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What’s a Business to Do? (In search of heroic capitalism)

[Editor note: This article first appeared in the October 2010 issue of Discovery, the quarterly newsletter of Koch Companies, Inc. This company's values include an adherence to free-market capitalism, in opposition to political capitalism or rent-seeking, currently the fashion at a number of major U.S. corporations. (Also see "The Future of  Economic Freedom"). ]

We live in an era when many people–including policymakers and media celebrities–view businesses and corporations with disdain or intense suspicion. Their way of thinking begs a simple question: What is the primary role of business?

Is it to create jobs and provide benefits?  Help advance a social agenda?  Or just to make as much money as possible, by exploiting customers and employees?

As a matter of principle, Koch companies believe there is only one reason for any business to exist: creating value.

“Value creation,” says Charles Koch, “involves making people’s lives better.

“It means contributing to prosperity in society.  If a company’s not doing that – enhancing the well-being of society – then it needs to go out of business.

“We all tend to pursue our own interests, but in a true market economy we can only prosper long-term by providing others with what they value.”

History and sound theory have both shown that the only way to consistently create value for society is to faithfully follow a set of reality-based principles.

For Koch companies, those are the 10 MBM® Guiding Principles, which include integrity, compliance, value creation, humility and respect.

Principled Approach

Koch employees are among the world’s most efficient at making products and providing services that customers value more highly than their alternatives.

Those products build and heat homes, protect the environment, help grow food, fuel cars and planes, purify water, help prevent disease, improve clothing and make vehicles safer.

In producing all these and many other products and services, Koch companies also strive to use less resources.

Those resources (economists call them inputs) can include labor, raw materials, energy and capital.

For example, Georgia-Pacific operates a pulp mill that has greatly reduced the amount of water needed to make the pulp that goes into disposable diapers and other products. In doing so, GP Cellulose has freed up more groundwater – a very important resource – for other uses. What’s more, efficient use of groundwater has helped prevent expansion of a saltwater plume in the aquifer that could foul public drinking water supplies.

Without profits, it wouldn’t have been possible to invest the $400 million needed to improve efficiency – thereby creating more value – at that pulp mill.

Similar stories can be told across many other Koch companies.

At Flint Hills Resources, more than $100 million in investments (made possible by profits) allowed the Pine Bend Refinery to produce ultra-low sulfur gasoline years before it was mandated by the federal government. That product – called Blue Planet – was highly valued by Minnesotans concerned about air quality.

Biting the Hand

In a system of economic freedom, a company will generate long-term profits only if it uses resources in a way that consumers value more than alternative uses.

Large or small, a company will not stay in business for long if it is not truly creating value. Unfortunately, the same cannot be said for governments. Most governments consume massive amounts of resources – primarily labor and capital – much of which doesn’t create value.

Was it worth more than $200 million of U.S. taxpayers’ money to build an airport in Johnstown, Pa., that services just three commercial flights per day?

Although it was never built, would the federal government have created real, long-term value by spending nearly twice that much for the infamous “bridge to nowhere” in Alaska?

“It is essential that use of resources is directed by consumers, rather than politically,” says Charles Koch. “When resources are directed for political ends, the result is misallocation.”

What About Jobs?

Job creation is one of today’s hottest topics.  Governments of many nations – liberal, conservative and even Communist – are under enormous pressure to “do something” about high unemployment and lagging job growth.

In reality, it is businesses of all sizes in the private sector, not the government, that tend to produce the sorts of jobs that create real, long-term value. Government interventions – particularly controls, subsidies, barriers to entry, tariffs and bailouts – misapply resources, thwarting the efficient production of what people value.

An economist would say such actions replace activities that convert resources to higher-value products with activities that convert them to lower-value products. Think about that for a moment.  If a business activity is really creating value, should it need to be subsidized?

Similarly, if a business is destroying rather than creating value, shouldn’t it be allowed to go out of business, rather than be subsidized or protected?

Productivity

Productivity is more than a business buzzword.  It is a key driver of success for all of society. The more productive we are in enhancing the value of resources, the better off virtually everyone is going to be.

By contrast, anything that interferes with productivity is going to make people less well off, especially the poor, who are least capable of weathering economic shocks.

It’s important to realize what makes us better off.  It’s not just how much money we have, but the availability of the goods and services we value. In the old Soviet Union, lots of people had rubles to spend, but there was very little of value to buy. Government policies resulted in chronic shortages of food, clothing and shelter.

Similarly, in any nation where government policies systematically destroy value, shortages of valued goods and services should be expected.

Good Idea?

Government-mandated transfers from one group to another don’t solve the problems of lower productivity and higher unemployment.

In fact, they make those problems worse.

If the government insists that someone should be paid $50 per hour in wages and benefits, but that person only creates $30 worth of value, no one will prosper for long. In a scenario such as this, as businesses lose money because of the government’s policy, employees will end up losing their jobs and fewer (if any) new employees will be hired.

Consequently, the result of what sounded good – making a guaranteed $50 per hour – will not be prosperity, it will be higher unemployment.

Anything that undermines the mobility of labor, such as policies that make it more expensive and difficult to change where people are employed, also increases unemployment.

In Europe, where stringent labor laws make it difficult and expensive to terminate someone – even for cause – this has become especially troublesome.

Similar policies that distort the labor market – such as minimum wage laws and mandated benefits – contribute to unemployment. Policies that make it difficult to get permits to build plants and equipment that are more efficient lower productivity and reduce wages.

All these obstacles interfere with the ability to create valued products and services, adversely affecting consumers, employees and employers.

Alternatives

In The Science of Success, Charles Koch wrote: “Societies that value freedom and prosperity protect their citizens’ rights to free speech, which greatly facilitates the discovery and the dissemination of knowledge.”  What we see in many nations today is just the opposite.

Citizens who are openly critical of the European Union bureaucracy in Brussels or the out-of-control government of the United States are being shouted down by politicians, government officials and their media and other allies.

Too many government elites think they know what’s best for citizens and ignore the wishes of the citizens themselves. Those in power tend to want to control more and more, all in the name of making things “fair.”  To do so, they pile on more rules, more regulations, more restrictions, more programs and more costs.

As Charles Koch has noted, this kind of thinking is a recipe for disaster – both for a company and for a government. “Over-specifying and enforcing particulars undermines prosperity,” wrote Koch. “It also facilitates corruption and abuse of power, subservience and stagnation.”

8 comments

1 Ken Langford { 01.17.11 at 2:49 am }

I just finished reading Henry Hazlett’s book “Economics in One Lesson” and I’m angry with every politician, be they republican or democrat, who has served our country for the last 64 years.

Mr. Hazlett warned of the penalties of not following free market economic practices and gave examples which we see clearly happening today.

Koch Industries is one of the few companies left today that create value following the lessons of Adam Smith, F.A. Hayek, Mises etc.. How have they survived this country’s practices?

I wish that a wand could be waved, but I’m afraid that much work is to be done to inform everyone, from politician to teacher, how badly this country’s leaders have represented the people. Instead of enjoying the retirement that I don’t feel I deserve, I will spend the remainder of my years talking to whoever will listen about our plight and how we must insist our politicians begin to tear down the barriers to freedom that have been legislated all these years.

2 rbradley { 01.17.11 at 12:11 pm }

Koch Industries is a very philosophic company, using first principles to avoid government-dependent profit centers in favor of market (consumer) driven businesses.

I harp on this because it is unique–and just the opposite of the company I worked at for 16 years, Enron (see my website http://www.politicalcapitalism.org/).

3 travis { 01.20.11 at 5:51 am }

The Koch Brothers through their subsidiary, Flint Hills Resources, recently expanded their involvement in the ethanol scam by buying two bankrupt ethanol plants in Iowa. Would they have bought these plants without the after-tax benefits, a government intervention in the market process? You decide.

Georgia Pacific, another Koch business, in an egregious act of pandering to anti-freemarket environmentalists, recently joined forces with the Dogwood Alliance and NRDC by pledging to no longer cut trees on supposedly environmentally sensitive woodlands including some 90 million acres in the Cumberland Plateau. NRDC’s hope is that other forest product companies will join with GP. That this might damage the value of privately owned forestland in these areas apparently is not a concern of Georgia Pacific.

While the Kochs certainly have the right to take these actions, it is hardly the actions of an enlightened supporter of freemarkets. As Mises said, there is no middle way. You are either in all of the way, or you are out. The Kochs are out.

4 rbradley { 01.20.11 at 10:40 pm }

There are two very interesting examples here that perhaps Koch can address in some way. It is good that they are on the table–perhaps there are others.

1) There is an ethanol mandate (10%) and special tax credits and a protective tariff that go along with that production. The former, I believe, drove the latter for Koch.

Buying a company in an industry dependent on special government favor is a profit opportunity in a mixed economy, what Israel Kirzner would describe as superfluous entrepreneurship. GIVEN the regulation, is Koch’s entry good or bad for the free market? I do know that Koch has opposed ethanol mandates fiercely in the past and still opposes them today. That to me is notable.

2) The green forestry campaign is something I will have to leave to others who have more information to dissect it. But this is civil society rather than political society in that this is a voluntary decision, although it could be that the alternative is holding out, complaining, and facing regulation or a boycott or something. This is a complex ‘civil society’ question, not only a political one. No, I do not like the bedfellows….

Finally, if it is all or nothing, black-and-white, is there a large free market corporation in America that you (Travis) can point to that has less ‘baggage” than Koch Industries, Inc.? Is this enought to damn the company for a free marketeer?

5 travis { 01.21.11 at 8:39 am }

I very much like your blog, so I will accept your assertion that the Kochs are better than most. I also understand that in the cluster-muck created by innumerable interventions by individuals in governments at all levels in our economy, purity is probably unattainable.

However, I think it matters how we use the term “free-market.” For example, in Obama’s recent op-ed in WSJ, he states “one of the reasons the free market has worked….”
We do not have a free-market economy. Further, Obama does not know what a free-market entails. By conflating our system of crony capitalism (state capitalism, corporatocracy, or whatever one labels it) with a free-market setting, we do great damage to the concept of a free-market. The masses think that the mess we have is a free-market. It is clear that there is much failure by individuals in this crony-capitalist mess, but it is the free-market that gets the blame.

Words have meaning.

I believe the Kochs entry into the ethanol scam is a bad choice for anyone who professes fealty to a free market.
With the expansion our of natural gas capacity and the possibilities from oil shale, ethanol will eventually fail the market test.

The eco-totalitarians have no interest in compromise. If the Kochs fall short of what NRDC wants, I assure you that the Kochs will be attacked again with great vigor. The eco-totalitarians want nothing less than the eventual demise of Georgia Pacific.

If you are wondering, I am a private sector consulting forester (37 yrs) and have forestry degrees from Clemson and Duke (back when Duke was still a forestry school and not a training ground for EPA bureaucrats). While I do not consider myself an expert on Mises, I am a student still trying to learn more about his great insights. On a couple of issues, the use of knowledge for one, I am a fan of Hayek although I think he sort of lost his way at the end.

Travis Cork
Conway, SC

6 rbradley { 01.21.11 at 9:21 am }

Travis:

I hope the discussion evolves from just us. There are important issues on the table.

Regarding your point on the misuse of the term ‘free market,’ I have a question for you. I commonly use the term “free-market capitalism” versus “political capitalism.” (I could have used ‘market capitalism’ but the ‘market’ might be ambiguous.)

What do you think of this distinction, or have I (and others) polluted the term ‘capitalism’?

7 travis { 01.21.11 at 2:11 pm }

Mr. Bradley;

I think we need to add “free” when talking of market capitalism. You and I may understand what we are talking about, but I do not think the masses do. I have no problem with political capitalism. I think it conveys to the reader that there is an undesirable connection between businessmen and government. That is, after all, the message we are trying to convey.

Travis

8 Kate7 { 01.30.11 at 2:21 pm }

If anyone on this board has a practical way to help here, I suggest we American citizens assist this organization in demonstrating that the EPA has NOT proven carbon dioxide is a GHG that harms humans. The Supreme Court told the EPA it could regulate GHG that are Proven to harm humans.

API response to State of the Union Address: ‘The President can do more to create jobs’
http://www.api.org/Newsroom/api-2011-sotu.cfm

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