Do Not Pass Go. Do Not Collect $200.
April 09, 2010
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Stop me if you heard this one before: an economic report is released and economists are suprised. That only happens, oh, every week or so. This week it was rising jobless claims. Economists are surprised. This is a minor indescretion, like a meteorologist being off a few degrees on tomorrow's high temperature forecast. Sadly, this is as good as it gets for modern economists. All too often they miss Level 5 Hurricanes heading straight for the coastline. It makes us wonder whether we need an economics profession at all.
In this blog, I am going to attempt to explain that we need more economic inquiry while also showing why current mainstream economic thought is so dramatically flawed.
I'll Trade You St. Charles Place for Marvin Gardens
We all played the Monopoly game as children and many of us still play. It's a fun game of luck and strategy. But it's just that - a game. Unfortunately, for mainstream econ, Monopoly is representative of real life in all the wrong ways. What do I mean by this?
Let's say you land on the Red properties (Illinois, Indiana, Kentucky.) You purchase them, build them up with hotels, and start collecting rents. Your rival lucks into the Green properties with higher initial costs, but higher rents. All other things being equal, your chance of beating your rival is very low. He has an unbeatable competitive advantage.
This situation, very common in a board game, does not in any way represent real life. In real life, there are an infinite number of ways, limited only by your imagination, that you can reclaim a competitive advantage. Your hotels on the board are homogeneous. You can't do anything to make your Red property hotels more attractive to increase your rents. In real life, the only thing stopping you from differentiating your product is YOU.
Competition is the dynamic rivalrous process of discovery that coordinates the actions of market participants.
The above definition of competition was the standard one up until the 1920's/1930's.
First off, what does the definition say? It says that entrepreneurs engage in a process of discovery. That means they are going out and looking for ways to satisfy consumers. It says that this process is crucial and essential because it coordinates market participation, i.e winners make money and are rewarded for satisfying consumer wants and losers lose money because they failed at this task.
Notice that it doesn't say that entrepreneurs are always right.
It doesn't say that consumers know what they want or are omniscient.
It doesn't say that there is no luck involved.
The definition makes none of these assumptions. There can be luck. There can be genius. There can be stupidity. There can be any combination of the aforementioned attributes. All of these things come together, but in the end the final verdict is whether or not consumer wants are satisfied.
Entrepreneurship is an essential element of economics. Ignore it at your own peril, and that is exactly what modern econ has done, starting with the scientistic revolution that occured in the 1920's (circa).
We Can't Model Human Behavior So We Pretend It Doesn't Exist
So what happened? The physical sciences had been extremely successful in explaining the physical realities of our world. Their spectacular success made them somewhat the envy of the academic world. Academics is a rather thankless job. If your ideas do not translate into immediate, tangible results that common people can grasp, acclaim is rare. Despite what romantics tell you, scientists and academics, just like every other human on this planet, find praise to be flattering.
The success of the physical sciences led many academic economists to break away from theoretical ideas and attempt to copy/mimic the physical sciences. After 80 years, the results have been completely disastrous. The theoretical schools saw this coming. You can't model human behavior. Humans do not bounce around in jars like atoms, reacting exactly the same way to outside forces. Humans react differently, they think differently, and they are unique entities with their own beliefs, goals, motivations, etc.
Nowhere is the failure of modern econ more striking than in the areas of entrepreneurship, competition, and monopoly.
The Textbook Challenge
I want you to take up the following challenge: get a hold of a college level Econ textbook, flip to the index and look up the word entrepreneur. I bet you will find nothing more than a quick reference to its existence, perhaps a page or two. Some recent texts (mid 1990's and beyond) have started to reflect an inreased desire to understand entrepreneurship and may dedicate a whole subsection.
Modern scientistic econ modelers can not develop a model of entrepreneurship and so it was almost completely removed from modern economic thought. Does this sound like a good idea to you? To remove one of the most essential economic forces from the study of economics? Do you see now why modern econ is challenged to come up with explanations for market phenomenon?
This willful ignorance had a terrible effect on modern econ's view of competition. How does modern econ view competition? Well, a lot like that basic Monopoly game described above. Competition was replaced by Perfect Competition, a non-existent fairy tale that magically fits econ models.
Perfect Competition has a few different forms, but the main elements are as follows: many market participants producing homogenous goods at pretty much the same amount of profit with no cost for entry/exit in the market. If any of those elements are not present, competition is said to be monopolistic. Yeah, ok. That's realistic!
I Have A Monopoly on Being Awesome
Can you think of a market, not just today but since the beginning of market economies, that has ever fit the description above? There is none. Even if two companies produce the identical product, it's still not the same product as there are many ways that two companies can differentiate the product - through superior service, for example. If the customer's view of the two products differs in the slightest manner, then it's not the same product.
So Perfect Compeition is a ridiculous fantasy. It's a child's game like Monopoly. Yet, it is a foundation of modern econ, replacing the study of entrepreneurship and real market discovery.
What a shame. What a waste. This type of nonsense has been taught to college students for decades, most notably in Paul Samuelson's best selling econ textbook written in 1948 (Samuelson's book remained a best seller for over 30 years.)
Fun Fact: Samuelson was so enamored by the production numbers released in the USSR that he exclaimed one day they'd outproduce America! Samuelson, like his student Krugman, does not differentiate between production that is useful and that which is wasteful. With an economic model of perfect competition as his core theory of market participation, how could he?
Where Are We Going Next? Straight to Jail.
I have to stop here for now. This is the ground work for understanding an upcoming post on the folly of Antitrust regulation.
People need to understand the basic precepts of economics as easily as they understand long division. These concepts are not so difficult that they can't be taught to your children. We would do our families and future generations a great deal of good if we come to understand these concepts and pass them on. Failing to do so allows crackpots like Samuelson to infect entire generations of college students with nonsensical and worthless economic models built upon fallacies.
David in Qatar
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