Monday, June 05, 2006

Take Care When Quoting Adam Smith on 21st Century Problems

I like to see writers sensibly using insights from Adam Smith in their pieces. The key word is ‘sensibly’. Christopher Knight of the Los Angeles Times, 5 June, is an example of this approach. He writes about a problem facing the Getty Trust Museum and hooks his piece to the ‘problem’ of it having an endowment worth $6 billion (it uses the income from it to fund its activities).

However, Christopher Knight catches attention with the heading (presumably written by a sub-editor): ‘Yes, you can be too rich’. But the real story is in the organisational structure of the Trust. Partly it’s about the top people running the Trust not being professional art people, being business people, and, worse, not spending their own money but somebody else’s. We could generalise and say that this is a problem of governments too, though in their case politicians tend to be professional, er, politicians, not business people, and they spend oodles of other people’s money in the form of taxation, the annual amounts of which make Getty Trust’s ‘problem’ of a mere $6 billion somewhat puny.

Worse, governments do not live off a fixed ‘endowment’, they live off the largest source of cash in the world, the US GDP – they set the extraction rate, coerce its collection and spend with an abandon that shows the Rake’s Progress to be a mere walk among the daisies while whistling.

However, back to the Getty Trust’s problem.

This is where the "too rich" part comes in. Unlike trustees at virtually every other art institution you might name, no Getty trustee needs to put a single dime into the place. Its huge fortune means the scramble for cash is not pressing, setting it apart from American nonprofit art centers.As a result, the Getty Trust is less like a typical charity and more like the corporations Adam Smith warned about. Getty trustees only manage other people's money. Smith's analytical model explains why, following the first explosive story of Getty executive suite chicanery in December 2004, trustees languished in denial, month after painful month. Even in the face of shocking profusion, the board was negligent.

Why is that a problem? Ask Adam Smith.In "The Wealth of Nations," the Enlightenment moral philosopher and economist recognized a quandary that bedevils the corporation concept. It's as much a problem today, in our foul era of Enron, Tyco, WorldCom, Adelphia, ExxonMobil and the rest, as it was when Smith published his book in 1776. He characterized the formidable conundrum as "other people's money."As businesses, corporations are distinctive because they separate ownership from management. Stockholders own the company, but they do not run it. Boards of directors and their hired executives do.That means corporate managers are using other people's money, rather than their own. Smith warned that "negligence and profusion" — profusion meaning extravagance — were an inevitable result.

So, what to do? As it begins to search for a president, how can the Getty Trust mitigate the prickly problem of being too rich?Simple: Listen to Adam Smith. Stop separating ownership from management.”

Imaginative use of Adam Smith’s Wealth of Nations is always good to see.

Smith wrote a trenchant critique of the Royal Charter Companies in Book V and he pulled no punches. The East India Company in particular was execrable in the worst degree for its misgovernment of India, the appalling behaviour of its officers and their toleration of corruption, including their own participation in its practices.

Being Adam Smith, he looked beyond the obvious defects of the practice of the officers of these large companies, funded by shares, managed by Directors and protected by their monopolist Charter, the original licence to plunder rather than create wealth. Looked for the weaknesses in their governance that facilitated the greed of their officers. And it is to these aspects that Christopher Knight has used imaginatively in respect of the Getty Trust.

Noting the separation of ownership from control (an analysis also picked up in the 1930s in respect of US private corporations) he explored the likely consequences of this separation and found them explained in part by directors of corporations not spending their own money. He compared this structure to the more common one in the 18th century in the commercial society of which he was familiar. In this structure, artisans, manufacturers (this meant workers using hand tools; there were few examples of power-driven machinery of the kind we mean by manufacturers today) and traders, were sole proprietors, using their own capital-stock, and with all their property at risk if they made errors. The Chartered Trading Companies were funded by shares at risk, managed by Directors with any shares they had a small proportion of the total capital at risk and hence the likelihood of them not being as careful as a sole proprietor with his own money at risk.

It is here that I think the attempt to use Smith condemning corporations for separation of ownership and control breaks down. Smith was totally prejudiced, for good reason against the monopoly Chartered companies with their share capitals and dispersed ownership; he found this a powerful reason for their corruption and malfeasance. To generalise from an 18th-century structure to the commonest feature of modern capitalism, popular since the 19th century, is in my view bordering on being problematical.

So, while Christopher Knight may have found a connection between whatever is wrong with the Getty Trust and the separation of the Trustees from being either artist experts or having their money at risk is interesting, and well argued, I think we need to be careful when we suggest that Adam Smith’s critique of a special feature in 18th-century capital formation applies strictly to the a 21st-century organisational structure.

Read Christopher Knight’s article at:,0,4222207.story?coll=cl-art-top-right


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