The death of Milton Friedman has been an occasion for celebrating the magic of capitalism, and fair enough. Capitalism is pretty great, and Friedman was its feisty defender when that view was far from universally held. But let's not get carried away. There are things capitalism does not do well; and other things that masquerade as capitalism at work, and wrongly claim its virtues.Capitalism is brilliant at setting the price of potatoes. But how good is it at setting the price of a large company? To all appearances, the stock market is capitalism operating under near-laboratory conditions. Yet the prices set are patently wrong. That is not my opinion. Well, yes, it is my opinion. But it is not only my opinion. It is held by America's financial leaders, though they don't put it quite that way. Actually, it is close to a provable fact. The free market cannot be setting the right price for financial assets like shares of stock, because often there are different prices with equal claims to be the product of free-market capitalism. They can't all be right.
In America, most people now have money invested in the stock market, either directly or through company, union or government-employee pensions. President Bush famously wanted to put money from social security, America's public retirement system, into the stock market as well. Publicly traded stocks are a good thing, goes the conventional explanation, because they allow people to share in the growth of the economy. They are good for society because, by creating a market and setting a value for corporate shares, they make it possible for corporations to raise money by issuing shares in the first place.
All of this depends, though, on the assumption that the stock market sets the right price for shares of big companies. But a whole separate part of corporate finance is based on the assumption that the prices are wrong. These special deals used to be called leveraged buyouts. Now the term is "private equity". The details are different, but the principle is the same. Private investors buy a company from its public stockholders. They have a letter from an investment bank saying the price is fair. They usually have the support of management, or actually are the management. The public stockholders have little choice. But time and again - surprise, surprise - the bank turns out to be wrong. The company is actually far more valuable. Soon the company is sold at a large profit, to another company or back to the public.
So free-market capitalism has decreed three different values for this company. One is set by the stock market; one is what the private investors are offering -usually a bit more than the market capitalisation. And one is what the private investors sell the company for a blink of an eye later - usually a lot more than the other two. Which is the true capitalist price? Which one represents the most sublime interaction of supply and demand? Anyone? Anyone?
Defenders of this procedure say it's not that the stockholders have been swindled. It's that the company is actually far more valuable in private hands because managers - even the same managers - can manage far better without the constraints of public ownership. Maybe. But if these deals aren't a swindle, then the stock market is a swindle. It does not maximise value for its working- and middle-class investors. It leaves money on the table waiting for "private equity" to swoop and pick it up. Furthermore, Friedman was wrong and the other famous economist who died this year, John Kenneth Galbraith, was right: the free market in corporate shares doesn't produce well-run companies.
Either the stock market is a fraud on the public, or these deals that dominate the business pages are a fraud on the public. Which is it.
Michael Kinsley. Related with A Capitalist Swindle.