#75 The Asymmetry of Risk & Reward

It seems to be commonly misunderstood today, the relationship between risk and profit for the entrepreneur and the vital role the accumulation of capital plays in a free and fair society. An entrepreneur (or at least a successful one) is typically an individual with an asymmetric knowledge of a particular industry or marketplace. Unique perspective or subject matter expertise put them at a vantage point for consumer demand which remains unmet, or consumer demand which can be met profitably (and perhaps at a lower cost than provided by a competitor).

An entrepreneur who seeks to use his calculations and asymmetric knowledge can choose to invest his accumulated capital in ventures which, should they better satisfy the wants and needs of consumers than existing mediums, will yield him profit. It will always be the case, that his calculations may be in error, his knowledge may be incorrect, or his execution may be lacking in which case he may lose some or all of his capital.

In this way, the marketplace is ruthlessly efficient in how it allocates capital to those who best solve the problems of consumers. Those who do it with the lowest cost and the most customer satisfaction are rewarded with an increase in their net capital. Those who miscalculate costs or fail in execution experience losses. Profit is the measuring stick of productive activity in a free market. In a voluntary exchange, both individuals (subjectively speaking) are better off post factum than they were before. Else, all other things being equal, they would not choose to engage in the voluntary exchange of goods and services.

Of course, as we know, governments often distort these incentives with artificially cheap access to capital, monopolistic regulations, and preferential tax treatment which can keep unproductive entrepreneurs in business (seemingly) indefinitely. However, in terms of a free market exchange, any market activity which rewards the entrepreneur with profit makes the whole of society more wealthy. The consumer is rewarded with the immediate satisfaction of whatever their present need or desire was (the morality and subjectivity of this is always on the individual) and the entrepreneur is rewarded with more capital, with which he may choose to improve his existing operations or divest into other ventures.

It is wholly absurd to assume that as a laborer one is entitled the the fullness of or an equal share of the profit which is obtained by the entrepreneur. The asymmetric nature of risk and reward and the difficulty in deployment of information to solve complex problems of consumer demand is a skill set in and of itself. And of course, where there is profit to be had for such activity, that profit margin exists because others were not meeting the demand in as cost effective ways as possible prior.

By profitably driving down the marginal costs of production, the entrepreneur not only more adequately satisfies the immediate needs of consumers, but also frees up extrinsic resources which can then be deployed in solving other problems. The laborer, however, solves a more immediate problem. That is the point at which the inefficiencies of technology must be overcome with human capital.

Certainly, the entrepreneur has the potential to see an asymmetrically large return from his business due to the specialized nature of his knowledge and the risk of loss of to his capital which he has deployed. The laborer agrees to part with his time (but not capital) for the entrepreneur in order to satisfy a particular process in the entrepreneurs plan of attack.

The wonderful thing about a free market society is that anyone can work their way up the ladder from easy to learn labor to an expert level understanding of a particular marketplace. Where, should they posses the right wherewithal and defer enough consumption in the immediate term to accumulate capital, they can engage in the entrepreneurial process as well.

If one were to seek to abolish the relationship between the entrepreneur and the laborer to establish a more egalitarian outcome in the market process, one would be hamstringing the engine by which economic progress is realized. Without the incentives of asymmetric profit, the entrepreneur is no more likely to risk his accumulated capital than a savvy man in a casino. Likewise, without the process and mechanisms for accumulation of capital, society can not see the benefits of industrious individuals who venture to solve problems in new and creative ways.

Worse yet, when bureaucracies attempt to structure the whole of a market economy from the top down, they are forgoing the asymmetric market place knowledge of the entrepreneur who meticulously calculates and attempts to predict future human action. How difficult is must be for one man who has worked with shoes his entire life to profitably predict demands of consumers in a year. How impossible it must be for one man (or even a group of men) to do the same for an entire economy.


Book of the Month:

Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics

-“Practically all government attempts to redistribute wealth and income tend to smother productive incentives and lead toward general impoverishment. It is the proper sphere of government to create and enforce a framework of law that prohibits force and fraud. But it must refrain from specific economic interventions. Government’s main economic function is to encourage and preserve a free market. When Alexander the Great visited the philosopher Diogenes and asked whether he could do anything for him, Diogenes is said to have replied: “Yes, stand a little less between me and the sun.” It is what every citizen is entitled to ask of his government.”

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