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Free Your Talent and the Rest Will Follow – Article by Orly Lobel

Free Your Talent and the Rest Will Follow – Article by Orly Lobel

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The New Renaissance Hat
Orly Lobel
October 17, 2013
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Imagine two great cities. Both are blessed with world-class universities, high-tech companies, and a concentration of highly educated professionals. Which will grow faster? Which will become the envy and aspiration for industrial hubs all around the world?

Such was the reality for two emerging regions in the 1970s: California’s Silicon Valley and the high-tech hub of Massachusetts Route 128. Each region benefited from established cities (San Francisco and Boston), strong nearby universities (University of California-Berkeley/Stanford and Harvard/MIT), and large pools of talented people.

We’ve all heard about Silicon Valley, but not so much Route 128. Despite their similarities, and despite the Bostonian hub having three times more jobs than Silicon Valley in the 1970s, Silicon Valley eventually overtook Route 128 in number of start-ups, number of jobs, salaries per capita, and invention rates.

The distinguishing factor for Silicon Valley was an economic environment of openness and mobility. For more than a century, dating back to 1872, California has banned post-employment restrictions. The California Business and Professions Code voids every contract that restrains someone from engaging in a lawful profession, trade, or business. This means that unlike most other states, California’s policy favors open competition and the right to move from job to job without constraint. California courts have repeatedly explained that this ban is about freeing up talent, allowing skilled people to move among ventures for the overall gain of California’s economy.

The data confirm this intuition: Silicon Valley is legendary for the success of employees leaving stable jobs to work out of their garages, starting new ventures that make them millionaires overnight. Stories are abundant of entire teams leaving a large corporation to start a competitive firm. Despite these risks, California employers don’t run away. On the contrary, they seek out the Valley as a prime location to do business. Despite not having the ability to require non-compete clauses from their employees, California companies compete lucratively on a global scale. These businesses think of the talent wars as a repeat game and find other ways to retain the talent they need most.

In fact, the competitive talent policy is also supported by a market spirit of openness and collaboration. Even when restrictions are legally possible—for example, in trade secret disputes—Silicon Valley firms frequently choose to look the other way. Sociologist Annalee Saxenian, who studied the industrial cultures of both Silicon Valley and Route 128 in Massachusetts, found that while Boston’s Route 128 developed a culture of secrecy, hierarchy, and a conservative attitude that feared exchanges and viewed every new company as a threat, Silicon Valley developed an opposing ethos of fluidity and networked collaborations. These exchanges of the Valley gave it an edge over the autarkic environment that developed on the East Coast. In Massachusetts, firms are more likely to be vertically integrated—or to have internalized most production functions—and employee movement among firms occurs less frequently.

New research considering these different attitudes and policy approaches toward the talent wars supports California’s modus operandi.

A recent study by the Federal Reserve and the National Bureau of Economic Research examined job mobility in the nation’s top 20 metropolitan areas and found that high-tech communities throughout California—not only Silicon Valley—have greater job mobility than equivalent communities in other states. Network mapping of connections between inventors also reveals that Silicon Valley has rapidly developed denser inventor networks than other high-tech hubs have.

Researching over two million inventors and almost three million patents over three decades, a 2007 Harvard Business School study by Lee Fleming and Keon Frenken observes a dramatic aggregation of the Silicon Valley regional networks at the beginning of the 1990s. Comparing Boston to Northern California, the study finds that Silicon Valley mushroomed into a giant inventor network and a dense superstructure of connectivity, as small isolated networks came together. By the new century, almost half of all inventors in the area were part of the super-network. By contrast, the transition in Boston occurred much later and much less dramatically.

Michigan provides a natural experiment for understanding the consequences of constraining talent mobility. Until the mid-1980s, Michigan, like California, had banned non-competes. In 1985, as part of an overarching antitrust reform, Michigan began allowing non-competes, like most other states. Several new studies led by MIT Sloan professor Matt Marx look at the effects of this change on the Michigan talent pool. The studies find that not only did mobility drop, but that also once non-competes became prevalent, the region experienced a continuous brain drain: Its star inventors became more likely to move elsewhere, mainly to California. In other words, California gained twice: once from its intra-regional mobility supported by a strong policy that favors such flows, and once from its comparative advantage over regions that suppress mobility.

A virtuous cycle can be put into motion geographically where talent mobility supports professional networks, which in turn enhance regional innovation. Firms can learn to love these environments of high risk and even higher gain. Rather than thinking of every employee who leaves the company as a threat and an enemy, smart companies are beginning to think of their former employees as assets, just as universities wish for the success of their alumni. Companies like Microsoft and Capital One have established networks of alumni. They showcase their former employees’ achievements and practicing rehiring of their best talent, hoping that at least some of those who leave will soon realize that the grass is not always greener elsewhere.

Most importantly, motivation and performance are triggered by commitment and positive incentives to stay, rather than threats and legal restrictions against leaving. In behavioral research I’ve conducted with my co-author On Amir, we find that restrictions over mobility can suppress performance and cause people to feel less committed to the task. Cognitive controls over skill, knowledge, and ideas are worse than controls over other forms of intellectual property because they prevent people from using their creative capacities, they don’t just prevent firms from using inventions that are already out there. So instead of requiring non-competes or threatening litigation over intellectual property, California companies use rewards systems, creating the kind of corporate cultures where employees want to work and do well. Again, a double victory.

Unsurprisingly, when Forbes recently looked at the most inventive cities in the country for 2013 using OECD data, the two top cities were in California: bio-tech haven San Diego, and the legendary home of Silicon Valley, San Francisco. Boston, still vibrant and highly innovative despite its most restrictive attitudes, came in third. Competition is the lifeblood of any economy, and fierce competition over people is the essence of the knowledge economy.

Orly Lobel is the Don Weckstein Professor of Law at the University of San Diego and founding faculty member of the Center for Intellectual Property and Markets. Her latest book is Talent Wants to be Free: Why We Should Learn to Love Leaks, Raids, and Free-Riding (Yale University Press, September 2013).

This article was originally published by The Foundation for Economic Education.
Review of Edward W. Younkins’s “Exploring Capitalist Fiction” – Article by G. Stolyarov II

Review of Edward W. Younkins’s “Exploring Capitalist Fiction” – Article by G. Stolyarov II

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The New Renaissance Hat
G. Stolyarov II
October 12, 2013
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Exploring Capitalist Fiction, a new volume of literary analysis by Dr. Edward W. Younkins, offers perceptive, relevant, and engaging commentaries on 25 works of fiction which portray the business world and its relationship to all areas of human life. The novels, plays, and films featured in the book span 125 years of literary culture – from The Rise of Silas Lapham (1885) by William Dean Howells to the 2010 Oliver Stone film Wall Street: Money Never Sleeps. This volume offers thorough coverage of both works that portray heroic entrepreneurs and economic liberty in a positive light – such as Ayn Rand’s Atlas Shrugged, Garet Garrett’s The Driver, and Henry Hazlitt’s Time Will Run Back – as well as works that are more critical of the business world – including Edward Bellamy’s Looking Backward, Sinclair Lewis’s Babbitt, Frank Norris’s The Octopus, and the Wall Street films. In each of his essays, Younkins provides a sequential summary of the fictional work, interspersed with commentary that highlights the philosophical and economic implications of major elements and integrates them with the historical context of the time period in which the work takes place.

Younkins is to be commended for emphasizing the value of fiction as a teaching tool for both students of business and individuals immersed in the business world. A thorough reading of the book’s Conclusion is highly recommended for attaining an understanding of the unique ability of fiction to communicate memorable lessons rooted in specific, richly detailed situations which render the conflicts, dilemmas, and options faced by individuals in the business world more palpable and engaging than would a sole reliance on lectures, case studies, and outlines of business and economic concepts. In addition, the Conclusion offers a fast-paced chronological overview of many more fictional works which address business themes and which have made their mark on the world of artistic culture.

As with his previous volumes, where Dr. Younkins provided integrated presentations of the thoughts of great philosophers and economists throughout the centuries, this book provides a refreshing focus on human flourishing and the application of the lessons of particular novels, plays, and films toward the improvement of both one’s own condition and the degree of prosperity found in the broader economy. This is not literary analysis for its own sake, but rather a book that highlights the lessons an individual can take from each great work and apply to his or her own life.

Younkins combines his support for free markets, entrepreneurial innovation, individualism, reason, and moral responsibility with an ability to point out the many valuable insights in those works which criticize capitalism as conventionally understood. He utilizes the insights of Austrian economics and his extensive knowledge of economic history to show how the bleak portrayals of businessmen and the business world in these books stem from the consequences of situations where the principles of honest free commerce and individual rights were violated. When critics of capitalism express their objections through fiction, they inevitably portray situations where fraud, corruption, morally questionable manipulation, corporatist special privileges, thoughtless conformity, and zero-sum thinking are involved. All of these are indeed negative attributes from the standpoints of free markets and rational philosophy as well, and Younkins’s analysis shows that the works of the critics do make valid points – provided that one understands that the system they are criticizing is the one that has actually prevailed in the Western world over the past century. This is the system which mixes aspects of capitalist free enterprise with significant aspects of corporatist cronyism as well as central planning. It is a system quite different from the free-market capitalism advocated by Henry Hazlitt, Garet Garrett, and Ayn Rand. Indeed, in Atlas Shrugged, the protagonists go on strike precisely against this sort of cronyist system, though one that is farther-gone than our own. In Tucker: The Man and His Dream, an excellent movie to which Younkins devotes  a chapter, this is also the system which attempts to suppress a genuine forward-thinking capitalist innovator, Preston Tucker, through the use of political force, motivated by the lobbying of the staid Big Three automobile companies.

For readers of all persuasions, Exploring Capitalist Fiction is an excellent means to appreciate the richness and variety of fictional portrayals of business, especially since the Second Industrial Revolution of the late 19th century. The book offers a concise introduction to many works and endeavors to motivate readers to seek out and experience the original novels, plays, and films. Hopefully, it will inspire many people to explore these great works of fiction, as it has already inspired me on multiple occasions.

Disclosure: The author received a free copy of the book in advance of publication.

This Isn’t the Way To Do Business: Review of John O’Hara’s “From the Terrace” – Article by Sarah Skwire

This Isn’t the Way To Do Business: Review of John O’Hara’s “From the Terrace” – Article by Sarah Skwire

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The New Renaissance Hat
Sarah Skwire
October 6, 2013
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John O’Hara. From the Terrace. New York: Carroll and Graff, [1959] 1999. 897 pages.

John O’Hara’s From the Terrace, a sprawling novel of business and politics, traces the career of Alfred Eaton from his boyhood in small-town Pennsylvania to his work in business, banking, D.C. politics, and, finally, to his retirement in California. As Howard Thompson observed in his New York Times review of the 1960 film adaptation, its director “logically . . . settled for about fifteen years” of the story. And I’d like to focus in even more closely—on a single conversation.

After college and World War I, Alfred and his friend Lex Porter decide to start an aviation company. Lex and his family will contribute the funding, Alfred will serve as the business manager, and they will hire an outside designer. Their goal is to do for airplanes what Ford, Dodge, and others have done for cars. As Alfred explains in a conversation with his father:

“We’re not deceiving ourselves. All we know is that aviation is the coming industry in this country. In ten years everybody’s going to want aeroplanes.”

“Personally, I’d rather have some Dodge Brothers, common or preferred.”

“Who wouldn’t? That’s a sure thing, for those who like sure things, and I like sure things, too. But we’re hoping to be Dodges.”

With the perfect hindsight the 21st century offers, we know the enterprise is doomed from the moment we hear about it. Personal planes still haven’t replaced the car and aren’t likely to. But from the standpoint of an entrepreneur in 1920, it’s a pretty good idea.

It’s a pretty good idea, that is, until Alfred, Lex, and their designer Von Elm try to get down to business. While they begin with a fairly clear plan to “build a small aeroplane of up-to-the-minute design and highest quality workmanship, built to sell to men who could afford Rolls-Royce automobiles,” they rapidly move away from this plan into a deadlock between the demands of practicality and the desire for perfect design. Lex, who wants to experiment and constantly change designs, argues, “If we sell an aeroplane in, say, November 1921, and another one in December 1921, the December one may be so different that you wouldn’t recognize it as coming from the same maker.”

Alfred quite rightly protests that this is no way to do business:

Let’s not think we’re going to build custom-made aeroplanes. I don’t care how much we charge for the aeroplane, we’re not going to start making money until we can produce it in some quantity. We ought to build next November’s aeroplane and manufacture it, produce it, till we have, say, fifty sold. And a year later we manufacture the new model, with all those refinements you speak of. We don’t sit around waiting for some guy to come and ask us to build a special ship for him. We make fifty and sell them.

As he later points out, all this chopping and changing requires only one thing—and that isn’t entrepreneurship or business acumen. It’s an “inexhaustible bank account.” Lex’s response to such critiques is telling: “Jesus H. Christ! Are we going to build Dodges? I thought we were going to build a fine aeroplane.”

This criticism of the very company that Alfred calls a “sure thing” and that he takes as his model, along with the conflict the criticism suggests, are at the very center of their business. It leads to Lex and Von Elm buying expensive engines without Alfred’s approval. It leads to a rift in their perceptions of the business and their plans for its future, and it leads to the company’s eventual collapse.

In my last column I praised the entrepreneurial spirit. And I am an enormous fan of the guts and drive, the expertise and steadfastness necessary in order to start and run one’s own company. But not everyone should do it. Lex shouldn’t do it. He wants to build planes. He wants to design planes. He doesn’t care if he sells them.

We’ve heard a lot lately in the media about how everyone doesn’t need to go to college, and how the ever-growing burden of student loan debt sometimes turns out to have been a bad risk for students, particularly in our sluggish economy. But while I am deeply concerned about that, I am equally concerned about glossing over the rigors of starting, running, and maintaining a business. It would be irresponsible, no matter how much we love entrepreneurship, to let students think that it is somehow a sure road to success, or a straight line to the top, or easier and more certain than a college education. And not only is it irresponsible, it’s insulting to the entrepreneurs who know exactly how much work it takes to get to the top—or even the middle—of an industry.

Expertise in entrepreneurship, like expertise in metaphysical poetry or string theory, is hard to come by. You have to study it, work at it, fail at it, and then do it some more until you get it right. It is a great road for those who are drawn to it. But like metaphysical poetry or string theory, it’s not a road for everyone.

Sarah Skwire is a fellow at Liberty Fund, Inc. She is a poet and author of the writing textbook Writing with a Thesis.
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This article was originally published by The Foundation for Economic Education.
Bookstore Wars: Creativity versus Scale – Article by Sanford Ikeda

Bookstore Wars: Creativity versus Scale – Article by Sanford Ikeda

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Sanford Ikeda
August 22, 2013
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Independent bookstores appear to be making a comeback after several years of decline. As reported by MSNBC, the number of independent bookstores has risen significantly.

Some 1,000 independent bookstores went out of business between 2000 and 2007, according to the American Booksellers Association (ABA), as consumers turned to online buying, downloading e-books, or flocking to Barnes & Noble and (now defunct) Borders. But the ABA said that since 2009, the number of independent bookstores has risen 19 percent, to 1,971.

If my arithmetic is right, that still means the industry hasn’t rebounded to where it was in 2000 (about 2,600 stores), but it’s not bad. Meanwhile e-book sales, which had been rising at triple-digit rates, have evidently lost a bit of steam, last year growing at about 5 percent overall.

These facts perhaps illustrate two important lessons:  First, the scale of a business’s operations is not the same thing as its competitiveness; and second, the kind of competition that counts in free markets has much less to do with efficiency than with creativity.  Selling books and digital media in massive volume seems to make firms sluggish in addressing customer preferences for more personalized service and responsiveness.

Efficiency and Scale Are Important

Free-market economists are typically painted by friends and foes alike as cheerleaders for efficiency. Indeed, many economists do tout efficiency as the prime virtue of the free market, keeping prices low and employment high. In standard economics, efficiency refers to using the lowest-cost means to reach a given end.

If Jack is in New York and wants to be in Philadelphia, then among the alternative means available to him—walking, boating, flying, driving, or taking the train—efficiency implies that Jack chooses the one that minimizes the cost to him of getting to Philadelphia. In manufacturing, the production process that, other things equal, produces a given rate of output at the lowest cost is the efficient one.

(Note:  Cost, like benefit, always refers to the cost to someone of doing something.  Sometimes the chooser experiences the costs, sometimes someone else does, but neither costs nor benefits are ever disembodied.)

One form of efficiency is economies of scale. Economies of scale occur when using more of all inputs (scaling up) increases output so much that the cost per unit of output falls. (In econ-speak that’s when the long-run average-cost curve slopes downward.) Critics pick up on this and argue that the free market therefore necessarily favors big businesses over small businesses because the bigger a firm is, the more efficient in terms of unit costs it tend to be, and that allows it to charge lower prices and drive smaller firms out of the market.

But Not as Important as Competition

That story, however, only looks at the relative efficiencies of existing firms and markets. If the fundamental goal is to improve the well-being of people as they see it, then you have to pay more attention to competition, particularly entrepreneurial competition. In that sense, competition trumps efficiency (as Israel M. Kirzner has explained).

That’s because, again, efficiency means choosing from among given alternatives the one that achieves a given goal at the lowest cost. Where the standard economic concept of efficiency falls short is that in the real world neither ends nor means are simply given to anyone. Ends and means, outputs and inputs, have at some point to be discovered by someone. Yes, efficiency is a good thing, like having a clean and orderly workplace, but it’s entrepreneurship in the competitive process that does the heavy lifting of finding the work to be done and putting you in a position to do it.

The resurgence of independent bookshops in the face of book megastores, I think, is an example of how creative competition overcomes the scale efficiency of providing a particular product. There’s nothing inherently wrong or uncompetitive about megastores or inherently virtuous about small businesses. Big and small businesses have their niches, whether online or in brick-and-mortar shops. But central to the competitive process is the ability, whatever your size, to be aware of changing circumstances and to adjust appropriately to them. The MSNBC article quotes an independent bookseller as saying, “We learned how to get books that people couldn’t find online, and to cater as much as we could to the customer. When a customer walks in, we try to make them feel wanted and at home.”

Scale economies in both the online and brick-and-mortar parts of the industry do little to win over customers who prefer personalized service or the intangibles of local businesses. Independent bookstores are more flexible, for example, at staging readings of local authors and other neighborhood events. The giant bookseller Borders Books, one of the pioneers of book retailing, apparently didn’t do a good job adjusting and closed a couple of years ago (I wrote about it here). Today Barnes & Noble scrambles to cope with competition from the e-book, Amazon.com, and, it seems, local bookshops.

While the diminished growth of e-book sales is hardly a harbinger of decline—5 percent is nothing to sneeze at—it does suggest that sometimes the demand side of the market doesn’t change quite as fast as the supply side—that is, a lot of innovation is just discovering better ways to satisfy fairly stable tastes. Still, it’s competition—for new markets, new techniques, new resources, and yes, new tastes—and not efficiency that drives, and is driven by, the creative discovery of ends and of means.

The Lesson Applied

The other day a friend told me that, when she told her fiancé she couldn’t understand why a mildly alcoholic beverage called “Chu-hi,” which is very popular in Japan, isn’t sold in stores here, his response was something like, “If there were a demand for it, it would be.” Knowing that I write this column she then said to me, “That’s the free market, right?”

Okay, class, what do you say?

Sanford Ikeda is an associate professor of economics at Purchase College, SUNY, and the author of The Dynamics of the Mixed Economy: Toward a Theory of Interventionism.
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This article was originally published by The Foundation for Economic Education.
Election Analysis: “Show Me Your Papers!” – Article by Charles N. Steele

Election Analysis: “Show Me Your Papers!” – Article by Charles N. Steele

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Charles N. Steele
November 11, 2012
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In my haste to let the religious right have it, I missed something important that suggests the GOP problem is deeper than just religious nuttery: the GOP has systematically refused to address immigration issues seriously.  Worse, they’ve adopted nativist hostility to immigrants and treat immigration as purely a law enforcement issue, one in which “suspicious-looking people” need to be ready to show their papers at any point.
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Hispanics voted almost 3 to 1 for Obama over Romney.  Anyone surprised by this wasn’t paying attention.  In a number of Republican forums this past year Hispanic politicians and party activists — all GOP members — voiced frustration that the primary campaigns were making it difficult for them to feel they had a place in the party.  Recall that the one and only intelligent thing Rick Perry said in his entire campaign was that children of illegal immigrants ought to be able to attend college at in-state tuition rates, since it was better that they be educated and productive rather than welfare cases.  It’s also the only thing for which conservatives raked him over the coals.
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Hispanics are about one sixth of the U.S. population and account for more than 50% of population growth.  Good luck selling them on the idea that Spanish accents and not-quite-white skin are cause for further police inquiries.

In fact, illegal immigration ought to be something conservatives support.  The primary reason people enter the country illegally is to work. Serious academic work dating at least to Julian Simon’s excellent book (available here for free!) have found that immigration, including illegal immigration, is on net beneficial for an economy.  Immigrants work harder and take less in government benefits.  Their work raises wages for non-immigrants.  They have higher rates of entrepreneurial activity.  In the recent financial crisis, illegal immigrants who were subprime borrowers had far lower rates of mortgage default than citizen subprime borrowers.  One would suppose that these would be the sort of people one would want to welcome, not drive away.  One would think these people would be prime constituents for a free-market message.

Certainly there are problems of crime, of crowding of public services, etc., associated with immigration, but many of these are at heart problems of the welfare state, rather than immigration.  Fixing these makes sense; fixating on immigration doesn’t.

If the nativists got everything they wanted on immigration — iron control over impervious borders, strict limits on who can enter, and deportation of 100% of all illegals — no important economic or social problem would be solved and the economic situation would be worse, not better.  But this wish list is impossible; economic forces cannot be legislated away, and neither can the human spirit.

The current Republican position on this issue is best described as stupidity, and one more reason they drove away potential voters.

Dr. Charles N. Steele is the Herman and Suzanne Dettwiler Chair in Economics and Associate Professor at Hillsdale College in Hillsdale, Michigan. His research interests include economics of transition and institutional change, economics of uncertainty, and health economics.  He received his Ph.D. from New York University in 1997, and has subsequently taught economics at the graduate and undergraduate levels in China, the Russian Federation, Ukraine, and the United States.  He has also worked as a private consultant in insurance design and review.

Dr. Steele also maintains a blog, Unforeseen Contingencies.

TANSTAAFL and Saving: Not the Whole Story – Article by Sanford Ikeda

TANSTAAFL and Saving: Not the Whole Story – Article by Sanford Ikeda

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Sanford Ikeda
October 3, 2012
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How often have you heard someone say, “There ain’t no such thing as a free lunch,” or, “Saving is the path to economic development”?  Many treat these statements as the alpha and omega of economic common sense.

The problem is they are myths.

Or, at least, popular half-truths.  And they aren’t your garden-variety myths because people who favor the free market tend to say them all the time.  I’ve said them myself, because they do contain more than a grain of truth.

“There ain’t no such thing as a free lunch” (or TANSTAAFL) means that, with a limited budget, choosing one thing means sacrificing something else.  Scarcity entails tradeoffs.  It also implies that efficiency means using any resource so that no other use will give a higher reward for the risk involved.

That saving is necessary for rising labor productivity and prosperity also contains an economic truth.  No less an authority than the great Austrian economist Ludwig von Mises has stated this many times.  In an article published in The Freeman in 1981, for example, he said:

The fact that the standard of living of the average American worker is incomparably more satisfactory than that of the average [Indian] worker, that in the United States hours of work are shorter and children sent to school and not to the factories, is not an achievement of the government and the laws of the country. It is the outcome of the fact that the capital invested per head of the employees is much greater than in India and that consequently the marginal productivity of labor is much higher.

The Catalyst

But the statement is true in much the same way that saying breathable air is necessary for economic development is true.  Saving and rising capital accumulation per head do accompany significant economic development, and if we expect it to continue, people need to keep doing those activities.  But they are not the source–the catalyst, if you will–of the prosperity most of the world has seen in the past 200 years.

What am I talking about?  Deirdre McCloskey tells us in her 2010 book, Bourgeois Dignity: Why Economics Can’t Explain the World:

Two centuries ago the world’s economy stood at the present level of Bangladesh. . . .  In 1800 the average human consumed and expected her children and grandchildren and great-grandchildren to go on consuming a mere $3 a day, give or take a dollar or two [in today’s dollars]. . . .

By contrast, if you live nowadays in a thoroughly bourgeois country such as Japan or France you probably spend about $100 a day.  One hundred dollars as against three: such is the magnitude of modern economic growth.

(Hans Rosling illustrates this brilliantly in this viral video.)

That is unprecedented, historic, even miraculous growth, especially when you consider that $3 (or less) a day per person has been the norm for most of human history.  What is the sine qua non of explosive economic development and accelerating material prosperity?  What was missing for millennia that prevented the unbelievable takeoff that began about 200 years ago?

A More Complete Story

Economics teaches us the importance of TANSTAAFL and capital investment.  Again, the trouble is they are not the whole truth.

As I’ve written before, however, there is such a thing as a free lunch, and I don’t want to repeat that argument in its entirety.  The basic idea is that what Israel M. Kirzner calls “the driving force of the market” is entrepreneurship.  Entrepreneurship goes beyond working within a budget–it’s the discovery of novel opportunities that increase the wealth and raises the budgets of everyone in society, much as the late Steve Jobs or Thomas Edison or Madam C.J. Walker (probably the first African-American millionaire) did.  Yes, those innovators needed saving and capital investment by someone–most innovators were debtors at first–but note: Those savings could have been and were invested in less productive investments before these guys came along.

As McCloskey, as well as Rosenberg and Birdzell, have argued, it isn’t saving, capital investment per se, and certainly not colonialism, income inequality, capitalist exploitation, or even hard work that is responsible for the tremendous rise in economic development, especially since 1800.

It is innovation.

And, McCloskey adds, it is crucially the ideas and words that we use to think and talk about the people who innovate–the chance takers, the rebels, the individualists, the game changers–and that reflect a respect for and acceptance of the very concept of progress.  Innovation blasts the doors off budget constraints and swamps current rates of savings.

Doom to the Old Ways

Innovation can also spell doom to the old ways of doing things and, in the short run at least, create hardship for the people wedded to them.  Not everyone unambiguously gains from innovation at first, but in time we all do, though not at the same rate.

So for McCloskey, “The leading ideas were two: that the liberty to hope was a good idea and that a faithful economic life should give dignity and even honor to ordinary people. . . .”

There’s a lot in this assertion that I’ll need to think through.  But I do accept the idea that innovation, however it arises, trumps efficiency and it trumps mere savings.  Innovation discovers free lunches; it dramatically reduces scarcity.

Indeed, innovation is perhaps what enables the market economy to stay ahead of, for the time being at least, the interventionist shackles that increasingly hamper it.  You want to regulate landline telephones?  I’ll invent the mobile phone!  You make mail delivery a legal monopoly?  I’ll invent email!  You want to impose fixed-rail transport on our cities?  I’ll invent the driverless car!

These aren’t myths. They’re reality.

Sanford Ikeda is an associate professor of economics at Purchase College, SUNY, and the author of The Dynamics of the Mixed Economy: Toward a Theory of Interventionism.

This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.

Ice and Economics – Article by David J. Hebert

Ice and Economics – Article by David J. Hebert

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David J. Hebert
July 21, 2012
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What can ice teach us about economics? We’ll see, but let’s begin with some fundamentals.

Prices, property rights, and profit (and loss) lead to information, incentives, and innovation. This simple statement contains nearly every lesson necessary for a free and prosperous society. But what do these words mean?

Prices convey information about relative scarcities and communicate to us the relative value of competing uses of a resource. They also economize on the acquisition of knowledge. When we see the price of a resource rise, market actors understand the need to use less of the resource. What they don’t know, however, is whether this rise is due to a disaster that destroyed some of the stock of that resource (an inward supply shift) or if a new, more valuable use for that resource has been discovered (an outward demand shift). These facts are irrelevant for a person who is currently using the resource, but from a societal level, her using less is necessary. If there is a disaster, we would want people to use less of it so that everyone else can still use some. If there is a new, more valuable use discovered, we would want the original users to use less so that more could be allocated towards this new use.

The Right to Exclude

Property rights refers not only to the right to use a resource, but also to the right to exclude others from its use. In this sense property rights provide the incentive to allocate the use of a resource efficiently across time, for example, to conserve it for later. With firmly established and enforced property rights, not only does the owner not have to worry about someone else taking his things but he also doesn’t have to rush out to gather the resources as quickly as he can. A situation where there are no property rights is susceptible to what is called the “tragedy of the commons,” where the resource gets depleted too quickly and never has a chance to replenish.

Profit (and loss) leads to innovation. Earning a profit is akin to being rewarded for doing something good. Suffering a loss is the opposite, a punishment for doing something wrong. In this case, the deed being done is the attempt to allocate scarce resources to where their will earn their highest return. People who successfully do this are rewarded with monetary gain, which we call “profit.” People who fail to do this experience what we call “loss.” In doing so, economic actors learn what works and what does not. Reducing the profitability of an activity through taxes or legislation or sheltering people from losses, therefore, acts to retard this learning process and stifles innovation.

This lesson is exemplified in early nineteenth-century Boston with the rise of the American natural ice trade. In 1806 Frederic Tudor sailed a ship full of ice from Boston to the Bahamas. Two years earlier Tudor had begun experimenting with insulation with the goal of bringing ice to the Bahamas.  When he was ready to set sail, he found that the ship captains refused to carry his cargo for fear of damaging their vessels. So he bought his own brig, the Favorite, and set sail February 10, 1806. He arrived in Martinique with a large quantity of ice still intact and began selling. The Bahamians loved the ice, which they had never seen before. Yet that first year Tudor lost a substantial sum of money, although he proved that ice could be shipped to the Bahamas. Now the objective became doing it at a profit.  Convinced his idea would be wildly successful, he continued his attempts to drive down costs and increase demand.

Higher Return

Meanwhile, as the price of the ice on the ponds rose, the people of Boston gained the information that the ice would bring a higher return in the Bahamas, thus they used less themselves and sold the ice to the Bahamians. In 1840 the ponds in the Boston area were explicitly divided, giving each person on the lake the right to exclude everyone else from harvesting any ice that wasn’t theirs. This allowed Tudor, for example, to invest in his ice and let it freeze longer so that it could better survive the long journey from Boston to India, which entailed crossing the equator twice and sailing around the tip of Africa. As Tudor earned profit from his venture, more people were attracted to the ice.

To continue to earn a profit, therefore, he had to find a way to outcompete everyone else. In 1825 Tudor enlisted the help of Nathaniel Wyeth, one of his suppliers. Tudor noticed that Wyeth’s ice was always significantly cheaper than everyone else’s and was cut in neater blocks which packed more easily. Wyeth had converted some old farm plows into ice-cutting plows and had fastened horseshoes with spikes to allow horses to pull these modified plows across the ice. By scoring the ice in such a fashion, Wyeth could break uniform sized blocks much quicker than his competitors, who were using hand saws that produced very rough and uneven edges.

These wouldn’t be the only contributions of Wyeth, as he went on to invent many other cost saving techniques. For example, Wyeth developed a conveyor-belt system that would haul the ice from the pond into the waiting icehouse.  He also invented bigger plows that could cut more blocks at once and poles that were used to guide the floating ice blocks onto the conveyor belt;  refined the above-ground icehouse, which allowed ice to be stored anywhere in the world for months on end without any external source of refrigeration.

New Insulation

Tudor and Wyeth also experimented with new means of insulating the ice from the heat, discovering that sawdust was not only a fantastic insulator but was also cheaply available from the sawmills around Boston. They also taught their customers new ways to use the ice, including making ice cream and storing the ice in iceboxes to preserve foods longer.

In short the three Ps lead to the three Is: Prices, property rights, and profit (and loss) lead to information, incentives, and innovation.  With these firmly in place, a free and prosperous society will follow.

David Hebert is a Ph.D. Fellow at the Mercatus Center at George Mason University.

This article was originally published by The Foundation for Economic Education.