How much more progressive is the corporate world than academia?

Academia is a hotbed of leftism and has been for centuries. At the same time, it’s also one of the most conservative institutions in the Western world. I don’t think this is a coincidence. Leftists are conservative.

The recent writings of Lucas, Mary, and Rick have highlighted well not only academia’s shortcomings but also some great alternatives, but what about stuff like this? The link is an in-depth story on how senior professors use their seniority to procure sexual favors from their junior colleagues. There is, apparently, not much universities can do about it either.

If a manager within a corporation tried any of the stuff listed in the report, he or she would be fired immediately. Sexual harassment is still an issue in the corporate world, but it is much, much easier to confront than it is in academia. The same goes for government work. The President of the United States couldn’t even get away with a blow job from a teenage intern without dire consequences in the 1990s.

What makes academia so different from corporate and government work? Is it tenure? Is it incentives? In the corporate world profits matter most. In government, “the public” matters most. In academia, it’s publish or perish. I don’t think this has always been the case. I think the publish-or-perish model has only been around since the end of World War II. Something is horribly wrong in academia.

In the mean time: corporations, churches, governments (it pains me to say this, but it’s true, especially when compared with academia), and all sorts of other organizations continue to experiment with social arrangements that attempt to make life better and better.

The veil of nostalgia

In article for Worth, titled “A new wealth gap is growing – attention inequality,” authors Joon Yun and Eric Yun of the Yun Family Foundation, an institute dedicated to “transforming the way people think,” argued that “attention inequality” is having a destructive force on society and expressed nostalgia for the days of “monoculture.” They defined this idyllic time as one where all attention was focused on one or two people or groups, e.g. the Beatles, and on no one else. The idea expressed by the Yuns is that the new internet world where everyone may take his best shot at fame is unfair, and a veil that should not have been lifted has been removed. In the meantime, everyone, described as “the heart-broken masses,” wanders through the selection at will, as customers as well as fame-seekers. The Yuns’ complaint is very similar to a running theme in the works of Michel Houellebecq: the free market of choice has created winners and losers and in doing so has destroyed the dreams and self-respect of the last group.

Perhaps the question is whether existing in a world of dreams, one in which a person could feel good about himself using the “might have been” fantasy, is an acceptable burden to thrust upon society. After all, in his short story “The secret life of Walter Mitty [which the Ben Stiller film butchered],” satirist James Thurber’s point was that living in dreams replaces action, allowing people to imagine themselves as people filled with unrecognized abilities. Even Thurber’s picture of the type for whom such an existence is necessary was probably accurate: a passive middle-aged man who had missed opportunities in his youth (implied WWII vet, so both chances to be a military hero and cash in benefits to start a business, further education, etc.) and resents his wife as the cause and the personification of the mediocrity of his existence.

But are we better off with the veil of mediocre monoculture lifted? Is the fact that revelation may not be pleasant for those who discover that they are unappealing to the modern market really a justifiable cause for concern? Is the old world of “monoculture” really something to look back upon with nostalgia?

My former composition and counterpoint teacher was also a concert pianist, who trained at The Juilliard School. While still a student my teacher was signed by a major record label. One of the tidbits I learned from him was that back in “those days (mid-20th century)” practically the only way a young (classical) artist had of obtaining notice was to be at an elite conservatory since that is where the scouts went almost exclusively.

The MO for finding the “latest new thing” made perfect sense for the time period. There was (and still is) a tremendous amount of investment on the part of the label that went into publicity for and grooming of a young artist. Further, in my teacher’s case, the label handled studio and recording expenses, created and booked concert tours, and handled venue costs. The artist did not have to repay the funding; however, total expenses would be deducted from any royalties should he/she become successful. The investment risk meant that going to places where the already-succeeding were clustered was the safest bet for the big labels. There was very little room in the equation for a person who was not already positioned to join the upper professional echelons, or someone who had no insider access.

Was a situation where the major labels acted as gatekeepers and only considered people who fit a certain profile really better than the current one where the internet and digital tools allow artists to perform directly to the audience? The nostalgia for a time of “monoculture” speaks to a yearning for a closed, stratified world. The world where my teacher grew up and worked was a world in which someone with big dreams could imagine himself as simply undiscovered, an unrecognized talent whose gifts would never benefit society. There is some security, a perverse comfort, in such a dynamic. A person never has to confront the idea that maybe he has no talent, maybe his music is not good enough, maybe what he does is something no one finds interesting, perhaps there is no market for him to fill.

The breakup of the “monoculture” has forced average Joe dreamer to confront these possibilities. Instead of only playing and dreaming in his garage, he can now release his own albums on iTunes and Prime Music, upload videos to YouTube and Daily Motion; he can have his own website and create his own publicity. He can wait to see if his work is accepted and if there is an audience for it. The Yun family has argued that the process of exposure and competition is cruel, that it breaks up human contact, that it consigns the vast majority who desire to be part of the “culture” to being part of the “heartbroken masses.” But the real question is: How is average Joe dreamer any better off under the old system? Isn’t a situation in which he at least has a chance to be seen, to make it big, better than one in which he is simply locked out? 

Nightcap

  1. The nature and origins of modernity Brian Micklethwait, Samizdata
  2. If poverty is declining, why worry about inequality? Pranab Bardhan, 3 Quarks Daily
  3. 800 years of change in Hawaii and the Pacific Glyn Ford, Asian Review of Books
  4. Are we still living in Western Civilisation? Ananya Chowdhury, ASI

Institutions, Machines, and Complex Orders (Part 3): Evolutionary drift

The affirmation that one should not judge the historical past with current values ​​forms a topic as widespread as the disobedience to it. However, a conscious exercise of the evaluative critique of the past allows us to identify continuities and disruptions in institutional patterns, i.e., in systems of incentives that are considered legitimate, whether by virtue of a question of social utility or principles.

Caste systems are obvious examples in which a differentiated attribution of rights, that is to say the legal protection of the interests of individuals assigned to a certain ethnic group, was interpreted as legitimate because it was a matter of principle.

While a caste is defined by an ethnic component, or at least with respect to its physiognomic marker, in the status system the ethnic differences lose preponderance, to transfer it to the different private orders or privileges that determine a function within the society. In both cases, both in the system of castes and status, it should be noted that they not only define privileges for its members but mainly establish obligations: war, worship or field work, for example. While the cult is reserved for a certain caste, in the status societies the cult is an institutionalized function, an order, whose members fulfilled certain procedures of admission and permanence.

In any case, beyond the similarities and differences in the systems of castes and status, what matters in this case is to emphasize that such attributions of rights and obligations, that is, of legal protection of interests, collective or particular, do not respond to a question of social utility but of principles. In the first place, because in such societies the power is fragmented and therefore there is no central power that can perform a critical judgment on the social utility of a given system of incentives; at the most, if there is a king, he assumes a role of primus inter pares, an arbitrator between castes or statuses or protector of order.

The emergence of central governments demanded the emergence of stable bureaucracies supported by a tax system to be systematized in a public accounting, that is, a calculation of utility. On the other hand, the incorporation of abstract procedures from private law to the administration of the government, displacing the systems of sages, mandarins, humanists, etc., allowed a better centralization and control and rational administrative decisions. However, what is important to note here is that such institutional innovations did not necessarily depend on a disruptive change, such as a revolution, but that many cases occurred through an evolutionary process, in which more efficient institutions displaced obsolete ones.

The emergence of central governments replaced fragmented political and social systems, because centralization allows a calculation of utility in decision making, which yields better results -not always but most of the time- than a decision system based mainly on honour. Most of the time but not always, since there is the possibility that, in a situation of extreme complexity, the calculation of utility has a wide margin of error and, in contrast, in such situations, a pattern of decisions based on emotions, traditions, or moral principles work as a kind of heuristic better adapted to the circumstances. After all, for the calculation of utility to be viable, it must have tools such as an accounting system, a literate bureaucracy, an abstract procedural system, among others. If you do not have such means, hardly a decision based on utilitarian issues is far from whimsical and arbitrary. Faced with such cases, traditional structures could be more efficient.

Another issue to consider is not to be confused between the rationalization of political power in a central administration – public budgets and control of their execution, a neutral and efficient tax system, administrative decisions of a particular nature adopted according to abstract and general procedures – with the rationalization of each subsystem of society and even of the individual in particular.

It is true that, as indicated by Max Weber, the bureaucratization of political power leads to the gradual bureaucratization of the rest of society: the generalization of the same accounting system for all companies, in order to verify compliance with tax obligations, the public instruction of the whole population, to name a few examples. These processes of rationalization are extremely beneficial and generate a jump in productivity. This is what William Easterly, in his work The Quest for Economic Growth, highlights as a phenomenon in which knowledge leaks and spreads throughout society. In this way the relations of complementarity generated by the knowledge shared with the rest of the individuals that make up a given community are much more important than the substitution effect could give an advantage to a single possessor of such knowledge. For example, having knowledge of accounting represents an advantage over the competition, but that all companies are organized according to reasonable and homogeneous accounting principles allows a jump in productivity throughout the system that yields even greater individual profits. Likewise, not only the leaking of knowledge is beneficial for all members of society, but reached a point is inevitable.

However, this does not mean that a rationalization of the society as a whole and of the individuals that compose it is necessarily possible or desirable; much less that such process is directed from a central political power. A process of compulsive and totalizing rationalization is not always modernizing. Both in biological and cultural terms, the evolution occurs in the margins, it is the mutations of small isolated populations that allow them to adapt to changes in the environment.

Moreover, the totalizing political systems, which not only seek to define from a central power each one of the functions of the social subsystems in function of a supposed calculation of utility, also seek to build a notion of “citizenship” that stifles the sphere of autonomy that defines each individual with civic obligations. Such conceptions are the first to see the processes of innovation and creative destruction and any individual initiative as dangerous. Thus, by cutting off all possible adaptation to changes in circumstances, by mutilating all possible discoveries, it is not uncommon for such political systems to experience stagnation and be displaced by other systems more open to innovation – or at least be invaded by results of said competition, discovery and innovation processes.

[Editor’s note: Here is Part 2; Here is the full essay.]

Nightcap

  1. Will UCLA ever escape John Wooden’s shadow? ESPN
  2. The politics of the classics in Japan John D’Amico, JHIBlog
  3. When Pakistan had jazz and cabarets in abundance Ali Bhutto, Guardian
  4. Lego vs. Lepin Rob Fisher, Samizdata

Three Lessons on Institutions and Incentives (Part 7): Breaking the mold

This role of entrepreneurs also depends on an abstract characteristic of technological knowledge: it works in a manner contrary to that of most goods, since it is more productive to the extent that it is more widespread in the population. This characteristic of the abstract nature of technological knowledge is related to the phenomenon of the combination of skills (matching of skills): the negative side of creative destruction lies in substitution phenomena (a computer program of inventory management increases the productivity of work saving the salaries of the army of employees who used to carry them with pencil and paper), but the positive side comes from the phenomena of complementarity.

As William Easterly exemplifies, the cardiac surgeon will be more productive in a first world hospital, where he will have specialized nurses, other qualified doctors like him, a sophisticated system of hospital administration, and so on, being the only cardiac surgeon in a hospital. city ​​of the third world, where it does not have professionalized nurses, nor the help of other medical colleagues, working in a hospital in which he himself has to deal with administrative issues. If there were only substitution relations, it would be convenient for a doctor to practice his profession in the most remote place possible. However, as relations of complementarity of knowledge exponentially increase the productivity of the professionals involved, the doctor will find it more convenient to practice in a health center that has the largest number of doctors and paramedics possible.

The latter does lead to the phenomenon of “traps”: any rational agent, who maximizes the utility of their choices will be discouraged to deepen their studies if they perceive that they can not give any use to their education. There are the cases in which a person discovers that in his country there is no technology or the necessary number of professionals to develop a specific activity, or that, existing, you will find prohibited the exercise of their profession based on restrictions regarding their race, caste, social class, sex, etc. Since, rationally, a person who is included in a particular group under which he will be found forbidden or will be hindered the exercise of his profession, he will find as the most rational of their alternatives to abandon their studies, so that their chances of progress will no longer be limited only by legal or social barriers, but because of their lack of suitability for high-paying functions. Such are the so-called “poverty traps.”

There are also wealth traps. There are those cases in which the individual knows that he is within a favored group or in which he knows a large number of professionals and, therefore, invests time and money in his education because he knows that he has high chances of success, which will then be confirmed. Obviously, such phenomena of divergence generates another problem, addressed both by Easterly and by Daron Acemoglu & James Robinson, which is that of polarized societies.

Easterly affirms that it is the exchange of goods and services, through the mutual benefits that they report to the parties that participate in it, the main source of wealth generation. Where individuals are allowed to exchange, in a stable institutional framework with a stable currency, is where prosperity flourishes. However, Easterly recognizes that bad luck can devastate nations, as are the cases of geological and climatic phenomena such as earthquakes, tsunamis or mudslides, as well as recognizing that the situations of individuals involved in a poverty trap can only be resolved through an active public policy that not only provides education, but also establishes the conditions so that the recipients of that educational system can count on certain expectations that they will be able to apply that knowledge acquired through education and that, consequently, it is reasonable to study.

Just as the bad star can affect the economic performance of the countries, so can a favorable conjuncture, such as the case of a transitory improvement in terms of exchange of a given country. But this favorable circumstance can become a counter-march. Easterly explains that, for a simple statistical matter, it is very difficult for both a nation and an individual to always remain on the crest of the wave, over the years everything tends to return to the average. The problem occurs when a country -or a person, too- got used to a certain level of spending in the boom years and intends to maintain it through debt or emisionism. We come to the cases in which, according to Easterly, the government can “kill the growth.” Public debt and inflation generate capital consumption and, consequently, poverty.

Another way that governments have to discourage growth is through corruption. Not only because it means a transfer of resources from productive activities to unproductive activities, but because it also means a bad signal for citizens. However, in cases of corruption, as noted above, wealth at least changes hands. There is another case, even more pernicious, in which the government’s actions, whether motivated by corruption or inspired by good intentions, destroy wealth, without even redistributing it: this is the case of inconsistent public policies derived from highly polarized societies.

Public policies that aim to favor a given industry, but at the same time need to agree on measures with other sectors of the economy, whose purpose is to compensate for the losses generated by those policies, can lead to a tangle of inconsistent regulations that, instead of transfer riches from one sector to another, directly destroy them. For example: exchange controls harm the export sector, since they generate black markets. The exporters will have costs that will be partly quoted according to the black market prices (which are higher) and they will have to liquidate the value of their exports at the official exchange rate, which will be lower. Regulations of this kind may not involve acts of corruption, but they do destroy wealth, which there is no way to recover.

Easterly lists numerous examples of everything that needs to be done to destroy growth. However, there is something that deserves to be especially highlighted: the progress or stagnation of nations does not depend on educational, cultural or geographic factors, but rather on the incentive framework that predominates. This incentive framework will always be abstract, that is, it can be applied at any time and place.

[Editor’s note: Here is Part 6, and here is the entire, Longform Essay.]

Three Lessons on Institutions and Incentives (Part 5): “Spontaneous” institutions

When Friedrich A. Hayek referred to the coordination problems among rational agents as a consequence of the dispersion of information in the economic system -and that made him worthy of the Nobel Prize in Economics- he did not refer to an information problem that could be solved with better statistical tools. This is also a problem of the economics of information and what Hayek himself called “limit relative to knowledge,” since the frontiers of science could be continuously extended, generating more and more information. The limit that Hayek qualified as absolute for knowledge came from the increasing degrees of abstraction and complexity characteristic of any “extended society.” This to the point of calling such phenomena spontaneous orders, or abstract or extended. Such orders allowed the prediction of the general configuration of the system, but they made impossible the concrete prediction regarding the relative position of each particular element of the system. If one looks for an example of such an institutional arrangement, Hayek himself would point as such to the legal systems that structured the mercantile communities, not because they lacked legislation or a state that monopolized its enactment, but because it provided the members of such a mercantile community of a dispute resolution system whose complexity acted as a guarantee of impartiality.

There is much talk of the virtues of institutions as guarantors of predictability, or legal security, or political stability and clear rules of the game. All of them are positive qualities that express the favorable consequences of a negative quality -negative not in the sense of pernicious, but of absence of a particular characteristic- that can be defined as “absence of arbitrariness.” In general, the concept of freedom is related to that of “free will,” which is very desirable for those who exercise it, but it could become a hell for those who suffer the free will of a third party. The institutions are, as it was pointed out, abstract limitations to the social human action that are structuring of the political, economic, and social interaction; in other words, they limit the arbitrariness of the decisions of own and third parties.

In a certain sense, institutions limit individual freedom, whether we define it in a positive way -as the faculty to exercise its own free will in a legitimate way- or negative -like the absence of coercion to exercise one’s free will. However, for the definition of freedom as absence of domination or absence of arbitrary coercion (similar to that coined by Quentin Skinner), institutions cease to be limiting of individual freedom to be functioning as the abstract devices that make it possible.

An institution is made up of a set of rules that not only limits the action of the rational agent and the action of a third party, but also limits, fundamentally, the actions of the political authority. The said procedural due process, for example, belong to the category of institutions that limit governmental action: no one can be punished except by a judgment based on a law prior to the fact of the process and dictated by its natural judges. The due process is not exhausted in this formulation, but this already constitutes in itself a strong restriction to the power of the government over the citizens. These limits make foreseeable the actions of the government that can interfere in the free will of the individuals and, therefore, define their spheres of autonomy.

Of course, although an institution by itself provides stability and predictability to the system and this generates dividends in terms of the coordination of expectations and individual plans, not all institutions are equally efficient if the mentioned predictability is taken as an evaluation parameter. A system of multiple castes, for example, depends on numerous but ambiguous indicators for the identification of each individual, necessary for the purpose of determining what rights and obligations that person owns. In contrast, a modern system, at the other end of the arch, which equates, with the exception of certain political rights, citizens with inhabitants, and agrees equal rights and obligations for anyone who proves distinctive features of humanity, drastically reduces the “transaction costs” of a system of social control structured around abstract institutions.

The summum of arbitrariness can be identified in despotic systems, in which the free will of the ruler or the group of rulers finds no abstract limit in the law -only concrete limits of other more powerful ones. In these systems, the rules are mere orders to the subjects that have a changing and unpredictable content. In any case, if there are positive laws, we are not facing the rule of law, but government through law. When a case of such extreme arbitrariness is exercised from one man to another, we call it slavery or, in the best of cases, servitude.

At the other pole of the arch we have, as has been pointed out, the modern system, which recognizes in each individual the inalienable right to exercise his free will within a sphere of autonomy that is equal for all. Thus, in a system of isonomy, knowing the limits of the sphere of autonomy itself, the limits of the spheres of autonomy of the third parties are known and, consequently, each individual can form expectations regarding a range of expected behavior of his fellows. They will have a high degree of certainty, as will their respective plans.

In the middle of the two poles of these two ideal types of legal-political systems we have the range of possible and specifically given societies, in which freedom as absence of arbitrary coercion (in the meanings given by both Skinner and Hayek) verify to a greater or lesser extent. What Daron Acemoglu & James Robinson do in this regard, is to open two axes of institutional analysis: the political and the economic, and in turn introduce the distinction between extractive and inclusive institutions. Extractive institutions would be halfway between despotism and isonomy: there are limiting rules of free will, but they are not equal for all, fundamentally restricting the right to access certain prerogatives: limitations on access to food, of political decisions or legal monopolies, to cite examples.

It is worth remembering that the birth of individual rights took place, primitively, as prerogatives that the powerful took from the despot. Such is the case of the Magna Carta of 1215. That is why it is said that rights do not pre-exist the individual but that they are conquered. These prerogatives that were pulling the sovereigns one by one and that is why there is no talk of “liberty” in the singular, but of “liberties”: of trade, of industry, of speech, of transit, etc. These prerogatives or liberties were initially torn from the ruler by militarily or financially powerful men and then extended to the rest of the inhabitants, to the point of recognizing their ownership every human being. Correlatively, by virtue of this process of institutionalization, in which each new prerogative was taken from the ruler, this implied a new limit to governmental power, so that the political system was evolving from tyranny to a constitutional system.

Following the course of this evolution, Acemoglu & Robinson work with the ideal substitute types of “failed state” and “modern state,” the complementary ideal types of “political institutions” and “economic institutions” and again with ideal substitute types of “extractive institutions” and “inclusive institutions.” Political democracy, with a plurality of voices and the extension of political rights, as to elect and be elected to public office, means the realization of inclusive political institutions. An economy that enjoys of sound money, a balanced public budget, openness to international trade, free access to markets, absence of legal monopolies and regulation of natural monopolies is the example of what inclusive economic institutions mean. For all this, we need a degree of political centralization crystallized in the modern state, which enforces the law, whose prescriptions must establish a public sphere whose administration the rulers must be accountable of.

Obviously, the analytical instruments of Acemoglu & Robinson are useful both in political and economic liberalism and, although they do not make a total use of almost three centuries of doctrinal and philosophical elaborations, their classification system is susceptible of being deepened by the incorporation of such concepts. For example, on the end of Why Nations Fail, the authors are at the crossroads of answering the question that serves as the title for the work. For this, they allude to the fact that certain critical situations cause a country to take one or another path: the development of inclusive political and economic institutions or the fate of stagnation, but that there is no such thing as a general law of history that determines that one or the other path will be taken forcibly at some specific historical moment.

This is how the authors invoke, timidly and tangentially, the current of cultural evolutionism, according to which the social customs and habits are evolving following the changes in environmental conditions, but without having a predetermined course, following an evolutionary drift. In the same way, they could have explained the institutionalization that the emerging state implies a modern state through the names and procedural principles that are previously in the uses and customs that make up private law. This is how Max Weber explained it and such studies can be used to delve into the historical analyzes formulated by Acemoglu & Robinson when answering why countries fail.

Notwithstanding this, these economists do establish certain patterns of institutional evolution that are apt to be applied when designing public policies or, plain and simple, a government program. In this sense, they allude to cases such as those of Argentina in the late nineteenth and early twentieth centuries, which had a resounding success at the moment of formal institutionalization through the enactment of a written constitution and the establishment of a central government of a federal nature. As explained by Acemoglu & Robinson, Argentina incorporated inclusive economic institutions, while it was slower to leave behind extractive political institutions. Initially, Argentina was strongly benefited by the “catch up” regarding the degree of progress of its economic partners, mainly England.

However, following these evolutionary patterns, sooner or later a crucial point is reached in which, in order for the economy to continue to progress, higher levels of competition must be developed that make it necessary to tolerate the impact of the so-called “creative destruction.” When the political system is extractive, it is much easier to resist innovation in the economic sphere when it threatens their economic rents. Arriving at that stage, there are the conditions given for the economic and political progress of a country to be reverted to extractive economic institutions.

That is to say, with inclusive institutions, both politically and economically, it becomes more difficult to find shortcuts to the sectors threatened by the creative destruction of all innovation that progress brings, in order to neutralize it. Once the regulatory, interventionist and protectionist apparatus that characterizes the extractive economic institutions is assembled, the contest moves to the political level: whoever has the springs of political power will distribute the benefits of the economic system. If we add to this a polarized society, it is not difficult to explain why the alternation of popular governments emerged from popular democracies and military civic coups. Specifically, in the case of Argentina, Acemoglu & Robinson add the factor of justice: for a country to be involved in such a spiral of institutional involution, it was necessary for justice to lose its independence from political power.

[Editor’s note: Here is Part 4; here is the entire, Longform Essay.]

Three Lessons on Institutions and Incentives (Part 3): Innovation means creative destruction

The concept of creative destruction was popularised by Joseph Schumpeter and assumes that the economy is in a equilibrium. The “entrepreneur,” therefore, is an unbalancing factor that, through innovation, displaces the winners of the prevailing situation until then, generating a new equilibrium. This notion was criticized by other economists such as Friedrich Hayek and Israel Kirzner, who saw that the entrepreneur, far from being a disequilibrating factor, obtained its benefits by identifying the points of disequilibrium of a system and arbitrating between them.

The concept of “creative destruction,” on the other hand, focuses on businesses that go to waste from the irruption of the entrepreneur. This emphasis allows us to understand why there will be those who see with fear or disgust the very idea of ​​innovation. In contrast, Hayek and Kirzner emphasize the benefits of the new equilibrium: greater efficiency in the allocation of resources and, consequently, a greater generation of wealth. The notion of Schumpeter allows us to explain why many oppose innovation, that of Hayek and Kirzner gives us reasons to move forward with it. Strictly speaking, in order for innovation not to cause damage at the aggregate level, it must satisfy the Kaldor-Hicks criterion, that is, the gains from innovation must be so high as to allow a hypothetical compensation to the ones who lost the new distribution of resources.

In short, the notion of creative destruction that both William Easterly and Acemoglu & Robinson use, although it might differs from Schumpeter’s, meets the said Kaldor-Hicks criterion. In these cases, innovation does not represent a social disvalue, but on the contrary it generates a benefit for the whole. Therefore, it goes without saying that any brake on an innovation of this nature generates social loss. At this point, if innovation -also called “creative destruction”- is systematically curtailed, in order to seek to protect activities that would otherwise be displaced, society may encounter the following scenarios: a relative delay (regarding its potential) of its development, or a stagnation, or setback. In all three scenarios, inequality in wealth and income increases, or society sees its standard of living delayed or diminished in a homogenous way. In this last case, the protected sectors are also harmed by the brakes imposed on innovation.

[Editor’s note: Here is Part 2; Here is the entire Longform Essay.]

Three Lessons on Institutions and Incentives (Part 2); Institutions: definition and subtypes

Implicitly, Douglass C. North, William Easterly, and Daron Acemoglu & James A. Robinson share the same notion of “institution.” In this respect, what must be taken into account is not a real definition of the former but its operative concept, that is, what characteristic features relate it to the rest of the concepts of each theoretical body. In this sense, we can affirm that for these authors an institution is a limiting factor for human interaction. More precisely, in terms of D.C. North, institutions can be defined as abstract constraints imposed on human social decisions that structure political, economic, and social interaction. The rational agent finds limited its action and its spectrum of choices by institutions, which can be derived as much from the law as from custom, his habits, or his moral constraints.

However, the particular limitations that a particular person experiences are not relevant, but those that are incorporated into the behavior of a large number of human beings that interact with each other, which allows them to recognize a structural pattern of human social action. In this way, although an institution limits human action, because it is widespread throughout the social fabric, building it, it allows each individual inserted in such a set of interactions to represent expectations about the behavior of their fellow human beings that have a high probability of being true (something similar to what Friedrich A. Hayek had previously enunciated in his concept of “spontaneous order”). These expectations allow each individual to make plans with a high degree of probability of accomplishment, or at least to identify those actions that could be ruinous. In this sense, an institution is not only a limitation of human action, but, correlatively, a motivator for it, i. e. an incentive. The structure of human interactions that institutions project in the political, economic, and social fields helps the rational agent to make more efficient decisions, since they have a lower margin of risk. Of course, not all the incentives generate the same economic performance.

It is true that any pattern of human interactions that constrains the scope of choices of the agent (i.e., institutions), however inefficient they might be, represent an advantage over the total absence of it, since it works as a hedge against the arbitrary power and violence from third parties. Thus, the main distinction to be drawn is between anomie and institutionalization.

This latter opinion is expressly stated in Why Nations Fail: the extractive institutions -the ones that establish rules that favor a group at the expense of the whole-, both politically and economically, although they are harmful, are less so than civil war, polarization, factions, or anarchy. Acemoglu & Robinson argue that a country that does not have “inclusive” institutions, but at least have extractive institutions, might experience a rapid development obtained from the importation of discoveries from better organized countries – the phenomenon of “catch up.” However, after reaching a certain maturity, if the country in question does not advance towards political and economic opening, stagnation and subsequent implosion will be difficult to avoid.

Here is where the book of Acemoglu & Robinson finds its point of greatest affinity with the work of William Easterly: to continue on a path of growth and development, countries and their ruling classes must be willing to admit that progress only comes through innovation and that all innovation is accompanied by a process of “creative destruction.”

[Editor’s note: You can find Part 1 here. You can find the entire Longform Essay here.]

The Paradox of Prediction

In one of famous investor Howard Marks’ memos to clients of Oaktree Capital, the eccentric and successful fund manager hits on an interesting aspect of prediction markets and probability alike. In 1993 Marks wrote:

Being ‘right’ doesn’t lead to superior performance if the consensus forecast is also right. […] Extreme predictions are rarely right, but they’re the ones that make you big money.

Let’s unpack this.

In economics, the recent past is often a good indicator for the present: if GDP growth was 3% last quarter, it is likely around 3% the next quarter as well. Similarly, since CPI growth was 2.4% last year and 2.1% the year before, a reasonable forecast for CPI growth for 2019 is north of 2%.

If you forecast extrapolation like this, you’d be right most of the time – but you won’t make any money, neither in betting markets nor financial markets. That is, Marks explains, because the consensus among forecasters are also hoovering around extrapolations from the recent past (give or take some), and so buyers and sellers in these markets price the assets accordingly. We don’t have to go as far as the semi-strong versions of the Efficient Market Hypothesis which claim that the best guesses of all publicly available information is already incorporated into the prices of securities, but the tendency is the same.

  • if you forecasted 5% GDP growth when most everyone else forecasted 3%, and the S&P500 increased by say 50% when everyone estimated +5%, you presumably made a lot more money than most through, say, higher S&P500 exposure or insane bullish leverage.
  • If you forecasted -5% GDP growth when most everyone else forecasted 3%, and the S&P500 fell 40% when everyone estimated +5%, you presumably made a lot more money than most through staying out out S&P500 entirely (holding cash, bonds or gold etc).

But if you look at all the forecasts over time by people who predicted radically divergent outcomes, you’ll find that they quite frequently predict radically divergent outcomes – and so they would be spectacularly wrong most of the time since extrapolation is usually correct. But occasionally they do get it right. In hammering the point home, Marks says:

the fact that he was right once doesn’t tell you anything. The views of that forecaster would not be of any value to you unless he was right consistently. And nobody is right consistently in making deviant forecasts.

The forecasts that do make you serious money are those that radically deviate from the extrapolated past and/or current consensus. Once in a while – call it shocks, bubble mania or creative destruction – something large happens, and the real world outcomes land pretty far from the consensus predictions. If your forecast led you to act accordingly, and you happened to be right, you stand the make a lot of money:

Predicting future development of markets thus put us in an interesting position: the high-probability forecasts of extrapolated recent past are fairly useless, since they cannot make an investor any money; the low-probability forecasts of radically deviant change can make you money, but there is no way to identify them among the quacks, charlatans, and permabears. Indeed, the kind of people who accurately call radically deviant outcomes are the ones who frequently make such radically deviant projections and whose track record of accurately forecasting the future are therefore close to zero.

Provocatively enough, Marks concludes that forecasting is not valuable, but I think the bigger lesson applies in a wider intellectual sense to everyone claiming to have predicted certain events (market collapses, financial crises etc).

No, you didn’t. You’re a consistently bullish over-optimist, a consistent doomsday sayer, or you got lucky; correctly calling 1 outcome out of 647 attempts is not indicative of your forecasting skills; correctly calling 1 outcome on 1 attempt is called ‘luck’, even if it seems like an impressive feat. Indeed, once we realize that there are literally thousands of people doing that all the time, ex post there will invariably be somebody who *predicted* it.

Stay skeptical.

Nightcap

  1. How does emigration impact institutions? Michelangelo Landgrave, NOL
  2. How Can Crypto-currencies Democratize Society? Chhay Lin Lim, NOL
  3. The Political is about to disrupt the crypto-currency scene -or at least they say so. Federico Sosa Valle, NOL
  4. A few further remarks on foreign policy and libertarianism Edwin van de Haar, NOL

No Country for Creative Destruction

Imagine a country whose inhabitants reject every unpleasant byproduct of innovation and competition.

This country would be Frédéric Bastiat’s worst nightmare: in order to avoid the slightest maladies expected to emerge from creative destruction, all their advantages would remain unseen forever.

Nevertheless, that impossibility to acknowledge the unintended favourable consequences of competition is not conditioned by any type of censure, but by a sort of self-imposed moral blindness: the metaphysical belief that “being” is good and “becoming” is bad. A whole people inspired by W. B. Yeats, they want to be gathered into the artifice of eternity.

In this imaginary country, which would deserve a place in “The Universal History of Infamy” by J.L. Borges, people cultivate a curious strain of meritocracy, an Orwellian one: they praise stagnation for its stability and derogate growth because of the stubborn and incorruptible conviction that life in society is a zero-sum game.

Since growth is an unintended consequence of creative destruction, they reason additionally, then there must be no moral merit to be recognised in such dumb luck. On the other hand, stagnation is the unequivocal signal of the good deeds to the unlucky, who otherwise could suffer the obvious lost coming from every innovation.

In this fantastic country, Friedrich Nietzsche and his successors are well read: everybody knows that, in the Eternal Return, the whole chance is played at each throw of the dice. So, they conclude, “if John Rawls asked us to choose between growth or stagnation, we would shout at him: Stagnation!!!”

But the majority of the inhabitants of “Stagnantland” are not the only to blame for their devotion to quietness. The few and exceptional proponents of creative destruction who live in Stagnantland are mostly keen on the second term of the concept. That is why some love to say, from time to time, “we all are stagnationist” – the few contrarians are just Kalki’s devotees.

These imaginary people love to spend their vacations abroad, particularly in a legendary island named “Revolution”. Paradoxically, in Revolution Island the Revolutionary government found a way to avoid any kind of counter-revolutionary innovation. It is not necessary to mention that Revolution Island is, by far, Stagnantlanders’ favourite holiday destination.

They show their photos from their last vacation in Revolution Island and proudly stress: “Look: they left the buildings as they were back in 1950!!! Awesome!!!” If you dare to point out that the picture resembles a city in war, that the 1950 buildings lack of any maintenance or refurbishment, they will not get irritated. They will simply smile at you and reply smugly: “but they are happy!”

Actually, for Stagnantlanders, as for many others, ignorance is bliss, but their governments do not need to resort to such rudimentary devices as censure and spying to prevent people from being informed about the innovations and discoveries occurring in other countries, as Revolutionary Island rulers sadly do. Stagnantlanders simply reject any innovation as an article of faith!

Notwithstanding, they allow to themselves some guilty pleasures: they love to use smartphones brought by ant-smuggling and to watch contemporary foreign films which, despite being realistic, show a dystopian future to them.

As everything is deteriorated, progress is always a going back to an ancient and glorious time. In Stagnantland, things are not created, but restored. As with Parmenides, they do not believe in movement, but if there has to be an arrow of time, you had better point it to the past.

Moreover, Stagnantland is an imaginary country because it does not only lack of duration, but of territory as well. As the matter of fact, no man inhabits Stagnantland, but it is indeed stagnation that inhabits the hearts of Stagnantlanders. That is how, from dusk to dawn, any territory could be fully conquered by the said sympathy for the stagnation.

Nevertheless, if we scrutinise the question with due diligence, we will discover that the stagnation is not an ineluctable future, but our common past. Human beings appeared very much earlier than civilisation. So, all those generations must have been doing something before agriculture, commerce, and institutions.

Before the concept of creative destruction had been formulated by Joseph Schumpeter, it was needed a former conception about how people are conditioned by institutions: Bernard Mandeville pointed out how private vices might turn into public benefits, if politicians arranged the correct set of incentives. The main issue, thus, should be the process of discovery of such institutions.

That is why the said aversion to competition and innovation is hardly a problem of a misguided sense of justice, but mostly a matter of what we could coin as “bounded imagination”: the difficultly of reason to deal with complex phenomena. Don’t you think so, Horatio?

From the Comments: Military intervention, democracy, and stability

Longtime reader (and excellent blogger in his own right) Tam has an interesting response to Chhay Lin’s thoughts on the Paris terrorist attacks:

It is an interesting read indeed but there are two or even more sides to every story. What we are also noting is that many of these groups that hate Western interventionist policies also hate their own people for being different in one way or the other. However, I agree that the misplaced perception of democracy as the superior form of governance overlooks the essential internal historical and socio-political factors behind the politics of the different countries that have become victims of Western ‘sanctification’ processes fronted by bombs after daring to opt not to embrace democracy. Libya and Iraq were stable before Western intervention.

Tam’s point strikes at the heart of the difference between military interventionists and non-interventionists, I think. Libya and Iraq were indeed stable, but not everybody was free. In Iraq, Shias, Kurds, liberals, and religious Sunnis were all brutally suppressed, and this oppression stood in stark contrast to the freedoms that secularists, women, union members, some socialists, and the politically apathetic enjoyed. The sociopolitical dynamics in Libya were the same, though with different local actors.

This reality is something that both sides of the interventionist debate recognize, though the interventionist side seems to place much more faith in government when it comes to “doing something.” Jacques and Edwin, for example, have both argued that bombing ambiguous factions in Iraq, Syria, and Libya would contribute to the freedoms of the oppressed factions in those countries. Looking back on the debate makes it clear that they weren’t wrong, but look at what those freedoms have produced. Those freedoms have come at the expense of the freedoms of the factions that the dictators were protecting.

What this situation shows me is that the states of the post-colonial world are unviable. Stability comes at too steep a price (dictatorship), and democracy’s unpredictability only leads to predictably violent results in the post-colonial world.

This impasse, which I cannot be the only one in the world who recognizes, has led me to take a hard glance at two specific peace processes in the Western world: The diplomatic efforts of Europeans after the Napoleonic Wars (“Concert of Europe”) and the founding of the American republic, which is, in my mind, the most successful endeavor in the history of international relations. Neither of these efforts led to the complete abolition of war, but both have helped to maintain a relatively peaceful co-existence between large numbers of factions for long periods of time.

The Concert of Europe bought time for factions in the region to solidify their legitimacy at home, culminating in both the creation of Germany and Italy in the late nineteenth century and the infamous overseas imperial  domains of France, the UK, and the Netherlands (among a few others). While this peace process brought about prosperity for Western Europe, it was not inclusive and it still adhered to the Westphalian notion of state sovereignty. What state sovereignty means is that each state, in the context of international affairs, has a right to do whatever it pleases within the confines of its own borders (such as massacre hundreds of thousands of people in the name of stability). The Concert of Europe was also the precursor to the post-1945 peace process that created the state system that we all live with today, though I would argue that there are some elements that could be republican, such as the IMF and World Bank, provided some changes in mindset.

Aside from the problems produced by the notion of state sovereignty, the states of the post-colonial world today suffer from an issue of legitimacy, both from domestic populations and from foreign ones. Domestically, all of the factions that stability-inducing dictatorships oppress do not buy in to the argument that the states purporting to govern them are legitimate. In foreign affairs, many factions do not believe that these post-colonial states are legitimate either. Hence the calls for bombing campaigns, proxy wars, or outright invasions and occupations of states like Iraq and Libya by states like the US or France (even if these invasions come at the expense of domestic and international rule of law).

This situation, where post-colonial states claim to have sovereignty within an international state system but where domestic and international factions ignore such claims, is where we’re at today. It’s the status quo, and while it worked relatively well in a small part of the world for about hundred years or so, it’s obviously failing today.

Enter the founding of the American republic. Unlike the Concert of Europe, self-determination à la breaking away from the UK was a guiding principle of the federal system, rather than state sovereignty. Like the Concert of Europe, the statesmen who crafted the American republic were concerned about invasion, hegemony, and all of the other bad stuff that happens in the international arena. So they set up an inclusive, republican system of states rather than attempt to balance power off on each other, like they did in Europe. The republican, or federal, system tied each state up into the affairs of the other states, whereas the balance of power system contributed to the formation of rival blocs within the system. This is why Europe switched from trying to maintain yet another balancing act to building an actual confederation (though one that is far too complex than it has to be) after World War II.

From a strictly war and peace view, the republican state system has led to one war so far (dating from 1789). From the end of the Napoleonic Wars, in 1815, to today, the balance of power state system has led to numerous wars.

Now, I know what you’re thinking: Woodrow Wilson’s foreign policy was based on self-determination, and his foreign policy was a disaster. This is true, though I would argue that Wilson was simply confused about what self-determination actually implied. For Wilson, recognizing the self-determination of various groups within empires would lead to state sovereignty for these groups, and that this state sovereignty would then be protected by the institutions trying to maintain a balance of power. Wilson never entertained the notion of republicanism when it came to recognizing the self-determination of peoples living in empires, he simply thought empires were undemocratic. Thus, he was actually a proponent of state sovereignty rather than self-determination.

What I am not arguing for here is a Concert of Europe-type effort for Middle Eastern actors. I think it would be a disaster, largely because regional efforts at peace-building (rather than, say, trade agreements) are useless in today’s globalized world. The Middle East needs the West, and vice-versa. Peace will only be achieved if self-determination is embraced (by not only large swathes of Mideast factions, but Western ones as well) and the new polities can be incorporated into existing republican-esque institutions. This way, more factions have a voice, and bad actors can be more easily isolated. I am not necessarily arguing that the US or EU should welcome burgeoning Mideast states into their federations, but policymakers and statesmen from these countries should at least start thinking about how to encourage and embrace the notion of a Middle East that looks a lot like our own republican world and less like the one we gave them following the destruction of the Ottoman Empire.

Stability is overrated, especially if the notion of creative destruction is taken into account.