A preoccupation with national liabilities diverts attention from the massive political devaluation of the nation’s assets.
“Starve the beast” is the new mantra of conservative economics. “Shrink the budget” is the new mandate for prosperity. “Keep what you earn” is seen as the moral foundation for lower taxes. All these formulations bear some truth, but they focus on accounting tautologies rather than on the dynamics of creative enterprise. Conservatives still urge lower taxes, but many no longer know how to defend them, distracted as they are by an economics of austerity that obsesses on the downside of deficits in a way inimical to the supply-side vision of abundance and unpredictability.
The first edition of Wealth and Poverty (1981) sprang from a period of essentially balanced budgets and trade surplus under Jimmy Carter and helped launch a siege of deficits and trade gaps under Ronald Reagan. During the Carter years, the government was mostly in the black while everyone else was in the red. Under Reagan, though, the trillion-dollar rise in government liabilities was dwarfed by a $17 trillion expansion of private-sector assets thanks to creative entrepreneurs. Over the decades following the Reagan revolution, government liabilities continued to expand, but once again private-sector-asset values increased, by $60 trillion more. Only over the past ten years or so have liabilities risen faster than assets, which have crashed. Improvements in policy and tax rates can instantly upgrade the value of all the assets in the economy without any physical change in their material composition.
Opposed to the reality of capitalism as a function of knowledge and creativity is the behavioral dream — implicitly accepted even among some supply-siders — of a “Skinner box” economics of stimulus and response, wherein lower tax rates impart a stimulus of reward for more work and risk-taking and thereby yield more revenues for the government. The implication is that the mere desire for wealth has something to do with the ability to create it. But as Steve Forbes observes in How Capitalism Will Save Us, explaining capitalism by self-interest or greed is like explaining airplane crashes by the force of gravity. Greed and gravity are general and ubiquitous in regimes of all sorts and therefore irrelevant to the extraordinary results of capitalist creativity.
Taxes do yield massively increased revenues as the rates are reduced. A successful economy, however, is driven less by the sharp edges of incentives than by the unimpeded flow of information and its conversion into knowledge and wealth through falsifiable experiments of enterprise. Increasing revenues come not from a mere scheme of carrots and sticks but from the development and application of productive knowledge.
The equation of lower tax rates and higher revenues remains perhaps the most thoroughly documented and widely denied proposition in the history of economic thought. It has been abandoned even by some former supply-siders who ignore the global tax revolution beyond our shores while obsessively analyzing ambiguous data from the Clinton era.
At a generation’s distance, it is clear to me that we, the original supply-siders, bear some responsibility for the failure to persuade. We were not radical enough — we allowed our own arguments to be ensnared by the mechanical economics of Adam Smith and his heirs. Even Arthur Laffer’s original and brilliant graph, after all, functioned almost entirely in the realm of rational expectations, stimulus and response applied to poor passive Homo economicus. Let him keep more of the fruits of his labor and he will labor harder, we proclaimed; increase the after-tax rewards of investment and more investment there will be.
By focusing on incentives rather than on information and creativity, free-market economists have encouraged the idea that capitalism is based on greed, although entrepreneurs cannot in general revel in their wealth, because most of it is not liquid. Greed, in fact, only motivates capitalists to seek government guarantees and subsidies that denature and stultify the works of entrepreneurs. The financial crash of 2007 and beyond reflected orgies of greed among crony capitalists awash in government guarantees and subsidies, sitting on their Fannies and Freddies, feeding in the troughs of Treasury privileges and government-insurance scams. Greed leads as by an invisible hand to an ever-growing welfare and plutocratic state — to socialism and near-fascist corporatism.
The secret of supply-side economics is not merely to incentivize people to work harder or accept more risk in order to gain a greater reward. That could be done under socialism. The reason lower marginal tax rates produce more revenues than higher ones is that the lower rates release the creativity of employers, allowing them to garner more information. They can move more rapidly down the curves of learning and experience. They can learn more because they command more capital to use in their trade. With more capital they can attract more highly skilled labor from around the globe. They can reduce time and effort devoted to avoiding taxes and interpreting regulations and consulting lawyers and accountants. With fewer resources diverted to government bureaucracy, they can conduct more undetermined experiments, test more falsifiable hypotheses, try more business plans, generate more productive knowledge.
It is not the enlargement of incentives and rewards that generates growth and progress, profits and capital gains for the entrepreneur and revenues for the government, but the combination of new knowledge with the power to test and extend it. Volatile and shifting ideas, not heavy and entrenched establishments, constitute the source of wealth. There is no bureaucratic net or tax web that can catch the fleeting thoughts of Eric Schmidt of Google, Jules Urbach of Otoy, or Chris Cooper of Seldon Technologies.
The key issue in economics is not aligning incentives with some putative public good but aligning power with knowledge. Business investments bring both a financial and an epistemic yield. Capitalism catalytically joins the two. Capitalist economies grow because they award wealth to its creators, who have already proven that they can increase it. Their proof was always the service of others rather than themselves.
As Peter Drucker has written, within companies there are no profit centers, only cost centers. Whether a particular cost yields a profit is determined voluntarily by customers and investors. Capitalism feeds on information that is outside of the company itself and therefore under the control of others. Only an altruistic orientation can tap the outside incandescence of information and learning that determine the success of capitalism’s gifts.
– Mr. Gilder is the author of 15 books, a venture investor, and a co-founder of the Discovery Institute. This article is adapted from the prologue to his Wealth and Poverty: A New Edition for the Twenty-First Century(Regnery).