Robert Herbold’s Shared Delusions

July 19, 2011

In a recent essay in the Wall Street Journal Robert Herbold, former chief operating officer at Microsoft, uses a recent trip to China to offer his opinion on what ails the United States. First, Herbold gushes about the success of China’s “five-year plans:”

In every meeting we attended, with four different customers of our company as well as representatives from four different arms of the Chinese government, our hosts began their presentation with a brief discussion of China’s new five-year-plan. This is the 12th five-year plan and it was announced in March 2011.

Of course, central planning is not compatible with the decentralized decision-making that goes with free markets. Yet, Herbold writes, “The autocratic Chinese leadership gets things done fast (currently the autocrats seem to be highly effective).”

And so, how to dig the U.S. out of its hole? Among other things, you guessed it, Herbold advises “start approving some winning plans.”

Herbold seems to be completely ignorant as to how “winning plans” really evolve. Are they really accomplished through central-planning and autocratic leadership?  Would I be rude to wonder if Herbold is a student of economics or history? Could he be unaware of what centralized “winning plans” have wrought in North Korea?

If Herbold is as deluded as he appears, many Chinese are not. Just a few days before Herbold’s essay appeared, Liu Junning wrote in the Wall Street Journal, “Westerners who think that authoritarian rule is China’s natural state misunderstand its culture.” Junning adds that China’s prosperity is not due to a mixture of central planning and markets.  Instead, “the most significant transformations from the perspective of boosting prosperity,” according to Junning, “have involved loosening of control over the people, not some alchemy of power and Marxism.”

Why is the Wall Street Journal allocating space for Herbold to share his delusions? Presumably because, as Junning points out, many others share the belief that Chinese success is due to central planning. Further, Herbold has credibility because presumably he had a successful tenure at Microsoft. But did he really?

In his 2002 Harvard Business Review article “Inside Microsoft: Balancing Creativity and Discipline,” Herbold describes the cultural differences between Microsoft and his former employer Proctor and Gamble:

It was exhilarating to experience this degree of informality and delegation of responsibility to individuals throughout the organization, which clearly fostered both creativity and speedy decision making. But the experience was also disorienting. At Procter & Gamble, where there was a procedure for almost everything, board meetings were tightly scripted affairs.

Herbold then explains his job which he held from 1994-2001:

My job was to bring some discipline to Microsoft without undermining the very characteristics that had made it successful. I hoped to do this by creating central systems that would standardize certain business practices and give managers instant access to standardized data on each business and geographical unit.

Herbold goes on to claim that his central-planning reforms were responsible for rising profit margins at Microsoft during his tenure. Then he “charitably” adds, “I don’t take sole credit for this.”  Nowhere in the essay is there any hint that Microsoft’s success had anything to do with an unprecedented mania for technology stocks, strongly rising demand for personal computers, and most importantly, Microsoft’s game-changing smash hit, Windows 95, which Herbold had absolutely nothing to do with.

Yes, like most of us, Herbold has legendary status in his own mind. But Herbold has not matured to the point that he can recognize that his legendary status is delusional. In other words, Herbold is as deluded about Microsoft as he is about China and, importantly, he is deluded about the way to cure the American malaise.

No doubt in the coming years the snake oil that Herbold peddles will be increasingly welcomed by a segment of the American population—those who almost every day ask, “Why don’t they do something?”

Every day, many entrepreneurs are doing more than “something;” they are inventing the future Microsofts of the world. They don’t need Herbold to tell them the “winning plan.” They need those who are ignorant and delusional to stay out of their way. As Herbold’s delusions are increasingly shared by others in the United States, future Microsofts will find their homes in other parts of the world.

The Market Takes Bewkes and Jobs to School

April 21, 2011

It was 2006 when I last set foot in a Blockbuster store. In 2008 my family cancelled cable television. A high-speed Internet connection and a $9.99 monthly subscription to Netflix satisfy my family’s video entertainment needs.

The incumbents claim they are not worried about families such as mine. Last December, Jeffrey Bewkes, the CEO of Time Warner, said dismissively of Netflix, “It’s a little bit like, is the Albanian army going to take over the world? I don’t think so.”

And now it’s about to get even worse for the incumbent media and cable companies. Netflix just purchased 26 episodes of a new series “House of Cards” starring Kevin Spacey. Maybe Bewkes should talk to the former management at Blockbuster who watched their seemingly invincible position vanish as they too sneered at Netflix.

But what could Bewkes possibly understand about competition and innovation? Time Warner, like all cable companies, built their market position in a way far different from the way Netflix has built their position. (Note: In 2009 Time Warner Cable became a separate company from Time Warner.)  Netflix grew by building a culture of innovation that consistently delivers entertainment to consumers inexpensively and creatively.  Time Warner, like all cable companies, built their market position by government grants of monopoly power; and that unearned market power allowed them to be oblivious to consumer needs. Apparently Bewkes literally cannot conceive of his privileges eroding; his dismissive attitude is not surprising.

“Of the many deals the [media] industry has made with Netflix,” Bewkes said, “this has been an era of experimentation, and I think it’s coming to a close.” Bewkes is projecting rather than correctly reading the market: Time Warner doesn’t innovate much, and they do little experimentation. Think of the USPS, your motor vehicle administration, or a Soviet made car and you have an idea of the type of products monopolies produce. Unfortunately for Time Warner, Bewkes doesn’t get to dictate how much experimentation other companies in the media industry engage in. If one company doesn’t want to sell to Netflix, surely other companies will.

There are two ways to earn profits—by turning to government for grants of monopoly power, subsidies, and protection or by satisfying the most urgent needs of the consuming public. Over the years, a corporate culture develops that supports the pursuit of either unearned privileges awarded by government or just rewards from consumers for a job well done.

Instead of focusing on competing, Bewkes depends on government to protect his eroding position. If with government’s help the cable industry is able to protect its position, Bewkes can charge them premium prices for the media he sells. Bewkes is not alone in relying on government. Will it surprise you to think of Steve Jobs in that same light as Bewkes? At first appearance, Jeffrey Bewkes and Steve Jobs would seem to have little in common. One man runs a company partially built by a government grant of monopoly and the other has run a firm known for its cutting-edge innovations. The connection is found in the way Jobs is responding to the eroding market position of his iPhone.

Over 2 1/2 years ago I wrote a blog post “Android Changes Everything.” Contrary to conventional wisdom, I predicted: “Android will beat Apple and any other closed operating system.” I wrote:

There are smart developers at Apple who have apparently made a pretty good product in the iPhone. But a handful of smart developers can’t compete against many smart developers, and pretty good can’t compete against great. Planned development can’t compete against the decentralized forces of spontaneous development. Self-organizing systems are more powerful than a thousand Steve Jobs; and they rarely behave as experts… predict.

And now less than three years later Wired’s current May 2011 issue cover blurbs “Why Android Beat the iPhone.”  The author Fred Vogelstein writes:

The competition is only going to grow more heated. Android doesn’t just use different carriers, different manufacturers, and different software than the iPhone; it represents a different vision for the entire mobile industry. Apple exerts complete control over the iPhone. It builds the hardware. It designs the operating system. It runs the marketing campaigns. And it curates and polices its App Store, refusing programs it deems potentially offensive or a threat to its own business….

Android, by contrast, prides itself on its lack of control. It gives away its operating system for free to anyone who wants it—though manufacturers must submit their phones for testing if they want to access its app market or run optimized versions of Google apps. Android doesn’t review apps before they’re added to its marketplace, pulling them only if users complain, and manufacturers can and do modify the look and feel of the OS on their phones.

In short, Android will continue to morph faster than the iPhone, and Android’s market share will continue to grow. Apple, of course, made the same mistake at the dawn of the PC era by refusing to license their operating system. Steve Jobs apparently is unrepentant about his earlier decision. Instead of following Android and opening up their operating system, Apple “is waging an all-out patent war on anything Android.” So, like Bewkes, instead of focusing on competing, Jobs is looking to the government to protect his eroding position. That strategy is likely to work as well for Apple as Time Warner’s reliance on government has worked for them.

Market forces are impersonal; they have no sense of entitlement, and they don’t care that Steve Jobs is a cultural icon. Market forces reward companies that devote their full energies to serving the consumer. Bewkes and Jobs may believe otherwise, but they will continue to be schooled by the power of the market.

The Diminishers

September 16, 2010

Before he resigned in the summer of 2009, Steven Rattner was Obama’s Car Czar (officially the leader of the Presidential Task Force on the Auto Industry) nominally in charge of the bailout of the automobile industry. Recently the Wall Street Journal published excerpts from Rattner’s new book Overhaul: An Insider’s Account of the Obama Administration’s Emergency Rescue of the Auto Industry.

In the excerpt, Rattner conveys a sense of gravitas as he relates stories of the endless meetings and the hard work that he and other administration officials put in on the automobile bailout.  Treasury Secretary Geithner and Larry Summers, Director of the White House National Economic Council, are large figures in his narrative. Rattner is writing to an audience that shares his view of the world: Washington insiders are powerful people who are smarter than everyone else, who work harder than everybody else, and by dint of their superiority, should plan the economy for us. For anybody else who doesn’t share that worldview, the Wall Street Journal excerpt serves as a reminder of how far America has gotten off-track.

Consider Rattner’s description of Summers. Rattner writes:

I was well aware of his reputation for bumptiousness . But working for him turned out to be stimulating, enjoyable and harmonious. Like me—with more justification in his case—Larry didn’t suffer fools. Titles and résumés meant little to him; he listened to what was said and decided whether the speaker seemed worthy of attention…

When he returned from a meeting in the West Wing, fuming about stupid ideas that had been put forward, Marne could calm him. Larry visibly worked hard to control himself. At one meeting I attended, a junior colleague in the bleachers (the couch on the other side of his office) offered an unsolicited comment. “That’s one of the silliest…” Larry began, but then caught himself and said, half under his breath, “That’s the old Larry. The new Larry says, ‘Have you thought about it this way?’ “

Once Diana Farrell, one of Larry’s deputies, began to offer an opinion, but before she passed the midpoint of expressing her thought, Larry interrupted to say (not harshly), “I’ve already considered that idea and rejected it…”

Larry was an economist, however, not a businessman. Occasionally I thought he didn’t have the best perspective on financial markets or business. I wasn’t sure that he wanted to be told bluntly that he was wrong, especially by a subordinate…

And Rattner’s conclusion about Summers? He writes: “Our discussions were the high point of my Washington experience; I would leave convinced that there could be no happier future circumstance than the chance to work for him again.”

Rattner seems to idolize Summers. We can imagine that Rattner was led to believe by Summers that he, Rattner, was one of the special bright ones. Bumptiousness means crudely assertive; and by many accounts, Rattner’s description of Summers is dead on. Summers thinks he is smarter than everyone else.

In their excellent new book Multipliers: How the Best Leaders Make Everyone Smarter Liz Wiseman and Greg McKeown observe how those leaders who think they are smarter than everyone else can actually diminish the intelligence of others. They call such people diminishers. They write:

Some leaders seem to drain intelligence and capability out of the people around them. Their focus on their own intelligence and their resolve to be the smartest person in the room had a diminishing effect on everyone else. For them to look smart, other people had end up looking down. We’ve all worked with these black holes. They create a vortex that sucks energy out of everyone and everything around them. When they walk into a room, the shared IQ drops and the length of the meeting doubles. In countless settings, these leaders were idea killers and energy destroyers…

The Diminisher’s view of intelligence is based on your elitism and scarcity. Diminishes appear to believe that really intelligent people are a rare breed and I am one of the few really smart people. They then conclude, other people will never figure out things without me.

Most of us understand well the dynamics of the diminisher. We have been both victim and victimizer as we have worked for diminishers and have played the part of a diminisher. Perhaps we are more of a diminisher in private with our spouse and children. Perhaps in public we have trained ourselves to appear more receptive to others, while not really listening to what someone else is saying. If so, no matter how polished our behavior is, we are fooling no one.

For many of us, age and the demands of our career begin to bring wisdom. The follies of our youthful arrogance fade as life and reflection teaches us that it is impossible for any of us to have but a fraction of the available knowledge that could be brought to bear on a problem. We learn that if not for the efforts of others, we would live in abject poverty.

But reflection often doesn’t come easy to those in academia or government. Privileges and protections in both fields of endeavor encourage an individual to believe that he or she is special. The diminisher can become a permanent role for such an individual.

To be sure, diminishers are prevalent in corporations too. But, they tend to be selected against in corporations. Why? A diminisher leaves important organizational intelligence on the table and, in so doing, diminishes the viability and profitability of his or her organization. There is no such profitability constraint in government or academia where intellectual arrogance is all too prevalent.

When we play the part of a diminisher, we assume that for anything to get done, everything has to be funneled through us. We assume control and micromanage everything.

Diminishers believe in a zero-sum game. Their status is enhanced as others look bad. In the world of the diminisher, there is no room for the genius inherent in each individual to shine.

Diminishers may think they are special, they may think they are the life of the party, but most would disagree. Working for Summers may have been a happy circumstance for Rattner, but most would feel otherwise. For most of us, having our ideas shot down through instant analysis by an arrogant person is not fun. Most Americans don’t believe that Summers’ self-proclaimed wisdom means he has any special insight into the car industry. The average citizen does not believe that Summers should be able to confiscate their earnings from their productive endeavors and redirect their earnings in a way that Summers sees fit.

Diminishers and the diminisher that lurks in each of us are inimical to a free society. Diminishers don’t trust others to make decisions, believing they should plan for the rest of us.  As we each decide to stop being a diminisher, we automatically withdraw our permission for all the Larry Summers of the world to intellectually bully and exercise power over us.

On the Wrong Side of History

June 28, 2010

Fear is the kryptonite of liberty. A fearful person, thinking he or she has no alternative, reaches out for any solution that promises to control what they find threatening. Often, my students initially embrace government-based solutions to problems before they understand how the market process works. For instance, they may support increased healthcare regulation fearing that market processes are incapable of solving the healthcare problem. Further, like most people, students support a clean environment. Initially they are likely to believe that more government regulation is the only way to get there. Yet, at the same time, students seem to me to be naturally inclined toward liberty. When freedom-based solutions are presented, they are quite receptive.

With that in mind, listening to some libertarians comment on the Gulf of Mexico BP disaster is painful to me. They sound more like Rush Limbaugh than  principle-based advocates of liberty. My students, at least, would soundly reject their inflammatory rhetoric.

Lew Rockwell is the chairman of the Ludwig von Mises Institute. His web site, one of the most visited libertarian websites in the world, is well worth visiting daily. Recently, Lew wrote:

A wildlife biologist visiting my town is “saving birds” in the oil spill, as he did after the Exxon Valdez leak. When the media is around, he and his colleagues are seen carefully cleaning birds, though this is virtually always futile. When the media are absent, they simply twist the poor animals necks, since they are dying. The whole business costs about $5,000 per bird.

I’m not sure how Lew would know this. Surely, Lew has not spending his days observing this wildlife biologist. Lew’s post was informal, but I can’t help but wonder on what basis he calculated the $5000 per bird? Has Lew learned that the government is paying the biologist $5000 a bird? If not, why does Rockwell need to disparage the efforts of the biologist?

Sadly, Lew’s biting remarks might have been influenced by the great libertarian teacher Murray Rothbard.  In July 1989, Rothbard wrote of the Exxon Valdez oil spill in Alaska. Rothbard’s essay was recently republished at Rockwell’s site. In the essay, Rothbard observed,

The problem, of course, is that environmentalists don’t give a tinker’s dam about paying for external costs. They have their own agenda, scarcely hidden any more. Look at all their bellyaching about the poor birds, and the sea otters, and the salmon, etc. Look at their whining, too, about the beauty of the pristine blue water now befouled with black or brown oil slicks.

(Well, hell, maybe a coating of black on blue waters provides an interesting new esthetic experience; after all, once you’ve seen one chunk of blue water, you’ve seen them all.) The environmentalists are in pursuit of their own perverse and anti-human value-scale, in which every creature, animal, fish, or bird, heck even blue water, ranks higher than the wants and needs of human beings. The environmentalists welcome this trumped up “crisis,” because they want to shut down the Alaska pipeline, which supplies a large chunk of domestic American oil; they want to reverse the Industrial Revolution, and get back to pristine “nature,” with its chronic starvation, rampant disease, and short, ugly, and brutish life span.

Now, protecting the environment is hardly “perverse and anti-human,” and lumping all environmentalists into one category is a straw man tactic. Ironically, notice the win-lose mentality in Murrays’s critique of what he claims is the win-lose belief of environmentalists: “Every creature, animal, fish, or bird, heck even blue water, ranks higher than the wants and needs of human beings.” Even if environmentalists did take Murray’s straw man position, Murray’s implied position—that the needs of human beings trump everything else and are separable from the needs of the environment—is equally absurd. Can it really be that the interests of human beings are separate from the interests of the environment?

Suppose that with more offshore oil drilling and more tolerance for pollution the price of oil could be reduced to $.50 a gallon. Should we sign up for the deal? Would human beings really win while the environment lost, or would both human beings and the environment ultimately lose?  Murray is implying that a utilitarian deal, where energy prices are reduced, is a free-market position. Those who have read Murray’s writings know that he took a profound position against utilitarianism. Yet, somehow, Murray seems to have had a blind spot here.

Albert Einstein wrote:

A human being is part of a whole, called by us the Universe, a part limited in time and space. He experiences himself, his thoughts and feelings, as something separated from the rest a kind of optical delusion of his consciousness. This delusion is a kind of prison for us, restricting us to our personal desires and to affection for a few persons nearest us. Our task must be to free ourselves from this prison by widening our circles of compassion to embrace all living creatures and the whole of nature in its beauty.

Einstein was neither an economist nor a libertarian, but do his words offer us guidance? Einstein offered us an elegant pointer to what both quantum physicists and the perennial spiritual wisdom teach—namely, there is order (invisible to our senses) which connects everything. This order, which quantum physicist David Bohm called the implicate order is as important to our understanding of freedom as is Hayek’s spontaneous order.

A study of history readily demonstrates that over time human beings have been following Einstein’s advice. The decision in Western civilization to move away from the tribe and, instead, to organize society around the rule of law is a reflection of a decision in our minds to widen our circle of concern and compassion. In tribal societies, those outside your own tribe are considered others unworthy of your respect. In contrast, societies organized by the rule of law usually become more inclusive as fewer individuals are seen as outsiders or others. Indeed, the free market—by fostering trade and specialization—forces an awareness of our inherent interconnectedness and, indeed, an understanding that there are in reality no separate interests. Can a business succeed long-term if it cheats its customers? The answer is “yes” only if the government protects it from competition.

At Rockwell’s site, Jim Davies recently wrote:

I was very disappointed to hear how the D.C. Mafia had subjected BP to what the possibly vertebrate Joe Barton (R-TX) called a “shakedown” for $20B to compensate those hurt by its oil spill, but had also made the company agree not to cap that sum (meaning the bill may be higher yet) and to let a government nominee administer the payments (meaning it is almost sure to be higher yet). Coupled with yet more apologies outside the White House, and inside Congress to the monotonously loathsome Henry Waxman (D-CA), this looked like an abject capitulation; for it has not yet been established that BP is even to blame for the spill, and the law – which government wrote – limits its liability anyway to $75 million. That was the basis on which BP hunted for oil, and on which its owners invested their money. Now that it has voluntarily exceeded that limit by a factor of at least 267, who can ever trust its word again?

Looking past the name-calling, there is much that a libertarian should find repellant in the comments of Davies. As I have observed in this blog, the law wrongfully limits liability to $75 million, but the cap is set aside in cases of “gross negligence or willful misconduct.” I would not want to be a BP lawyer arguing that neither negligence or misconduct occurred in this case. But more importantly, to defend the limit on liability is to defend special privilege. Suppose the government passed a law that automobile drivers from Auburn, Alabama, would be subject to only $75 of damages for any accident that they caused. Suppose an Auburn driver caused a catastrophic  accident. Would a libertarian conclude that the government is unfairly shaking-down the Auburn driver if it demanded more than $75 from the driver? In the Deepwater Horizon disaster, the government’s liability limit allowed BP to behave recklessly. It is puzzling why a libertarian would not be stressing the heart of the matter.

According to a May 2010 NBC/Wall Street Journal poll, “more than 80% see problems with America’s two-party system—with 31% believing it’s seriously broken and that America needs a third party.” As I have written many times in this blog, the growing public dissatisfaction with politicians is not necessarily salutary for advocates of liberty. We are likely see a splintering of the political process; unprincipled populists of all ideologies are likely to gain ground as segments of the public embrace ad-hoc fear-based solutions. Further reduction in our liberty is the most likely result.

Decades from now, when liberty is again on the ascendancy, we may be emerging from years of relative economic deprivation and from the hardships caused by war. We will have had to suffer through the pain of seeing that win-lose solutions posed by unprincipled populists do not work. Human beings will be ready to understand that all living things are inherently connected. We will know that win-lose solutions to problems are antithetical to the cause of liberty.

As advocates of free markets—where win-win transactions are the normal occurrence—libertarians should now be advocates of win-win solutions, not win-lose solutions. It would be tragic if libertarians—who have been on the right side of history on so many issues—were to be on the wrong side of history now.

The Market Reveals

February 18, 2010

As a consumer who has not set foot in a mall in over three years, I didn’t exactly have a visceral reaction to Wednesday’s Wall Street Journal headline that the nation’s largest operator of malls, Simon Properties Group, is bidding for its bankrupt rival, General Growth Properties. Clothes shopping for my family had long ago shifted to the Internet and out-of-the-mall discounters such as Kohl’s.

For a family on a limited budget, it is good to have a Kohl’s nearby. About twice a year Kohl’s send us their coveted “take an extra 30% off” coupon. Usually these coupons come between fashion seasons. We shop their racks for 60% to 80% off items and combined with our extra 30% coupon (and no sales tax in New Hampshire) we walk out with bags of clothing for a very modest price.

Yet, it was not too long ago that it would have been almost impossible to shop at a discount clothier occupying the niche between Wal-Mart and full-service department stores. For many, during the 70s, 80s, and 90s, a day at the mall was the ultimate shopping experience. Before that, going “downtown” to a major department store was the norm. From 1992, when Kohl’s first had a public stock offering, until today, they have gone from 80 stores to over 1000.

While Kohl’s has prospered, many malls and their traditional department store anchors are in a state of their irreversible decline. Allow me to ask a few questions:

  • Did the president, Congress, or a federal agency direct the consumer transition from shopping at malls to shopping at stand-alone stores like Kohl’s? Did they tell Kohl’s where they must open, what products they should stock, and what prices they should charge? Did any government agency tell Kohl’s to whom to extend credit and then guarantee to backup the credit Kohl’s extended?
  • As the fortunes of traditional department stores declined, did the federal government care about guaranteeing the jobs (and the bonuses) of department store executives?
  • Are there unclothed masses of Americans because department stores are closing their doors?
  • Should there be government subsidies for department stores to prevent further closings? Should we be forced to abandon Kohl’s and Internet shopping in order to shop at malls? Should we revitalize the inner-cities by subsidizing the re-opening of downtown department stores?
  • Does anyone miss shopping at a mall?

Of course, my questions are ridiculous. No one directed anything, and subsidies would direct resources into areas that are not in keeping with the preferences of consumers. The growth of Kohl’s and the decline of department stores happened as a result of consumer preferences and the rise of the Internet. This is part of a natural cycle of growth and decline from which no industry is exempt.

In the not-too-distant future, the growth of Kohl’s will begin to peak, as new entrepreneurs find new ways to better satisfy consumer needs. The free market is demanding; it requires you to do your best every day; and when you no longer choose to do so, the result is inevitable. So inevitable that many firms and individuals expend their human energies not in serving the public, but in trying to exempt themselves from the natural cycle of growth and decline.

Do you long for equilibrium—a world with less change? If so, who would you place in charge of deciding the pace of change? How much of your standard of living would you be willing to sacrifice? In other words, would you be willing to pay a premium price for clothing so that malls thrive?

This may seem to be a far-fetched example, but it is not. It gets to the crux of the matter of how markets work. Again, consumer preferences are revealed through the marketplace every day; and capital and labor are continually reallocated by entrepreneurs who are sensitive to these preferences. To the extent we thwart these preferences, we destroy the engines of our prosperity, and we harm real people.

This past weekend, as we checked out at Kohl’s with our shopping basket filled with $4 turtlenecks and other bargains, my wife and I began a conversation with the friendly, energetic cashier. The lines had been steady all day, but she was not complaining—she was glad that the store was thriving. She told us she had a twenty-three year old son at home who neither walked nor talked. Now, I’m under no illusions that being a cashier at Kohl’s is a well-paid occupation; but this cashier was clearly glad for the work. Perhaps the store provided her needed flexibility in scheduling; perhaps it was simply an oasis from the demands of her daily life.

Would my family be better off if a government agency, rather than the market, was in charge of the clothing industry? Would the cashier be better off? Apparently, millions of Americans would say “yes”—not to this specific example—but to the generic idea that it is too risky to allow the market to reveal the changes that are necessary for an economy to thrive. This false idea has impoverished nations throughout history.

Bonuses and Free Markets

January 28, 2010

Writing in the Wall Street Journal, columnist James Stewart observed this about Wall Street bonuses:

Despite the populist stereotypes, I recognize that many people on Wall Street deserve to be highly paid. They are talented, smart, highly educated, hard-working and generate enormous revenues and profits. They work in an intensely competitive environment with little or no job security. This being a free country, they are entitled to spend their money any way they want.

Stewart’s observations echo those of others, but that doesn’t make his argument correct. First, salaries in a free-market are not a function of how hard we work or how smart we are. I am highly-educated; people often tell me I’m a smart guy. It is not uncommon for me to work up to 16 hours a day, seven days a week. Many of my readers can probably say they are just as hard-working or as smart. Yet, our earnings in a year won’t equal a fraction of the bonus that financial industry employee are being paid.

To the characteristic of being “hard-working,” Stewart rightfully adds the idea that these well-compensated workers generate “enormous revenues and profits.” Profits are indeed a measure of value contributed to society—but only if they are earned through non-coercive means. For example, I generate far more tuition revenue than my salary. Since students voluntarily sign-up for and pay for my classes, we can conclude that I contribute more to society than I am paid.

This is not so for many of the Wall Street and banking industry workers receiving bonuses. Many of them have generated “enormous revenues and profits” due to Fed policies. For instance, near- zero interest rates have created enormous opportunities for arbitrage by trading unstable currencies. At the same time, these same near-zero interest rates have significantly harmed those who save; and thus, they harm the economy. The profits on Wall Street are being paid by the rest of us.

More than this, many financial industry workers, if not bailed out by the taxpayer, would’ve lost their jobs during the subprime mortgage crisis. They destroyed value via the disastrous risks they took, and the reaction of the market would have been to reallocate both capital and labor to those who would better serve the most urgent needs of the public. This necessary process was short-circuited by bailouts. On these grounds and more, we can conclude that, in most cases, these bonuses are not deserved as Stewart argues. Instead, these bonuses are a reflection of disastrous policies that are helping to destroy the economy.

Stewart advocates some vague reforms, such as no guaranteed bonuses:

At the same time, reform is in everyone’s interest. For bonus recipients themselves, it will quell calls for even worse sanctions. For shareholders, it should boost profits and share prices, which will also benefit all those employees being paid in stock. For the public at large it should restore some sense that people being paid large bonuses might actually deserve them.

Stewart’s idea air of reform is absurd. For those who have earned their bonuses as a result of disastrous policies, any income they earn is too much and is not “deserved.” It is like allowing a street mugger to keep a fraction of what he steals from you on the grounds that he has worked hard. To borrow a line from Mish Shedlock: “Like rats on a ship made of cheese, [Wall Street does] not understand that consuming the ship will cause them to drown.

Stewart doesn’t get it. There is no need to meddle in compensation decisions on Wall Street. Eliminate the bailouts and the problem solves itself.

Lessons from Iran

June 22, 2009

In the 21st Century, billions still suffer under the rule of corrupt, murderous despots. What many do not understand is that human beings suffer because they consent to do so. The “they” I speak of is the collective will of the nation and not of specific individuals.

Consider Iran. In 1989, Ayatollah Ali Khamenei became the Supreme Leader of Iran with the divine right to rule; an Ayatollah is not elected. Last week he pronounced his divine sanction on the reelection of Iranian President Mahmoud Ahmadinejad and ruled that all further disputes over the presidency were to end.

On the surface, it is easy to label the victims and the victimizers here; and on one level, we would be correct. Yet, however satisfying our story of good guys and bad guys is, it doesn’t point us toward change.

Human beings exist in relationship to one another. A moment’s reflection tells us that, at least until now, the powers of Khamenei have flown not from divine authority but from the will of the population. Yes, I concede, there is at least a minority of Iranian people who have had enough of this theocracy and of Basij, its vicious militia/vigilante enforcement arm. But if you doubt that Khamenei rules by popular support of Iranians, ask yourself this question: “How powerful would Khamenei be if he lived in the United States? If he was an American, could he establish a theocracy?”

You might answer, “Very powerful, if he had the power of a brutal militia behind him.”  But that begs the question of how the Iranian theocracy formed and why many Iranians take up arms in its defense. A full answer is beyond the scope of this blog post, but we can simply say that many Iranians share a common understanding that their society should be formed as a theocracy.

In Iranian society there is a great deal of suffering, not the least of which is that Iran’s full range of human potential is not being expressed. Why would anyone choose to be a victim of such a society? One reason is that victims escape responsibility for their own choices and their own failures by saying, “It is for the good of God,” or “Divine will has ordained this.”

We can wish the Iranians well as they bravely strive to create a new, collective understanding of how their society should be organized. At the same time—as our own house is not in order—we can learn from them important lessons.

Once a tyrannical despot is in place, he or she is not easily dislodged. That is why our founding fathers put strict limits on the coercive power of government. The spontaneous forces and institutions that build a free and vibrant civilization are not easily rebuilt once they are destroyed. As we continue to relinquish our own freedoms, getting our freedoms back will not be simple. It will not be a matter of simply saying that we made a mistake and we want to start over again.

There is all the difference between activities that are organized around government and activities organized around a free-market. If, for instance, you go out to eat and have a bad meal, you simply do not patronize that restaurant again. If you go to the Motor Vehicle Administration, stand in a long line and are treated rudely, you have no other viable option. Our lives run smoothly and we are free to develop and express our human potential to the extent that we are free to choose. Yet, collectively, we are rushing to turn over to the government more and more aspects of our daily lives—automobiles, health care, energy, etc. When the limit on what government can do is determined by a vote and not by a principle, freedom is surely lost.

Before we silently sneer at people who worship Ayatollahs, we might wonder what flawed human beings we Americans worship? Through what distorted lenses do we see? To whom do we turn over our own responsibilities so that at the end of the day we have someone to blame?

The Republicans and the Democrats—and those who worship them—play this Kabuki dance: Whoever is out of power gets to blame the other party for all the ills that befall the country. Daily, Republicans and Democrats and the pundits bang each other over the head with foam mallets; and the public reinforces its collective belief that it really does matter which party is in power.

But, how can it matter? Both parties—acting without principles—have been taking the county in the direction of larger budget deficits, more ruinous foreign adventures, and less domestic freedom for many decades. As we choose to be distracted by this Kabuki dance, we neither educate ourselves or our children on the principles that support prosperous and free societies.

If we are Democrats, we claim to be victims of Bush. If we are Republicans, we claim to be victims of Obama. All of this is a lie. We have created, through our own collective ignorance, the mess we see. We would rather blame than be mature enough to take responsibility and become a free people.

Before it gets better, things are going to get a lot worse in the United States. The stakes we face are incalculably greater and the consequences harder to overcome than a bad restaurant meal. Our Iranian brothers and sisters are teaching us just how high the stakes can be.

Behind The Two Doors

September 29, 2008

No one won today in Congress. Today’s historic vote defeating the bailout bill is just an opening battle in an ongoing war that may last for decades.

Today’s defeat of the bailout may be a pyrrhic victory. The bipartisan, reactionary forces led by Secretary Paulson, Fed Chairman Bernanke, President Bush, House Speaker Pelosi, and Congressman Frank will be back again very shortly. And let’s make no mistake; although those who support the bailout may call themselves Republicans or Democrats, they are reactionaries—reactionaries in the sense that they long for a world where entrenched wealth gets to keep it forever. After they destroy America, those who now are poor or middle class need but stand by and hope for a few handouts.

They want a world of old Europe that our Founding Fathers fled and overthrew. Thanks to our Founding Fathers, there is no nobility in America, or permanent titles of privilege, or permanent grants of wealth. In America, many families have made great fortunes; and then their children and grandchildren have squandered their fortune. Contrary to popular belief, if you look back 100 years, there are great turnovers among those who constitute the wealthiest in America.

Those who are currently on Wall Street and the reactionary politicians who enable them want to take no chances on what the market will reveal next. They desperately want to steal America’s money; they are willing to destroy America; and in the process, they will throw every man, woman, and child overboard in their cowardly attempts to get on the first lifeboats.

Consider for a minute Congressman Barney Frank, who postures as a friend of the little man, and is tirelessly working for this bailout. Guess who is the largest recipient in Congress of campaign money from mortgage bankers? Guess who received over $600,000 of campaign money this year from political action committees—including those representing Wall Street interests. That’s correct—it is Barney Frank.

We are told a free market is to blame for our current mess. Nonsense! It is reactionary politicians like Barney Frank and President Bush. In a free market, many more financial institutions would be bankrupt already; great fortunes among their major shareholders would have been lost and their CEOs disgraced. In a free market, there are no politicians to steal other people’s money so that those who have wealth can keep it. The free market punishes fools and the greedy without remorse.

Yes, this is a bailout and not an investment in America, as some are nonsensically claiming. If this was a good investment, Henry Paulson would be liquidating his own vast wealth in order to get in on the ground floor. Until he does this, don’t let anybody tell you that this is an investment in America.

As I sat at my computer this afternoon and saw the terrible plunge on Wall Street unfolding, I couldn’t help myself. I got up, turned on the TV, and tuned to CNBC. Commentator after commentator was asking breathlessly some form of these questions: “Why is the public against the bailout? Don’t they know that this is for their own good and how much they will suffer if Congress doesn’t pass this?” As I listened, I heard in their voices the belief that the bill will be passed eventually; I heard how they were looking forward to the suffering of the “peasants” who dared to oppose them. Talk about wolves in sheep’s clothing.

They may be right, some form of the bill may pass; but they have overplayed their hand. A populist uprising has begun. A populist uprising is never principle driven; but instead, it is fueled by anger, fear, and class hatred. Down the road, especially as economic conditions worsen, this will not be a good thing. Think of the French Revolution and you will know how badly a revolution driven by populist sentiment can end.

So where do we stand right now. If by some miracle, no bailout is passed, Chairman Bernanke and Secretary Paulson are fired, and in November, the public repudiates every politician who voted for the bailout, then a deflationary depression will begin. That’s the best case scenario. Those financial institutions that have failed will be revealed and liquidated. Many fortunes both large and small will be lost, and the social carnage will be enormous. Yet, out of that, in no more than a year’s time, the rebuilding will begin; and a healthy and sustainable economy will emerge.

If, on the other hand, the reactionary forces prevail, more money will be thrown after bad; foreigners will withdraw from our capital markets; and eventually, a hyperinflation will begin. In that terrible scenario, it is likely that the United States will split apart; and many cities will descend into anarchy. You can see why I prefer the deflationary depression.

The choice behind the two doors—deflationary depression or hyperinflation—is a terrible and tragic one. Don’t trust reactionary forces to make the choice that is best for you.

Android Changes Everything

September 17, 2008

Do you remember life before Amazon? Do you remember life before Google? Or even, life before personal computers? Every so often a new product creates a sea change so big that life before the product seems like just a vague memory of a previous existence in a foreign land.

And now there is Android. Android is an operating system for mobile phones that is being developed by Google. I would bet on Android to crush the iPhone and other competitors.

Now, this is a rather bold prediction coming from someone who hardly uses his mobile phone, has never seen an iPhone, and knows nothing of Android other than what he has read in news stories. True confession—I have never sent a text message. So, what the heck can I know about the future of mobile phones?

In contrast to my prediction, many technology experts, such as Matt Asay, believe Android is no match for Apple’s expertise. Asay explains, “In part this is because Google may lack the aesthetic touch that Apple has in spades, just as Microsoft does… Android is still no iPhone killer.”

Asay is wrong. Aesthetics are critical when products are close competitors in price and quality, but no amount of design aesthetics would currently sell many Changfengs (a Chinese car) over Hondas in the United States. The why is clear—a Changfeng would not be in the same quality league as a Honda.

I understand that to Apple fans, such as Asay, my comparison is ridiculous. The iPhone to them is the current pinnacle of mobile phone development. However, what Asay may not understand is the enormous flexibility and innovative capacity of open source operating systems. Unlike the iPhone and every other competitor, Android is an open source operating system.

True, there are smart developers at Apple who have apparently made a pretty good product in the iPhone. But a handful of smart developers can’t compete against many smart developers, and pretty good can’t compete against great. Planned development can’t compete against the decentralized forces of spontaneous development. Self-organizing systems are more powerful than a thousand Steve Jobs; and they rarely behave as experts, such as Asay, predict.

Google is not going at this alone. Scott Taves writes that Google has put together a “collaborative group including Google and more than 30 semiconductor and software companies, mobile operators and handset manufacturers.”

But it doesn’t stop there. Most importantly, Google is encouraging independent teams not affiliated with any company to develop applications for Android. To kick off interest among developers, Google is awarding $10 million dollars in prize money to developers with the best applications. Developers, according to Google’s Eric Chu, “will be able to make their content available on an open service hosted by Google that features a feedback and rating system similar to YouTube…We feel that developers should have an open and unobstructed environment to make their content available.”

Even before the first Android phone has even been released, there are applications that will interest even a “not much use for a cell phone other than to call and say I’m stuck in traffic” person like me.

How about these features? You are out shopping and about to buy something on impulse. But you wonder, is it a good price? You scan the barcode of the item into an Android phone; and the phone gives you the best price online, as well as the prices at local merchants nearby you.

Or, consider this. There is an emergency; immediately, you need to physically locate a family member. Android will be able to do that too.

Here is the bottom line—free-markets always beat centrally planned economies; and similarly, Android will beat Apple and any other closed operating system. Due to compounding inherent in the market’s discovery process, five years from now, the Android powered mobile phone will be a gadget that we could hardly recognize today. In ways we can’t anticipate today, the long-promised era of convergence among all of our various electronic gadgets with different operating systems will be at hand. If Google is successful with Android, imagine next a Google computer with the open source operating system Linux. Imagine your phone seamlessly integrating with your computer. Imagine no longer having to gnash your teeth over whatever future proprietary operating system Microsoft will be trying to sell. If I was Microsoft, I would be very scared. But then again, those in Microsoft who urged a movement away from proprietary software have long ago been forced out of the company.

A world without Windows is hard to imagine, but then again, so was a world with personal computers. Smart people make mistakes, because they can’t anticipate the power of markets to change the status quo. In 1977, when IBM and Digital Equipment Corporation (DEC) dominated the computer industry, DEC’s CEO, Ken Olsen, said, “There is no reason for any individual to have a personal computer in his home.”

Of course, there turned out to be thousands of reasons; but those reasons needed to be discovered by the market process. Android will unleash a new process of discovery, and the results are likely to be as revolutionary as the personal computer.

Parts of this piece may read like a gushing press release for Google. I assure you that I am not on Google’s payroll. With unrelenting bad news unfolding in the economy and the iron fist of government increasingly choking off innovation, it is good to know that American entrepreneurs are still busy changing the world and making all of our lives better in the process.

This is the free-market at its best. Without any direction from politicians, Google is about to revolutionize the world—again.

Fatal Ignorance

August 6, 2008

This past weekend, heavy rains resulted in a power outage at our home. We went to bed early, as millions did before there was electricity, and then were awakened by a knock at the door at 10:30—a town policeman advised us to evacuate because the only road to our home was washing out from swollen brooks. There was some chance, he added, that the road would collapse on us if we attempted to leave. Fortunately, our home was not in danger of being flooded, and so we opted to stay put but move our car to a neighbor’s lot on a road out of danger. I did so successfully, and then I walked back to our home through the cascading water and stones swept by the brook onto the road.

Having lived in or near major cities for most of my life, and now living in a rural area, I am very conscious of the differences in the two. Living in a rural area, I am more conscious than I am in the city of just how interdependent we all are. The cycles and vagaries of nature are more palpable; and unlike a city where you may know just a few of the neighbors on your block, you get to know on more than just a “say hello” level, your neighbors, the mailman, the farmer who grows your food, your painter, and your shopkeepers. Unlike what many naively believe, shutting the door on the rest of the world is less of an option in a rural area than it is in the city. In a rural area, it is hard to maintain the fiction—as some city dwellers do—that we are independent captains of our own lives.

I often try to generalize from my experiences and see what lessons I can learn—sometimes it is a familiar one, an old lesson looked at through fresh eyes. Nothing like going without to help one appreciate the familiar; I began to reflect on electricity. Electricity is an invention that has transformed the world; yet before it was available to the public, the idea of an electric current powering machines and lighting homes was not conceivable to almost all individuals.

You may be familiar with the recent surveys that show that high school seniors lack basic knowledge of history, that they have no knowledge of the principles of American government, and that they have no knowledge of geography.

As importantly, many are ignorant of how “anything happens” in the course of a market process. What do I mean? Well, take electricity. If you asked most how or by whom electricity was discovered, they would probably search their minds for familiar names and guess that Ben Franklin or Thomas Edison discovered electricity. They would have little knowledge or appreciation for the fact that research into electricity began thousands of years ago, and it took the efforts of many individuals in multiple societies across epochs to finally bring electricity into our homes as a usable tool.

In the 1957, the BBC presented a mock documentary on the Swiss spaghetti harvest which “explained” how a mild winter had resulted in a bumper spaghetti crop. The documentary fooled millions who had little idea of how the food they eat was grown, harvested, manufactured, and then transported and sold in stores.

This ignorance of history, economics, and our natural worlds is destructive to the maintenance of a free society. Why? If many can believe that a single individual can invent electricity, it is not much of a leap to believe that if government gets to harness more resources, it can improve our lives faster than the market process can. After all, if one man can invent electricity, think of how quickly the government can solve the problem of high energy prices. Indeed, polls show that most support the government spending billions to do just that.

Whenever a problem or a need arises, “someone should do something about it” is the rallying cry of the ignorant. The ignorant believe in the silly fairy tale that some politician can wave a “magic wand” and make something, like a new form of energy, happen. When that politician fails at what never can be done, the ignorant turn to the next political hopeful while maintaining their own ignorance. And there is, of course, an endless supply of politicians who are ready and willing to exploit their ignorance.

Nobel laureate Friedrich Hayek’s great insight was that socialism could never work because it could never solve the knowledge problem—that is, it could never obtain but a fraction of the information necessary to build a modern economy. The corollary of his initial insight is that a free-market economy uses far more information and thus solves problems far faster than a socialist economy ever could. The idea that socialists could conquer the knowledge problem and wave the “magic wand” to shape the world according to their “superior” knowledge was what Hayek called the “fatal conceit”—fatal because it results in poverty, starvation, and war.

There has been more material progress in the past century than in all of recorded history up to that time. The ignorant have no idea that this progress is due to the efforts of free-men and women and not to the directions of politicians.

Many among the ignorant believe in a relatively static world, and so it is natural for them to believe that government can fine tune what is fixed. They have only the vaguest idea that others in the past lived far differently than we do now and that those who will come after us will live far differently than we do—if the blessings of liberty continue to be enjoyed. Their fatal ignorance of how progress happens is crippling the American experiment in liberty.


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