Market-Based Management®

Economics and Entrepreneurship

This is a guest post by Chris Cardiff. In Chris's words he, "struggles to teach and apply MBM as a member of the Charles G. Koch Charitable Foundation MBM team."

Approximately 17 jillion people have seen the Keynes vs. Hayek "Fear the Boom and Bust" rap video now (if you have not, prepare yourself for a video that even non-economists enjoy). The Wall Street Journal continues to spread the meme with a recent profile of Professor Peter Boetkke titled "Spreading Hayek, Spurning Keynes." The article credits Boetkke with reviving the Austrian economics tradition over the last decade. It goes on to discuss how Austrian ideas of government non-intervention in the economy are gaining even more traction now as the tidal wave of Keynesian spending not only failed to spur the economy but contributed to making it worse.

MBM is signifcantly influenced by general economic thinking and Austrian economics. Opportunity cost, marginal analysis, creative destruction and more are rooted in economic thought. But what about central planning? Austrians argue against it for the economy but don't we need it in the firm?

In the "Use of Knowledge in Society," Hayek was careful to differentiate between "central planning" by the government, which he thought was harmful, and decentralized planning by individuals and organizations which led to beneficial competition. “This is not a dispute about whether planning is to be done or not. It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals.” Translating this into the firm, if all the planning is done by one authority at the top of an organization it will inherit some of the same problems of trying to centrally plan an economy.

Both society and organizations face a similar problem: how do you establish an environment that maximizes the entrepreneurial efforts of individuals? The entrepreneur and a dynamic economic environment are at the heart of Austrian economics. As supervisors and individuals, what do you do in your teams to foster Principled Entrepreneurship?

Thanks to Chris for his contribution. If you'd like to submit a guest post for potential publication on this blog, please email drafts to Ann at ann.zerkle (at) cgkfoundation.org.

Hunches

How do you know when you should listen to a hunch?

I've been trying to work my way through Michael Polanyi's Personal Knowledge. It's a good read, but often makes my brain hurt! Anyway, Polanyi had a very interesting way of thinking about discovery and hunches. I've barely got my mind wrapped around some of his ideas, so consider this a preliminary lesson from Personal Knowledge and conversations about Personal Knowledge with my work colleagues.  

In short, I think we should investigate our hunches when we have personal knowledge about something.  I don't know anything about art, so if I view a work of art and have a hunch that something is fishy about it, it's probably not a good use of my resources to invest in my hunch. However, if you've read the book Blink, the introduction tells a story about a "Statue that Didn't Look Right." The art experts couldn't even articulate why they thought the statue wasn't an original. Those with deep knowledge about art had an instinct that something was wrong with it. In the end, the statue wasn't an original. 

With all that said, principled entrepreneurs don't blindly follow hunches even when they do have deep personal knowledge of the subject. I think personal knowledge increases the likelihood that a hunch is right, but we still have to use economic and critical thinking skills, be disciplined and make sure the risk is appropriate when investigating our hunches.

Entrepreneurship

Earlier I put out a poll about nature versus nurture when it comes to entrepreneurship, and I didn't put out my own answer. In general, I think we all have our natural inclinations that we can work to improve upon.  I will use the Guiding Principle of Principled Entrepreneurship™ to motivate my more detailed answer: 

Principled Entrepreneurship™ 
Demonstrate the sense of urgency, discipline, accountability, judgment, initiative, economic and critical thinking skills, and the risk-taking mentality necessary to generate the greatest contribution to the company and
society. 

***Warning: This is Ann's take and not representative of research or any official view. I'm putting out specifics in hopes of starting a conversation.***

So, off the cuff, here's my two second take on each attribute. 

Sense of Urgency: This can be cultivated. However, my personal experience has been that there has to be some baseline of nature that is close to the appropriate amount you need for your job. A sense of urgency is not panic, but it's also not a lack of urgency. 

Discipline: I think that discipline is mostly a learned skill, but some of us are more naturally inclined to it than others.  

Accountability: This is a tough one to think about. I keep getting wrapped up on if this is a internal accountability or an external accountability. Does anyone have any thoughts about accountability? 

Judgment: This might be a cop-out, but I put this 50% nurture and 50% nature. I've encountered people who just seem to have good judgement despite little experience. I've know people who've gained judgement over time, and others that despite great learning opportunities, never seem to develop judgement. 

Initiative: I think this follows a basic model of some baseline that we can improve upon.

Economic and critical thinking skills: I firmly believe that if someone is sufficiently intelligent, they can be taught these skills. I don't know exactly what "sufficiently" is, but people are economists every day and can work hard to consciously apply their thinking deliberately. 

Risk-taking mentality: We all have some natural level of risk we are willing to take. When it comes to risk-taking mentality at work, I think it's about attuning our risk-taking to what is appropriate for our team, workplace and job. In this sense, I do think this is a learned skill. Those of us who are naturally inclined to take more risks have to learn how to tone it down. Those of us that tend to be very risk adverse may have to learn to take more risks. 

As I wrote this, it was amazing how interrelated they are. Without discipline, how can one systematically apply their economic thinking? Without initiative, how can people take time to learn economic thinking skills? Can one have a sense of urgency without initiative? Moreover, I'm glad that I have co-workers to help me to be a principled entrepreneur! Let me know what you think in comments. 

A question about entrepreneurship

I often find myself wondering how much of entrepreneurship can be taught. Do some people just have "it" (whatever that means) while others do not? 

Please share your take on this in the poll below. Do you think entrepreneurship is more about nature or nurture?  I ask you to think beyond people who start businesses. Let's use Tony's definition: Entrepreneur: Someone who sees an unmet need, often before customers themselves see it. The entrepreneur discovers a way to profitably meet that need, and organizes the resources and people to deliver the resulting value to customers.

 So, what do you think: 

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.

Making Money the Old Fashioned Way

This would be hilarious were it not also tragic (HT: Coyoteblog). PickupPal is an internet site that allows would be carpoolers to meet online and coordinate travel plans. Drivers post when and where they are going, while passengers post where they want to go and how much they are willing to pay. Sounds like an ideal win-win situation—the folks save money, gas, and reduce congestion. However, not everyone was thrilled with PickupPal, and an Ontario bus company sued alleging that PickupPal operated as an unregulated transport company. The bus company won. The Ontario Highway Transportation Board fined PickupPal $11,000 Canadian dollars and ruled that ridesharing is only legal if it is between home an work, does not cross municipal boundaries, and is with the same driver each day (who can only be paid no more frequently than weekly).

While prosperity springs from multiple sources, at its core lies the amount of freedom that people have to exchange with one another. When this freedom is circumscribed by legal boundaries, then society is almost always worse off. Of course, while we as a society may wish to limit some exchanges (arms dealer and terrorist for example), restrictions like those placed up PickupPal are both silly and destructive. The bus company is better off, but the good people of Ontario now have a slightly lower standard of living. We may laugh at this example, but all over the world consumers have their choices by similar legal boundaries. Paradoxically, most of these laws are championed by “consumer advocates,” who advocate for consumers by limiting their choices. Needless to say, companies are more than happy embrace laws that protect them from additional competition. While the title of the article is “I’ll Never Let Canada Live This Down: Evil Carpool Startup Fined,” I cannot help but think that we will see PickupPal sued south of the border soon. Cities and states won’t stand for the loss of revenue or the lucrative practice of selling taxi cab monopolies. The excuse will be lame—probably something having to do with quality or the service will be blamed for the inevitable traffic fatalities or some sort of carpooling serial killer—but it will come; and we will all end up a little poorer.

Entrepreneurs and Disaster

Last week ago, I was struck by this Wall Street Journal article recommended by Jamie Peterson at INVISTA. The article concerns the sprouting of entrepreneurship in the aftermath of the recent devastating Sichuan Earthquake in China (unfortunately, reading the full article requires a Wall Street Journal subscription).

Interestingly, entrepreneurs are often the first to swing into action following a natural disaster (the first trainloads of lumber for rebuilding arrived the very day after the Great Chicago Fire of 1871). However, sometimes the imposition of price controls and “anti-gouging” statutes quash these efforts by removing the incentives needed to induce the effort. Although price spikes following natural disasters are common, price controls only force the squandering of scarce resources within the affected area, while choking off flows of supplies from outside. If allowed to operate, the price mechanism usually forces prices back down fairly quickly and sometimes even gluts the market.

I wrote about this phenomenon a couple years back in the ABA's Journal of Natural Resources & Environment, and economist Russ Roberts has dedicated his latest work of economics-influenced drama to the topic. However, the overwhelming need for flexible markets following natural disasters is not the purpose of this post: it is that, despite decades of being told to despise entrepreneurship and other “bourgeois” values, in the wake of disaster, many Chinese discovered their inner entrepreneur. A lot of folks make silly comments like “markets are not compatible with _____ culture” (personally, I blame this false mental model on Max Weber’s attributation of capitalism to some vague notion of “Protestant work ethic”).

The Sichuan Earthquake reminds us that people are naturally entrepreneurial. Entrepreneurship is in our blood and no amount of cultural conditioning or even brute force can completely stamp it out (considerer the phenomenon of black markets). Of course, some countries exhibit greater levels of entrepreneurship than others, but this is because some countries do a better job of facilitating the human desire to benefit one’s self through the service of others. True, one’s inner entrepreneur maybe repressed by governmental, cultural, or overly bureaucratic corporate environments, but it is always there; and a little shove from within makes a much better catalyst than an earthquake.

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.

Dutch Invent Robotic Gas Attendant: Will probably be banned in New Jersey

As silly as it sounds, ordinary folks are not allowed to pump their own gas in some parts of this country. I tried to do so once on the New Jersey Turnpike and received quite a talking to. Having others pump my gas has always made me feel uncomfortable, but thanks to some clever Dutchmen, I can remain in the comfort of my vehicle and enjoy full service without the guilt.

The new robotic gas attendants cost about $111,000 (HT: Drudgereport), so it will be interesting to see if they end up being economically viable. However, profit margins in retailing gasoline are only a few pennies a gallon (gas station owners make most of their money selling all of the other things people buy while they fill up), but perhaps the lure of robotic attention will allow gas retailers to add a few extra pennies in margin. Considering the winter we are having, I would have been more than willing to drive out of my way and pay more for robotic service. Once again, the combination of entrepreneurship and technology has conspired to make human life much better.

Is There a Case for NOT Teaching Our Children Economics?

I’ll preface this post with a caveat: I believe that for the most part that there is not a lot of formal economic education in the United States, and one can often only find it in the higher levels of education. That being said, I do believe that Americans get a hearty education in economics throughout their lives—mainly through their own interaction with the world’s largest and mostly free-market economy. Most Americans may not read Smith, Von Mises, Hayek, Freidman, ect., but their day to day learning allows them to “get” economics anyway. I would argue that most Americans realize that if they produce things that others value, then they will be rewarded, and that those who succeed at this should be allowed to keep most of the value they create and entrusted with more economic resources. Furthermore, Americans tend to get irked when folks steal from one another (illegally and legally), and nothing upsets them more than hearing of someone who has lost their home to the unscrupulous misuse of eminent domain or otherwise failed to earn their windfalls without hard work and/or risk. Thus, I believe that Americans grow up and prosper with a hearty—and largely self constructed—respect for property rights, the profit motive, risk, incentives, and the rule of law.

Despite my own hearty respect for this culture economic self-teaching, I have always been a big fan of teaching economics to middle and high school students—7th grade seems a good place to start. However, comments on this article on the “economics education” received in some countries have been floating around the economics blogosphere, and I am starting to think that perhaps it might be better to forego any attempts at economic education and just maintain the current system of letting folks learn it in the marketplace. The reason being, that while some countries do provide economic education for their youngins, what passes for “economics” is not just wrong but rather disturbing.

P.S. The link from the Economist's article does (at present) not link to the full article in Foreign Affairs, but should hopefully soon be restored.