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Thursday, October 25, 2007

It's the uncertainty, stupid!

Economic progress is about adapting to changing circumstances. While an individual or entity may try to act purposefully in pursuit of a defined goal, the unknowable future and not entirely known present leaves us grappling with substantial uncertainty. Freedom to take a trial and error approach across a wide array of opportunities is probably more important than any notion of efficiency.

This idea was at the heart of the Innovation and Adaptation post in which was included:

Mancur Olson addresses uncertainty, innovation, adaptation and institutions in the conclusion of his final book, Power and Prosperity:
Because uncertainties are so pervasive and unfathomable, the most dynamic and prosperous societies are those that try many, many different things. They are societies with countless thousands of entrepreneurs who have relatively good access to credit and venture capital. There is no way that a society can predict the future, but if it has a wide enough array of mutually advantageous transactions, including those for credit and venture capital, it can cover a lot of the options - more than any single person or agency could ever think of.

At least when a society has the appropriate institutions and government policies, the overwhelming majority of the firms that make huge profits are doing a huge service to the population. In a society with the right institutions and public policies, the prevailing prices will approximate the true values and costs of marginal quantities of the goods and productive inputs. A great excess of revenues over costs means that the enterprise is almost certainly putting more value into the society than it is taking out.

Economist Israel Kirzner discusses the vital role of the entrepreneur in coping with uncertainty and the problem this creates for most conventional economic thought which takes key factors as "givens" rather than outcomes of a discovery process.

Duke University Economist Mike Munger explains why a broader range of innovations will be created and the benefit of that can be realized if rules and institutions favor private enterprise most of the time in public vs private choice.

In the 1970s, even most of the non-socialist world wondered whether any system of private, decentralized innovation and development could stand up to the planning and market direction of the Japanese juggernaut. Central planning, whether of the socialist (U.S.S.R) or corporatist (Japan, Sweden) flavors, seemed to many to be the more powerful economic engine.

How times have changed! Nobody (well, nobody outside of college English departments) still believes that socialism outperforms markets, of course. And Japan has gone into the same muddy tank that Sweden has wallowed in for years. Even Alfred Kahn, Jimmy Carter's inflation guru, said by the end of the '70s that we should "Cast a skeptical eye on glib references to the alleged success of government interventions in other countries in picking and supporting industrial winners."

But we still face the same basic problem. The boundary we fight over today divides what is decided collectively for all of us from what is decided by each of us. You might think of it as a property line, dividing what is mine from what is ours. And all along that property line is a contested frontier in a war of ideas and rhetoric.

For political decisions, "good" simply means what most people think is good, and everyone has to accept the same thing. In markets, the good is decided by individuals, and we each get what we choose. This matters more than you might think.

On many kinds of policy, where one unique alternative must be selected from among many, and the legitimacy of that choice is at least as important as the choice itself, democracy has no equal. One defense budget, one speed limit on any one stretch of road, one standard width for railways, and one choice (left side or right side?) for driving automobiles.

But many choices aren't like that. There may not be a "we" that has to choose at all, imposing the median view on everyone. Instead, individuals can make their own choices. This is particularly true for innovations, or new ideas cooked up by some oddball. Some (in fact, most) of those ideas will fail, but we can't tell the winners from the losers in advance. The most significant innovations and advances in human history have been the result of the efforts of men and women too determined, or maybe just too strange and isolated, to know that the whole world was betting against them.

And that brings me to my final two points, the really key points I want the reader to take away from this essay. The first one is this: The conventional wisdom rejects innovation, and is usually right; that's why it's conventional. But the reason Median Joe is right to be skeptical is that most innovations are just balloon juice.

Still, a pessimist would then point out (and be right!) the flip side: the conventional wisdom is nearly always wrong, at least at first, about innovations that work. If you always say no, you do turn down all the bad ideas, but you turn down all the good ideas as well. Only if the innovation gets its chance, probably to fail but possibly to succeed, on its own merits and unconstrained by the views of Median Joe, will we find out what works and what doesn't.

Second, and no less important, this problem, this choice between collective and individual judgments, is at least as vital today as it was when Khrushchev was threatening burial, or Honda was nearly getting run off the road, or even when the two Steves were noodling in their garage. True, no one wants to return to a Soviet system, or an industrial policy with an agency of experts who make national investment decisions. But we still face the same basic problem: can I decide, and risk just my money, for great reward if I'm right? Or will we decide, and risk our whole future budget, on things we aren't very good at deciding?

We have become too accepting of the views of the middle, in too many aspects of our lives. Worse, we have fallen victim to a soft but encroaching political paternalism. In many cases, it isn't even the median citizen who enforces his views on everyone. Instead, special interests and "public" lobbyists dominate the making of rules and decisions that force all of us to act as if we all had the same views on risk, taste, and service.

The thing to keep in mind is that market processes, working through diverse private choice and individual responsibility, are a social choice process at least as powerful as voting. And markets are often more accurate in delivering not just satisfaction, but safety. We simply don't recognize the power of the market's commands on our behalf. As Ludwig von Mises famously said, in Liberty and Property, "The market process is a daily repeated plebiscite, and it ejects inevitably from the ranks of profitable people those who do not employ their property according to the orders given by the public."

Effective but limited government gives us the freedom to adapt and thrive. Some people still don't like this answer!

As an afterthought, here is a blog search of uncertainty.


Bret said...

"Nobody (well, nobody outside of college English departments) still believes that socialism outperforms markets, of course."

Nobody but English departments and apparently Harry Eagar!!! :-)

"Effective but limited government gives us the freedom to adapt and thrive. Some people still don't like this answer!"

That's because the word "adapt" implies change which to many, many people is easily the scariest word in the English language.

Howard said...

...the word "adapt" implies change which to many, many people is easily the scariest word in the English language.

Yes, I just remind myself that stagnation and decline is even scarier than forward looking change.

Bret said...

Since I'm a technology nerd, change is exciting. As a result, I don't even need to remind myself of stagnation and decline to be willing to adapt. I'm just saying that stagnation is probably not a dirty word in many people's vocabularies - unfortunately for me.