Crisis, governments and the micro-macro conundrum

Layoffs and salary cuts are individual firm responses to a crisis that may make sense from a micro perspective- it is about saving money – but they will have dire consequences on the macro level.

I lived through this in Greece. Ten years ago, every firm was expecting the worst to come from the memorandum. They started making people redundant, pulling out from planned investment and cutting salaries. Unemployment went up, demand collapsed, public revenue went down, more austerity measures were needed and the downward spiral deepened. The country ended up losing one third of its economy in just four years.

Will it now be Greece on steroids everywhere?

The side effects of myriads of micro adaptations appear on the macro level. This is a key problem for economics and is particularly challenging for Austrian economics. Entrepreneurs creatively respond to a crisis by adopting a cautious and defensive approach long before some of them could spot new opportunities for investment and take positive action to exploit them. But if they all choose to first play ‘defense’, they shape the macro-environment in patterns that keeps telling most of them “keep on protecting yourself”, “there are more risks than opportunities out there”. Both supply and demand are on a continuous downward spiral. While some discerning entrepreneurs will spot some opportunities even in the direst of the circumstances, their plans need time to materialise and some may never come to fruition. In the meantime, most economic actors are not well positioned to start what they know to do well, and many have already lost their money in activities that went downhill.

On the other hand, the side effects of a large top down intervention such as the global lock down confirms the Austrian critique that central planning is also a risky endeavour. In an effort to control a complex reality, radical top-down interventions can divert investment to the specific activities they prop up, which appear sustainable for as long as this diversion lasts. Restrictive measures can also backfire, such as Greece’s shock austerity that was intended to balance the budget in Greece, or can prolong a precarious environment, such as the debt-fuelled bailouts elsewhere to save the banking system.

The problem is that policymakers do not have the tools to gain a full grasp of any potential unintended or undesired consequences from their actions. When they focus on one range of analysis, such as preventing a spike of deaths during the epidemic, the measures they take can generate a cascade of negative side effects in areas off their alarmed radar which they may have no idea how to arrest or fix.

I don’t see this micro-macro antithesis as an automatic validation of post Keynesianism in the sense that capitalism is always inherently unstable. It is unstable in periods of crisis when the micro and the macro can become a contradiction.

Exogenous shocks periodically happen. But it is worth studying what post Keynesians state: a crisis can emerge endogenously as in the financial markets.

The way out may be to think in terms of resilience rather than stability. I am inspired by Hilton Root’s forthcoming book Network Origins of the Global Economy. Resilience is the capacity of a system to accommodate turbulences and absorb shocks in recurrent episodes of instability. The system is unstable but can withstand the stresses.

Are multiple adjustments by adaptive agents able to bring about resilience in a system? Or do we need a central node to gain control and bring about order? Is a centrally-induced order a structure of relations that can be resilient over time, given that it depends on the health of the central node and knowing that the capacity of governments to understand and predict is limited?

Eco’s ‘How to eat ice cream’

A friend recently gifted me a vintage copy of some of Umberto Eco’s essays translated to English. One of the essays, titled “How to eat ice cream,” opened with an anecdote Eco said was based on his childhood. In the story, there was an ice cream vendor who sold regular cones for two cents and ice cream pie cones for four cents. Eco said his parents and grandmother would buy him which ever type he requested, but there was a limit. Young Eco envied the neighbor children who would parade down the street carrying a regular cone in each hand. But whenever he asked for four cents to buy two cones, the adults would flatly refuse and tell him that he could have a pie cone instead. As an adult, he mused:

[…] I realize that those dear and now departed elders were right. Two two-cent cones instead of one at four cents did not signify squandering, economically speaking, but symbolically they surely did. It was for this precise reason that I yearned for them: because two ice creams suggested excess. And this was precisely why they were denied me: because they looked indecent, an insult to poverty, a display of fictitious privilege, a boast of wealth. […] And parents who encouraged this weakness, appropriate to little parvenus, were bringing up their children in the foolish theatre of “I’d like to but I can’t.” They were preparing them to turn up at tourist-class check-in with a fake Gucci bag bought from a street peddler on the beach at Rimini.

The parenting method must have worked because he became Umberto Eco. What Eco recognized was that his parents had inoculated him against false consumerist behavior. The preventative measures were not against the so-called consumerist society but ostentatious display, the process of “keeping up with the Joneses.”

Around January 2018, there was a meme floating around social media. It said something along the lines of “Entrepreneur: someone who lives a few years the way most people won’t so that they can spend the rest of their lives living the way most people can’t.” I very belatedly discovered Carl Schramm’s 2004 book The Entrepreneurial Imperative. Schramm identified the 1950s as the time when American society ceased valorizing business ownership and virtuous risk in favor of material security. As part of the “security first” mentality, children and young people were openly discouraged from seeking independence or from being different in a positive way. The world was one of ossification and stagnation, even as the federal government and media pushed a strong Keynesian message of “consume to grow.” On a side note, now that I think about it, Keynesian economics resemble the children’s video game Snake: one guides the snake to food so that it will grow but eventually it becomes so big that it bites itself – Game over.

Even given the massive propaganda effort put into promoting Keynesian theories, scapegoating “consumerism” or “consumerist society” is a form of escapist thought, a dodging of responsibility. Eco spotted the cause and effect nature of being a parvenu. The desire for “fictitious privilege” creates a set of priorities that cause one to spend his wherewithal thoughtlessly. In turn a “boast of wealth” strategy leads to “’I’d like to but I can’t’” through ensuring that there is no money when real opportunity arrives. The world becomes one of abundant middle as the effort to possess everything spirals.

True heroes of capitalism

Steve Jobs, Elon Musk, Bill Gates, John D. Rockefeller, and so forth and so forth. The list of successful entrepreneurs who have become household names is long. To an extent they are the heroes of capitalism, they succeeded, often against all odds, though often with crucial help of far more unknown others, yet they did it and changed whole industries, if not the lives of all people on the globe.

Capitalism is about freedom, to have the liberty to start a business, to start selling a new product or new service. Or if you’re a big company: the freedom to buy somebody’s else’s idea, or to invest huge amounts into research, development, and/or (re)design. It is one of the most important pillars of our civilization, this process built on economic freedom, trade, specialization, barter, openness for odd things or tolerance for people who venture into new directions. Despite many setbacks, opposing ideas and much room for improvement, all around the globe, it still all adds up to what we are now: the richest and most healthy people in the world of all times. And this is not meant teleological, it is certainly not the end of the development, there is more to come, of course.

However, capitalism is built on failure. It is only in a limited number about the success stories, in far more cases it is about hard failure. For every success there are many more failures, people who went bust, companies that did not make it. In the US this is a fact more known and far more accepted than in Europe. Here, if you went broke, you would be indebted for the rest of your life and seen as a social failure as well. Happily, that stigma is not as strong as it used to be, but it is sure not out of existence either.

Therefore, the true heroes of capitalism are those who fail. The men and women who put in their life savings, or take a big loan, to start a business, or take over a franchise, or what have you. Working their ass off, taking risks, without any sight on a certain reward. Also, at least here in The Netherlands and surely elsewhere too, without the social security that employees may count on.

Still, they go for it, they chase their dream, to remain independent, because they hate to work for a boss or manager, because they believe in their great idea, because they want to get rich, or a combination of these elements. And then they fail, have to fire their personnel who depend on them, they can’t pay the bills anymore, file for bankruptcy, and have to accept that their dream is over.

That is hard. I want to congratulate them though. Because without them, our capitalist system would remain static, since no new ideas would drip into the economy. In short: capitalism would grind to a hold. So thank you, all you failed entrepreneurs, for putting in the effort, for trying and working hard. You are true heroes.

Discovery Processes

A good friend of mine encouraged me to read this note published by James Jay Carafano, Vice President of The Heritage Foundation.

Despite being as compelling as it is well intentioned, the article misses to mention one of the main arguments for free markets: what once Friedrich Hayek described as “the competition as a discovery process.”

Indeed, the concept is insinuated in Carafano’s piece of writing: “He decided to make a splash in the sports car market by jumping into the race car racket. Initially, he planned to do it by buying the world’s premier race car manufacturer, Ferrari. But that plan fell flat. So Ford moved to Plan B: to field his own, all-American team.”

Businessmen, like any other kind of people, are rational: initially, they try to maximize their profits by avoiding competition. They are not heroes and nobody can ask them to be so. People, businessmen included, respond to incentives.

When there is not any other choice than competition, then innovation, ingenuity, and creativity arise. Not because of a change in the mind of certain businessmen, but for new innovative entrepreneurs outperform the non competitive ones.

The free market capitalist system James Jay Carafano praises is mostly an institutional arrangement named -once  again- by Hayek as “competitive order.” Nevertheless, the most interesting question for our times is not about the virtues of the said free market capitalist system -which seem to be out of discussion- but whether competition under the rule of law deserves to have a Kantian “Cosmopolitan Purpose.”

My Startup Experience

Over the past 4 years, I have had a huge transition in my life–from history student to law student to serial medical entrepreneur. Essentially, I have learned a great deal from my academic work that taught me the value that we can create if we find an unmet need in the world, create an idea that fills that need, and then use technology, personal networks, and hard work to create novelties. While startups obviously tackle any new problem under the sun, to me, they are the mechanism to bring about a positive change–and, along the way, get the resources to scale that change across the globe.

I am still very far from reaching that goal, but my family and cofounders have several visions of how to improve not only how patients are treated but also how we build the knowledge base that physicians, patients, and researchers can use to inform care and innovation. My brother/cofounder and I were recently on an entrepreneurship-focused podcast, and we got the chance to discuss our experience, our vision, and our companies. I hope this can be a springboard for more discussions about how companies are a unique agent of advancing human flourishing, and about the history and philosophy of entrepreneurship, technology, and knowledge.

You can listen here: http://rochesterrising.org/podcast/episode-151-talking-medical-startups-with-keith-and-kevin-kallmes. Heartfelt thanks to Amanda Leightner and Rochester Rising for a great conversation!

Thank you!

Kevin Kallmes

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 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.]

Innovation and the Failure of the Great Man Theory

We tend to think about innovation as inventions and particularly about the inventors associated with them: Newton, Edison, Jobs, Archimedes, Watt, Arkwright.  This Great Man Theory of incredible technical innovation is mostly implicitly held by quite a few of us, celebrating these great men and their deeds.

Matt Ridley, the author of The Rational Optimist and The Evolution of Everything among other credentials, has spent a lot of time and effort in recent years arguing against this theory. In his recent Hayek Lecture to the British Institute of Economic Affairs he convincingly outlines his case: so many independent innovations take place roughly at the same time by different people. The Great Man Theory leads us to believe that  hadn’t it been for Edison, we’ll all be in the dark and humanity deprived ofall the benefits that came with the innovation.

Not so. There were a great number of contemporary inventors who came upon versions of the lightbulb (Ridley cites 21 or 23 or them, depending on whom you include) around the same time as Edison. The story can be repeated for most other great inventions we know of: laws of thermodynamics, calculus, most metals, typewriting machines, jet engines, the ATM, Oxygen. Indeed, the phenomenon is so common that it has its own term: simultaneous invention.

It seems, in complete contrast to the Great Man Theory, that history provided a certain problem, a sufficient number of people working on solving it at a certain time, and eventually similar inventions taking place around the same time. The process is, Ridley concludes, “gradual, incremental, collective yet inescapable inevitable […] it was bound to happen when it did”.

Interestingly enough for those of us schooled and fascinated by spontaneous orders and bottom-up social and economic phenomena, the Great Man Theory is remarkably similar to other beliefs about the world. It is a symptom of the same reasoned short-comings that makes us humans susceptible to believing in zero-sum thinking, top-down organizing and “design-implies-a-designer”. Instead of grasping the deep insights of gains from trade, spontaneous order or evolution, we are tempted by the militaristically directed organizations that we believe we understand rather than the emergent order of many independently acting individuals’ trials and errors.

Precisely this bias makes us susceptible to the mistake Mariana Mazzucato has become famous for wholeheartedly embracing: the idea that, whatever the innovation, government probably did it. That government innovation is productive – or at least more productive than is commonly presumed – and indeed societies can greatly benefit from ramping up government R&D spending. Nevermind incentives, track records or statistical robustness.

Indeed, what Ridley points to is precisely that valuable and life-changing innovation cannot be directed. Admittedly, some innovation does occur in labs, but only a vanishingly small part. Mazzucato and other top-downers could have benefited greatly from listening to Ridley (or reading his book The Rational Optimist; or reading Demsetz’ devastating 1969 article ‘Information and Efficiency’).

Coming full circle and espousing the Hayekian insights, Ridley notes that the price is everything. Specifically the reduction in prices is what matters for innovations to be spread and adopted rather than the ideas themselves. Very little happens in terms of adoption and transmission until prices start to fall dramatically (hint, hint, Bitcoin… or nuclear energy, or renewable energy…). Like the printing press and the steam engine, interesting things start to happen when prices fall – not because an innovation is particularly cool in some subsection of society.

Innovation is a deeply decentralized yet deeply collective process. We face similar challenges that occassionally come to similar conclusions – and history would in all likelihood have progress exactly the same had we not had a Newton or Edison or Jobs.

Nightcap

  1. Legendary fart battles in the Samurai Era Richard Farrell, Vintage News
  2. The other side of Weimar (Germany) art David Bennun, 1843
  3. India’s ingenuous approach to life Christian Koch, BBC
  4. Revisiting the American Century Ronald Radosh, Claremont Review of Books

Nightcap

  1. The criminal as entrepreneur Cedric Muhammad, American Affairs
  2. Did the British Empire depend on separating families? Sumit Guha, Not Even Past
  3. What does nationalism mean in a contested state? Daniel Solomon, New Republic
  4. ‘In the long run we are all dead’ Adam Tooze, London Review of Books

Nightcap

  1. Centuries-old German toy shop conquers internet Katrin Terpitz, Handelsblatt
  2. Interviews with Nazi Filmmakers [pdf] Gary Jason, Reason Papers
  3. Comparing Mao to Hitler and Stalin Ian Johnson, NY Review of Books
  4. 10 Weapons That Forged British Empire (my latest at RealClearHistory)

Does business success make a good statesman?

Gary Becker made the distinction between two types of on-the-job training: general and specific. The former consist of the skills of wide applicability, which enable the worker to perform satisfactorily different kinds of jobs: to keep one’s commitments, to arrive on time to work, to avoid disturbing behavior, etc.. All of them are moral traits that raise the productivity of the worker whichever his occupation would be. On the other hand, specific on-the-job training only concerns the peculiarities of a given job: to know how many spoons of sugar your boss likes for his coffee or which of your employees is better qualified to deal with the public. The knowledge provided by the on-the-job training is incorporated to the worker, it travels with him when he moves from one company to another. Therefore, while the general on-the-job training increases the worker productivity in every other job he gets, he makes a poor profit from the specific one.

Of course, it is relative to each profession and industry whether the on-the-job training is general or specific. For example, a psychiatrist who works for a general hospital gets specific training about the concrete dynamics of its internal organization. If he later moves to a position in another hospital, his experience dealing with the internal politics of such institutions will count as general on-the-job training. If he then goes freelance instead, that experience will be of little use for his career. Nevertheless, even though the said psychiatrist switches from working for a big general hospital to working on his own, he will carry with him a valuable general on-the-job training: how to look after his patients, how to deal with their relatives, etc.

So, to what extent will on-the-job training gained by a successful businessman enable him to be a good statesman? In the same degree that a successful lawyer, a successful sportsman, a successful writer is enabled to be one. Every successful person carries with him a set of personal traits that are very useful in almost every field of human experience: self confidence, work ethics, constancy, and so on. If you lack any of them, you could hardly be a good politician, so as you rarely could achieve anything in any other field. But these qualities are the typical examples of general on-the-job training and what we are inquiring here is whether the specific on-the-job training of a successful businessman could enable him with a relative advantage to be a better politician -or at least have a better chance of being a good one.

The problem is that there is no such a thing as an a priori successful businessman. We can state that a doctor, an engineer, or a biologist need to have certain qualifications to be a competent professional. But the performance of a businessman depends on a multiplicity of variables that prevents us from elucidating which traits would lead him to success.

Medicine, physics, and biology deal with “simple phenomena”. The limits to the knowledge of such disciplines are relative to the development of the investigations in such fields (see F. A. Hayek, “The Theory of Complex Phenomena”). The more those professionals study, the more they work, the better trained they will be.

On the other hand, the law and the market economy are cases of “complex phenomena” (see F. A. Hayek, Law, Legislation and Liberty). Since the limits to the knowledge of such phenomena are absolute, a discovery process of trial and error applied to concrete cases is the only way to weather such uncertainty. The judge states the solution the law provides to a concrete controversy, but the lawmaker is enabled to state what the law says only in general and abstract terms. In the same sense, the personal strategy of a businessman is successful only under certain circumstances.

So, how does the market economy survive to its own complexity? The market does not need wise businessmen, but lots of purposeful ones, eager to thrive following their stubborn vision of the business. Most of them will be wrong about their perception of the market and subsequently will fail. A few others will prosper, since their plans meet -perhaps by chance- the changing demands of the market. Thus, the personal traits that led a successful businessman to prosperity were not universal, but the right ones for the specific time he carried out his plans.

Having said that, would a purposeful and stubborn politician a good choice for government? After all, Niccolo Macchiavelli had pointed out that initiative was the main virtue of the prince. Then, a good statesman would be the one who handles successfully the changing opportunities of life and politics. Notwithstanding, The Prince was -as Quentin Skinner showed- a parody: opportunistic behaviour is no good to the accomplishment of public duties and the protection of civil liberties.

Nevertheless, there is still a convincing argument for the businessman as a prospect of statesman. If he has to deal with the system of checks and balances -the Congress and the Courts-, the law will act as the selection process of the market. Every time a decision based on expediency collides with fundamental liberties, the latter must withstand the former. A sort of natural selection of political decisions.

Quite obvious, but not so trite. For a stubborn and purposeful politician not to become a menace to individual and public liberties, his initiative must not venture into constitutional design. No bypasses, no exceptions, not even reforms to the legal restraints to the public authority must be allowed, even in the name of emergency. Especially for most of the emergencies often brought about by measures based on expediency.

On granting the Nobel to Kirzner

In a little over a week, the Nobel Prize in economics will be unveiled. A part of me wishes that Robert Barro wins or maybe Dale Jorgenson or even William Baumol. However, I would be thrilled if Israel Kirzner won. Back in 2014, he was mentioned for the prize and it was the year that Jean Tirole, deservedly, won the prize. Since then, I have been dreaming of it as it would cement into the mainstream the best that the Austrian school of economics can offer.

Unlike many of colleagues, I have always had sympathies for numerous points made by the Austrians. Throughout my training, the Austrian school of economics was largely derided as cranks. Initially, I jumped on the bandwagon and I believed the Austrians to be crazy. However, I became exposed to many of their key points and like Edmund Phelps, I felt that the “best of the Austrians” could not be rejected so easily. True, there is some wheat to sort from the chaff, but the same applies for every school of thought.  I realized that most of their inputs in macroeconomics were largely incorporated in models like Lucas’ Islands Model or in Prescott’s Time to Build. However, what most intrigued me was how they used general equilibrium as a teaching tool, but not as a research tool. General equilibrium is useful for understanding key axiomatic assertions, but when you have an “applied economics” question, it is a hard tool to use – especially for an economic historian like me.

Kirzner is the perfect representation of the best that the Austrian school has to offer. In a way, his entire work can be summarized as such: it is the process leading to (new) equilibrium(s) that is the most interesting aspect of economics.

It is when I understood that insight that I finally grasped the deeper meaning of Hayek’s claim that “competition is a discovery process”. Entrepreneurs are people who look for the $100 bill on the sidewalk by innovating, by exploiting arbitrage opportunities and by discovering what consumers really want. They are constantly heading towards an equilibrium point. But as they try to do so, they shift the ability to produce and consume to greater levels and, in doing so, they generate a new equilibrium. And the process continues as long as human beings are humans.

For someone who studies economic history like I do, this is the most fruitful way of looking at social interactions. After all, the industrial revolution is everything except an equilibrium and the industrial revolution is most momentous structural break in history. The search for equilibrium and the creation of new equilibriums are by far more useful tools for questions like the end of “Malthusian pressures” or the beginning of the Industrial Revolution.

Of course, I am veering into excessive simplification of Kirzner’s contribution. But consider his book, Competition and Entrepreneurship. Alone, it has 7,362 citations (according to google scholar).  This is half the citations obtained by the most cited article in the American Economic Review (Armen Alchian and Harold Demsetz’s Production, Information Costs and Economic Organization). It’s close to 3,000 more citations that Deaton and Muellbauer’s “Almost Ideal Demand System” (4,775 citations). And Deaton won the Nobel last year!

By virtue of being affiliated with the Austrians, mainstream economists could have relegated him to obscurity. However, for such a citation count to be achieved, he must have been to showcase the best that the Austrian school has to offer. Just for that, maybe his contribution should be recognized.

Elon Musk on the Heroic Journey for a Fantastic Future

In ‘The Entrepreneur on the Heroic Journey’ (1997), Dwight Lee and Candace Allen write that entrepreneurs are heroic figures of society whose accomplishments are worth celebrating. Elon Musk is certainly an entrepreneur whose ingenuity and drive to create a fantastic future are admirable. In our current times when it seems fashionable to castigate entrepreneurs and those who have earned a fortune, it is nonetheless hard to read Ashlee Vance’s biography of Elon Musk and not to be in awe of his accomplishments. Elon Musk perfectly matches Lee and Allen’s description of our modern day heroes: individuals who shape society by serving the people and adding value to society through their entrepreneurial activities.

According to Lee and Allen, a hero travels through three stages.

1. The first stage of the modern entrepreneurial hero is a venturing away from the world of accepted norms. The hero asserts “There is a better way, and I will find it!” Deviating from familiar social norms and customs, he travels into unknown territory while risking failure and loss for some greater purpose or idea. That is exactly what Elon Musk did several times in his life. First, as a teenager when he dropped out of the University of Pretoria to leave South Africa for Canada. For someone who has an early inclination toward computers and technology – Musk had taught himself the BASIC programming language at the age of 9-10 and created homemade explosives and rockets – South Africa was like a prison. Although he did not know back then what exactly he wanted to achieve in Canada, his curiosity and intrinsic desire to leave an everlasting impact on the world led him to the United States. His daydreams at Queen’s University and the University of Pennsylvania usually led him to the conclusion that the Internet, the Renewable Energy, and the Space industries were the areas where he could make a huge impact. Back then, Musk already vowed to pursue projects in all three. This was in 1994 when few could’ve predicted the many ways in which the Internet would change people’s lives, when the last successful American automobile startup (Chrysler) was dates back to 1925, and when the American aerospace industry was dominated by only Boeing and Lockheed Martin. A vow like this was surely considered super-crazy. Musk pushed himself, characterized by energy, vision and bold determination into the unknown.

2. In the second stage, the entrepreneurial hero sacrifices himself for a vision or dream he has, putting his own comfort at stake. The two Internet companies he founded were Zip2, the Web’s first yellow pages, and X.com that would eventually merge with Confinity to form PayPal. The second stage of the entrepreneurial hero is his overcoming of hardships and challenges. With just $28,000 invested in Zip2, Musk seemed to never leave the office and slept on a beanbag next to his desk. He would take showers at the YMCA and when Heilman, an early Zip2 employee, would come into the office at 7:30 or 8:00 AM he would give him a kick so Musk would wake up and get back to work. Musk’s slavish devotion to the success of his startups is best expressed when he told a VC investor, “My mentality is that of a samurai. I would rather commit seppuku than fail.” (Vance, 2015, p. 72)

Zip2 would eventually be taken over by Compaq Computer for $307 million and would earn Musk $22 million for his 7% stake in the company.

Musk’s second start-up was X.com which was an initial attempt to create an online bank. During his internship at the Bank of Nova Scotia, he found out that “bankers are rich and dumb” (p. 83) and that this provided a massive opportunity to disrupt the industry. Realizing that money is nothing but an entry in a database, Musk thought that he could enter the industry with relatively little investment. This could however not be any further from the truth. The regulatory issues they were facing seemed insurmountable and several of the early employees of X.com soon left the company after believing that Musk’s vision to disrupt the banking industry is unrealistic. One other X.com employee said, “There were a million laws in place to block something like X.com from happening, but Musk didn’t care” (p. 92). Despite such issues, Musk held on and secured a banking license, FDIC insurance and formed a partnership with Barclays.

Musk had also faced many other misfortunes in the two companies that he founded soon after he left X.com: Tesla and SpaceX. In 2008, he was almost broke while divorcing his first wife – fearing he had been wasting almost all of his $180 million he earned from the sales of PayPal to eBay. SpaceX had just enough money for its fourth Falcon 1 launch, and possibly the last launch of SpaceX. Tesla had still not delivered on its promise to produce its Roadster and needed a government loan at a time when other automobile and financial corporations were also struggling. In Musk’s words: “I remember waking up the Sunday before Christmas in 2008, and thinking to myself, ‘Man, I never thought I was someone who could be capable of a nervous breakdown.’ I felt this is the closest I’ve ever come, because it seemed… pretty dark.”

3. In the third stage, the heroic entrepreneur returns to the community with his product, service, or new process. Having been just days or weeks away from bankruptcy for both Tesla and SpaceX, Musk had eventually survived and created the first successful car company since Chrysler in 1925 and was now competing with Boeing, Lockheed Martin, the Russians and the Chinese in the aerospace industry. Tesla has since delivered the Roadster, the Model S, X and is planning to deliver the Model E which will have a starting price of $35,000 by late 2017. Tesla is on its way to alter the automobile industry. SpaceX had produced rockets that can return back safely on earth which significantly lowers the costs of sending rockets into space. Elon Musk’s reward for increasing benefits to society are his profits and his wealth that he could only have accumulated when people value his products enough that they are willing buy them.

Looking at the many accomplishments of Musk and how he has served the public with his products, I believe that he can truly be considered a modern hero. The greatest contribution I think is that he has given people hope and renewed faith in what technology can do for mankind.

References
Allen, C., & Lee, D.R. The Entrepreneur on a Heroic Journey, 1997
Vance, A. Elon Musk: Tesla, SpaceX, and teh Quest for a Fantastic Future, 2015

Coase’s “Nature of the Firm”: An Anthropological Critique

But is it a good one? Is it even made in good faith? I need help.

From American anthropologist John D Kelly’s The American Game…:

Ronald Coase’s theory of the nature of the firm rescued, for neo-classical economics, the existence of firms or corporations as rational entities […] Markets always come first, and the problem of the existence of firms is depicted as the problem of why a rational manager would rely on employees rather than markets. State planning and private firms are taking over what already exists, integrated by the price mechanism of markets, and are successful to the extent that they lower costs, since there are a variety of costs involved in market transactions. Thus marginalist analysis implies that an equilibrium will always be found between planning structures and integration by price mechanism, especially since, as Coase says in “The Nature of the Firm,” “businessmen will be constantly experimenting, controlling more or less” and “firms arise voluntarily because they represent a more efficient method of organizing production.” The rise of the firm, as Coase imagines it, is always a movement from many pre-existing contracts to a controlling structure, “For this series of contracts is substituted one.” (94)

The emphasis is mine. Kelly continues:

This imaginary fits poorly the situations that were precisely the actual origins of firms, as when banks gave mortgages to planters, or stock markets funded companies of young agents, prepared to cut plantations into captured wilderness for tropical commodities […] usually employing labor moved long distances and disciplined by direct violence. There is more in the universe than Coase’s imagination, more motives for controlling powers of firms than their cost efficiencies. (94-95)

Kelly goes on to give a brief account of 1) how corporations created commodity production out of thin air, 2) how these corporations were tied to European imperialism, and 3) how they used slaves and indentured servants even when it would have been cheaper to hire the locals.

I want to address Kelly’s summary of Coase’s paper (here is a pdf, by the way, in case you want to follow along), mostly because I’ve never read it although I know it’s important, but first I want to make a couple of digressions. Libertarians would more or less answer Kelly’s three charges listed above as follows: 1) yes, and this is a good thing, 2) state-sponsored corporations and private firms are two distinct entities with two very different incentive structures, and 3) see #2. There is also an issue of accuracy in regards to Kelly’s brief summary of world history since 1600. I don’t want to get into the details here, but I do want you to recognize that I am reading Kelly critically. My last digression is simply to point out that libertarians and Weberian Leftists like Kelly have more in common than we think.

To get back to Coase’s paper, and Kelly’s critique of it, I want to highlight one sentence from Kelly’s book in particular and then turn it over to the peanut gallery in the hopes of gaining some insight:

Markets always come first, and the problem of the existence of firms is depicted as the problem of why a rational manager would rely on employees rather than markets.

Is this the puzzle Coase was trying to grapple with in his paper? I ctrl+f’d Coase’s paper (“employe” – not a typo) and couldn’t find anything that actually confirms Kelly’s summary, but it would be an interesting project (if I am right in stating that Kelly’s summary of Coase’s paper is not accurate) to follow this line of thought and delve into Kelly’s insight about the reliance that entrepreneurs/firms have on employees (rather than markets)…