Various Thoughts

There is no point is bashing away at old economics or old economists. They are what they are. And it isn’t as if there is a compelling alternative to orthodoxy, if there were we wouldn’t be in this never ending and unproductive cycle of throwing stones at the establishment.

I think we all ought take comfort in the fact that a few decades ago things were so much different. The generation that trashed economics was on the rise and on the outside once. There are great reputations to be made fixing and updating the entire enterprise. In a business where incentives are so lauded, I imagine the incentive of fame should bring a savior soon enough.

Meanwhile it was sobering to read:

“The modern industrial system is no longer essentially a market system. It is planned in part by large firms and in part by the modern state. It must be planned, because modern technology and organization can flourish only in a stable environment, a condition the market cannot satisfy.” – J.K. Galbraith, “The New Industrial State”

Looking back at the state-of-the-art analysis concerning business organization in the first post-war decades we find a picture so discordant with modern business theory that it is hard to connect the two. There was a distinct feeling back then that the complexity of a modern economy would overwhelm the ability of the simple structures of a market and that long and complicated production processes therefore needed to be set within a controlled environment. That environment being a bureaucratic and centrally planned “meso-economy” called a business firm.

These vast sprawling technocracies were filled with managers rather than entrepreneurs. Individual skills and qualities were subservient to the overall cooperative enterprise. Galbraith says elsewhere:

“By taking decisions away from individuals and locating them deeply within the technostructure, technology and planning remove them from the influence of outsiders.”

Central planning looms large in Galbraith’s analysis. As it does in other writers of the time. The modern illusion that large corporations are somehow nimble market-driven organizations appears nowhere. There was an acceptance of the reality that the vast array of economic transactions enclosed within the boundaries of modern firms were organized not along decentralized market principles, but were subject to a highly controlled and centrally planned management process. The skill required to manage one of these behemoths was more akin to that required in the Politburo of the Soviet Union than it was to anything taught in free market economics classes.

This is, of course, why contemporary economic theory so completely bungles industrial organization.

Our major corporations are still centrally planned. They have to be. Galbraith was onto something. Production that extends through time – as does most – is consequently exposed to uncertainty. The likelihood of error, failure, misjudgment, or other complicating factor grows with the more time required. So for the process to take place at all such sources of potential breakdown need to be eliminated or minimized. The best way to do this is to establish, in advance, the entire process, and then to enforce the sequence of steps carefully and repetitively. This establishes reliability in the finished product. It eliminates the vagaries of the market calibration by ignoring the market altogether. It ensures that the required resources are available when needed in the appropriate spot in the production sequence. It smooths out the vagaries that market volatility always imply. It would be impossible, as a practical matter, to produce complex products by reference to the market at every step in production.

We can draw a simple conclusion from observing this reality: centrally planned and controlled allocation of resources dominates de-centrally planned and market allocation of resources in any solution that extends over time and requires multiple steps. In other words practically all business. In other words much of our economy.

That is if we theorize the economy as a set of transactions rather than as a melange of agents doing “final” transactions. Once we include into our set of transactions all those that are interim in a production process, rather than focusing only on the final product, not only do we vastly expand the number of total transactions in the economy, but we alter entirely our perspective on their facilitation. Central planning becomes crucial. Even a cursory empirical look confirms this.

By focusing on final transactions exclusively and thus consigning production to a “black box” orthodox economics has avoided dealing with the coexistence in a modern economy of diverse allocative methods. Transactions are both centrally and de-centrally expedited. And they are both cooperatively and competitively mediated. With each playing a significant role at different stages of a product lifecycle.

The recent erroneous obsession with the supposed superiority of de-central allocation has deprived economics of an ability to connect itself with the reality of business and thus with a major component of the economic landscape that the discipline purports to describe. It has led to a disconnect that hinders understanding. For instance, large corporations set prices they are not price takers, and their prices are not set by applying marginal analysis the way economics is forced to imagine. Orthodoxy has to retrofit marginal analysis into a firm’s decision making because to do otherwise would imply having more than one allocative model. This means, in turn, making absurd assumptions about a firm’s cognitive capacity and its data collection ability. It is a classic instance of having only one solution for all problems no matter what.

Unfortunately, in recent decades orthodox economics has invaded business theory and upended the more pragmatic views of people like Galbraith. Nowhere is this more evident than in financial theory and in particular in the rise of modern attitudes towards shareholder value. The discordance between such theories and the reality of central planned business could not be more acute. Business schools fill students heads with the pseudo science of modern microeconomics, and those students promptly go into a world dominated by central planning. Not only this but they spend their work lives creating market failures and other devices to allow for exactly the kind of profits that microeconomics tells us are not possible.

The cumulative damage is there for us all to see. Our businesses may be better off, but our economy is not.

There is a paradox in shareholder value. The more businesses pursue it, the worse the economy becomes, causing a diminution in shareholder value, which causes another turn of the screw. Each round of pursuit of value has its own collateral damage – more wages are cut, more workers fired, and more technology deployed. Managers reward themselves unconstrained by the social damage they are inflicting. Inequality rises and eventually dampens demand sufficiently to make shareholder values return to their original position.

Supply, apparently, begets its own demise.

Or, perhaps greed does.