How Capitalism Will Save Us (7 page)

A prime example of capitalism’s “web of trust”: the auction site eBay, where customers buy and sell to one another anonymously, based on little more than a thumbnail product profile, a seller rating, and a credit card number.

EBay’s sellers and buyers are not always honest. But most often they
are. Without this expectation of reliability there could be no commerce. People would not be able to buy, sell, and create wealth—not only on eBay, but in any market.
⁸

Trust, not greed, was the reason that so many people were duped by Bernard Madoff. Few could anticipate his over-the-top villainy because such a willful violation of the rules is relatively rare. Madoff’s annual returns to clients also appeared reasonable.

The idea that capitalism is based on greed is belied when taking a closer look at the great fortunes of the people on the
Forbes
400 list of wealthiest Americans. Number 33 on the 2008 list, Jeff Bezos, founded the hugely successful Internet bookstore
Amazon.com
, which has since become an online megastore selling virtually anything. He built his $8.7 billion fortune not because of greed, but because he correctly saw the potential of emerging Internet technology to do a better job selling books than bricks-and-mortar retailers.

And what about Oprah Winfrey (number 155 in 2008, with a net worth of $2.7 billion)? Her story is well-known: born in Mississippi, she rose to become a TV talk show host, actress, producer, publisher, and owner of a media empire. Her productions and publications promote positive values of self-improvement. She has also built her fortune by bringing wealth to others, launching the media careers of personalities like Dr. Phil and Rachael Ray. As if all of this were not enough, she has donated millions to charity, including starting a school for girls in South Africa.

Henry Hillman (number 134 in 2008, with a net worth of $3 billion) was not self-made. He inherited his family’s steel fortune. But he, too, has been anything but greedy. He has invested in real estate, medical technology, and other high-tech companies. Hillman has been one of Pittsburgh’s most active philanthropists—a heavy supporter of medical and computer research. He has given some $20 million to cancer research and recently gave $10 million for a new computer science research building at Carnegie Mellon University.

Number 68 on
Forbes’
2007 list was James Sorenson. The inventor, who passed away a year later at age 86, made a $4.5 billion fortune from medical devices, including a patented plastic catheter and a disposable surgical mask. Sorenson had more money than he could ever spend and nothing to prove. Yet he started another new venture, Sorenson Forensics, in 2006, shortly before his death. The company’s genome-based technologies have
helped solve cold-case murder mysteries. Asked why he risked his capital so late in life to start yet another new business, the habitual entrepreneur replied, “It soothes the soul to help people.”

John Drummond isn’t on the
Forbes
400 list. His business,
Unicycle.com
, started out as a hobby. Drummond discovered that the unicycling he’d loved as a child could help him take off weight.

Yes, Drummond had a self-interested reason for building his business—he had been laid off by IBM and needed a job. But he also wanted the sense of personal fulfillment that comes from bringing something good to others. Drummond felt that people would enjoy unicycling and appreciate its unique, if quirky, value as a fitness workout. He succeeded because he was an innovator: he made a hard-to-find product more easily available over the Internet.

Today Drummond’s business has franchises in eight countries, and he recently started another business,
Banjo.com
.

The claim that capitalism is based on greed is often used by politicians to sell solutions to economic problems that are supposed to be more moral—from taxes on windfall profits to government health insurance. These government-imposed remedies are supposed to deliver greater morality and fairness. But as we will show repeatedly in this book, they generally do neither. That’s because political solutions are not developed to serve the Real World needs of people who make up a market but the narrower concerns of those who happen to be in power. They’re frequently less fair, and less moral, than grassroots market solutions.

If greed is the one-sided taking of what does not belong to you, then what does one call pork-laden stimulus packages and other legislation that channel taxpayer money into things like “low bush blueberry research” and a water taxi service in, yes, Pleasure Beach, Connecticut—politicians’ personal projects that produce few if any economic benefits. Whatever you may call them, such “solutions” divert capital that could have been put into productive innovations that would have created more wealth for more people. Is that moral?

W
hen gasoline prices soared between 2004 and 2008, people were enraged by the profits being made by oil companies. A Gallup poll found that more Americans believed the high price of gasoline was due to oil company greed rather than to other factors, including the Middle East conflict. Politicians from California senator Barbara Boxer to then New York senator Hillary Clinton called for measures to “get tough” on “Big Oil.” Vermont senator Bernie Sanders sputtered in an editorial: “Exxon-Mobil has made more profits in the last two years than any company in the history of the world.”
⁹

Similar indignation has been directed at the pharmaceutical industry. Critics accuse drug companies of “gouging,” among other transgressions, calling for various government regulations to rein in “Big Pharma.” “Other countries don’t allow prescription drug companies to gouge their customers,” complained former Congressman Tom Allen (D-Maine).
¹⁰

The critics aren’t entirely wrong. Bernie Sanders is correct when he says that oil company profits were the highest in history. And it’s true, as Tom Allen suggests, that newly developed brand-name drugs can cost more in America than in other countries. The cholesterol-lowering medicine Lipitor, for instance, costs about sixty cents a pill in Paris and around four dollars in Philadelphia.
¹¹

Yet these emotional accusations reflect a misunderstanding of the myriad and complex factors affecting pricing and profit. People who decry oil company profits, for example, don’t understand that a major factor driving up oil prices was the weak value of the dollar on currency markets, a result of the Federal Reserve Bank printing too many greenbacks. Also driving up prices was the high demand for oil, driven by rapid growth in India, China, and eastern and central Europe.

Both factors, of course, have little to do with profit. In nonrecessionary times, the typical net profit margin of oil companies—what they
make off each dollar of revenue—is only around 8 percent. That’s far less than the profit margins of banks (over 19 percent), software companies (17 percent), and even food producers (more than 9 percent). And it’s just a little higher than the profit margin of Starbucks, which is around 7 percent.

Pharmaceutical profit margins are ordinarily around 18 percent or 19 percent, only nominally higher than those in the software industry. Yet they’re especially reasonable considering that only about one in a hundred drugs ends up on the market. Each drug that makes it must generate enough revenue to cover the development costs of the ninety-nine drugs that didn’t—as well as the cost of future drugs. And bringing a single drug to market costs a major pharmaceutical company anywhere from $800 million to $1.5 billion.

If a drug company does not come up with new, successful drugs, profits stagnate—and stock plummets. Pfizer, for example, has had a dearth of blockbuster drugs in recent years. The result: the stock had plunged over 70 percent in value between 1999 and 2008.

Yet some people believe that pharmaceutical makers and oil companies shouldn’t be allowed to make a profit—or that their profits should be limited through taxation or price controls. They don’t understand how profit functions and the role it plays in a Real World economy.

Profit does more than make some people rich by generating dividends and capital gains. It is also the way our economic system mobilizes people to provide for others. This goes beyond merely serving as an incentive: profit is a critical barometer of demand, telling producers where they should invest—or where they should cut back. It keeps supply flowing smoothly.

For example, if demand soars for, say, coffee, producers will raise their prices. And why not? Java is in greater demand and thus more valuable. So what happens? The lure of higher profits encourages producers to grow and process more. New coffee suppliers may also be enticed to enter the market. The result: supply increases.

Then something else happens: profits create competition. Higher profits bring more players into the market. To compete, producers have to slash prices. The result: profits eventually fall.

An example: Xerox, inventor of the modern photocopying machine. The enormous profits the company made with its first copiers soon
attracted countless competitors, including Canon, Ricoh, and Mita (now Kyocera), to name a few. At one time only large offices could afford these machines. Today they’re so cheap that even students can afford desktop models. And not only do they copy, they scan and print, too.