News reaches us that a number of bankrupts – Scottish businessmen apparently – are fiddling the system. If true, then this is extremely serious: bankruptcy is the most important part of our economic system.
Since we humans are prone to making mistakes, all of our economic systems are at risk. So we need a tool which will recognize the failures and then try to do something about them. The capitalism and markets system does this rather simply. If you make mistakes, you’ll run out of money and you will disappear. The system neatly excises anyone not adding value by pushing them into bankruptcy.
If a business has stopped making profit, this is a way of reallocating its resources so that they start adding value again.
Bankruptcy as a Method of Resource Allocation
It isn’t a punishment for getting something wrong. Bankruptcy is more hard-headed than that. If a business has stopped making profit, this is a way of reallocating its resources so that they start adding value again. Any organization – however owned, run, or capitalized – will have economic assets, whether land, labor, machinery, or buildings. The task, therefore, once the failing activities have been identified, is to move those assets to where they can add value.
This often brutal and not necessarily entirely fair – but it is a crucial part of economic efficiency. We don’t want to have potentially productive assets lying idle, nor do we want them devoted to activities which subtract value.
This is the crux of the system. Unsecured creditors are likely to lose much, if not all, of what they are owed. Shareholders should lose everything they’ve devoted to the enterprise on the entirely fair grounds that since they get the profits, they should also shoulder the losses. They were going to take the profits, rightly so, of something that worked. They’ve laid their own assets on the line to enable that. The line has been reached – thus they should lose them.
