Patience Is a Market Virtue

Why the free market can provide for the long term, while the government can barely plan past next Thursday.


Paper entrepreneurialism [which characterizes US business] involves little more than imposing losses on others for the sake of short-term profits for the firm.
Robert B. Reich
The Next American Frontier

We also recognize the limits placed on the American economy by huge corporations that dominate productive investment and make their investment decisions increasingly on short-term profit criteria.
Martin Carnoy, Derek Shearer, and Russell Rumberger
A New Social Contract

If we are to maintain our fiduciary relationship to the generations to come, then we must maintain our lands, and their lands, in perpetual trust. These last remnants of our great natural heritage are not ours to destroy for short-term profits.
Ernest F. Hollings
United States Senator

It is a widely held belief that, left to the market, business people will ignore the interests of the future in their obsession with short-run profits. After all, the profits made today are theirs, while the problems that arise in the future will be burdens shouldered by others. This emphasis on short-term profit supposedly explains why much of our industrial base is eroding and we are being outcompeted in world markets, why we ran head first into an energy crisis, and why we have been despoiling our environment and adding to the list of endangered species.

The solution to these problems that is urged upon us is as predictable as the sunrise: If we are to control the "rape-ruin-and-run" impulses of the marketplace, we must substitute collective action for private action. We need, in short, to rely more on the political process and less on the market process if we are to satisfy our obligation to future generations.

This collectivist "solution" takes on wide-ranging forms. For example, in the widely remarked book The Next American Frontier, Harvard professor Robert Reich urges the federal government to establish banks that would provide "deserving" industries low-interest loans for expanding their capital base. Or consider the interruption in the flow of oil from OPEC countries in 1973. Critics of the market process simply assumed that what was needed was direct federal control over the pricing and allocation of our energy resources. And it is generally assumed that unless the government directly regulates decisions made in private markets, our environment will be sacrificed.

No doubt market decisions can be, and often are, short-sighted. These decisions are motivated primarily by the desire to advance private objectives. Market decisions take the future into consideration only if it is in the interest of market decisionmakers to do so. This is certainly not surprising. After all, how many individuals will sacrifice their well-being, and that of their loved ones, in order to promote the ill-defined interests of future generations?

But what is the basis for the widespread faith that while decisionmakers in the private market are short-sighted, those who work for government can be trusted to put things right if only given the power to do so? Is this because politicians and government bureaucrats have less concern for themselves and more concern for the future than other people? Surely this is not the case, and it is doubtful that many people believe it is. More likely, the expectation is that the self-interest of politicians is tied, not to business profits, but to their response to citizens who can express their concerns at the polls, concerns that obviously include long-run considerations. As opposed to the profit incentive in the market, political incentives supposedly combine self-interest and concern for the future.

This sounds plausible. But it is not true. The incentive structure of government generates little motivation for political decisionmakers to consider long-run consequences of their actions. Political decisions tend not only to be shortsighted, but to be even more shortsighted than those made in a market setting. If, as many believe, we face serious problems because of the myopia of the marketplace, attempting to solve these problems with politically inspired solutions will quite likely make matters worse. Former British Prime Minister Harold Wilson did not know how right he was when he remarked, "In politics, a week is a long time."

Examples of the short attention span of the political process abound. Our nearly bankrupt Social Security program clearly points to the political and economic consequences of politically truncated time horizons. And surely it is the near-term focus of political incentives that accounts for the chronic failure of attempts to reduce the federal budget deficit.

We repeatedly find ourselves in situations that no one would have chosen over relevant alternatives in the past. Yet these alternatives were overlooked, because politically we were unable to look ahead to long-run consequences. And once having opted for the short-term expedient, there is no easy or obvious way to extricate ourselves. The only genuine escape requires the politically unacceptable: imposing immediate costs on well-organized interest groups.

From monetary policy to poverty programs, we have hugged one political tar baby after another. As a result, in case after case there seem no good options left. Proposals for addressing these problems are typically cosmetic quick fixes reflecting the very short-run perspective that led us into the problems to begin with. Confronting the problem of inflation with wage and price controls, or "solving" the problem of declining productivity by creating a federal development bank to allocate capital to favored industries, illustrate the political attractiveness of substituting temporary pretenses for genuine solutions.

In making the case that political decisionmakers face incentives to ignore the future consequences of their actions, the first thing that comes to mind is the importance attached to surviving the next election. The politician knows he will not be rewarded for the long-run benefits of a policy he champions if, because of the short-run costs imposed by the policy, he is defeated at the polls. This political impatience to generate benefits before the next election favors policies that provide immediate payoffs and impose deferred costs. If the payoff is realized before the upcoming election and the cost can be postponed until afterward, the policy will likely find political favor. Patience may be a virtue, but in the political arena it is a virtue that is seldom seen as its own reward.

Social Security legislation provides a case in point. From 1950 (when the first major increase in Social Security benefits was approved) through 1974 (after which benefits have been indexed to the cost of living), Congress increased Social Security benefits 11 times. Eight of these increases occurred during election years. Furthermore, in seven out of these eight cases the increase in Social Security taxes to pay for the additional benefits was postponed until after the election. Veterans' benefits follow the same pattern. According to one study, "Since 1962, [veterans'] benefits have increased an average of $660 million (at annual rates) between the third and fourth quarters of election years, but only $220 million in years without elections."

Why don't voters, through the electoral process, say nay to these shortsighted politicians? The whole concept of voting is based on the hope that politicians will respond to public concerns, concerns that clearly include long-run considerations. So why are these long-run considerations so often ignored?

Unfortunately, citizens have little motivation to acquire the information necessary to assess the long-run consequences of political decisions. Informed and far-sighted political decisions provide benefits to citizens whether or not they themselves are politically informed. So being informed on broad political issues gives the informed voter no more claim on the advantages of sound public policy than the claim of the uninformed.

It is rational, then, for individuals to remain politically ignorant while concentrating attention on areas where additional knowledge can provide a private advantage. Surely our well-being is influenced more by political decisions that determine whether we are at peace or war than it is by personal decisions on where we buy gasoline. Yet, most people are more informed on where gasoline is a nickel-a-gallon cheaper than they are on the particulars of foreign policy.

Occasionally, the immediate consequences of a policy can be associated with that policy without detailed information or expert knowledge. But even the most-informed will find it difficult to accurately anticipate the long-run consequences of a government policy or to assign precise responsibility for these consequences once they arise. Politicians are fully aware of this problem. They recognize that they are much more likely to be held accountable for the near-term results of their decisions than for the long-term results, so they focus their time perspectives accordingly.

An all-too-pertinent example is the political popularity of inflationary policies. An expanding money supply permits politicians to provide immediate and highly visible benefits for which they can easily take credit. Interest rates can be temporarily reduced, employment can be temporarily increased, subsidies can be doled out, services can be provided, and public projects can be financed. It is only after a lag, which from the political perspective is of considerable duration, that citizens pay for these benefits through higher inflation. Yet politicians have been remarkably successful at avoiding blame for inflation. A public ignorant of basic economics is gullible to the political rhetoric that blames inflation on excessive profits, inflated labor union demands, poor harvests, greedy oil sheiks, or irresponsible consumer spending.

The imperative of surviving the next election can explain why the political process is short-sighted. But it does not explain why it is more short-sighted than the market process. Corporate managers, for example, do not have particularly long tenures on average. And those to whom they are responsible—the stockholders of the corporation—normally are only modestly informed about the details of management decisions. So can't the logic that explains political short-sightedness similarly show that private-sector decisionmaking is excessively short-sighted?

National industrial policy advocate Robert Reich argues just that: "Managers who anticipate a short tenure with their firm unsurprisingly have little interest in long-term solutions to its basic problems. Their goal is to make the firm (and themselves) look as good as possible in the immediate future." And there seems to be an empirical basis for this argument. The average tenure of a corporate executive is, in fact, less than that of the average member of the House of Representatives. So why wouldn't business people have as little, if not less, concern for long-term consequences than do politicians?

It is here that the role of property rights enters the picture, although analysts such as Reich conveniently ignore that role. No social institution does more to motivate current decisionmakers to act as if they cared about the future than the institution of private property. All economic decisions—whether deciding when to consume a candy bar or how much to invest in a long-lived hydroelectric project—require a comparison between present and future values. Efficiency always requires that some current benefits be sacrificed in order to realize even greater benefits in the future, with this future often extending beyond the life expectancy of current decisionmakers. Obviously, unless those currently in control of resource decisions are in a position to realize some of the distant benefits from current sacrifices, there will be few current sacrifices. It is private-property rights that allow decisionmakers to capture some of the long-run gains that flow from current sacrifices.

At one level, the argument here is completely obvious. If ownership rights are well defined and enforced, then the owner of a resource is confident that he will still own the resource in the future and can benefit accordingly if its future value increases. If you think your candy bar will taste better if eaten two hours from now, you will take that future value into consideration.

But this cannot explain why private ownership motivates people to make investments that will not pay off until long after they are dead. Why, for example, replant white oak and Douglas fir forests that will not be harvested for 60 or more years? The explanation lies in the transferability of property rights.

The owner of farmland, for example, may be old and heirless. Personally, he may not care a thing about the future productivity of his land. But if property rights in land are transferable, there is little worry that this farmland's productivity will be depleted through shortsighted mismanagement. The immediate wealth of the owner is directly tied to the value that younger individuals who might buy the land place on the long-run productivity of the land. The old, heirless owner will make decisions as if he were concerned about future values. As long as property rights are transferable, those who best accommodate the tension between present and future demands will have both the opportunity and the motivation to buy resources from anyone who is insensitive to future concerns.

How does all this relate to corporate decisionmaking? Corporations, like farmlands, have well-defined and transferable ownership claims—stock in a corporation can be bought and sold. This has far more influence on the time perspective of corporate managers than does the length of their tenure. That corporate stock can be traded creates both the information and the incentives for stockholder decisions that encourage corporate managers to consider the long-run consequences of their actions. Because stockholders have a private stake in the value of their stock—and can trade the stock depending on its performance—they have a more-personal interest in the long-run consequences of corporate decisions than citizens have in the long-run consequences of political decisions. Moreover, stock ownership gives them more control over corporate managers than citizens have over political managers.

From the information provided through the stock exchanges, stockholders can easily determine whether the return from owning shares of, say, IBM compares favorably or unfavorably with the return from shares of Xerox, for instance. Certainly this is an easier task than most citizens faced with trying to determine whether they would be better off under a Reagan administration than a Mondale administration.

With corporate stock easily traded on organized markets, management decisions that reduce the long-run wealth of a corporation will be reflected immediately in the price of its stock. If, for example, the management of a corporation decided to borrow against future income in order to finance exorbitant dividends, stockholders would recognize immediately that they were worse off. And the value of their stock would, in response to long-run effects of the excessive dividend policy on the corporation's wealth, decline by more than the value of the additional dividends. The existence of stock that is undervalued because of myopic mismanagement creates both the incentive and the opportunity for a more future-oriented management team to assume control of the corporation—through a takeover bid, a proxy fight, or (more likely) a merger—and thereby raise the value of its stock.

Citizens have no such claims against the long-run wealth of the general political community. Consequently, they are less sensitive to reductions in that wealth. On the other hand, they are highly sensitive to reductions in temporary, but individually realized, benefits that result from political decisions. Therefore, one would predict political support for a government policy similar to a corporation's borrowing to finance current dividends.

Consider, for example, a policy of persistent deficit spending in order to finance a certain level of government expenditures. Such a policy allows the government currently to provide benefits, at the expense of crowding out private investment. The result is, of course, a reduction in the country's future wealth. That such a policy can be practiced with political impunity is evident from the record. Since 1960 the federal budget has been in surplus exactly once, with the almost unbroken string of deficits tending upward at a rapid rate. This record reflects myopic mismanagement that, pursued by a business, would have swift repercussions.

When contrasting the difference in corporate and political time perspectives, two additional features of private property should be considered. First, the transferability of corporate stock enables property interests in the present value of a corporation to be concentrated. That is, a large percentage of a corporation's stock can be, and often is, owned by a small percentage of the stockholders. The dominant stockholders will have both the incentive and the means to keep management focused on the consequences of their decisions, and thereby responsive to the long-run concerns of all stockholders.

Also, privately owned corporate stock allows for compensation arrangements that create a direct management incentive for far-sighted decisions. Typically, a significant portion of the compensation received by corporate managers is tied to the value of the corporation's stock. This compensation takes the form of payment in stock, dividend income, and capital gains.

Economist Wilbur Lewellen compared this stock-related compensation with wage compensation for managers in 50 of the largest manufacturing corporations over the period 1940–1963. The average stock-related compensation for top executives, according to Lewellen's calculations, was more than four times larger than their average after-tax wages. The advantage realized by all stockholders from this type of management compensation is obvious. Because the wealth of managers is held hostage by the willingness of stockholders to continue holding their stock at existing or higher prices, managers face strong incentives to make decisions reflecting the long-run concerns of the stockholders. No comparable connection exists between the personal wealth of political managers and the long-run impact of their decisions on the wealth of the country and their constituents.

Whether a politician or a political bureaucrat is involved, the basic reason political myopia is more acute than market myopia comes back to the lack of transferable property rights to the community-wide consequences of the decisions being made. Neither politicians nor political bureaucrats can, at the end of their tenure, auction off the capital value created by their decisions, as can corporate managers. The flow of benefits received by these political decision-makers cannot be expected to extend beyond their tenure.

In the case of government bureaucrats, the flow of benefits they receive is certainly tied more to increases in their bureau's budget than to the general wealth-increasing effects of their activities. For example, if a bureau's budget is based on the number of long-lived projects it is constructing, bureau managers will have a strong incentive to justify new projects whether or not those projects are warranted by a realistic comparison of costs and benefits.

Neither can interest-group recipients of government programs sell common stock in government—stock that would reflect the increased present value generated by the interest group's willingness to moderate current demands. When an influential group is in a position to exploit the political process for immediate gain, it realizes that it would reap no future benefits in exchange for refraining from exploiting the situation now. Each interest group is in much the same position as a buffalo hunter in the 1870s: Each knows, perhaps, that all would be better off in the long run if everyone reduced his demand. But because no one owns the buffaloes, everyone also knows that the buffalo (public largesse) he doesn't capture today, someone else will capture tomorrow. Without property, there will be little patience.

Yet this fact is almost always overlooked. Instead, the standard response to the problems blamed on market myopia is to bring on the even more myopic instruments of government control and regulation.

When energy supplies were reduced in 1974, for example, the market response was entirely appropriate to concerns about future availability: energy prices increased, signaling the desirability of conserving energy resources for the future and providing a strong incentive to do exactly that. The prevailing attitude communicated through the political process, however, was that we were running out of resources because of short-sighted market decisions.

The plea for government action was immediate and intense. And government action was what we got. Price ceilings were imposed, ensuring that consumers would want more energy now and that less would be invested to develop future energy supplies. Mandatory allocation schemes were imposed, guaranteeing that energy usage would be determined by short-run political pressures rather than by long-run economic considerations. Relying on the private market for energy supply and allocation would have served us far better in the long run (and the short run as well) than did the government programs that exacerbated rather than moderated our energy problems.

And though major American industrial corporations have, over recent decades, behaved myopically, allowing their capital to become outdated and their ability to compete on world markets to erode, much of this can be explained by government-imposed distortions. Because of import restrictions, the US steel industry, for example, has not faced the intense competition that provides the best incentive to maintain productivity. Moreover, through the penalties of inflation and taxation, government policy has actively discouraged capital investment in basic industries. Yet advocates of a national industrial policy use market myopia as a justification for more government involvement in the economy.

The call by Robert Reich and others for more government control over investment funds is a guaranteed prescription for neglecting the long run. The political allocation of investment funds is sure to favor large firms with strong unions (such as Chrysler Corporation) over the small but innovative firms that, when allowed to compete in the private market for capital, provide much of our future productivity and employment.

Even in the environmental area where market decisions may seem to be least attuned to the long run, government solutions are suspect. Our waterways and airsheds that necessarily receive our waste products are not owned and controlled as private property. Therefore, as we would expect, in the absence of private property—recall the buffalo—people have no incentive to consider the long-run consequences of their decisions. As a result, many of our environmental resources are excessively used.

The opportunity exists for government action to moderate the harmful use of our environment to the long-run benefit of all. Unfortunately, special-interest politics often results in exactly the opposite. A coalition of eastern electric utilities and the United Mine Workers, for example, has successfully lobbied for legislation requiring expensive sulfur-removing scrubbers on all new power plants, not just ones that burn high-sulfur eastern coal. The result has been a competitive disadvantage for the cleaner low-sulfur western coal, higher electric rates for consumers—and in many cases more sulfur emissions into the atmosphere.

The Army Corps of Engineers builds dams whose costs greatly exceed their benefits without even considering the enormous environmental costs. Surely few environmentalists see the special-interest water projects that dot the landscape as examples of far-sighted political activity.

To take another example, the toxic waste tragedy at Love Canal did not result from the profiteering of Hooker Chemical and Plastics Corporation, as widely believed. It stemmed from the insistence, over Hooker's objection, by the school district in Niagara Falls, that land owned by Hooker be used to build a school. Hooker Chemical was worried about the long-run consequences of building a school and a housing project over a toxic waste dump; the school district was not!

Examples of political myopia abound, but the point by now is clear. Government is far from a flawless substitute for any market short-sightedness. And indeed, failures of the market are often accentuated by government attempts to correct them. At no time is this more true than when the complaint against the market is that profit-seeking business people shortchange the future. They are in fact the future's best hope.

Dwight Lee is a research fellow at the Center for Study of Public Choice at George Mason University.