thoughtomation

removing the "mis" from information

Thursday, March 10, 2005

Bankruptcy Boondoggle

Successful business requires reasonably consistent rules; without consistency, risk skyrockets. Unless there is a compelling reason to change the rules - and if there is one, it is yet to be articulated - then the conservative (or at least free-market conservative) position is that healthy markets require regulatory stability.

Let's say I'm in the business of selling widgets. Demand is exceeding supply, which presents me with a choice if I want to increase my gross profit. I can either raise the price of a widget, or increase supply to satisfy the excess demand, or some combination of the two. If I want to increase supply, I also need to take into account a capital investment that gets amortized over a period of time, and figure that into the cost of my widget.

If I know the rules of the market and have reasonable assurance that they will remain constant, I can calculate precisely how to increase profits the most, what the price of a widget should be, and how many I should make. I can also determine with precision the timing and size of my new widget factory.

However, if I can't depend on the rules of the market to remain constant, I can't make any calculation at all with precision. I must guess what the rules might be, at least over the period of time I am paying off my capital investment in my widget factory. If the rules change - say, a sudden, punitive tax on widgets is introduced - this can easily turn a profitable, expanding company into a money-losing failure. With no reasonable assurance that no such change in market conditions is likely, expansion becomes a far riskier choice - perhaps so risky that it might not be worth it to build the new factory.

In this way, inconsistency of rules shrinks markets, halts expansion, and drives up risk.

The flip side is also true. If, like the credit card companies (CCCs), our widget company owner decides that his priority is to distribute as many widgets as possible regardless of whether his customers even have the ability to pay for them, by overexpanding in this he not only puts his own widget company on a course towards bankruptcy, but also damages the market for more responsible widget companies who are behaving in a classical capitalist manner, trying to maximize profits.

Now our widget company has screwed itself, since it depended for its expansion on revenues that are not collectible. Other widget company owners breathe a sigh of relief, knowing that the reckless competitor will go out of business and cease distorting the market through oversupply.

Sadly, these other widget companies would be wrong; their reckless competitor, instead of going out of business, gets the government to pay for every widget sold, even when those revenues are uncollectable in the market. Had the other widget companies known from the start that this rule would change, they could have adjusted their strategies accordingly and earned their fair share of the market. Sadly, we've decided to punish the other widget companies for behaving in a classic capitalist rather than a corrupt manner - the corrupt company pockets the profits that only it is eligible to receive from the government, and the responsible ones go home empty-handed.

It is because of shenanigans like this that I am not and will likely never be a Republican. It is unfortunate that there is no less corrupt option on the ballot.

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