Destruction is Not Profitable

March 15, 2011

You might recall the scene in The Social Network where the Winklevoss brothers take their case against Mark Zuckerberg to then Harvard president Larry Summers. In the scene, Summers is rude, arrogant, and dismissive, which by all accounts is exactly how he is in real life. Summers, who has also been Secretary of the Treasury under Clinton and Obama’s Director of the White House National Economic Council, is known for his confidence in his own great intellectual prowess.  In a recent interview on CNBC, Summers claimed that the devastation in Japan could actually temporarily boost the economy as rebuilding takes place.

Other economists have argued that the destruction will provide a long-term benefits:  “This is a Keynesian stimulus program that nobody can argue with: just rebuilding the city of Sendai,” said Marcus Noland, deputy director of the Peterson Institute for International Economics in Washington.” The Wall Street Journal reports that: “Some economists [unnamed] have argued that a quake could actually lift the economy in the long run.”

I find these predictions offensive. The suffering of the Japanese population is far beyond the experience of most of us. I wonder if Summers and Noland would consent to having their homes and hometowns destroyed in the name of stimulating the economy.

Last night I asked my 15-year-old children, sophomores in high school, whether they thought destruction could stimulate the economy? My daughter was puzzled, “Why would you even ask such a question?”

“How could it?” my son challenged. He correctly explained that resources going into rebuilding towns that were once perfectly usable are resources that would no longer be able to satisfy other needs. My son gets an A in my economics course; Summers and Noland earn Fs.

Of course, official GDP data may indeed show the stimulating effect of government spending; but this is simply how GDP is counted. Any money government spends is counted dollar for dollar in GDP. If government hires workers to dig holes and then fill the holes again, GDP may increase. But surely no one would argue that the economy has improved by such a measure. Having workers dig holes and fill them up again is not contributing anything to satisfy the urgent needs of consumers.

Currently in Japan, “evacuation centers have half a million people in centers and schools that don’t have water, electricity and oil”. Government efforts to resupply the population are of course necessary. Those efforts will cost more than the displaced population would ordinarily spend on their own food and shelter. GDP will thus increase, but in no real sense has the economy grown.

Similarly, government cleanup efforts in the failed nuclear reactors will cost far more than energy companies would’ve spent generating power. Again GDP may increase, but that is simply a problem with how this statistic is calculated.

In 1848, the great French economist Frédéric Bastiat first published his essay “What Is Seen and What Is Not Seen.” Bastiat distinguishes for us the bad economist from the good economist: “There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.”

Next, Bastiat dismantles what has come to be known as the “broken-window fallacy”:

Have you ever been witness to the fury of that solid citizen, James Goodfellow, when his incorrigible son has happened to break a pane of glass? If you have been present at this spectacle, certainly you must also have observed that the onlookers, even if there are as many as thirty of them, seem with one accord to offer the unfortunate owner the selfsame consolation: “It’s an ill wind that blows nobody some good. Such accidents keep industry going. Everybody has to make a living. What would become of the glaziers if no one ever broke a window?”

Now, this formula of condolence contains a whole theory that it is a good idea for us to expose, flagrante delicto, in this very simple case, since it is exactly the same as that which, unfortunately, underlies most of our economic institutions.

Suppose that it will cost six francs to repair the damage. If you mean that the accident gives six francs’ worth of encouragement to the aforesaid industry, I agree. I do not contest it in any way; your reasoning is correct. The glazier will come, do his job, receive six francs, congratulate himself, and bless in his heart the careless child. That is what is seen.

But if, by way of deduction, you conclude, as happens only too often, that it is good to break windows, that it helps to circulate money, that it results in encouraging industry in general, I am obliged to cry out: That will never do! Your theory stops at what is seen. It does not take account of what is not seen.

It is not seen that, since our citizen has spent six francs for one thing, he will not be able to spend them for another. It is not seen that if he had not had a windowpane to replace, he would have replaced, for example, his worn-out shoes or added another book to his library. In brief, he would have put his six francs to some use or other for which he will not now have them.

Let us next consider industry in general. The window having been broken, the glass industry gets six francs’ worth of encouragement; that is what is seen.

If the window had not been broken, the shoe industry (or some other) would have received six francs’ worth of encouragement; that is what is not seen.

And if we were to take into consideration what is not seen, because it is a negative factor, as well as what is seen, because it is a positive factor, we should understand that there is no benefit to industry in general or to national employment as a whole, whether windows are broken or not broken.

Now let us consider James Goodfellow.

On the first hypothesis, that of the broken window, he spends six francs and has, neither more nor less than before, the enjoyment of one window.

On the second, that in which the accident did not happen, he would have spent six francs for new shoes and would have had the enjoyment of a pair of shoes as well as of a window.

Now, if James Goodfellow is part of society, we must conclude that society, considering its labors and its enjoyments, has lost the value of the broken window.

From which, by generalizing, we arrive at this unexpected conclusion: “Society loses the value of objects unnecessarily destroyed,” and at this aphorism, which will make the hair of the protectionists stand on end: “To break, to destroy, to dissipate is not to encourage national employment,” or more briefly: “Destruction is not profitable.”

“Destruction is not profitable.” What can be simpler to understand? Apparently it takes a keen intellect to think otherwise. But, by behaving badly, Larry Summers is doing us a great service. Through his prediction he is exposing the utter intellectual and moral vacuity that is behind Keynesian economics. In his world, governments need not be concerned about the effects of its policies on individual citizens or, for that matter, the real impact on the economy. All government needs to do is spend and say it has increased GDP. If the understanding of Summers and others like him is limited to measurable but problematic statistics, their understanding is shallow indeed.


Field Guidance

September 23, 2010

I recently read a news story about North Korea’s despotic leader, Kim Jong-il. He was on the scene at a coal mine, according to the North Koreans, to provide “field guidance” to the mine’s workers. Most North Koreans tolerate or support a system that has starved millions to death and has reduced most of the rest to a state of unimaginable deprivation. Support for the regime can be traced, in part, to relentless propaganda that first Kim Jong-il’s father, Kim Il Sung (the so-called Great Leader), and now Kim Jong-il (the Dear Leader) are semi-divine and possess powers far beyond those of mortal men. Apparently, one of those powers is an ability to dispense accurate field guidance.

Waiting in the wings to succeed his father is Kim Jung-Un. The North Korean propaganda machine is going full steam ahead as it reports on Kim Jung-Un, calling him “the brilliant comrade.” No doubt his brilliance will allow him to dispense field guidance at least equal to that of his father and grandfather.

If it wasn’t for the terrible human suffering in North Korea and the possibility of war on the Korean Peninsula, it would be easy to view all of this nonsense with amusement. It is easy to dismiss what we hear in North Korea believing it is something totally different from the American experience. Unfortunately, we are not so different. In the United States there are plenty of “brilliant comrades” dispensing “field guidance.” The only difference between North Korea and the United States is the degree to which their “field guidance” has ruined the economy.

Consider Larry Summers, the president’s current (but set to depart early next year) chief economic advisor. Last week we covered his arrogance, now let’s take a look at some of his pearls of wisdom. One of Larry Summers’ pronouncements on the automobile bailout is shared by Steven Rattner in his book Overhaul: An Insider’s Account of the Obama Administration’s Emergency Rescue of the Auto Industry:

“We’re already in Vietnam,” Larry Summers said in a separate meeting, referring to the all-but-certain decision to provide more aid to the auto makers. “I can imagine doing something in Cambodia.” By that he meant indirectly helping a few key suppliers, the equivalent of fighting from Vietnam and not sending ground troops across the border. But there he drew the line: “There’s no way we’re going into Laos.” He wasn’t about to commit the government to a full-scale invasion that involved bailing out the entire supply chain.

Apparently, Summers speaks in metaphors that only those attending a Georgetown cocktail party could appreciate. Is this brilliant “field guidance” or nonsense from a meddling and, despite his reputation, apparently mediocre mind? Consider this: While Summers was president of Harvard he approved the purchase of over 3.5 billion dollars of financial derivatives involving interest rate swaps. Like most of these derivatives, this ended badly for Harvard as Harvard lost approximately two-thirds of its investment.

Despite this, Summers had the temerity to appear on CNBC last week and pronounce that: “This administration is committed to fixing the disaster brought about by the last one which was solely a function of financial deregulation.” Of course this is absolute nonsense and flies in the face of Summers’ own record at Harvard. A major cause of the disaster has been decisions made by individuals, such as Summers, who believed they were smarter than the rest of us. They took risky bets and then demanded to be bailed out.

If the United States was completely unlike North Korea, Summers would have been repudiated by now. Rather than issuing economic advice to the president, he would be out of a job like the millions of workers his policies have helped to displace.

Of course, Summers is not the only one dispensing “field guidance” in the United States. To be fair to Summers and our other field guides, they are not as vicious as their North Korean counterparts. But they are just as wrong about their abilities as are those in North Korea’s Kim dynasty.

Consider Congressman Barney Frank. As chairman of the House Financial Services Committee, Frank is generous in giving out his “field guidance.” For example, regarding the automobile industry, in June 2009, Frank called Fritz Henderson, then GM CEO, and demanded that Henderson keep open a GM distribution center in Frank’s Congressional District. Frank discussed with Henderson “the facility’s value to GM.” Henderson agreed to keep the facility open after having his arm twisted. In his own mind, Frank was dispensing needed “field guidance” on corporate assets.

Or consider President Obama. Rattner relates this conversation:

Mr. Obama had asked, “Is there any way these guys are going to avoid bankruptcy?”

“Unlikely,” he was told.

“Why can’t they make a Corolla?”

“We wish we knew,” replied his advisers.

Again, this is a conversation best fit for a Georgetown cocktail party. Most people outside of government and academia understand that one could no more “make a Corolla” then “make a Mozart.” The ability to make a reliable, inexpensive car like a Corolla is grown over many laborious interactions through a discovery process that takes many years. A Corolla cannot be ordered up by central planners. GM and Chrysler could not make a Corolla because their top-down, hierarchical organizational structure with all their plans did not allow for enough innovation and discovery. If a Corolla could simply be ordered up, Chrysler would be the number one carmaker in the world; and North Korea, the world’s wealthiest economy.


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.


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