Nightcap

  1. The Use of Knowledge in Society F.A. Hayek, American Economic Review
  2. On conservative nationalism and foreign policy Emma Ashford, War on the Rocks
  3. Europe’s ‘solidarity’ crumbles in the face of a crisis Kai Weiss, CapX
  4. Bigger Brother: surveillance capitalism Tim Wu, New York Review of Books

Nightcap

  1. Why didn’t we see this coming? Scott Sumner, MoneyIllusion
  2. Against ageism Irfan Khawaja, Policy of Truth
  3. Expose the young Robin Hanson, Overcoming Bias
  4. Humility, not certainty Victor Davis Hanson, City Journal

Nightcap

  1. The inverted anthropologist Arnold Kling, askblog
  2. Dishonesty is a core nationalist value Scott Sumner, EconLog
  3. What does the superhero craze say about our own times? Iwan Rhys Morus, Aeon
  4. The ant queen is not actually a central planner.” Rick Weber, NOL

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.

Institutions, Machines, and Complex Orders (Part 5): Logical models

There is a thin line between the abstract model of “natural selection of institutions,” its instantiation in an imaginary example that interprets it and the application of that theory to interpret historical experience. The latter does not test the model, but is the result of the organization of the record of events around this interpretive model. The instantiation in an imaginary example is a visualization that allows us to identify the inconsistencies in the model -if there are any- and to test general predictions about the behaviour of the variables. Such interpretations of the model assume that the rest of the variables remain unchanged, that is, the ceteris paribus condition.

If the abstract model does not have inconsistencies, i.e.: if in its imaginary interpretation, contradictory events do not arise, and, nevertheless, its explanatory or predictive power is contradicted with the experience, this does not imply a refutation. On the contrary, it is an indicator that another set of events are acting that neutralize the effects of the process described by the theory. In this case, although the theory does not achieve results in terms of explanations and predictions, it does fulfil a heuristic function: that is, it inspires new lines of research and discovery.

One such line of such lines is, for example, how politics plays out in the process of natural selection of social habits and practices. As indicated by the School of Public Choice, the regulations on economic activity that affect the distribution of corporate profits, assign monopolies, restrict imports, intervene in the market of credits and capital to favour certain activities over others, among others many cases of economic dirigisme encourage the development of practices known as “lobbying.” Investing in human capital and new technologies means an opportunity cost that will never be assumed if higher yields are obtained as a result of influencing government decisions that protect the producer from competition, or allowing the State to sell at a price higher than the market price. Therefore, if experience is indicating a low capacity for innovation, lack of initiative and stagnation, it is most appropriate to focus the observation on which incentives are acting effectively in that country.

The counterpart of the logical models is the empirical models, the latter consist of abstractions of elements that occur in reality, highlighting their common notes to obtain various classifications of such elements, and they are a simplified scheme of perceived reality. However, any system of abstraction of the common notes of a set of objects requires a prior conceptualization of such notes as defining a set or class. In order to classify diverse populations in countries, it is previously necessary to be in possession of the notion of population, for example.

On the other hand, abstract notions are not necessarily conformed by a deliberate operation of consciousness, but by the perception of series of events that are repeated and differentiated from one another, generating in the cognitive apparatus an association of diverse stimuli. Out of habit arises the expectation that from the appearance of a particular event or series of events a range of determined events will follow and not follow another range of events of various kinds. On these spontaneous classifications, articulated around the repetition of events, their differential in the system of stimuli of the nervous apparatus, and the predisposition generated by the habit of waiting and ruling out the consequent appearance of other events and stimuli is that consciousness is conformed and the cognitive apparatus of the knowledge subject.

But, likewise, those “spontaneous classifications” allow the appearance of an abstract set of functionally related notions whose ordering does not depend on a deliberate decision. These are the cases of norms with empirical observation and of what Douglass North called “informal institutions.” The value of the contribution of Friedrich Hayek in Law, legislation and Liberty consists in both the positive legal norms (deliberately created by the legislator) and the informal institutions that condition our conduct also depend for their enunciation of that abstract order of notions that it arises from pure experience.

These logical models -as they are abstract- that make up the consciousness and the cognitive apparatus of the subjects, are in permanent trial and error testing and, therefore, in continuous reformulation. It is a kind of negative feedback process in which the frustration of an expectation is corrected in the interpretative scheme of reality that the individual has, in a process of continuous readjustment. From the invariant reiteration of a certain series of events, a structure is formed that serves as a parameter to order other events of less frequency or more erratic behaviour.

To the extent that the subject continues its experimentation, the spontaneous classification system that makes up its consciousness becomes more complex, incorporating new ranges of events, adjusting its frequency and incorporating new structures. These are the relative limits of knowledge. They depend on the experimentation and the readjustment of the abstract patterns that allowed the subject to classify the events of reality.

However, knowledge can also grow in another direction: consciousness can focus not on the events that come from its perceptions but in the analysis of the classifications themselves. In this activity, the abstract classification schemes that had been shaped by habit do not apply to reality, but reflect on these classifications and extend and reformulate them, not in terms of their experience, but in virtue of their abstract speculation. This is the task of deliberately shaping the logical models to be applied to the interpretation of reality.

The elaboration of a legal theory -for example, about representation-, the description of a market structure -for example, monopolistic competition-, the outline of a sociological explanation -through the ideal types statement, to cite a case- , are situations in which the subject of knowledge does not experiment on events, but reformulates the classificatory systems that until then had arrived spontaneously. Knowledge in this case does not grow in specificity, but increases in levels of abstraction.

These are the cases in which the historian questions not only the interpretative frameworks he uses, but also the conditions that underlie these interpretative frameworks. The philosophy of science dabbled in the scientific paradigms (Thomas Kuhn), or in the research programs (Imre Lakatos), or in the great stories (Jean Francois Lyotard). The common denominator of these three concepts can be found in that they lack an “author,” they are inferences, true conjectures that we make about the framework in which a given scientific community develops tacitly.

Many interpret these currents of philosophy of science, although diverse, as relativistic, since they lend themselves to postulate that the statements of science are conditioned by the historical circumstances that serve as the frame of legitimation. There would not be a truth in itself, but a truth enunciated in a frame of reference. Another way to see it is to interpret these scientific communities structured around a set of practices, procedures, and validation rules whose origin is mainly spontaneous in a sort of “abstract discovery machines.”

In general, a series of physical devices conformed in a process of transforming inputs into exits is called a machine. But such physical devices are organized according to an abstract plane that assigns them functions for a certain process. This plane can be interpreted through mental operations without resorting to the construction of the physical machine, throwing said mental operations verifiable results; we are faced with an abstract machine. In recent times, the term “algorithm” has also been used to compare an information process that does not depend on the free will of the researchers, but consists in the follow-up of an automatic process.

In this line, Friedrich Hayek characterized competition as a process of discovery, that is, as an abstract machine that processes data and yields results that describe reality. In fact, the discovery would be the only function of a system of free competition that gives a differential over the rest of the systems. A monopoly, whose margins of profitability were controlled either by a maximum price or by a tax on profits, would be more efficient in terms of the production of a given good, than a set of small producers without market power and without scale. The scale of the monopolistic producer allows greater efficiency at a technological level than small producers competing with each other, being able to resolve economic inefficiency through regulatory or tax tools. However, in what a system of free competition is incomparably superior is in terms of the discovery process that drives its own dynamics. These are the benefits that innovation brings, as a consequence of an unanticipated system of free competition or competition, which far exceed all the supposed advantages of a regulated system.

It is this innovation that produces, most of the time involuntarily, an institutional system of free competition, called by Acemoglu & Robinson “inclusive economic institutions” – the one that allowed Hayek to characterize it as a process of discovery, in other words, as an abstract innovation machine.

This characterization of innovation processes through institutions that function as algorithms that produce new knowledge can also be extended to scientific communities and to the evolutionary process of legal norms.

[Editor’s note: you can find Part 4 here, and the full essay can be read in its entirety here.]

Nightcap

  1. The trend of economic thinking F.A. Hayek, Economica
  2. Against moderate politics Jason Sorens, Cato Unbound
  3. Socialist fantasies Sarah Skwire, EconLog
  4. “From the ashes, modernity arose, but at a cost” Thomas Lecaque, Age of Revolutions

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.]