The principle that, given perfect competition and complete markets, the productive decision is to be governed solely by the objective market criterion represented by attained wealth–without regard to the individuals’ subjective preferences that enter into their consumptive decisions–will appear repeatedly throughout this study. We will call this principle the Separation Theorem.
This quote is from J. Hirshleifer, Investment, Interest, and Capital, 1970. It’s the textbook that Jack Hirshleifer used in my course on capital at UCLA in the spring of 1973. The point is that it makes sense to choose productive activities to maximize wealth and then use the wealth to maximize your utility, but not to mix the two. And, of course, you can get utility by giving to charity.
Here’s investor Kevin O’Leary making the same point, only more clearly, in a specific context in his interview with Nick Gillespie of Reason. Gillespie asked O’Leary what’s wrong with Whole Foods CEO John Mackey’s idea of “conscious capitalism,” which includes the idea of giving some percentage of corporate profits to charities that the CEO favors.
O’Leary says:
Let me give you an example. Let’s say I can invest in two financial services companies. One of them decides, the CEO decides, that he wants to support a charity. And he wants to give $100 million to that charity across four quarters. Now, it’s not my charity. My family supports multiple charities but none of the ones that I support [are ones] he is supporting. My message to him or to her is: You deliver me my profits; I will decide which charities I want to support; you have no right to do that on my behalf. I don’t agree with you. I don’t care what you like. You should take your portion of the your salary or the stock you own and the dividends you get and you deploy it the way you want. The core of the business is to deliver profits to the shareholders who then will redeploy it in any way they wish.
Drop the statement “you have no right” and this is a beautiful application of the separation theorem.
The whole interview is worth listening to. I found particularly interesting, even if I was not totally persuaded by, O’Leary’s statements about how his businesses even in California are benefiting from Trump’s deregulation. The example he gives about windows [at about the 16:00 point] in a “wine and design” business sounds like a local or state regulation, but he says that it was in part due to a federal regulation that Donald Trump’s administration abolished.
READER COMMENTS
nobody.really
Aug 1 2019 at 7:55pm
Eh.
The Separation Theorem clearly has advantages, and may prove useful in many contexts, especially where inter-personal utility is concerned. But perhaps not when intra-personal utility is concerned.
To take the easy example: Farmer Jones puts on his producer hat, grows apples, and sells them all at wholesale prices to maximize his profits. Then, putting on his consumer hat, he goes to the market and buys back some of his apples at (higher) retail prices. Optimal?
To take the less easy example: Farmer Jones works every day, as long as he can, to amass as much wealth as he can. At age 70 he sells his farm and begins life as a consumer, amassing all the utility he can. But after all those years of hard labor, his body is basically spent; he certainly cannot maintain an erection. And he has no friends.
In contrast, Farmer Smith worked reasonably hard, but took time off to date, find a wife, have kids, etc. When he sells the farm, he has a smaller bank account than Farmer Jones, but a network of family and friends that he can call upon, and a wealth of happy memories that he can enjoy, even as his body fails.
The Separation Theorem appears to advocate Farmer Jones’s lifestyle, with clear phases of wealth maximization and consumption. But who really thinks that lifestyle is optimal? Money proves to be an imperfect substitute for certain things. There are limits to how much even rich people can buy back time and opportunities forgone.
Or, to take a less stylized example, consider successful businessmen: How many of them live in abject squalor in order to save each dime to invest? Some do, I imagine, but most don’t. That is, even successful businessmen choose to forego some opportunities to invest in order to consume. (Admittedly, in many lines of work, the line between investment and consumption will not be clear. So to make the thought experiment work, you need to imagine businessmen who derive little advantage from conspicuous displays of wealth, etc.)
Matthias Görgens
Aug 1 2019 at 9:01pm
The Farmer Jones examples are not how the separation theorem works.
Matthias Görgens
Aug 1 2019 at 9:08pm
The separation theorem merely suggests you are putting on different hats when you make your different choices.
It doesn’t suggest you need to separate your life into different phases. Nor does it suggest that a business can’t pay its employees or investors with things other than money when that more efficient (for tax reasons or transaction costs).
And for the example cited in the article, the charitable giving by the company is essentially consumption for the CEO (and perhaps the employees who agree). And the investor quoted might as well have said that he wants more dividends and less semi-obscured CEO compensation.
(Tax optimisation with charitable payment is an interesting example: if you pay dividends as money and then the investor gives to the exact same charity the CEO would have given, you lose a share of money to tax inefficiencies. But it’s only a loss, if the government that gets the taxes is less effective per dollar than the charity.)
Mark Brady
Aug 2 2019 at 5:12pm
Thank you for a well-argued comment.
Benjamin Cole
Aug 1 2019 at 9:00pm
I think Milton Friedman was right, that corporations should be, and should be considered as, amoral organizations.
But, we should keep in mind that corporations can and do unleash unlimited funds into academia, media, think tanks, lobby groups, trade associations, PR, and even political campaigns. The largest corporations today are the multinationals, also known as the supranationals. They have many a hired mouthpiece, and are able to color how stories are framed in US media.
It is wise to keep government out of corporations but it is also wise to keep corporations out of government.
Alan Goldhammer
Aug 2 2019 at 7:41am
At about the 9-10 minute mark O’Leary talks a bit about healthcare and comments about the British, German, Finnish and a couple of other systems. Then he makes the statement about how electronic medical records (EMRs) will help streamline the US system. this is just another comment from someone who does not understand the cost drivers of healthcare. EMRs may shave a percent or two off the costs but that’s about it. Doctor salaries, Rx costs, hospital and diagnostic costs are much greater cost components.
I think your comment about Trump’s deregulation helping O’Leary’s businesses is wrong. He comments on state and local regs and not national regulations. I don’t see any of Trumps regulation changes doing much at all (look at how much the coal industry has rebounded). Contra Trump’s MAGA approach, O’Leary is big on off shoring of manufacturing jobs!
David Henderson
Aug 2 2019 at 10:11am
Yes, he’s off on the electronic records thing.
Re the state and local regs, he does say that what was behind them was a federal mandate. As I said in the post, that’s what I wasn’t totally persuaded on.
Cyril Morong
Aug 2 2019 at 1:20pm
From Adam Smith:
“I have never known much good done by those who affected to trade for the publick good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”
Scott Sumner
Aug 2 2019 at 3:56pm
Speaking of “separation”, I’d encourage Kevin O’Leary to also separate his views on Trump’s economic policies from his view of whether Trump is a good family man. Not that Trump’s personal life matters, but he weakens his case with his remarks in that area. If he describes Trump as a good family man, what am I to think of his claim that Trump’s deregulation is dramatically helping the economy?
In other words, just don’t say anything about Trump’s personal life if you want to be taken seriously.
David Seltzer
Aug 6 2019 at 11:25am
When I purchase equities in the markets, I do so with the expectation of risk adjusted returns. When those firms engage in “conscious capitalism” I’m getting less reward for assumed risk. Their job is to maximize my wealth. If they don’t, I will sell the security, thereby lowering its price to fair value.
Tom West
Aug 7 2019 at 8:46pm
The The Separation Theorem assumes there are only two hats, and that is manifestly untrue.
Anyone who has anything to do with business knows that there is an entire ethical range stretching from utterly unethical (but not technically illegal) to highly charitable. I doubt even Mr. O’Leary would suggest that you are morally obliged to act in a manner that harms human beings if you could make money from it.
And if that is indeed the case, then he’s not arguing separation, but simply where he’d put the dividing line.
The binary choices of false dichotomies are popular rhetorical tricks, but we shouldn’t mix them up with reality, which tends to be analog.
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