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King Bob

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Voters wisely defeated Issue 1 in Ohio. If you remember, I wrote about how Governor Bob Taft of Ohio as part of his Third Frontier Project sponsored a bill that would allow government funds (obtained through a $1 billion bond issue) to be invested directly in private businesses, predominately biotechnology companies, to "spur" Ohio's economy.

According to Governor Taft, "traditional industries are declining or have departed. Our per capita income lags the national average. Talented graduates are leaving Ohio for other states." This is about the only thing that he says is true.

In an editorial yesterday Governor Taft writes to the people of Ohio:

"I am committed to our Third Frontier Project to make Ohio a leader in creating high-paying jobs in the knowledge economy. We must build on Third Frontier investments already made and affirm our commitment to invest $1.1 billion over a 10-year period to attract more private and federal funds. We must continue to fund the creation of Wright Centers of Innovation through the state's capital budget and dedicate tobacco settlement and other funds to venture capital, biomedical technology and growing sectors of the economy. And we must help companies develop new products and new jobs through the Innovation Ohio Loan Fund. Our quality of life hangs in the balance. Failure is not an option. We must persevere."

The irony did not escape me as I read on the very same page in an editorial by Jeff Jacoby called "Give Thanks for Capitalism":

"Adam Smith called it "the invisible hand" - the mysterious power that leads innumerable people, each working for his own gain, to promote ends that benefit many. Out of the seeming chaos of millions of uncoordinated private transactions emerges the spontaneous order of the market. Free human beings freely interact, and the result is an array of goods and services more immense than the human mind can comprehend. No dictator, no bureaucracy, no supercomputer plans it in advance. Indeed, the more an economy is planned, the more is plagued by shortages, dislocation and failure."

These are two diametrically opposing views; someone here has to be wrong. Let's take a quick look at capitalism first, the invisible hand, and then compare that to government intervention, the visible hand.

The Invisible Hand:

Sheryl is an independent saleswoman for medical companies who specialize in distributing infertility drugs: they buy the drugs and develop specialized protocols for patients according to a doctor's prescription. Sheryl realizes that these processes are inflexible and expensive to design for individual patients; in addition the patients are commonly making mistakes in a process that requires precision. She invents and patents an organizer kit that is flexible and can coordinate a very high percentage of protocols into an easy to understand step by step process.

A neighbor of hers works at a bank and introduces her to some people in their venture capital division. These experienced people quickly recognize the value and business sense of this product. Because of the state government's realization that entrepreneurial activity is the cornerstone of the economy, it has eliminated pork barrel legislation that protects big companies. It has also reduced taxes and even created further tax incentives for start up companies. It has provided an environment that encourages new companies to emerge and prosper.

Because of the state's pro small business and pro capitalist stance, there is sufficient capital available for the private sector, which is solely motivated by the economics of profit. The bank is able to structure a deal that provides incentive for both parties to succeed: the deal is part equity and part debt.

Sheryl starts a new company to buy the medications directly from the drug distributors and to produce her patented kits. Her strategy is to take the kits directly to doctors, who immediately recognize the value and prescribe them to patients, who in turn experience much better results and a lower cost.

Very quickly Sheryl's business takes off; the company's revenues increase exponentially at the expense of its competition. Several of these existing distribution companies fail and there workers are laid off. Sheryl's company is able to hire many of these workers, the most productive ones. Sheryl is not forced to hire anyone that is unproductive, workers who because of tenure or legal restrictions would not have been forced out of their jobs at their old companies.

Sheryl's company is able to provide a much better service to consumers at an overall better price: the process is more flexible and there are fewer retrials. In general, consumers of her product find that they have more disposable income, money that they can spend on other things.


The Visible Hand:

The state of Ohio is heavily involved in investing in medical and biotechnology companies. Through several layers of consultants who have been awarded long term contracts, the state has devised a protocol of funding the development of new products and their distribution to hospitals and clinics. Boards and committees of predominately state employees, civil servants, and consultants are set up to review and approve new protocols.

Sheryl talks to her neighbor about her kit idea; he then sets up a meeting with this bank's venture capital division. Unfortunately at the meeting Sheryl is told that the bank is not involved in this area and neither is any other private capital group that they know of given the state's heavy involvement. They recognize the value of the idea, however, and give her the name of the contact at the state review board responsible.

After several months of wading through the bureaucratic process of getting in front of the review board, Sheryl is able to present her idea and waits for a response.

Two of the consultants on the review board recognize immediately that this idea would have a profound negative impact on at least two of the companies that they have separate long term contracts with.

After a few more months of waiting for a response, Sheryl is turned down by the state review board for funds to develop her product. Sheryl gives up on her idea.

This dramatization is only meant to show that the capitalistic system is ruthless in its pursuit of economic profit. Because of this, it destroys inefficient businesses in lieu of efficient ones. Over the long run the economy benefits though increased productivity and a higher standard of living for all. When extraneous processes are introduced that have ulterior motivations, this system is interrupted.

Governor Taft in trying to scare the people of Ohio into advocating government control of the capitalistic process is exactly wrong in saying "failure is not an option". Failure is the only option: it is how the capitalistic process destroys inefficient businesses and replaces them with efficient ones.

Let us hope that there are not too many King Bobs out there.




No positions in stocks mentioned.

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