Capital Allocation: Optimized for Whom?

A commonplace in popular debates about economic policy is that so-called “free markets” are ideal because they “optimize allocation of capital.” This rhetoric is used to support the assertion that government “interference” inherently “distorts” markets—which would otherwise be “free”—making allocation of capital somehow less than “optimal.” This supposedly sub-optimal allocation is then purported to have some dire consequences such as a lower standard of living for all and, potentially, the end of civilization as know it.

Intellectual rigor, however, demands that we ask what “optimal” means in this context. Is optimal allocation that which yields the greatest gain in equity over a three-year investment? Or that which returns the most cash by the end of a trading session? And to what extent should risk be calculated into our definition of what “optimal” allocation is?

Anyone who makes assertions about “optimized” allocation of capital must define it—and be prepared to defend that definition. But few, if any, can do so.

In fact, self-styled defenders of “free markets” rarely give much thought to what they actually mean by “optimal.” Rarer still are those who understand the inherent problem with any appeal to consequentialist arguments in support of their position. Thus their rhetoric fails to stand up well to the clear light of reason.

Still another question we may ask purveyors of optimization rhetoric is “Optimized for whom?” Capital is owned by individuals or institutions. Is optimized allocation that which allows these individuals and institutions to out-perform their peers? If so, should we understand growing disparity in capital formation to be the desired and inevitable outcome of any “optimal” economic system? If not, can we craft a definition of “optimized allocation” that has as its natural and empirically verifiable consequence better outcomes for parties other than the one allocating the capital?

Of course, some will respond to these questions by simply asserting that a rising tide lifts all boats—ignoring the fact that this principle only applies to boats docked in the same place at the same time.

Others will resort to the “Look at Roosia” argument. The economic history of the last century, however, merely indicates that regulated markets of liberal democracies out-perform the fully state-run economies of countries with limited access to warm-water ports. It does not offer evidence that the elimination of environmental regulations will improve anyone’s standard of living—except perhaps that of those who create wealth in the short term by implementing high-margin manufacturing processes that non-coincidentally pump toxins into regional watersheds.

The case of “optimized allocation” is just one of many that underscores the need for coherent metaphysics as the underpinning for any assertion of truth in any field—be it economics, science or religion. If we don’t understand what underlies the assertions we make, we cannot adequately test their validity. And if we don’t adequately test their validity, then we subject ourselves to something other than reason.

 

That, most certainly, is not optimal.

Leave a Reply

Your email address will not be published. Required fields are marked *