This post has been rattling around in my head for a while, and was finally prompted by a post left in sterno‘s journal.

Now, before we get started, let me make one thing abundantly clear. I am a capitalist. I am probably the biggest capitalist you will likely ever meet. For more than a decade, I have made money directly from the work that I do, without relying on an outside business for my full support. Even now, as a salaried employee, I am a minority partner in the company which employees me, and I have at least two other business ventures running at any given time, one of which typically pays my rent.

I am not a socialist, nor do I believe socialism is anything but a broken and inherently unworkable economic system which does little besides deprive those citizens who live under it from benefitting from their own labor.

However, I am also a fan of government oversight of business, and of environmental and social restrictions on the actions of business.

“But Franklin,” you say, “how can that be? Isn’t that a form of socialism? Isn’t the whole point of capitalism the notion that market efficiencies work best when unencumbered by government intrusion?”

And the answer is “no,” because without such oversight, businesses tend to adopt a weird sort of pancake socialism–an inverted socialist system where profit is concentrated, but the costs of doing business and the risks associated with business practices are socialized.

There are tangible risks associated with environmentally or socially negligent behavior. Take, for example, a hypothetical chemical business that produces acetic acid, and as a byproduct produces methylmercury. Methylmercury is difficult and expensive to contain and to get rid of safely, so let us assume that the business disposes of it by dumping it into a lake. (This is not entirely hypothetical; a company doing just that in the Japanese city of Minamata in 1956 caused the largest case of mass mercury poisoning on record.)

The business that pumps methyl mercury into a lake is increasing the risk of serious health consequences for the people living round that lake. Those risks come with a significant dollar value attached; in this hypothetical case, the dollar value may be the cost associated with medical treatment, the cost incurred by lost productivity, and the cost inflicted on the local fishing industry as the industry collapses.

These costs are not borne by the business that did the dumping. The business is not really a capitalistic enterprise; it keeps the profits from its various activities, sure, but it does not pay the costs associated with the risks incurred by its business methods. Those risks are socialized–spread across the population.

In a conventional socialist arrangement, the one everyone thinks of when they think “socialism,” a worker works but does not keep the profits from his work. The profits–the results of his labor–are distributed across the population.

In the inverted socialism that comes along with lax regulation of environmental and social practices, a business keeps the profits from its work, but the costs associated with doing business are distributed across the population. This artificially increases the business’ profit; the socialization of risk means that some of what would otherwise be the business’ expense are paid by the community–even those who do not work for that business–and by other businesses impacted by the first business’ practice. Profit is not distributed, but cost and risk are.

This socialization of risk amounts to a subsidy paid by the people surrounding the business which inflates the business’ worth and increases its profits without increasing production or efficiency. Because the risks are subsidized and the costs associated with those risks are socialized, businesses which operate in a manner that socializes risk end up at a competitive advantage over businesses which shoulder the full costs of doing business.

It need not even be something as blatant as dumping toxic byproducts into the environment, and thereby socializing the risk and forcing others to assume the costs associated with that risk. This kind of “pancake socialism,” or inverted socialization of risk, may happen even in the service sector. For example, when an independent mortgage writer writes a mortgage, he is paid a percentage of the value of that mortgage, and at that point he’s done. The company who underwrites the mortgage, which may or may not own the mortgage throughout its entire life, shoulders the risk associated with the mortgage, but the guy who initially sold it has a different set of motivations. He is paid for every mortgage he writes, regardless of whether or not the underwriter profits from it or it goes into default. Therefore, his incentive rests only with writing the maximum number of mortgages possible, for the highest dollar value possible. He has very powerful incentive to issue risky mortgages, to artificially inflate the ability of the person buying the mortgage to pay, and to minimize the apparent costs associated with the mortgage. In fact, absent any kind of oversight, he may even have incentive to intentionally mislead his clients about the cost, and even to write mortgages which he knows damn well his clients can not afford. He does not bear the costs associated with the risk incurred by the mortgage underwriter.

The mortgage underwriter is in a similar position. It profits from writing mortgages; obviously, if the number of mortgages which go into default reaches a certain threshold, the underwriter will fail, but the more mortgages it underwrites in the short term, the more profit it generates, Particularly when it socializes its own risk by then turning around and selling those mortgages to others.

The total amount of money available to finance mortgages is finite. If a large number of mortgages go into default, this can diminish the pool of money available, which ends up dragging down much of the rest of the economy. A society which permits mortgage lenders to operate with little oversight is a socialist society; it encourages the socialization of risk by separating the risk from the profits. If the housing industry fails…well, the mortgage agents and the owners of mortgage issuing companies still made their millions; they’re set. The costs of the failure are not born by those individuals; the costs are socialized, and end up being paid by everyone, regardless of whether or not they benefitted from the mortgages.

“Socialism” is something of a dirty word in American culture. The best way to defeat any policy is to label it “socialist.” Yet we are a highly socialist society; it’s just that we socialize risk, and we socialize cost, but we don’t socialize profit. Businesses that work without oversight are socialized businesses; they expect everyone else to pay for their operational costs, while still concentrating profits internally.

This imposes significant barriers to entry into many industries; the socialization of risk benefits large businesses over small businesses. It makes up a hidden cost subsidy for businesses in areas where oversight is poor when they compete with businesses in areas where those businesses must pay the full cost of doing business, including the cost of waste management and risk management.

And you know what? As a capitalist, I think that’s fucked up.