[FoRK] Capitalism's Fundamental Flaw

Eugen Leitl eugen at leitl.org
Fri Nov 6 08:58:03 PST 2009


Capitalism's Fundamental Flaw

Sramana Mitra, 11.06.09, 06:00 AM EST

The system isn't rewarding the right people: innovators and creators.

Growing up in pre-liberalization India, I embraced Ayn Rand as the one who
best articulated a philosophy that rang true to my naturally entrepreneurial
mind. Capitalism, meritocracy, individualism, self-correcting market
economics, innovation, excellence, integrity, fairness, work-ethic,
justice--many of the values that I worship are also those that Rand
celebrates in her fiction through her unforgettable characters.

But as I have developed a deeper understanding of how capitalism works today,
I am beginning to see flaws that are unlikely to correct themselves.

To be fair, most flaws will self-correct. For example, in the venture capital
industry, we have seen a decade-long scam of taking limited partners for a
ride, raising big funds, extracting large management fees to the tune of
millions annually, and then returning negative on the investment. This, for
sure, has already started self-correcting. According to the National Venture
Capital Association, the number of venture funds declined to 1,366 in 2008,
down from 1,883 in 2001. In 2009, this decline continues, and over the next
decade, I believe, both the number of funds and the amount of money going
into venture capital will go down significantly.

This is pure capitalism at work. Investors and limited partners come to
realize that funds are not performing, and they pull the plug on them.
Non-performing funds die, those that do well survive, new funds crop up and
the industry as a whole gets right-sized. Some looters get away with their
riches, but mostly, their careers are over.

Also, in the recent financial crisis, we've seen the government intervene on
a massive scale, including putting billions into dead or dying companies such
as General Motors. Thankfully, however, the government did not continue to do
so, and GM entered bankruptcy as it very well deserved. No matter how
stupidly Michael Moore's new film, Capitalism: A Love Story, argues that GM
owed its plight to management not respecting the unions, most intelligent
people acknowledge that it was the union-enforced inflexibility that brought
about the outcome. Here too, capitalism is doing its job of self-correcting.

The banks, however, are another matter altogether, and this is where I think
capitalism has hit a roadblock. The government has intervened to save many of
them, and now, these bailed out banks want to hand out billions in bonuses to
their non-performing employees. Capitalism gave way to welfare economics, and
now the government has to intervene further to limit these looters from
behaving badly by imposing taxes and regulations. A whole messy cycle that
brings me to the core "bug" in the system that Rand once sold me on, fully
and completely.  Read All Comments

Too many sacred tenets in Rand's philosophy stand violated. Integrity,
justice, fairness, work-ethic, excellence--all have fallen prey to greed.
Rand's flaw? She assumed integrity is implicit in the characters of the
"leaders." It isn't. And hence again, most intelligent people are coming to
the conclusion that the government must intervene to stop further shameless
looting of taxpayer money. Free-market capitalism gets halted, regulation
makes sense.

But there is another less obvious bug in capitalism that I don't believe
regulation can quite handle. It is the fundamental flaw that our celebrated
system rewards speculators much more than creators. A relatively junior
hedge-fund manager or a bond trader on Wall Street makes a great deal more
money in his career than Charles Kao, who invented the basic physics making
optical communication a reality. Dr. Kao, now 73, won the Nobel Prize this
year, but his net worth would not compare favorably with that of George

Yet, who added the real value? Soros or Kao?

In 2009, 30 million people sit unemployed in America. Yet, the speculators
have managed to lift the stock market up, and the media pretends that we're
having a recovery.

We're not having any recovery. We need the innovators, the entrepreneurs, the
creators, the scientists, the technologists--those who build value, those who
create jobs--to lead us out of this nightmare. Not a bunch of speculators who
make money regardless of whether value gets created or destroyed. In fact,
many of them are incentivized to destroy value by spreading fake rumors about
companies and stocks, and they do so often. Some get caught, most don't.

And our talented youth gets seduced by this profession of speculation known
for its easy and abundantly flowing financial rewards, avoiding those that
require much greater intellectual capacity. Most importantly, very early in
their lives, our talented youth come to realize that fields that may earn
them a Nobel Prize--cancer research or multi-core computing--may not make
them rich. But moving money from here to there will.

And thus, we lose Berkeley Ph.Ds in nuclear physics to hedge funds and MIT
computer scientists capable of delivering computing to 6 billion people to
derivative manipulation on Wall Street.

Rand, somewhere down the road, you lost me. I don't see how free market
capitalism fixes this systemic flaw.

And I am deeply disturbed.

See this discussion on Capitalism 2.0 on my blog for more on the subject.

Sramana Mitra is a technology entrepreneur and strategy consultant in Silicon
Valley. She has founded three companies and writes a business blog, Sramana
Mitra on Strategy. She has a master's degree in electrical engineering and
computer science from the Massachusetts Institute of Technology. Her three
books, Entrepreneur Journeys, Bootstrapping, Weapon Of Mass Reconstruction,
and Positioning: How To Test, Validate, and Bring Your Idea To Market are all
available from Amazon. 

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