Risky Business

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There I was, minding my own business and rereading Emerson’s Nature (with the intent of writing something about how the Transcendentalists would reject out of hand today’s “green” cult) when I was interrupted by rhetoric so strikingly stupid I was compelled to put down the old book.

The president was on the television, babbling:

And when you look at what independent economists are saying about the American Jobs Act, my jobs plan, uniformly what they are saying is, this buys us insurance against a double-dip recession, and it almost certainly helps the economy grow and will put more people back to work, and that's what the American people want . . .

It’s excruciating to me how this affirmative action-borne halfwit misuses the word “insurance.” And this is more than just a semantic objection — the stupidity that statists show about matters of risk and insurance are a major reason America is stumbling toward bankruptcy.

I make my living writing about risk and insurance for professionals and interested laymen. It’s important stuff, a nexus of philosophy and finance. So it galls me particularly when some hack yammers about “insurance against . . . recession.” That’s like insurance against bad luck or unhappiness. There’s no such thing.

Insurance entails many elements but two are most important: risk identification and risk transfer. The first involves understanding and organizing the specific causes of loss that a person or entity faces in given circumstances. The second involves finding a counterparty willing — for a fee — to indemnify the person or entity against the losses that occur from those specific causes.

The point here is that no one, and no form of insurance, can eliminate risk. All that insurance does is move the risk around. Done well, it moves the risk in a way that makes economic sense to all parties involved.

The president believes that his latest spending spree is insurance. If so, who’s the person or entity identifying the risk? He? We? And who’s the counterparty agreeing to indemnify against the specific losses? They? A bunch of rich guys who aren’t Jeffrey Immelt?

The answer, of course, is nihil and null set. The American Jobs Act transfers nothing and insures against nothing. And I hazard the prediction that will accomplish nothing.

Hacks like Obama confuse the concepts “insurance” and “subsidy.” And this isn’t a new mistake for the president. Four years ago, when I reviewed his meager campaign document The Audacity of Hope for this magazine, I wrote:

Obama’s most tortured pages are the ones that deal with issues of risk and security in public policy. Like most statists, he has a weak understanding of risk theory.

“The bigger the pool of insured, the more risk is spread, the more coverage provided, and the lower the cost. Sometimes, though, we can’t buy insurance for certain risks on the marketplace — usually because companies find it unprofitable. Sometimes the insurance we get through our job isn’t enough, and we can’t afford to buy more on our own. Sometimes an unexpected tragedy strikes and it turns out we didn’t have enough insurance. For all these reasons, we ask the government to step in and create an insurance pool for us — a pool that includes all of the American people.” (177–78)

This passage makes Obama seem either ignorant or willfully misleading about risk allocation and insurance. . . . no [counterparty] — including the state — can “step in” and create a risk pool after a loss (in his words, a “tragedy”) has occurred. The purpose of risk pools is to gather resources before a loss occurs, so that they can be allocated when one does.

That part about stepping in and setting up risk pools after a loss is important. It’s essentially what Obama is doing now — arguing for more borrowed money to be spent “creating jobs” after high unemployment numbers have been reported.

This willful stupidity about risk and insurance explains much about Obama’s ineffectiveness as an executive. And I still wonder today what I did four years ago: do statist hacks believe in collectivism because they don’t understand risk and rewards? Or do they believe in collectivism first and then ignore risk because its rules contradict their halfwit pieties?




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Getting There from Here

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Libertarians have little reason for optimism these days. Things could have been different. If government interventions since the 1930s had not crowded out profit-oriented enterprise, then programs for retirement, medical care, relief of poverty, dependable energy, and protection of property rights and of the environment would have evolved in more satisfactory ways. Private enterprise would have taken account of increasing life expectancy, increasing mobility, reduced intergenerational solidarity within families, improving medical technology, and changes in the labor force and labor market. The details of flexible evolution could not have been (and cannot now be) foreseen.

Government has forestalled any such evolution. The Great Depression, itself the consequence of botched policy, brought many experiments, including Social Security and privileges for labor unions. Wage controls in World War II brought employer-centered medical insurance. Politicians now have ample opportunities to urge their bright ideas, including more regulation as well as more spending.

It is easy to recommend limited government in a libertarian society. But how can we get there? “Entitlements” and commitments to police the world have saddled the government with extreme financial burdens on top of the explicit and ever-growing national debt.

Libertarian politicians must be willing to negotiate. Academicians, though, should not fudge their analyses in hopes of political influence. A generation ago, Clarence Philbrook rightly condemned such “realism” (American Economic Review, December 1953). Among politicians, everything should be on the table, even tax increases. I rather admire the sober approach of the Simpson-Bowles commission. It is scandalous that politicians should be intimidated into signing Grover Norquist’s antitax pledge. The recent debt-ceiling increase may have been a legitimate bargaining chip, but it was irresponsible to resist any compromise that included it. It is deplorable to call people like Michelle Bachmann libertarians (as I have heard in conversation). The Republican presidential aspirants (including, apparently, the eager-to-be-drafted Sarah Palin) hardly command enthusiasm. Among academics, dogmatic outright anarchists also harm the cause of a free society.

Getting there requires starting from here, which requires restoring government fiscal health on the way. (Remember about sometimes taking one step back to take two steps forward.) Ways can be found to shrink deficits and debt as fractions of GDP and eventually even in absolute terms. That is feasible, fiscally and economically.

Politically — that is another story. Voters, by and large, have become too dependent on government to tolerate libertarian ideas any time soon. Drift will continue, and the government will eventually have to repudiate its debt and other commitments. Default will not come openly but through inflation, through destruction of the dollar.

I am anxious to be shown wrong. Can anyone offer any plausible grounds for cheer?




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Cesspools of "Education"

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As readers of this journal know, I like to highlight work being done by classical liberal thinktanks. A recent piece by the estimable George Leef of the John William Pope Center for Higher Educational Policy affords me the opportunity to do so. It touches a topic about which I have written myself.

The topic is the dirtiest, darkest secret in American education: the general weakness of university education departments, through which pass most future teachers. These departments effectively control the teacher credentialing process in most states. They are truly cesspools of educational mediocrity.

Leef reviews a paper by an economist, Cory Koedel of the University of Missouri. Koedel conducted a detailed analysis of the grades given in education department courses, and we are all shocked — shocked! — to find grade inflation rampant.

Koedel found that profs in education departments award good grades to virtually all their students. In many ed school classes, all “students” receive As. It’s Carrollean: all the kids are winners, so all must have prizes. Koedel notes that this was recognized as a problem half a century ago. And I recall reviewing a book back in 1987 (Education’s Smoking Gun, by Reginald Damerell), a book that excoriated ed departments as hopelessly obstructionist and patently useless. But given the continuing decline of American students in the international rankings, this matter seems worth addressing with renewed interest.

Koedel notes that one reason for the easy grading is that there is no market discipline to check it. If an engineering department routinely gave As to even the most incompetent students, the market would punish it—very soon, its graduates would simply not find jobs. But no such discipline faces incompetent education school grads.

Of course, if we privatized the public school system by voucherizing all the schools, there would suddenly be market discipline. But I won’t pursue that topic here.

Leef adds a second reason for the fact that grade inflation is especially rampant in ed departments: they are ruled by an ideology that includes the view that the role of the teacher is to impart self-esteem directly to the student. Ed profs are merely being consistent — making their students feel good by shoveling the As at them.

I have no doubt that a big part of the problem with ed schools is a loopy leftist ideology, a kind of aging hippie Weltanschauung that worships books like Pedagogy of the Oppressed. It’s no surprise that when Bill Ayers decided he wanted to stop waging revolution and start working for wages, he became an ed school prof.

But I suspect that another part of the problem is simple ignorance about how to instill self-esteem. Alas, ed school profs don’t read Aristotle (he is, after all, a really dead white male). His view is one that the best teachers instinctively hold. It is that the way to create self-esteem is not to try to instill it directly, but instead to help each student develop his potential, his virtues; and from the exercise of his virtues he will get his rightful self-esteem. If you have a student who has ability at, say, math and music, encourage her to develop those abilities as far as she can, and from the mastery of those subjects will flow her self-esteem.

I am grateful to Leef for pointing out something of which I was unaware. Japan — a country where student performance has traditionally been excellent — has no ed schools. All teachers must actually get an undergraduate degree in an actual academic subject, and then find a teacher with whom they can apprentice, to learn the mechanics of the profession.

This raises the intriguing question of whether we could implement such a system here. Certainly something like that is being done by the group Teach for America, which takes Ivy League graduates in solid subjects and just gives them a course in the mechanics of classroom instruction. Its graduates are highly sought after.




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More on Government Motors

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Earlier this year, President Obama went on one of his gloating tours, touting the wisdom of his nationalization of General Motors and Chrysler. Theirs was a corrupt bankruptcy that strongly rewarded the UAW, one of Obama’s major financial contributors. The new GM then posted a few months of improved sales, leading to much crowing by all the corrupt cocks.

But lately, the road for what is derisively termed “Government Motors” has become rather bumpy, as illustrated in a recent story. The report is about how the New GM is trying desperately to get a dismissal of a class action lawsuit filed on behalf of 400,000 Chevy Impala owners.

The suit, filed by one Donna Truska, argues that the Impalas — made between 2007 and 2008 — had defective rear spindle rods, leading to rapid tire wear. The plaintiff claims that GM has breached its warranty, and demands that GM fix the cars.

But the new GM argues that since the cars were made by the Old GM, it is not liable for the repairs, and the 400,000 Impala owners should therefore go to hell. Of course, the New GM was only too happy to take over the losses of the Old GM so it could stiff other taxpayers out of future taxes on the New GM, but it doesn’t want to assume any liabilities.

And of course, back in March of 2009, as GM headed toward bankruptcy, Obama promised that in any action he took to “save” GM, consumers would have their warranties honored. As he trumpeted at the time, “Let me say this as plainly as I can. If you buy a car from Chrysler or General Motors, you will be able to get your car serviced and repaired just like [sic] always. In fact, it will be safer than it has ever been. Because starting today, the United States will stand behind your warranty!”

Another Obama lie, of course. He stood behind GM warranties about as much as he has stood behind the American dollar . . .

Meanwhile, shares of the New GM hit a new low of $22 a share.




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The Passing Paradigm

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The latest much-ado-about-nothing crisis passed, with a result that should seem familiar. In 2008, Americans were told that if the TARP bill (a $787 billion taxpayer-funded welfare handout to large banking institutions) wasn’t passed, the stock market would crash and massive unemployment would follow. After an unsuccessful first attempt to pass the bill amid angry opposition from constituents, the bill passed on a second vote. Subsequently, there was a stock market crash followed by massive unemployment.

This time, our political-media cabal told us that if Congress was unable to pass a bill to raise the debt ceiling, the government would not be able to meet its short term obligations, including rolling over short term bonds with new debt. US debt would be downgraded from its AAA status, and a default would be imminent. After the melodrama, Congress passed the bill raising the debt ceiling. Standard and Poor’s subsequently downgraded US Treasury debt anyway, and deep down everyone knows that a default is coming as well, one way or another.

We are seeing the end of a paradigm. Thomas Kuhn argued in The Structure of Scientific Revolutions (1962) that anomalies eventually lead to revolutions in scientific paradigms. His argument holds equally true for political paradigms.

A paradigm is a framework within which a society bases its beliefs. For example, people at one time believed that the forces of nature were the work of a pantheon of gods. Sunlight came from one god, rain from another. The earth was a god, as was the moon. With nothing to disprove the premises of the paradigm, it persisted. People went on believing that sunlight and rain were the work of sunlight and rain gods because there was no compelling reason for them to believe otherwise.

However, within any paradigm there are anomalies. Anomalies are contradictions — phenomena that cannot be explained within the framework of the paradigm. People have a startling capacity to ignore or rationalize away these anomalies. While it may defy logic to continue to believe that rain comes from a rain god even after evaporation and condensation has been discovered and proven, people would rather ignore the anomalies and cling to the paradigm than face the fact that the paradigm is false.

There is at least one thing that will be quite obvious: centralized government is insane.

But once there are too many anomalies, the paradigm fails, and a new one must take its place. This new paradigm renders the old one absurd, even crazy. At some point in the future, people will look back on the political paradigm of the 20th and early 21st centuries. There is at least one thing that will be quite obvious to them: centralized government is insane.

Consider the premises upon which this present paradigm relies: all facets of society must be planned and managed by experts. The judgment of the experts trumps the rights or choices of any individual. The choices made by the experts will result in a more orderly society and greater happiness for the individuals who compose it. There will be better results from one small group of experts controlling everyone than multiple groups of experts controlling smaller subgroups of society.

Of course, libertarians reject every one of these assumptions on its face. A free society does not tolerate “planning” or “management” by anyone. All choices are left to the individual, as any attempt to plan or manage his affairs amounts to either violation of his liberty, looting of his property, or both. However, let’s assume that the first three assumptions of the present paradigm are valid and merely examine the last. Even that does not hold up to scrutiny.

Suppose an entrepreneur starts a business. At first, his market is local. He opens retail outlets that are overseen by store managers. The entrepreneur is the CEO of the company and manages the store managers. Even at this point, the CEO must trust day-to-day decisions to his managers. He has no time to make everyday decisions as he tries to expand his business. The managers do this for him and he concentrates on strategic goals.

His business is successful and soon he begins opening outlets outside of the original market. He now has a need for regional managers to manage the store managers. He manages the regional managers and leaves the details of how they operate within their regions to them.

The business continues to expand. With retail outlets in every state, there are now too many regions for the CEO to manage directly. The CEO appoints executive directors to manage larger regions, each composed of several smaller ones. There is an executive director for the West Coast, another for the Midwest, and another for the East Coast. Of course, the CEO has the assistance of his corporate vice presidents who manage sales, operations, human resources, and other company-wide functions from the corporate office.

Now, suppose that one day the CEO decides to fire the executive directors, the regional managers, and the store managers. He will now have the salespeople, stock clerks, and cashiers for thousands of retail outlets report directly to him and his corporate vice presidents. Would anyone view this decision as anything but insane?

As silly as this proposition sounds, this is a perfect analogy for how we have chosen to organize society for the past century. The paradigm rests on the assumption that every social problem can be better solved if the CEO and his corporate staff manage the cashiers and the salespeople directly. As in all failed paradigms, anomalies are piling up that refute its basic assumptions.

This paradigm assumes that centralized government can provide a comfortable retirement with medical benefits for average Americans, yet Social Security and Medicare are bankrupt. It assumes that a central bank can ensure full employment and a stable currency, yet the value of the dollar is plummeting and unemployment approaches record highs (especially when the same measuring stick is used as when the old records were set). It assumes that the national government’s military establishment can police the world, yet the most powerful military in history cannot even defeat guerrilla fighters in third-world nations. It assumes that the central government can win a war on drugs, yet drug use is higher than at any time in history. It assumes that experts in Washington can regulate commerce, medicine, and industry, yet we get Bernie Madoff, drug recalls, and massive oil spills.

Hundreds of years ago, the prevailing medical science paradigm assumed that illnesses were caused by “bad humors” in the blood. Operating with that assumption, doctors practiced the now-discredited procedure known as “bleeding.” They would cut open a patient’s vein in an attempt to bleed out the bad humors. As we now know, this treatment often killed the patient. Most rational people today view the practice of bleeding as nothing short of lunacy.

Ironically, this is a perfect analogy for the paradigm of centralized government. The very act of a small group of experts attempting to manage all of society drains its lifeblood. It is the uncoerced decisions of millions of individuals that create all the blessings of civilized society. It is the attempt by a small group of people to override those decisions that is killing society before our very eyes. Someday, people will look back on our foolishness and laugh as we do now at the misguided physicians who bled their patients to death. The present paradigm is dying. The revolution has begun.




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A Call to Repentance

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Are there libertarians who still regard President Obama with affection?

I understand that some people voted for him because they wanted to punish Bush and his fellow Republicans. The Republicans were warlike, and they were spendthrifts.

Well, if punishment is on the agenda, I want to be first in line to give some. Plenty, in fact. I’ll never get over George Bush’s ability to lie, lie, and keep on lying. But did you expect something better from Obama, you who supported him?

You did. I know you did. I heard you — at length.

As you said, Bush went to war, twice. But Obama continues running both wars, and he started a third one, the marvelously useless war in Libya. If he doesn’t get us involved in Somalia or Haiti, it will be a wonder.

As you said, Bush spent too much money. But Obama started off by spending a trillion dollars on a feckless economic program. He instituted a healthcare scheme that, basically, nobody wanted, which will cost at least half a trillion more and will give us notably less effective healthcare.

On August 8, Obama addressed the nation’s economic problems by demanding higher taxes and accusing those who don’t (such as you) of having caused the present economic distress. While he was talking, the stock market dropped like a rock. It lost 634 points that day.

But perhaps those who expected something libertarian out of Obama were right in one respect. His presidency has been wonderful for the gold market.




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The Perfect Ending

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After an agonizingly protracted battle, congressional leaders and the president reached an agreement to raise the debt limit, with some minor cuts in spending now and supposedly more cuts in the future, cuts that will be determined by a bipartisan panel.

There has been considerable rending of clothes and gnashing of teeth on both the left and the right sides of the political spectrum. But really, the agreement probably captures the mood of the majority of Americans.

As I have noted before, people are only just beginning to see the entitlement spending iceberg towards which the nation’s economy has been sailing for decades. But polls show that the public — including self-described Tea Party members — still strongly support the major culprits in the fiscal follies with which the country is beset: the entitlement programs, especially Social Security and Medicare.

In sum, the public is beginning to see the problem, but remains clueless — or, to wax Nietzschean for a moment, deliberately blind — to the real cause of the problem.

The agreement had immediate effects; though not ones, I daresay, that were comprehended by the supercilious solons who spawned it. And I’m not talking about the Standard & Poor’s downgrade.

First, as the US Treasury reported, the national debt immediately shot up $238 billion to a grand total of $14.58 trillion, officially hitting the mark of 100% of GDP. We as a nation have hit that mark only once before, right after World War II, the biggest foreign war we ever fought. We are now there again, in a time of comparative peace. As the report drily notes, this debt level puts us in the league of countries such as Italy and Belgium.

The second effect was not a stock market rally created by the exuberant joy of investors, relieved that disaster had been averted, but instead a massive sell-off, caused at least in part by the recognition that disaster looms.

All this brings to mind the old adage: a country gets the government it deserves.




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A Big Fish May Slip the Net

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Last year, Illinois bucked the national trend and voted for a very leftist governor — Pat Quinn, who had assumed the governorship in 2009 after Rod Blagojevich was impeached and removed from office.

Despite winning by only a narrow margin, Quinn has governed as any devout leftist would. He has pushed wind and solar initiatives, signed a law eliminating the death penalty, and increased taxes like crazy. In the face of a $15 billion budget deficit, he raised the personal income tax from 3% to 5%, and increased corporate taxes from 4.8% to 7%. He also instituted a sales tax on internet sales (the “Amazon tax”). Businesses let it be known that they would consider leaving the state if his tax increases passed, but he went ahead anyway, laughing in their faces.

Now businesses may get the last laugh. They are indeed beginning to leave. Especially illustrative is the recent announcement by the CME Group that it is "evaluating” whether to move some operations to other states. It is currently in talks with Florida, Tennessee, and Texas. What do these states have in common? Hmm . . . let me think. Wait . . . Oh, I know. They don’t have state income taxes, and they are notoriously pro-business.

CME is a pretty big fish. It is the parent company of the Chicago Mercantile Exchange, the Chicago Board of Trade, and the New York Mercantile Exchange (which includes COMEX, the New York Commodity Exchange). With 2,300 employees and revenues of between $2 and $3 billion, CME would be a real loss to Illinois’ economy if it departed. But Illinois would, quite frankly, deserve it.

As for Quinn, he probably doesn't care. He probably expects that if Obama passes another “stimulus” bill, money will be shoveled Chicago’s way — in the Chicago way.




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Theory and Practice

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The E-Trade Baby Blues

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When I was in college I learned about a theory called “the cultural contradiction of capitalism,” which claims that capitalism calls upon the public to assume two conflicting personas. As producers, people must be rational and responsible; but as consumers, they need to be irrational, carefree, and gluttonous, so they will buy as much as possible.

I recently recalled this theory while watching one of the incredibly annoying “E-Trade baby” commercials on television. The E-Trade baby’s message is that investing is fun and easy and, by implication, even a toddler could handle it. Although I am an aspiring lawyer, I do have some degree of background on investment advising, and I consider this message absolutely irresponsible. Investing is difficult. To beat the averages and outperform the indexes (which is the only sensible goal for day-trader-type, individually managed investing accounts such as E-Trade sells), an investor needs brilliance, discipline, and a ton of luck.

Investing without understanding how to research stocks is like gambling your life savings at a casino. A rational strategy for saving for retirement would include buying index mutual funds and highly rated bonds with gold or gold-related stocks as a hedge against inflation. Picking individual stocks (even supposedly “safe” or large-cap stocks such as IBM or Microsoft) is too risky for someone investing retirement savings. It is mathematically impossible to predict future stock prices accurately enough to eliminate the risk that your portfolio will be wiped out by bad luck or short-term swings on precisely the day when you need to dip into your savings. Stock-picking is not suitable for any investor unless you spend several hours each day researching your stocks. But actively managed investing for mainstream America is what the E-Trade baby sells.

Many Americans learned the dangers of Wall Street investment when the recent recession ate their portfolios. And Wall Street is a symbol of capitalism for the American public; when retirement accounts go down, Main Street always blames Wall Street. This happened in 1929, when the stock market crash started the chain of events that led to the Great Depression and the New Deal. It happened recently when the so-called Great Recession instigated the Dodd-Frank Wall Street Reform Act.

My own opinion is that a fool and his money are soon parted. The American investing public believed that stock prices and real estate values could never go down, and that the principle of “more reward requires more risk” did not apply. The public got what it deserved. But although I blame the investors, it is undeniable that Wall Street, from Goldman Sachs to Jim Cramer to E-Trade, promoted itself as an easy, riskless way for mainstream families to make money and save for retirement. The investing public’s “irrational exuberance,” to quote Alan Greenspan, can only help Wall Street to make money. Vast fortunes are made by investment banks when stock market bubbles inflate. Wall Street is partially to blame.

What I am trying to get at here is that even though libertarians love capitalism, we do not have to love everything that results from the profit motive. My favorite movies are the original Star Wars trilogy. But George Lucas, desiring to milk as much money from his franchise as possible, has produced several re-edited versions, each more atrocious than the last, and also filmed the pathetic “prequels.” Similar stupidity was behind the decision to film “Harry Potter and the Deathly Hallows” as two separate movies instead of one, dooming the two movies to artistic ineptitude. Generally, whenever a novelist or movie studio produces something good that people like, sequel after sequel follow, for no other reason than to make easy money and feed off the brilliance of the original.

Even though libertarians love capitalism, we do not have to love everything that results from the profit motive.

From a different angle, consider the widespread use of “intro rates” to persuade people to buy cellphone or cable TV services or six-month intro rates on credit cards. Are consumers so stupid that they don’t plan more than six months ahead? Ads full of colorful sights and sounds and subliminal associations but empty of facts and information about why their product is superior are the rule on television, not the exception. The stupidity of the public makes advertising easier. It is easier to sell car insurance by building a brand image around a jingle or a cartoon character than to produce a product that can be objectively demonstrated through scientific testing to be better than its competitors. Ads paid for by businessmen are a huge part of what shapes American culture and the American media — which helps explain why American culture is so strongly slanted in favor of shallowness, stupidity, and irrationality (though this is not a complete explanation, but merely one piece of the puzzle). America is full of instances in which businessmen appeal to consumers not on the basis of reason and logic but through gimmicks and psychological manipulations. Judging by the widespread success of ads like the E-Trade baby, many members of the public make some horribly irrational choices, in their consumer goods no less than their political beliefs.

You can’t blame capitalism for the fact that people make bad choices. Consumer irrationality is not a valid excuse to strip people of their freedom to choose. Wall Street gives us a far higher standard of living than any of the Soviet states ever achieved, and capitalism is the only system with a proven track record of prosperity and progress.

Nevertheless, the moral of this story is that the profit motive has a dark side. I know that some would say that the desire to make easy money by appealing to irrationality is not actually in any businessman’s long-term rational self-interest. I completely agree. Yet it is natural for people to seek to make money as easily as possible, and we see what results. Instead of blindly insisting that the profit motive can do no wrong, we should take the more refined approach and recognize that the fault lies with the people themselves, not with freedom as an economic system.

So I support the profit motive — but supporting the profit motive does not mean supporting everything that results from the profit motive.




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