State of Innovation

Patents and Innovation Economics

Ayn Rand & Economics

Many people first become interested in economics because of Ayn Rand’s works such as Atlas Shrugged.  Ayn Rand did not develop a science of economics, she defined the moral codes for an economic system – specifically capitalism.  In the very first sentences of Capitalism: The Unknown Idea, Rand states:

This book is not a treatise on economics.  It is a collection of essays on the moral aspects of capitalism.

As a result, when students of Rand want to understand the science of economics they would often start examining the works of classical economics.  Adam Smith explained that the invisible hand resulted in people pursuing their own interest efficiently allocating scarce resources.  He also explained how specialization resulted in increased wealth using the example of a pin factory.  Commonly, people will then read Hayek who explains the limits of bureaucrats’ knowledge and how the price system is an information system for organizing resources.  Friedman who explains the problems of manipulating the money supply and Austrian economists who show that the value of a product (service) is subjective.  This study usually leads to two organizing principles of economics: supply and demand and that wealth is created in a free market by competition driving down the price of goods.

This leads to certain conflicts between economic science and Ayn Rand’s Philosophy.  For instance, if competition is an unqualified good then antitrust laws that encourage competition should be good.  But Ayn Rand believed that antitrust laws interfered with the free market and property rights.  If competition was constantly squeezing profit margins how could any person or firm become significantly wealthier than the average person unless they subverted the market.  The extreme version of this was set forth in the book “A Random Walk Down Wall Street.”  The stock market has already priced in all generally available information, so there is no way to beat the market.[1] This is related to the efficient market hypothesis, which is the application of perfect competition to the stock market.  The conclusion from economic science is that those people who get wealthy somehow subvert supply and demand by excluding competition and therefore are not competing fairly.  In other words, people who become wealthy in a free market are acting immorally.  The common solution to this dilemma is to note that human skills vary significantly from one person to the next.  Those with higher skills are able to consistently stay ahead of their competition.  We should not demonize them because those people who get rich do so by providing pleasure to a large number of people.

Alternatively, people who have enjoyed Any Rand’s works usually are interested in business and consider running a successful business, virtuous.  When they start to study business, they find that the last thing you want to do as a business is compete on price with a commodity product or service.  The whole goal of a business is to find or create a market where you can have a competitive advantage.  This is in complete contradiction to what they have learned from economic science.  Markets where a business is able to sustain a competitive advantage result in misallocation of resources, according to economic theory.  However, these are exactly the conditions a successful business seeks.  Ayn Rand says that capitalism and creating wealth in a free market are both virtuous.

By now our objectivist is completely confused.  One solution is to concentrate on personally creating wealth and ignore the free market theorists.  Their ideas of perfect competition are not consistent with Rand’s ideas anyway.  This person will then spend more time studying business.  As they start studying business they will learn that all the really tough problems involve management of people, either customers or employees.  Great business ideas and inventions are a dime a dozen, right?.  A successful businessperson needs to concentrate on the motivations and goals of customers and employees who may not be rational.  Because people are not rational we need to concentrate on their emotions.  This is beginning to sound more like Ellesworth Toohey or James Taggart than John Galt, Dagny Taggart or Howard Roark.

Finding this line of thought a little too emotive our objectivist will search for the real bastions of capitalism.  This search will lead them to Wall Street and the stock market, where no one is afraid to say they are trying to make money.  Here they will find fundamental and technical analysis of stocks.  Fundamental analysis is based on a detailed understanding of a company’s financial statements.  So real wealth is created by finance, right?.  When they study technical analysis they learn that the art of divination is not dead.  Nevertheless with economics focused on the money supply, government debt, tax rates, supply and demand and business focused on venture capital, stock prices, initial public offerings, and bond rates it appears that real wealth is created by finance.  Funny John Galt was not an financier instead of an inventor[2].  How could Ayn Rand have gotten things so wrong?

[1] Of course this does not apply to insider trading.

[2] There are inventors in finance and despite the bad name financial innovation has gotten recently, financial inventions have been critical to the modern economy.  For instance, fractional reserve banking is key to unlocking dead assets and more recently swept banking accounts increased the value of banking deposits.  Even collateralized mortgage obligations probably decrease risk and increase access to capital, when they are not manipulated by GSEs and given false bond ratings by government sanctioned ratings agencies.

November 28, 2010 - Posted by | Innovation | , , , ,

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