Perfect corruption and the slow death of innovation

By Rich Purtell

Adam Smith is widely considered to be the “Einstein of modern economics” with his Wealth of Nations monumental work published in 1776. He brought forth many concepts of free market capitalism which helped to usher in an era of unprecedented global economic growth:

• Division of labor. He demonstrated the greatly increased productivity by having people specialize at certain tasks.
• Free trade. Along with this concept comes the need to move capital, labor, and natural resources to where they are most needed. Again the emphasis is on efficiency and productivity.
• Freedom to choose one’s own career path. A move away from birthright concepts, overly restrictive apprenticeships, etc.
• The need for personal liberty and private property to stimulate people to strive for a greater standard of living for themselves and their offspring.
• Wealth as a measure of individual prosperity in terms of access to goods and services, as opposed to the hoarding of gold and silver.

Smith envisioned “perfect competition” in which all of the people of earth benefited by being able to obtain the most wealth through a system which allowed for the most efficient producers to bring together labor, capital, and natural resources to produce the best value.

Smith’s view in how to maximize opulence was in how productive and efficient the world economy would become.

What Smith could have explored in greater detail, was a truth in that while “perfect competition” is desirable from the point-of-view of consumers, it is not such a desirable steady-state condition for producers. Profit margins shrink. There is always intense pressure to control costs and improve efficiency.

So from a producer’s perspective, there is a motivating force towards innovation and change, less everything become a commodity and not very profitable. These factors drove entrepreneurs to step into new ventures. Frederic Bastiat was one of the more prolific economists to discuss innovation and change.

In modern times, some (perhaps many) may believe we are living in an innovative period. I disagree. For example:

• Space travel: We put men on the moon over 40 years ago. We have not been back. The US Space shuttle program was based on 70s technology, ran for several decades, then stopped. The US currently has no launch vehicle to reach the International Space Station.
• Automobiles: The Otto cycle internal combustion has been tweaked and refined for over 100 years. Carburetor to electronic fuel injection. Electronic ignition. But we are still using pistons, valves, camshafts, oil, coolant. The engine technology hasn’t changed that much really. Hybrids are made out to be some radical change, but really are not fundamentally different from diesel-electric trains which have run for decades.
• Hollywood movies: Prequels, sequels, and reboots. Too much concern about risk from complete new story lines.
• Computer: Since the transistor was invented we have squished things smaller and smaller, but the basics of how computers work has not changed. Other electronic gadgets similarly have shrunk in size, but the core technology is not really changing rapidly.

So if innovation seems to be stalling out, why is this happening? I’d say we are shifting too much towards “perfect corruption.” For example:

• Government procurement practices are opposite of what they should be. Anti-competitive buying strategies such as: standardization, strategic sourcing, and pre-set pricing schedules are oriented towards tried and true commodity products, where competition should be prevalent. Conversely, innovative products and methods are shied away from due to concerns of high prices from lack of competition, when competition is deliberately avoided for commodity products!
• Economic experts said in the 1970s and 1980s that we would see an era of downsizing of businesses around the world. The computer age and global shipping made it possible for small companies to achieve Smith’s “division of labor” benefits. As businesses grow larger, efficiency is lost due to inter-communication difficulties and other management and control issues. While this pattern may have started forward somewhat, large companies have fought for their own survival by influencing government to throw up many crippling roadblocks to smaller companies. New age protectionist strategies have evolved: Too big to fail bailouts, subsidies, occupational licensing (losing ground back to the pre-Smith age), tax incentives, extreme regulatory burden.
• Economic policies which socialize risk and privatize gain do not in fact stimulate real innovation. Instead we are seeing stagnant growth and capital being used for speculation and malinvestment. The paradox of socialized risk strategies is that many of the TYPES of risks being taken are not supporting the growth of wealth. Capital is being risked, but not for stepping far into new realms. Marginal and gradual innovation is promoted, as discussed earlier, rather than radical departure in new directions. Dissatisfaction from the low profits of “perfect competition” was a stronger innovative motive than we have seen from public risk and ultra low interest borrowing such as ZIRP Federal Reserve policy.

In short, the Keynesian shift is failing, and we should strive to go back to the concepts of Smith, Bastiat, and others. Strive for a blend of perfect competition, dynamically involved with innovation and entrepreneurship. Efforts to control the market have had excessive impact on limiting innovation, and thusly have stimulated corruption.

Any effort to thwart corruption which also unintentionally stifles innovation, is likely to be unsuccessful. Again producers desire to move off center from a “perfect competition” mode which is an undesirable state for them. Innovation must be encouraged, even if this means suffering from a certain degree of corruption. For example overly zealous FCPA (Foreign Corrupt Practices Act) enforcement can scare off all but the largest Multi-National corporations from exploring business opportunities in developing nations, thus having a monopolizing, anti-innovative effect.