Market-Based Management®

A “no brainer?”

Scientists say that the human brain is the most complex thing we know of in the whole world.  A free market society may very well be the second most complex thing in the whole world.  If this is so then maybe we can learn something about ourselves and about the free market by comparing the two.

 

According to Wikipedia “The human brain has been estimated to contain 50–100 billion neurons, of which about 10 billion are cortical pyramidal cells. These cells pass signals to each other via around 100 trillion synaptic connections."

The U.S. Census Bureau estimates the human population of the Earth reached six billion, seven hundred forty-nine million, four hundred seventy thousand, and eleven (6,749,470,011) on 12/25/2008.

 

Despite its complexity scientists understand quite a lot about the brain.  Its unimaginably complex operations are performed within an organic structure.  Some parts of the brain tend to specialize in certain functions like motor control, spatial awareness, and language.  Billions of individual brain cells pass trillions of signals between one another through a type of electrical and chemical transaction.

 

Despite its complexity, economists understand quite a lot about the free market.  Its unimaginably complex operations are performed within an organic structure.  These structures include widely accepted rules of just conduct such as the freedom to speak and freedom to contract, property rights, prices, profits, and losses, the rule of law and limited government.  Billions of individual human beings pass trillions of profit, price, and loss signals between one another through a type of transaction called buying and selling.

 

With each passing moment the human brain organizes trillions of bits of information carried out by billions of individual cells.  With each passing moment market economies organize trillions of bits of information carried out by billions of individual people.

 

No one scientist, in fact all the scientists in the world cannot control a human brain.  The mathematical complexity of continuously ordering trillions of transactions between billions of cells cannot be approximated even by the most powerful computers imaginable.  But, somehow the brain carries out trillions of transactions every few seconds and barring an intervention of some sort, e.g. sickness, madness, drugs, or injury, the brain tends to survive and prosper by making the best use of the body’s limited resources.

 

No one planner, in fact all the planners in the world cannot control even one market economy much less the economies of the entire world.  The mathematic complexity of continuously ordering trillions of transactions between billions of people cannot be approximated even by the most powerful computers imaginable. Yet, somehow the individuals who make up the market carry out trillions of transactions every few seconds and barring an intervention of some sort, e.g. trade barriers, nationalization, price controls, etc. market economies survive and prosper by making the best use of the society’s limited resources.

So what is happening inside the human brain that makes the seemingly impossible ordering of unimaginable complexity into such a “no brainer?”  Dr. Hermann Haken suggests that the brain is self-organizing.  “The human brain is the most complex system we know in the world. . . . The central question is: who or what steers the numerous neurons so that they can produce macroscopic phenomena such as the coherent steering of muscles in locomotion, grasping, vision i.e. in particular pattern recognition, decision making etc.. An early proposal that the brain acts as a self-organizing system according to the laws revealed by synergetics was made by H. Haken in 1983. . . , A similar suggestion was made in the context of dissipative structures by Kugler, Kelso and Turvey (1980).”

And, what is going on inside free market economies that makes the seemingly impossible ordering of unimaginable complexity into such a “no brainer?”  Economist Friedrich Hayek suggests that markets are self-organizing.  “A spontaneous order is a system which has developed not through the central direction or patronage of one or a few individuals but through the unintended consequences of the decisions of myriad individuals each pursuing their own interests through voluntary exchange, cooperation, and trial and error. This process of spontaneous evolution is not restricted to explaining the growth of the economic order but can also account for the development of language, money, culture, law, social conventions and even morals and ethics.”

The human brain and the free market have some things in common.  Both are unimaginably complex and both operate on the principle of spontaneous self-organization.  The thoughts created by billions of individual cells in our brains, and the prosperity produced by billions of individuals in the free market are, as Adam Ferguson said, “the products of human action but not human design.” 

Our conclusion:  Complex systems, like human brains and free markets must be free to operate without undue intervention.  Brains and markets cannot be managed by central plan. With that said, perhaps a lesson from nature is in order:

 

A centipede was happy quite,

Until a frog in fun

Said, "Pray, which leg comes after which?"

This raised her mind to such a pitch,

She lay distracted in the ditch,

Considering how to run. – Anonymous

Parking A Lot

About a year ago I realized I was paying too much for parking. The GP parking lot was very nice and the walkover bridge made it extremely convenient but parking on the street was a lot cheaper. It seemed the only sensible thing to do. My opportunity cost, the value of the most valuable alternative given up when you choose to use a resource in a particular way, for staying in the GP lot was just too high. I took the elevator to the ground floor and told the office manager that I was moving out of the GP lot. “We are sorry to lose your business,” he said. “May I ask why you are leaving us?”

“Too expensive.”  I smiled.

Parking on the street, while a lot cheaper, did have some disadvantages. The down sides included rain, wind, weather, and a whole lot of aggressive panhandlers. Still it seemed by far the best decision all things considered.

Everything was fine for a few months. Then things began to go south. I arrived before sunrise one morning and stuffed my $3.00 into the slot under the appropriate number in the money box. When I returned to my vehicle that evening I was shocked to see that my front and back driver’s side wheels were booted. A bright sticker on my window warned me not to attempt to drive away. “Duh.”  

I dialed the 800 number on that sticker and tried to explain. They promised to have someone there soon. Thirty minutes later a young man arrived. He was carrying a clip board and a pen. “Why did you boot my car?” I asked in my calmest possible voice.

“Because you didn’t pay.” He said.

“You are mistaken,” I said. “I did pay.” There are no receipts given when you stuff dollar bills into the slots at this lot so I was doing my best to sound honest.

The young man shook his head. “50 cents short,” He said.

“No way!” I said. “I’ve been parking here for months. I know I paid $3.00”

“The price is 3.50,” he said.

“When did the price go up?” I asked.

“Last night.” He said. “There’s the sign.” He pointed.

“How much is the charge to remove the boots?” I asked.

“Fifty dollars.” He said.

“Fifty dollars! But I’m only 50 cents short.” I exclaimed.

“Fifty dollars.” He said.

Exasperated, I handed him a credit card. “You know I’ll never park here again.” I was unable to hide the anger in my voice.

He smirked and handed me a receipt. “Someone else will.” The boot bandit took out his keys and set my captured vehicle free.

Despite this setback I felt that my opportunity cost for parking in the GP lot was still very high. To avoid any possibility of being booted again I moved to my next best alternative. It was a parking lot several blocks away from the headquarter building. It meant a longer walk with more rain, wind, weather, and a whole lot more panhandlers, including one particularly aggressive fellow who promised to protect my car from harm each day for a reasonable fee. Despite the attempted blackmail, I felt it was worth it to park in this lot because it had a machine that gave me a receipt. You simply put the receipt on your dash and you are good to go. I figured I was safe from the boot bandit at least.

In the months that followed I noticed that there were a lot of folks getting boots placed on their wheels in this new lot too. Since everybody got a receipt I suspected these were mostly people who were trying to get away with parking without paying. That’s what I thought until one day I talked to one of the boot victims. It was an older woman in a business suit. She reminded me of my mother.

“What happened,” I said. “Did you forget to put your receipt on your dash?”

“No,” She said. “I paid. I put the receipt on my dash. They did this.” She pointed to the boots on her front and back wheels. “So, I called the number. They claim that I moved my car during the day and returned to the same slot.”

“Did you?” I asked. “Did you leave and come back?”

“No.” She said. “I’ve been at work in my office several blocks from here all day long. “I never left the building.”

As we were chatting a car pulled up and a young man stepped out. He had a clip board and a pen. The young man ignored the woman’s insistence that she had not moved her car and demanded $50.00. She paid. The boot bandit smirked and set her vehicle free.

The next morning it rained. I arrived at the parking lot early. Although I was planning to find a new lot with honest ownership I hadn’t begun my search yet. So I put my credit card into the machine expecting a receipt. Nothing happened. Just then another patron drove up beside me. He rolled his window down. “The Machine’s broke,” he said.

“Thanks.”  I shook my head.

The rain was picking up. Naturally, I had an early morning meeting with no time to spare.  I pulled into the lot next door. It was one of those where you stuff the money into a slot. No receipt. It didn’t seem to matter in this land of the boot bandit anyway so I parked and hurried over to the money box. I rolled a dollar bill carefully and pressed. Try as I would I could not get it into the slot. In frustration, I moved my car to another slot and ran back through the rain to the money box. The second slot was also very tight. I managed to get one dollar in but the second dollar got stuck half-way. I tried and tried to press the dollar fully into the slot. The rain picked up. Finally, in frustration I gave up. One dollar was lost, sunk cost, but the other one, was stuck half way so I tried to retrieve it. I pulled gently, and then a little harder, and a little harder. The dollar split in half.  More sunk cost. “Ya!”

I was really running out of time so I pulled into the lot next to the building. Every parking space was full. The rain pounded down in sheets. It was at that moment that I realized that my opportunity cost, the value of the most valuable alternative given up when you choose to use a resource in a particular way, for not parking in the GP parking lot was now higher than all of my outdoor alternatives. Without hesitation I pulled into the GP parking building. I parked on the fifth floor. I took the elevator down to the ground floor. I walked into the parking garage office. The office manager said, “Good morning sir.  Don’t I know you?”

“Yes.  You know me and I’m back. I’d like to sign up for monthly parking again,” I said.  He handed me a form.

“You know,” I said. “I really like parking here a lot.”

“Glad to have you back.” He smiled.

Self Interest

In the 1990’s my younger brother decided to seek a better life for himself.  He went to school and became a certified air conditioning contractor. He found work right away. He was very successful. His work was top quality. Customers loved him. They asked for him by name. My brother worked his way into the role of project manager in record time. His output was so extraordinary that his employer told him that he was “indispensable” to the business. He was rewarded for his efforts. Over the years my brother managed to save a bit of money. 

 

Each year my brother would win awards for outstanding sales performance, customer service, and the like. Friends and family routinely suggested he go into business for himself. He considered it. But year after year he kept on working for his company. He knew that going into business for himself would be every expensive and very risky. More importantly he didn’t want to hurt his employer by leaving, and potentially becoming a competitor.  He didn’t want to be selfish.

 

Then one day it happened.  An “angel” arrived in the form of a former customer. My brother was faced with an opportunity that would be very hard to refuse. The former customer was so impressed with my brother’s work he offered to sponsor a significant percentage of the startup costs if my brother would open his own shop. My brother considered the trade offs. Stay with his current employer and continue to make a secure living, or, risk it all and go solo on the hope of making it really big. 

 

For a long time he pondered the opportunity. It meant risking his hard earned savings and going on the line for a big loan. Failure would be very expensive indeed. Finally he decided take the plunge. With a heavy heart he approached his boss of many years and told him the news. He was going solo.  His new shop would open on the other side of town within a few weeks. His boss tried to talk him into staying but my brother’s mind was made up. That night, and for many nights to follow my brother agonized over his decision. His feelings were a mixture of excitement, anxiety, and guilt.

 

A few weeks later my brother’s air-conditioning shop opened. He placed orders for equipment. He bought a truck. He had a sign painted. Within a week he had his first contract with a local firm and it was a big project. He placed ads in the local newspaper for help. Within three months he had several contracts and six full-time employees. He bought more trucks. After six months he had so many orders he was forced to hire more people and buy more trucks and more equipment. Next he hired a full time salesperson and a full time project manager. He held a party to celebrate their first year in business. Several employees gave spontaneous speeches expressing their gratitude for the opportunity my brother created for them.

 

The business continued to grow.  At the end of two years my brother had 14 full time employees. His operation had expanded so much that the shop was barely big enough to hold the equipment. Despite all the success my brother still felt guilty. He still felt bad about leaving his old job. Finally he made some calls to find out what happened to his previous employer after he left. To his surprise they were doing just fine. 

 

My brother’s experience illustrates one of the fundamental lessons of the free market. Only by serving others can we serve ourselves. We see this same phenomenon played out again and again. Individuals seeking to fulfill their own self-interest have created the great abundances of our society. From light bulbs, to computers, to cell phones, to cars, to houses, to air conditioners, the vast number of products and services we enjoy were produced by other individuals who were simply seeking to serve their own self-interest.  Or, as economist Walter Williams said,

 

One of the wonderful things about free markets is that the path to greater wealth comes not from looting, plundering and enslaving one's fellow man, as it has throughout most of human history, but by serving and pleasing him.

 

So it was with my brother.  He started by seeking a better life for himself by earning certification as an air conditioning contractor. By starting his own business in an attempt to better serve his own self-interest he provided his wife and children with a better life and a far brighter future. In the process he created 14 new full-time jobs. Think if it, 14 families enjoying a better life because of his “self-interested” decision. And finally, by taking a self-interested entrepreneurial risk, my brother ended up maximizing his contribution to society.  He is now serving and pleasing hundreds of people in his community.

Creating Jobs by Breaking Windows

Like anyone who grew up playing with GI Joes, I still find military hardware neat—an enthusiasm tempered only by the massive costs involved. Most folks are familiar with the mental model of “guns or butter,” but this idea was plainly lost on the BBC in this article on the two new aircraft carriers to be laid down in Scotland. According to the BBC, these two great efforts will “create” thousands of jobs. Simply put, they will do nothing of the sort. True, we will observe thousands of Scots heading to the yards, but what we will not see are the thousands of others who would have been going to work somewhere else, had a portion of society’s scarce resources not been redirected towards these floating behemoths.

While a society certainly needs protecting, and the freedom of the seas is essential to global prosperity, such projects do not “create” jobs—they simply redirect them from somewhere else. Economists classify the BBC’s mistake as the fallacy (sometimes parable) of the broken window. In the fallacy of the broken window, some punk kid breaks a baker’s window. A bystander quickly remarks that the damage is a good thing, stating authoritatively that the breaking of the window will boost employment by providing work for a glazer. What the bystander does not see are all the other things the baker may have done with the resources now dedicated to re-glazing. You are probably thinking that this makes perfects sense (and that is because it does). However, as you listen to the news coverage of the aftermath of Hurricane Gustav or even the presidential race (politicians love to talk about “creating” jobs), I can guarantee that some candidate or pundit will count the devastated homes and commit the fallacy of the broken window. The fallacy of the broken window is translated into MBM through our mental model of opportunity cost. Opportunity cost defines the cost of something not as mere dollars and cents, but whatever else could have been done with the time or resources at hand. Every “created” job must be paid for with another job (or jobs) somewhere else. Unfortunately, the victims never know what has happened to them, nor do they see the broken window that has put them out of work.

Spontaneous Order Revealed

Spontaneous order is a key mental model in Market-Based Management and is loosely defined as the miraculous emergence of order from the seemingly chaotic interaction of billions of human beings. Adam Ferguson famously described it as "the result of human action, but not the execution of any human design." In MBM, spontaneous order represents our mental model of how the world works. That is, the world is made up of billions of self-interested individuals who provide for one another by pursuing their own self interests. If an individual or business fails to provide for others, then it will fail in providing for itself. I was acutely reminded of spontaneous order while viewing this short clip on the BBC. It depicts GPS tracking of ships, planes, and taxis (among other things) traveling in and around the British Isles within a 24 hour period. Not only is the clip amazing, but it serves a reminder that chaos is often not so chaotic.

Creative Destruction Threatens Snail Shortage

Where have all the good snail collecting jobs gone? The answer appears to be nowhere—the problem is finding people willing to fill them. Snail gathering is hard work, but someone has to do it—otherwise Europe’s gastropod lovers (the French in particular) will go without escargot. Unfortunately, relatively high wages in France and the extension of protections to some species of snail nudged the French snail industry into slow decline some years ago. Fortunately, the demise of the Berlin Wall brought a flood of slimy molluscans from Eastern Europe, as impoverished villagers in Poland and Bulgaria proved only too happy to perform the dirty work and keep the escargots flowing.

That was until economic development in Eastern Europe brought better things to do, and would-be snail gatherers have moved on to more rewarding occupations. Now there is consternation in France that foreign supplies of snails may dry up and deprive Frenchmen of their beloved escargot. The pending snail crisis is an example of newer and better jobs crowding out the old—a process the great economist Joseph Schumpeter popularized as “creative destruction”. By providing greater opportunities, the rising tide of Eastern European prosperity is simultaneously destroying its snail industry. This is a telling reminder that, while we are bombarded with tales of this or that industry failing or moving oversees, the truth of the matter is this is often a symptom people of a country finding better things to do. At the same time I fear not for the French. I am sure they will get their snails from somewhere, as the nations of Eastern Europe pass the torch of snail gathering to peoples with lower opportunity costs, who will be delighted (and much better off) for receiving it.

Do You Have a Bad Job?

Of course, whether you have a bad job or not is not something I can answer, but luckily some folks think they have figured out as to what a “bad” job really is. This article in the Arizona Republic (HT: Coyoteblog and apologies as I basically parrot his post), cites an unnamed study, which classifies 35% of Arizona jobs as “bad,” because they pay less than $17 an hour and offer no benefits. On the other hand, 22% of Arizonans apparently have “good” jobs, which the study defines as making more than $17 an hour with health insurance, retirement plans, and various other unnamed benefits. Unfortunately, as there is no link or naming of this study, I have no way of determining the “goodness” or “badness” of the remaining 43% of Arizona jobs, which exceed $17 an hour but fail to include all the “good” job basket of mystery benefits (however, considering the percentages of insured/uninsured most of these “limbo” jobs presumably come with the big benefit—health insurance). The 43% would also include entrepreneurs and the self-employed who cannot technically offer themselves any benefits. This also begs the question as to whether any of those in "bad" or "limbo" jobs happened to fall under the benefits of parents or spouses with "good" jobs.

Confusion over percentages aside, the whole idea of measuring “good” or “bad” jobs is pointless. For starters, a person’s evaluation of his or her job is their own. I know lots of folks who make great money with fantastic benefits and positively despise their jobs. I know others, who make little and get by without health insurance (usually because they are young and healthy), who are overjoyed by their work and overall existence. Furthermore, as Coyote points out, retirees (and there are a few of them in Arizona) who work part time in leisurely, but relatively low-paying jobs, would still hold “bad” jobs despite possessing insurance coverage through Medicare and probably already well stocked in the retirement plan department. The same goes for teenagers or college students who may work part time while remaining covered under their parents’ health insurance with no real need for a 401(k) or employer subsidized life insurance. The best (see “bad”) job I ever had was in grad school, when I also happened to be flat broke—but living fairly well in my statistical poverty and misery.

There also remains the “compared to what” issue. Ten bucks an hour ain’t a bad racket if you have no skills and may not even speak the language. Had this study been conducted in China, it would have found nothing but “bad,” jobs even though Chinese factory workers may earn wages thirty times better than their previously “bad” job of starving peasant. The lesson here is the power of subjective value. Whether it is compensation, working conditions, music, movies, or dinner, different folks value different things differently, at different times, places, and situations; making defining “good” or “bad” jobs from the standpoint of a third party a waste of time and effort in addition to communicating little useful knowledge.

Conceiving Wealth—Past and Present

A common charge leveled at the modern economy is that “we don’t make anything anymore.” True, while services have accounted for a greater share of GDP since around 1911, our natural inclination is to think of wealth as the creation of goods, rather than the provision of services, trade, banking, or other financial services. Of course, wealth really has not so much to do with what is produced (good, service, or the completely intangible), but is more or less a reflection of the values people place on these whats. All that being said, we often have difficulty identifying new forms of wealth as being valuable. Consider this quotation from the great 18th century economist Francois Quesnay regarding the creation of wealth or value in what was then an economy slowly shifting from agriculture to manufacturing and commerce.

“Those who make manufactured commodities do not produce wealth, because their labour increases the value of commodities only by an amount equal to the wages which are paid to them and which are drawn from the product of landed property. The manufacturer who makes cloth, the tailor who makes clothes, the cobbler who makes shoes do not produce any more wealth than do the cook who makes his master’s dinner, the worker who saws wood, or the musicians who give a concert. They are all paid out of one and the same fund, in proportion to the rate of reward fixed for their work, and they spend their receipts in order to obtain their subsistence. Thus they consume as much as they produce; the product of their labour is equal to the cost of their labour, and no surplus wealth results from it. Thus it is only those who cause to be generated from landed property products whose value exceeds their costs who produce wealth or annual revenue.”

It would appear that before complaining that “we don’t make anything anymore” people floated concerns about workers not growing things anymore. One can only imagine what we will hear form the pundits of the future, “we just don’t consult anymore?”

P.S. I have not drawn this quote in order to bash Quesnay. He was one of the finest economists of his time and exerted incredible influence on Adam Smith. However, the quote both illustrates the fallacy that only tangible things have value, and testifies that great thinkers past and present still don’t quite get everything right.

And Now for Some Astronomically Stupid Rules

I remember when I was a kid getting a special tour of the Houses of Parliament, but if I had dropped dead during the tour, I would have been in very big trouble as it is apparently illegal to die in the Houses of Parliament. It is also illegal to enter the chambers in a suit of armor. Liverpool’s ban on walking around topless seems pretty run of the mill—until you notice the exception chiseled for women working in tropical fish stores. If you are ever in need of a restroom in Scotland, simply knock on the door of a resident, for denying someone the use of your home convenience is against the law.

These laws are extremely silly, and we are left wondering, “why on Earth would they do that?” However, economist F.A. Hayek hypothesized that society doesn’t often know why it adopts certain rules, they have just found that they are better off with them, often assuming that the rules managed to solve some sort of long-forgotten problem. Perhaps dying, or plague ridden members of Parliament had been making proceedings difficult .

However, we should not mock all silly rules too much. Sometimes when we remove the seemingly superfluous rules, the long-forgotten problem pops up again. If the underlying problem has gone away for good, then the old rule may inhibit better rules or conditions. Caution is necessary, however, as the making of new rules often leads to unintended consequences that prove worse than the underlying problem.

All three problems manifest themselves in business and society. Legislators or managers mock “the old ways,” and cause disaster when they believe they know better. The starvation of millions of people in the 20th century certainly reminded humanity that property rights were probably “a keeper.” As for good intentions but unintended consequences, Congress quietly dropped a proposed law requiring airplane passengers to buy seats for babies, after calculations showed that the law would result in the deaths of more children in car accidents. Despite rapid changes in technology, rules governing the “natural telephone monopoly” lasted for decades. Over the years, these outdated rules and regulations cost American consumers billions of dollars in unrealized savings and access to new technologies.

Three things to think about before changing, adopting, or throwing out any old or new rules in your city, county, state, country, or workplace. Oh, and since the article on silly rules picks on the British, one of my students dug up this gem (HT: Kasey Jolly) from my adopted hometown of Wichita.

"In Wichita, at the intersection of Douglas and Broadway, all motorists are required to stop at the intersection, exit their vehicles, and fire three shotgun rounds, before continuing on their way.”

So that explains all the gun racks—time I became a law-abiding citizen.

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.