Market-Based Management®

Joke

What do you get when you cross The Godfather with an economist? 

An offer you can't understand.

Blog Navigation

Allow me to point out some other features of this blog besides the posts and comments. 

On the left side you will note a couple of sections -- one called "Market Perspectives" which lists the previous Market Perspectives that have been published on D-Net.  The next Market Perspective paper is coming soon on Corporate Social Responsibility. 

Below the Market Perspectives section is the "What We're Reading" section that lists out the books members of the MBM team are currently reading or others are recommending.  If you click on the individual book links you will be taken to Amazon.com where you can read more info (and order as well if you want).

To the right of the blog, you will find several sections for finding posts and comments -- there are "Recent Comments" and "Recent Posts" sections as well as a calendar at top where you can click on a date and read everything posted on that date. 

There is also on the right side a "Links of Interest" section where you will find links to other resources.  Cafe Hayek, for example, is a blog updated often daily with high quality commentary by George Mason economists Russ Roberts and Don Boudreaux. 

Keep the comments, questions, and ideas coming!!

LTV vs. MTV

Earlier we saw how the Labor Theory of Value (LTV) proclaimed that the value of something is roughly equivalent to the labor that goes into producing it. A more general form is the "cost-of-production" theory of value -- basically, that something's value is determined by the cost to produce it.

I've cautioned that this isn't the appropriate way to value something -- labor, planes, toothbrushes, translation services, etc. To explain why, allow me to pose to you an age old question that perplexed some very smart people: what's more valuable, water or diamonds?

Most people will say, "duh! water is much more valuable than diamonds! You can't live without it for goodness sakes!" Great. So if I offer you a glass of diamonds or a glass of water, you're going to choose the water? Hello?

How do we resolve this? On the one hand we all acknowledge that water is necessary to sustaining life and therefore more valuable than any amount of diamonds. On the other hand, we'd trade a glass of water for a glass of diamonds in a heartbeat? This is the "diamond-water paradox" in economics.

It was initially resolved by a frenchman named Turgot. He said that value was in the eye of the beholder -- that value was subjective. Things don't have value in and of themselves, but only insofar as people have a desire for them. This desire changes continuously based on a person's needs and the relative options available at the time.

So when water is plentiful, we prefer diamonds. When stuck in the middle of a desert, we'll trade a truckful of diamonds for a glass of water.

In the 1870's the economists Jevons, Walras, and Menger each independently took this idea and ran wild with it. What resulted is the "marginal revolution." The simple version is that the value of something is determined by its exchange value. The exchange value is determined by its marginal utility. Value is driven at the margin by demand.

In other words, what something costs to produce doesn't determine its value, although the cost to produce may determine if it in fact gets made. It's value is whatever it can be exchanged for at the time we wish to exchange it.

Using this information, you tell me -- what's a fair wage?

The alternative theory of value

"You have to admit that a Boeing sells for more than a Cessna, Beech, or Learjet."

I freely admit it - but that does prove the 'labor theory of value' is right. Ben has not yet posted his alternative to the LTV so I thought I'd dive in.

As Ben has already mentioned the value of something is not driven by the labor costs to produce the finished product.  The very notion is absurd. If demand for 777's decreased dramatically resulting in a drastically reduced price would the Boeing union people argue that their wages should be decreased to reflect the new lower sale price? I seriously doubt it! 

The real driver of value, whether we are talking about the price of planes or the price of labor that builds those planes is the marginal theory of value. The essential idea is that to have value an object must be both useful and scarce to a consumer.  What do you think would happen to the wages of car mechanics if a majority of existing mechanics suddenly retired with no young new mechanics to replace them? The wages of mechanics will increase because consumers now have fewer alternatives (mechanics have become scarce).

The price of the plane, whether it is a Boeing, Cessna, Beech, or Learjet has nothing to do with the wages paid.  If an engineer at Boeing is so much more productive and is able to create real value for customers, then other companies are willing to bid for her services until her wages approximate her marginal contribution to firm.  If Boeing is not willing to effectively compensate its engineers then other firms will bid them away. 

Claiming you are entitled to a higher wage because the product you helped produce fetches a high price is inappropriate and wrong-headed.  Better to ask about every individual’s contribution or else we are left with the notion that our Boeing representative really wants higher wages for everyone at Boeing, including the cleaners. Surely the cleaners at Boeing should be paid more than the cleaners at Cessna, Beech and Learjet; after all aren’t the Boeing cleaners cleaning offices at a firm that makes planes that sell for a lot more than Cessnas and Learjets?    

The Power of Dispersed Knowledge: A Tasty Example

Lobster is a tasty treat. How this delicacy arrives on a plate in front of us is nothing short of a market miracle — an intricate process that harnesses the dispersed knowledge of people, places, and circumstances. An article (subscription required) in today’s Wall Street Journal provides a good example of the disruption that can come from supplanting dispersed knowledge:

“…Maine's lobster population was doing well. Catches were going up, and surveys showed that the stock of young lobsters and egg-producing breeders was on the rise. Yet under the new law, the [federal agency] ran its mathematical models and concluded, in spite of the evidence, that lobstermen needed to 'rebuild' egg production.”

A local lobsterman knew the federal regulations “ignored the thousands of egg-producing female lobsters that lobstermen marked as breeders and threw back. Maine lobstermen had long prided themselves on this homegrown conservation practice.”

“…Lobstermen had no way to counter the federal assessment, and were forced into years of frustrating regulatory negotiations. For a time, conservationists at the Monterey Bay Aquarium even followed the feds' lead and, on their widely disseminated Seafood Watch list, advised consumers to avoid eating lobster altogether.”

Each person in society, in an organization, or in this case a local community, has important knowledge. Market processes harness this knowledge by allowing people to make their own assessments and decisions. Successes are copied, failures are discarded, and we enjoy a tasty dinner. No planner made this possible. Instead it was the unseen coordination of knowledgeable people, who, in this case, overcame obstacles to suppress their knowledge.

The Rule of Law Ain't What it Used to Be

A tip o' the hat to Rod Learned for passing along this editorial from last Sunday's LA Times (may require free registration).   It's a hoot of a read about a stupid law banning shrubs over 40 inches in Santa Monica and how the local City Council decides to deal with it...  Thanks Rod!

Tax cuts for the rich, because the poor don't pay any.

Reading Alan Krugman's op-ed in the NYT on Monday (free subscription required) I was struck with his use of the tired old tax cuts for the rich argument.  It doesn't die inspite of the facts.  The reason the rich get all the tax cuts is because they are the only people paying any. (See the National Taxpayers Union site) In 2002,  96.5% of all personal income tax revenue came from the top 50% of income earners, and almost one-third of all personal income tax revenue comes from the top 1% of income earners. 

The income mobility of indiviudals must not be forgotten - this means those we might classify as poor today (such as college students planning to graduate next year) will probably not always be poor.  The people who make up the categories of 'rich' and 'poor' are therefore not static groups but are in constant flux.   

So the next time someone tells you that Bush's tax plan (or anyone else's for that matter) was simply tax cuts for the rich you can tell them you're in favor of tax cuts for the poor as well- if they were paying any!

What do Incentives and Light Bulbs Have in Common?

Okay - I really was going to write on the alternative to LTV (labor theory of value) in this post... but I'm going to shirk on my promise again just so I can tell a good story. The promised post is coming soon.

I came across a wonderful quote by M. Gorbachev today:

"Amazing, unexpected things happen when people are given meaningful incentives to lay claim to the benefits of their actions."

That's coming from the mouth of someone who was, at the time, the leader of the Soviet Union.

It reminded me of a journal story I read on a flight to Moscow years back about light bulbs. They were in short supply in Moscow, like most things of value, and folks had to wait 3-4 hours in queues to get just one (so they were nominally underpriced but expensive in real terms -- rather than paying in rubles, you paid in time spent in line not doing other things).

There emerged a black market in burned out light bulbs. That's right: burned out light bulbs. Now... what possible value could such things have to anyone?

The consumer would go to the black market and buy the burned out light bulb, take it to his workplace and replace a working light bulb with the burned out bulb. Then he would call the Maintenance Dept. and tell them the light bulb needed to be replaced.  Interestingly, the maintenance person replaced the light bulb in record time. Why would that be, you ask?

Why, so he could sell it to the black market, of course! The turn around time on burned out light bulbs -- from sale, to install, to return to the black market -- was estimated to be less than 24 hours.

Meredith Olsen made a nice point in her comment to a previous post -- birds don't know physics, but they fly anyway. Incentives matter.

Fun Fact: Oil from the Saudis

I will post soon, as promised, on the alternative to the LTV -- especially regarding the concept of a "fair wage."  In the meantime, I wanted to throw this out... Dennis Gartman, of the Gartman Letter, wrote the following this morning:

"The average American, the average European, the average newscaster, the average left-of-centre American college professor all share one basis view of the world: that the US is inexorably tied to Middle-Eastern oil supplies that make the US vulnerable to blackmail and/or to ill-advised foreign policy decisions.  We offer two facts that shall serve a 'items for conversation at a cocktail party.'  Firstly, that the US' largest supplier of crude on a regular monthly basis is now Canada... and shall likely continue to be for the very long foreseeable future; and secondly, that Saudi Arabia supplies but 1.5 million barrels per day of crude to the US while the US consumes 20 million barrels per day!

Ask the average American what percentage he or she thinks the Saudis supply and we suspect that the figure would be 50% or more.  [...]  so badly informed is the average American in such things [w]e dare say that less than 1 in 100 would [guess] less than 10%, but that is the reality."

Job Dumping

Germany's unemployment rate is the highest it's been since WWII at 12 percent.   Of course, people are concerned.  Jobs once held by Germans are being performed by people from Eastern Eurpoe for a lower wage.  The German government has formed a new task force to battle "wage dumping" and examine ways to expand minimum wages to some sectors.

Fabian Löw, a young entrepreneur, decided to use the internet to tackle the situation.  He has created a website called www.jobdumping.de.  Germans can name the price for which they are willing to work and bid downward to compete against others in order to secure the job.  Based on a news story that I caught on NPR, it sounds like individuals can also post their skills/qualitifications and companies can bid on their services (likely driving wages up for skills that are in demand by multiple bidders). 

JobDumping has brokered 1300 individual jobs since opening in November (mostly temporary work).

It's probably no surprise that Germany's unions are not pleased about the idea of workers directly bidding against one another for lower pay.  Comments such as "It's a scandal," "It's immoral," and "First, I thought it was a bitter joke," have come from union representatives.

Löw would like to take the site to other countries. 

Sweden is one such country.  A Swedish LO (union) representative states that "This is a silley idea, and I don't think it will get very far in Sweden....Capitalism has inflicted worse injuries on us that this."

There, of course, is another side to the story.  The side of those who gain employment (even if it is temporary) from this service.  Monika Saewert, a bookkeeper by training, has completed seven job assignments through the site.  Saewert states, "Come on, if I take a job, I have an idea of what I need to earn. No one forces me to do it."  She also finds bookkeepers for small construction companies that need some accounting done, and the site has helped her serve these clients.

The free exchange of labor and wages...isn't it great?!!