Market-Based Management®

Infrastructure, Markets, and Commerce

There is a lot of talk afoot of the need to rebuild the nation’s infrastructure, and a favourite charge of anti-marketeers is that markets cannot provide complete, integrated networks of roads, bridges canals etc. However, while the market may not provide transportation networks as extensive as those built, subsidized, or sponsored by government, the market would be more likely to provide transportation infrastructure where it would bring the most benefit to the most number of people, while maximizing the efficient use of society’s scarce resources. Of course, those wishing their teeny village a multimillion dollar bridge would be fresh out of luck. Furthermore, the public would be denied admittedly impressive but value-destroying white elephants, such as the Channel Tunnel or the Big Dig. However, this is not to say that the government cannot build worthwhile projects (anyone who has flown into Reagan National Airport can tell you it really needs a much longer runway), but the question remains that even if the market fails to produce a worthwhile public project, then will the politicians and the planners get it right?

I was recently reminded of this quandary while working my way through Tim Blanning’s The Pursuit of Glory: The Five Revolutions that Made Modern Europe: 1648-1815, which includes a chapter discussing the nature of roads and road-building in seventeenth and eighteenth century Europe. Relying on contemporary accounts, Blanning begins a typical historian’s gush about the grand nature of French road-building and the colossal task undertaken by tens of thousands of workers and vast expenditures by the central government. However, unlike most historians, he digs a little deeper and discovers that, for all the highways’ grandeur, few people bothered to use them. Consider the following quote from Arthur Young—an Englishman touring France in the early eighteenth century. Although much (and grudgingly) impressed with the French roads, he observed that they had emptied a mere ten miles out of Paris and while moving south he observed:

“In 36 miles, I have met one cabriolet, half-a-dozen carts, and some old woman with asses. For what all this waste of treasure?”

So why had such massive roadworks failed utterly to encourage commerce? The answer lies with who decided where the roads went. Eager to impress important persons at court, ministers built roads to serve the latter. Accordingly, the Duc de So and So might have a beautifully paved road running to his remote country chateau, while a major commercial hub went un-serviced. In addition to serving the powerful, the royal roads had also been built to convey the king’s post, edicts, and orders to the far corners of the realm. Thus, the French roads tended to shoot out like spokes in a wheel from Paris towards the regional centers of administration. Unfortunately, while this ensured a straight shot from Paris to many locations, getting from anywhere to anywhere else in France by royal road meant going through Paris. The Sun King’s roads may have radiated out from Paris, but they allowed little in the way of lateral movement, which greatly reduced their commercial utility (a fine road is of little value if one cannot get to it). Despite the dearth of traffic, Frenchmen could rightly take pride in their roads, but often reproducing Young’s fair-mindedness, French travelers to England declared her roads just as fine—If not better—than their French counterparts. According to visitors (French and otherwise), the problem with English roads was that they were too crowded with a steady movement of carriages and carts that one Frenchman described as “magical.”

So why were the English roads crowded and the French roads bare? A logical suggestion might be that the English government employed smarter planners or had a better road-building bureaucracy than the French. However, the truth of the matter is that while the French government dedicated huge amounts to road construction, the British government hardly lifted a finger. True, English locals did owe a customary duty to keep the roads in their district in repair, but this custom had long since degenerated into farce with the gatherings of workmen quickly degenerating into a combination of shirking, drinking, and brawls (not necessarily in that order). This all began to change in 1695 when an entrepreneur petitioned the British Parliament to allow him to build a road upon which he might charge a toll, which would be collected at either end and admission granted through the turning of a pike. No doubt encouraged by a share of the promised revenue, Parliament rapidly agreed. Seeking to maximize the volume of his turnpike, the entrepreneur picked a location that would serve the most traffic. Furthermore, in order keep the revenue flowing fast and furious, he made sure that the road remained in top condition and that the maximum amount of traffic moved smoothly. Following the profits of this first trail-blazer, numerous entrepreneurs began petitioning Parliament for the right to serve the public for a nominal fee. While the turnpike acts came slowly at first (only 25 passed in the 1730s), the improved roads apparently made it easier for members of Parliament to get to London to pass more turnpike acts. The number of turnpike acts increased to 37 in the 1740s, before exploding to 170 during the 1750s and an additional 170 the following decade. By 1770 an estimated 15,000 miles of roads had been built in Great Britain, while the traveling time between most places in the British Isles declined by a factor of four.

What was true in the eighteenth century is true today. Markets can and will provide infrastructure provided they are allowed to. Meanwhile, government sponsored infrastructure is more likely to serve the interests of politicians than the people. History is littered with “bridges to nowhere,” and that trend is unlikely to change anytime soon.

Did Adam Smith Hate Businesspeople?

In his excellent book Basic Economics, Thomas Sowell makes a startling observation on page 508 regarding the great economist Adam Smith—nowhere in Smith’s The Wealth of Nations does Smith say anything nice about businesspeople. Here are a few gems from The Wealth of Nations:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary. (Book I, Chapter X, at 144)

The last part must have been lost on the framers of the Sherman Act.

The proposal of any new law or regulation which comes from [businessmen], ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it. (Book I, Chapter XI, at 278)

So many examples, but ethanol comes to mind.

The enhancement of price occasioned by both [high tariffs and government granted monopolies] is every-where paid by the landlord, farmers, and labourers of the country, who have seldom opposed the establishment of such monopolies. They have commonly neither inclination nor fitness to enter into combinations; and the clamour and sophistry of merchants and manufacturers easily persuade them that the private interest of a part, and of a subordinate part of the society, is the general interest of the whole. (Book I, Chapter X, at 142-143)

This is the reason Americans pay double the world price for sugar and do not notice.

The capricious ambitions of kings and ministers has not, during the present and preceding century, been more fatal to the repose of Europe, than the impertinent jealously of merchants and manufacturers. … But the mean rapacity, the monopolizing spirit of merchants and manufacturers, who neither are, nor ought to be, the rulers of mankind, though it cannot perhaps be corrected, may very easily be prevented from disturbing the tranquility of any body but themselves. (Book IV, Chapter III, at 519)

Ouch! Granted this is before Kaiser Bill, Hitler, Stalin, Mao, and Paul Pot.

Even his famous butcher (of the butcher, brewer, and baker) is not immune:

The trade of butcher is a brutal and odious business. (Book I, Chapter X, at 112)

So why did Adam Smith, the father of modern economics and perceived patron saint of all markets and business, say such nasty things about businesspeople? The answer lies in how most businesspeople used to make their money. In free markets, sellers can only make money by serving their fellow men. In Smith’s time, many businesses and interest groups enjoyed government protections and subsequently charged higher prices. Although the abuses in Great Britain had not been as bad as under the Tudors and Stuarts one hundred years earlier, many government monopolies (including a Revolutionary War igniting monopoly on tea) still operated at considerable expense to the public. In short, thanks to the backing of the state, the average businessperson was more crook than servant. In fact, our modern perception of the entrepreneur as one who strives to deliver a superior product at a lower cost only started to emerge two hundred years ago. For most of history, the “rich” have been so because of their pseudo-kleptocratic relationship with the state. Incidentally, this is probably the source of the famous Bible verse regarding camels going through the eyes of needles and rich men not going to Heaven. Market-Based Management uses a mental model known as profiting by the political means to define such relationships—where a business profits via government sanctioned force or fraud.

MBM considers any form of political profit completely unacceptable. In a MBM culture, the only acceptable profit is via a mutually beneficial and voluntary exchange between customer and company, which we call profiting by the economic means. Despite his disdain for businesspeople, Smith noticed that once deprived of their government-granted privileges, the still-contemptible merchants and manufacturers could only profit by serving their fellow humans. This is Smith’s lasting legacy. He did not appear to have a high opinion of his fellow man but observed that free markets forced even the worst people to provide for others—even those who might hate one another. The real Adam Smith was no ideologue, but a careful observer of human beings. Incidentally, he also gave away most of his money to the needy, which remains a little known fact—probably because he didn’t tell anyone. I like to think that Smith might have a different opinion of today’s businesspeople, but he would probably tell us not to kid ourselves. The many cheap and high quality products we enjoy today are not there because human beings are any better than they were in Smith’s day, but because the invisible hand forces them into what is best described as public service.

On the Integrity of Nations (and Business)

I find great pleasure in discovering Market-Based Management principles in books completely unrelated to business or economics. While reading The Second World War by Sir Winston Churchill, I came across this remarkable passage in chapter 16:

Honesty is the best policy, several examples of this will be shown in these pages. Crafty men and statesmen will be shown misled by all their elaborate calculations. … If a government has no moral scruples, it often seems to gain great advantages and liberties of action. But all comes out even at the end of the day, and all will come out even more even when all the days are ended.

Churchill was speaking of Molotov-Ribbentrop Pact of 1939, in which Nazi Germany and the Soviet Union agreed to ten years of mutual non-aggression and the division of Poland (the non-aggression part ended in June 1941). Neither party to this pact possessed much in the way of scruples, and both eventually suffered horribly for short-term gains. Business is much the same (minus the death and destruction), which is why MBM stresses acting with integrity and maintaining a commitment to a vision of long-term value creation. Businesses can (and do) often make strong short-term gains by sacrificing their integrity or skirting the limits of legality, but the chickens inevitably come home to roost. As Charles Koch has said many times, “if we wanted to make a quick buck, then we would just rob banks.” No business or nation can succeed long-term without integrity, which is why integrity is MBM’s Guiding Principle Number One. Too often folks respond with more than a little cynicism to the emphasis MBM places on integrity. “We’ll, your just saying that because it sounds nice,” is a common response. However, if, as Churchill suggests, lacking integrity can lead to the demise of nations, then it can spell only doom for any business. True, preaching integrity in business does sound nice, but it is also essential for long-term success and—most importantly—survival.

The Heroic Entrepreneur

Most folks tend to think well of entrepreneurs. We cannot help but admire those who work two jobs to scrap together capital, while tinkering away in their garages or basements at night. Of course, the opinions of some tend to diverge after the erstwhile struggling entrepreneur transforms himself into something resembling a captain of industry, technology, or even coffee, but even the critics of free-market capitalism cannot help but offer grudging respect for the energy, effort, and chances taken by the entrepreneur.

While we admire the entrepreneur, we often forget that bygone entrepreneurs used to risk much more than bankruptcy or the other adverse effects of over work—they often put their lives on the line to provide goods or services for others. Nathaniel’s Nutmeg: How One Man’s Courage Changed the Course of History is the story of the first English traders who ventured to the East Indies (present day Indonesia). From rough seas, scurvy, and rotting ships to the literally “cut-throat” competition from the Dutch and native cannibals, Nathaniel’s Nutmeg details how entrepreneurs in search of fantastic profits risked, and often gave, their lives to feed Europe’s demand for spices. Ten pounds of nutmeg that cost less than one English penny in the East Indies would sell for two and a half pounds sterling in London—a markup of 60,000 percent! Of course, the King would take a reasonable cut, but there was little talk of windfall taxes on the lucky few who returned to fortunes and a lifetime of free drinks exchanged for tales of the East Indies.

The story itself centers on the tiny (about two and a half miles long) East Indian island of Run, which, although almost completely forgotten, used to be one of the most famous places in the world. One of the more inaccessible of the Spice Islands, it was here that English traders befriended locals and bought huge cargoes of nutmeg under the noses of the powerful Dutch East India Company. After years of being piqued by the cheeky English, the Dutch eventually attacked and seized Run triggering war between the two countries in the 1660s. At peace negotiations in 1667 (following two years of stalemate), the Dutch and English settled on an exchange of territories each had seized from the other. The Dutch would gain control of Run, while the English received what had been the disappointing colony of New Netherlands, which we now know as New York City and New York State. At the time, most observers thought the Dutch got the better of the bargain.

Not Forgettable: A Review of The Forgotten Man

I was not sure whether Amity Shales’s The Forgotten Man: A New History of the Great Depression would be worth my time, as I had read criticism of the book as some sort of shrill revisionist attack on Franklin Roosevelt. However, whoever made these accusations obviously did not take the time to read the book. The tone is calm, scholarly, and even handed. Shales presents Roosevelt as the affable man he was, who (like any politician) faced the dual pressures of addressing crisis and re-election. In fact, if Shales takes aim at anyone (and her tone is definitely not one of attack) the lone target is most certainly Herbert Hoover.

The Forgotten Man is a refreshing look at the actual events of The Great Depression. Too often The Depression is discussed in terms hardly fit for a fifth grade history book—Hoover did nothing, Roosevelt did everything, then World War II finally lifted the country from its depths. In her smooth, matter of fact tone, Shales recounts how Hoover’s response to the depression was not one of passivity but of great energy and vigor. Unfortunately, Hoover’s medicine of higher tariffs, higher taxes, and tighter monetary policy proved the worst possible prescription for the nation’s economy. International trade all but broke down as other nations retaliated with higher tariffs of their own. Tight money triggered deflation, which combined with the government’s pressure on business to keep wages high led to massive unemployment. Substantially higher rates of taxation caused entrepreneurs to shun risk and investment. What may have been an otherwise mild downturn triggered by a stock market bubble (not unlike the most recent recession in 2001) stalled into a prolonged economic slump that arguably did not fully pass until after World War II.

As for Shales’s treatment of Roosevelt, she holds her fire and sticks to the facts. Her depiction of the New Deal as a series of experiments is historically accurate, as is her insight into the complexity and confusion within the whole program. This description of the New Deal is a longtime coming, as most histories have only ever spoke of the New Deal in generalities and seldom bothered to sift through and detail exactly how its programs worked. Of course, bits of the book probably could have been left out. While I enjoyed the asides into Father Divine (a fascinating man I had zero knowledge of) and the founding of Alcoholics Anonymous, I felt they detracted from the narrative—although they do remind the reader that The Depression did not kill hope. Perhaps the most fascinating aspect of the book is its attention to Wendell Willkie (the Democrat turned Republican, who would run against Roosevelt in 1940). At first I thought Shales might be talking Willkie up a little too much, but a little research into the man revealed an exceptional personage, who was an important figure during The Depression notwithstanding his running for president. Willkie would go on to both serve and support Roosevelt during World War II and also made a name for himself campaigning against racism. Anyway, I will let readers decide for themselves, but The Forgotten Man is a treasure trove for anyone interested in economics, politics, and history—happy reading!

The Grumbling Hive Revisited: Did Modern Economics begin with a poem?

I recently came across "The Grumbling Hive," a poem written by Bernard Mandeville in 1705. Although long and difficult to read, this remarkable poem explores how the market process channels human vices toward productive ends (people can only get what they want by providing for others). Although "The Grumbling Hive" is tame by today’s standards, it created a firestorm upon publication, and was widely denounced for supposedly thumbing its nose at morality (the 1723 edition would earn Mandeville an indictment for nuisance). I’ll let the poem speak for itself.

While Adam Smith made the same point (albeit much more tactfully) seventy-one years later, "The Grumbling Hive" is a bit of a “lost” work in the history of economics and certainly deserves more attention.

A Reminder from the Deep

A lot of people think that profit is a dirty word—and sometimes it can be. If Peter spends $500 dollars on a gun and robs Paul of $1,000, then his $500 profit is tainted. The same is true if Peter pays the authorities $500 to put his competitor Paul out of business. However, if Peter spends $500 creating something that Paul buys for $1,000, then Peter’s $500 profit is well deserved even with the very high margin. Paul has something that he values more than $1,000, Peter has an extra 500 bucks, and we have witnessed wealth creation.

The wonder of markets is that those seeking profit can only realize it by providing for others. Make something for $20 and no one will buy for more than $10, then you are not providing value for others and better find something that does—and quick. It is this motivation that takes human nature and channels it in to creating the free and prosperous society.

In many of the college courses taught by the MBM Institute, we like to start with the Introduction from How the West Grew Rich by Nathan Rosenberg and L.E. Birdzell. Although the Introduction offers many insights into the peculiar rise of prosperity is some parts of the world, one of the main themes is that the lessening of many different social, political, and religious conditions allowed European entrepreneurs to go forth and make profit. They responded by building businesses, seizing on innovations, and undertaking risky ventures and opportunities. Free from the risk of confiscation, price controls, or arbitrary government intervention, the entrepreneurs began talking the natural risks (weather, climate, etc.) that had for so long impeded human development.

I was reminded of the risks taken for profit by this article on a perfectly preserved 17th-century shipwreck recently discovered in the Baltic. It looks like a Dutch vessel—probably one of the hundreds or thousands that plied the Scandinavian timber trade. While the wreck is remarkable, I cannot help but think that the people on this ship probably died trying to provide for themselves and their families by supplying goods for other people—many of whom they neither knew and might not have even liked.

Another Plug for an Underrated Book

A few months ago (in celebration of the Fourth of July), I blogged about how the introduction of property rights in the first American colonies saved early America from starvation. However, property rights are about much more than averting death; they are the key to a prosperous society and, more importantly, instrumental in promoting peace and cooperation amongst people. Market-Based Management emulates the productive and peaceful institution of property rights through decision rights, which are employees’ ownership and accountability over their roles, responsibilities, and expectations.

Traditionally, societies adopted property rights because they worked, while experiments at communal ownership ended in conflict and often starvation. While the effects were manifest, however, no one was quite sure why property rights proved reliably effective. People took property rights as a given—at least, until someone was dumb (or arrogant) enough to think he knew better.

Although the value of property rights can be thought of as a "given,” we should still be curious about them. So, while I steadfastly recommend against opening a property law book (mine is purposely glued shut), I can offer Tom Bethel’s excellent book The Noblest Triumph: Property and Prosperity through the Ages. The book is remarkably intelligent and clear. The New York Times went as far as to label it “amusing.” In fact, it is the kind of book that you will annoy those around you with continuous statements of “did you know….?” I can almost guarantee that The Noblest Triumph will not only provide valuable insight into a typically difficult subject, but it is one of those rare books that the reader can feel making him or her smarter.

Adam Smith, Unplugged

Adam Smith’s The Wealth of Nations (1776) is arguably one of the most important books ever written. The problem is that the book is 500 pages long, and despite its groundbreaking insightfulness, can be a real snoozer. I have only ever been able to manage about 30 pages at a stretch, which is probably par even for people interested in the topic. Furthermore, in order to really understand Smith, one must also read his first work The Theory of Moral Sentiments (1759), which is another Herculean task in itself. This unfortunate situation dictates that Smith’s admirers (myself included) are deprived of a complete understanding of the man and insights that we owe so much to.

Thankfully, humorist/smart guy P.J. O’Rourke has taken it upon himself to read both books and do all of the heavy lifting for us. In his new book, On the Wealth of Nations, O’Rourke offers an entertaining insight into both Smith the man and his world-shifting revelations (HT: Ben Pratt). Frankly, I'm amazed that such a fine book has flown so far under the radar screen, but I feel it is a must read for anyone with an interest in economics or just becoming a little bit more informed. Even if you are the rare type of person who can zip through Smith while understanding it flawlessly, On the Wealth of Nations is still worth your time, if anything just for the sheer novelty of O’Rourke’s ability to find so much funny trapped in “The Dismal Science.”

Looking for Adventure and Finding Economics

Economics is not a popular topic, and understanding of it is not widespread.  Accordingly, literature, film, music, and popular culture in general are almost completely devoid of solid economic understanding.  Economists usually confound the problem by writing for fellow economists and not the public at large—although the latter trend has been shifting of late.  Indeed the giants of economics (Adam Smith, von Mises, Hayek, etc.) can be almost unreadable—at least on the first try.

With this in mind, I was delighted to find an excellent piece of good economics in an unlikely place.  Being a big history geek with a fondness for swash and buckle, I have been going through Bernard Cornwell’s Sharpe series of books, which are set against the backdrop of the Napoleonic Wars.  The following little speech by Colonel McCandless to Private Sharpe struck me as a succinct and clear summation of the forces behind a prosperous (not to mention livable) society.

Without trade there is no wealth and without wealth there is no society worth having. Without trade, Private Sharpe, we would be nothing but beasts in the mud.  Trade is indeed worth fighting for, though the good Lord knows we don’t appreciate trade much.  We celebrate kings, we honor great men, we admire aristocrats, we applaud actors, we shower gold on portrait painters, and we even sometimes reward soldiers, but we despise merchants.  But Why?  It is the merchant’s wealth that drives the mills, Sharpe, it moves the looms, it keeps the hammers falling, it fills the fleets, its makes the roads, it forges the iron, it grows the wheat, it bakes the bread, and fills the churches and the cottages and the palaces.  Without God and trade we would be nothing.

If only there was more such economic wisdom in literature, film, and the arts.  Of course, it might put me out of a job, but it would be worth it.