Historical Myths

I am sceptical about the assertions made in this column by Casey Mulligan generally, but I came across an inaccurate historical statement that is a particular pet peeve of mine.

Professor Deaton explains how “the emperors of China, worried about threats to their power from merchants, banned oceangoing voyages in 1430."

This is inaccurate and completely mangles the impact of merchants and sea power in Imperial China. First of all, we need only look at Wikipedia to see that oceangoing voyages were banned prior to Zheng He's voyages by the founder of the Ming dynasty, the Hongwu emperor. This ban obviously wasn't a huge barrier and Chinese ships continued to dominate international trade in the period after 1430.

Second of all, merchants had at worst mixed effects on the emperors power, and probably increased it. Active emperors, such as the Yongle emperor, saw their power increased by these expeditions and tended to support them (the Hongwu emperor opposed them for rather idiosyncratic reasons, it wasn't the only policy he would bequeath on his successors that would weaken the Empire).

The major reason for the ban resulted from the Emperor's need for continued support from the scholar-gentry. Concessions to the scholar gentry largely reflected a decline in the Emperor's power not an increase in it. Ocean going voyages, such as Zheng He's, represented an increase in the power of the eunuchs within the Imperial bureaucracy and thus an increase in centralized power and the influence of the Emperor. Restrictions on ocean trade resulted from disputes within the Imperial bureaucracy and a win for the decentralized, local power of the scholar gentry against the government.

In order to be complete I should mention that another major reason for the restrictions on ocean going trade was a desire for the government to supply its northern and western garrisons. There was a belief (not necessarily incorrect) that merchants would be unwilling to engage in the relatively less profitable trade to these areas without a combination of restrictions and incentives to get merchants to trade there. This alternative was embarked on because the Ming government had a very laissez faire attitude towards internal commerce (this did not extend in any way to international commerce). The government was unwilling to raise taxes sufficiently to cover the cost of supplying these garrisons directly so instead resorted to a kludge to get the private sector to fulfill needs that would otherwise go unmet (it strongly resembles a lot of public-private partnerships that the US uses, our health care policy being a great example).

This was driven by a perception by Chinese officials that the north and west represented the greatest threats to the empire and not the overseas frontier. It also should be added this perception was entirely accurate, the empire would be extinguished by the Manchu to the north. The Manchu in turn learned this lessen and continued land centric policies to protect themselves. Eventually, of course, the maritime focus of Europe would prove more dynamic but you can't get that far if horse nomads come and kill all the rich merchants.

Ok, I went a bit deeper into the particulars of the situation than I probably needed to. But the perpetuation of this historical myths are a pet peeve. Conservatives are always telling these mostly made up tales of how the government is opposed to private wealth. This is rarely the case, most of the time governments are aided by and support commercial expansion. It is non-governmental elites that generally oppose the entrance of new power centers and cut off commercial expansion. They are often able to use the government to do this but this is a result of threats of non-cooperation or outright opposition that causes government officials to cave against their better judgements. If you actually read about the governments and the disputes occurring within them the most common case is that they regard commercial expansion and merchants as sources of power and not a threat. It is other factions that regard the rise of the commercial classes with distrust because they (accurately) see the rise of the commercial class as presenting the government with a way to free itself from their dominance. But this isn't a story that most Conservatives like, so instead we hear a constant mangling of a rather more complicated history to present a story of governments opposing markets, even if in most cases governments supported and extended them.

Meritocracy? Make me laugh.

I loved Delong's comments on Piketty's "Capitalism in the 21st Century."  Read the whole thing.

Full passage I lifted the title from:

Third, meritocracy? Make me laugh. In my view meritocracy does not produce inequality. Rather, true equality of opportunity produces relatively small income differentials because there is always somebody almost as good eager to bid for your high-paid job. Inequality emerges either (i) when this generation's human capital is last generation's wealth, or (ii) when other non-meritocratic factors are creating jobs that are the equivalent of covering yourself with glue, standing outside at a corner in Canary Wharf, and watching the money stick to you as it blows by.

It's surprising to me that these observations aren't more obvious to people. But there is a lot of wealth (and egos) with a strong interest in obfuscating this.

[Update: I would propose a partial solution. Allow companies to free themselves from ownership eliminating most safe investments and forcing holders of wealth to fulfill a socially useful function of investing in risky startups and financing capital investment through bonds. In the long term this would take most capital out of the hands of individuals and put it in organizations while making capital relatively cheap for new start ups. Unlikely, I admit.]

Wealth Creation and Competition

Being fatigued from moving does not good blogging make.

What I was trying to get at in my earlier post is why is it that the right figures some people should be compensated based on the wealth they create while others should be compensated based on supply and demand? A great deal of inequality is being driven by norms which dictate which frame should be applied to which workers. If one frame or the other were used universally a great deal of inequality would disappear.

Income Inequality and the Question of What Creates Value

For all that they talk about free markets you'd think that the right wing would have a good grasp of how they work and their implications. However, almost everything I read from the right wing seems to imagine an agrarian economy in the early phases of marketization.

Today's example comes from Kevin Williamson at the National Review. He asserts that:

Incomes are going up at the top and stagnating or declining at the middle and lower end of the spectrum, but — and this is critical to understanding our challenge — the high incomes at the top do not cause the lower incomes at the bottom, nor vice versa. There is no such thing as “national income” or “income distribution.” There is no bucket labeled income the contents of which are ladled out by the government or by the statistical aggregation we call “the economy.” If people at the top made less money, that would not free up money for everybody else.

This is fair enough as an assertion, I'm not convinced but it's plausible. However, he contradicts this view just a paragraph down. Contrast:

The integration of global markets means that returns to successful entrepreneurship, managerial excellence (real or perceived), sought-after skills, etc., are very high and growing. Imagine the case of the CEO of a business worth $1 million: If through administrative skill or innovation* he adds 50 percent to the value to the business, he has created $500,000 in new wealth. Now consider the case of the CEO of a business worth $400 billion, as ExxonMobil is. If a CEO through administrative skill or innovation adds a mere 0.5 percent to the value of the enterprise, he has created $2 billion in new wealth. Scale matters: To be the third-largest car dealer in Muleshoe, Texas, is one thing; to be the third-largest car dealer in Houston is another; to be the third-largest car dealer in Texas or the United States still another, and to be the third-largest one in the world quite another thing. 

With:

Nutella creates jobs in high-wage and low-wage countries alike, and it even manufactures in high-wage countries such as Canada and Germany, in part to be close to its final customers. But if you work in the back office of a bank, it does not much matter where you are — your product doesn’t spoil, doesn’t require shipping, and doesn’t have to be physically in hand to be consumed. If you work in a job like that, you are now in much more direct competition with a very large market full of relatively low-wage overseas competitors than were Americans during the short-lived golden age that persisted from the end of World War II to the turn of the century.

Did you notice how he shifted from value creation and scale for high wage workers to competition for low skill workers? Why are the two groups being treated differently? Why does scale justify high incomes for the wealthy but not for the not wealthy? Wouldn't it be just as possible for a firm to award all of its employees based on the value they create, adjust for the organization's scale, and not just those at the top?

The Problem is Ideology Not Interest Groups

David Brooks has a column today on how we need to strengthen executive authority. He draws this conclusion from a Francis Fukuyama article which argues that the checks and balances in US government have made the country ungovernable given current conditions.

I don't have much to say on Fukuyama's contribution, but I think the Brooks column is terrible. Small changes within the existing political framework to lessen interest groups' influence have a recent history of backfiring. Ending earmarks was supposed to allow legislators to see the bright light of reason and pass clean bills, instead it has allowed them to wallow in a fantasy world where the darkness of ideological purity has eclipsed reason's sun entirely. There is no reason to believe that the Executive is any more able to act purely than the legislative, simply more possibility of ideology blinding them to even the few rays of reason's light that used to filter through attached to interest group's grubby dollar bills.*

Interest groups were always a manageable problem, most of our great legislation was passed with compromises to industry which were relatively minor compared to the advantages of the bill. Far more tragic is that these bills can't pass at all.

The real problem is that much of our political class has been swept away into a sea of ideology which distances them from any connection to the real world. This ideological insanity is focused on the welfare state. There is simply no reasoning with people who believe that the welfare state creates dependency, who ignore our assets to argue that current liabilities are unmanageable, and that have been arguing since Goldwater that Social Security won't be around for our kids.

There is no evidence for these beliefs and it makes it impossible to compromise with since it positions the issues as a zero sum game. One side believes that strengthening the welfare state will strengthen us as a country, the other the opposite.

It's like trying to argue defense policy when the other side believes the biggest threat to our security is Skynet and the rise of the machines. How can you argue defense policy with someone that believes that mechanization is the greatest threat and that our military should go back to black powder to forestall this otherwise inevitable catastrophe? There is no compromise possible here, giving in to this insanity simply weakens us and anything we do to strengthen ourselves will be denounced as making the rise of the machines closer and more inevitable.

The dynamic created makes it impossible to acknowledge even legitimate concerns. The ideologically pure can gain credibility by pointing out flaws in existing programs. Those trying to defend those programs then lose credibility when they either propose reforms, which are denounced in turn for inevitable compromises and flaws, or defend the flawed programs. Since the ideologically pure never have to propose a positive vision, all they really want to do is tear things down, it is easy for them to raise their credibility with the public while the side that actually has to make policy inevitably loses it. Since we only have two programs that really work fairly well, Social Security (excepting SSDI which is an outdated mess) and Medicare A and B (C and D need significant reform), a strong credibility gap is inevitable.

But until the anti-welfare state ideology is put down we can't have real reform. We need a debate over what to do with unemployment insurance, the medical system, retirement planning (Social Security is inadequate and 401ks a complete failure),  anti-poverty programs (welfare reform turned out to be strongly pro-cyclical, though AFDC was terrible, and food stamps aren't really designed for the role they've taken as our primary anti-poverty assistance and fill this role poorly), disability insurance, and a host of other programs. But right now we can't have these discussions. One side gains political capital by attacking them, but then drones on about dependency which shuts off any adult-level conversation. Democrats can't acknowledge the very real flaws because once they do they make an opening to attack the programs. And they can't propose any reforms because that creates another opening.

So Brooks is way off target. What we need is for pundits like him to acknowledge the destructiveness, insanity, and detachment from reality of an ideology that proposes ideas like dependency and the makers and takers line. As long as these ideas remain powerful and current our country will continue to be a mess. This is a cultural war and men like Brooks are its soldiers. It will be won or we will decline based on their efforts and the use of the platform they were given.

So far things aren't looking good.

* I may be pushing the metaphor a bit far.

Signing Up for Obamacare was Fast and Easy

Just completed my application for health insurance. It was fast and easy. Didn't run into any lag or other problems. I ran into two very small user interface problems. First, when I tried to copy and paste my previous employer's phone number into the employer phone number box it cut off a digit. Easily fixed by manual input. Second, at the end of the application it gives a message that I will need to pay the first month's premium for the policy to go into effect and that the insurer will contact me for this. Below this my information is summarized and below that is a big green button that says PAY FOR HEALTH PLAN. This button does nothing, probably because of the information given above it. Not a problem, but rather silly.

Not sure how the back end of the site is running, I'll update when I get information from Humana.*

Where the National Review Obligingly Decides to Sound Like the Bad Businessperson I Mentioned in Yesterday's Post

I had been waiting some time to write about how the Republican Party increasingly sounds like the party of bad business. The article I hooked the post on was somewhat tangential, today, however, the National Review has excellent timing in sounding exactly like the fool I was wanting to write about in a post on the minimum wage.

A number of academic studies purport to show that a higher minimum wage has little or no effect on unemployment. That may be true in certain narrow short-term circumstances; for it to be broadly true in the long run, the facts of supply and demand would have to be other than what they are. In fact, a higher minimum wage is a barrier to employment for the young, the lightly skilled, and those who are not currently in the work force but wish to be, a wish that can be desperate indeed for those who have long been unemployed.

Here's a classic bad management approach. Real studies show something other than what I want so instead I'm going to assert my opinion and call it fact. Case closed.

The scary thing is that I've come across this now and then in the real world. People really do think this way. Obviously, real labor markets do not function this way. Wages are set with a combination of bargaining power and the value of the product of labor.* Raising the minimum wage will shift the distribution of income increasing investment opportunities for producers of goods purchased by low wage workers. This in turn will increase investment in these communities, spur entrepreneurship to meet demand that is now backed by currency,** and create net jobs for this sector. Individual firms may find it harder to deal with the higher wages but the systemic effect will be a net increase.

An even more incredibly stupid assertion follow a few paragraphs down.

There is a way to increase wages while increasing overall employment, and that is to raise the demand for labor. Unfortunately for the planners and schemers in Washington, doing so requires more than simply passing a law. Higher demand for labor is the result of a growing and productive economy, which requires substantial capital investment, innovation, entrepreneurship, and — worst of all from the White House’s perspective — time. If Toyota should decide to add another factory to its U.S. operations, it will not be built overnight.

 When I read this I had the immediate image of a fat, cigar chomping guy sitting in a smoky country club paying cards. Well it's unfortunate that you have to starve but you see fixing things take time, you see.

This is bullshit. Capacity utilization is still well below historical capacity utilization and well below peak. (http://www.federalreserve.gov/releases/g17/current/) The industrial plant necessary for new jobs is already there sitting idle. What we lack is people with money to buy the goods this plant could produce, this just sounds more absurd and out of touch from a magazine that opposed the auto bailout and should be well aware of how many plants were shuttered just a few years ago. What does the National Review think happened to all these shut down plants? Did they get up and walk to Canada?

Then there's the standard blather about education etc. with a bunch of sniping at the Democrats over their opposition to policies without great track records. Go ahead and read the whole thing, it's worth a laugh if nothing else.

What really stand out to me, however, is that this sounds really out of touch with how modern companies do business. While there are far too many poorly run businesses that still treat labor as an expense to be aggressively cut, growing, successful business are realizing that their workforce is an asset to be invested in. A nudge, like a minimum wage increase, that will force recalcitrant business owners to review their wage practices and to really grapple with costs like turnover and efficiency gains from long term employees will probably increase the competitiveness of American businesses.

Other companies realize the systemic nature of these changes. Walmart is a great example.*** While they receive a great deal of deserved scorn for their anti-union stance they are on record as supporting a national minimum wage increase. Interestingly, they are also on record as opposing minimum wage increases at the municipal and state levels.

This isn't as contradictory as it seems to the bad business thinkers over at National Review. Walmart stores have very large catchment areas, they would be strongly negatively impacted relative to retailers located in a lower wage areas or those with smaller catchment areas which do not have to compete across jurisdictions with different minimum wage regulations. However, with a national minimum wage increase these discrepancies causing localized disadvantages won't exist. Everyone will be on an even playing field. And with its unmatched supply chain efficiency Walmart can probably generate an even greater cost advantage in a higher wage environment.

Of course, systems thinking is impossible for those with the strongly individualistic bent of the writers and editors at the National Review. However, it is the norm in large, efficient business like Walmart. This is why companies like Walmart are crushing the small and medium business owners that make up the most ideological committed portion of the right wing, people that thrive in big organizations must think and act on this level to survive while most of the managers and owners at these organizations remain committed to the idea that it is individual merit that matters and act on this assumption, both in their business decisions and in how they treat their employees. With predictable results.

Angry Bear on Food Stamps and Dependency

Since dependency is the false belief that causes more damage to the American polity than anything else I can think of (with the possible exception of climate change, but the negative effects of a belief in dependency are a threat here and now while climate change is a future threat), I feel the need to link to another Angry Bear post commenting on a paper examining the impact of food stamps on health and use of government programs later in life. Like other research on the subject, it confirms that receipt of government benefits increases self-sufficiency later in life. As I've stated many times, the actual research points in the opposite direction that hacks like Paul Ryan claim. False ideological claims, like the dependency hypothesis, are doing untold damage to our Republic.

Anrgy Bear on Cooperatives

Since I just wrote about something similar, I thought it worth linking to an Angry Bear post on cooperatives. I haven't had time to watch the video but it provides a bit more information on their importance (including Mondragon).

The only thing I have to add is that I am skeptical how much room there is for the growth of cooperatives given the extreme levels of wage inequality in the US. As I stated, I believe a system that alters manager's incentives so that they use profits to achieve the same goal would gain more traction given current economic realities. I admit, however, that worker cooperatives have more intuitive appeal and would more directly address extreme levels of executive compensation which my thoughts do not.

Republicans are Increasingly Becoming the Party of Bad Business

The New York Times today had an article on how many big businesses are planning for future carbon pricing and are even embracing this change. As they say this represents "a striking departure from conservative orthodoxy and a reflection of growing divisions between the Republican Party and its business supporters."

I believe this trend represents a deeper, partially generational, shift in business culture. The old culture, which remains the culture of many in senior management, was the highly individualistic, greedy, heroic type of businessperson featured in films such as Wall Street or as the hero of Ayn Rand novels. Modern business culture, by contrast, is highly collectivist in nature, group projects, participatory management, and systems thinking are modern best practices. In an article by Deming, for instance, he claimed that over 90% of faults are caused by the system and are management's responsibility.

However, while America's best performing companies embrace these new concepts, and have profits to show for it, old styles of thinking are far more common. Surveys indicate that the vast majority of businesses are badly managed, only the largest international firms are majority well managed. Surveys of investment decisions indicate that around 30% use gut feeling for investment decisions and another large proportion use primitive methods like pay back periods.

These types of attitudes match up perfectly with a lot of what I hear from the right. On a number of issues, like climate change referenced in the NY Times article, we hear of skepticism of modern science which matches well with the skepticism we see in many (mostly smaller) businesses of modern statistical methods and the focus on process. The right wing is constantly talking about individual initiative and attributing success or failure to individual traits, this is also perfectly congruent with the divide in best business practices between the modern systems approach and the old methods which relied strongly on individual performance reviews and attributing success/failure to individual traits while ignoring process.

 In short, the ideological right increasingly looks like the terrible business manager who never wrapped his head around the modern focus on the customer, emphasis on value creation, statistical methods,** or systems focus. Instead, they want to somehow bring back the days when business was done with a handshake, personal relations mattered more than credentials,*** and hard work**** led to profit.  They see this as how the competitive, free market is supposed to work. They haven't come to terms with the fact that the reason they are struggling is that today they face real competition and are feeling the true sting of the free market, the old system they thrived in was one of privilege and security.

This results in the stereotypical right winger being rather like a bad manager. They have no idea how to build a system that adds value, all they know how to do is to try to cut wages, bid low, or pressure suppliers to drive down costs. The idea of value chain focus, participatory management, flat organizations, and a systems focus is anathema to how they run business and how they see government. They just don't get it. Furthermore, these people are angry and frustrated. They are the small and mid sized businesses that used to be sheltered from competition with the big guys. Now the big players are moving into even the smallest towns bringing these folks directly into competition with the market forces they pay lip service to buy never felt until now.

The rift between these small and medium business owners and large corporations is becoming increasingly stark. To succeed against international competition big business long ago adopted more inclusive and collectivist methods. This is leading to a growing cultural rift between the traditional supporters of the Republican Party and the new business elite who thinks very differently. It will be interesting to see how it plays out, but it is shocking to me how different the values and teachings of business school diverge from current right wing ideology.*****

Shareholders are Non-Value Added

I never thought studying for an MBA would turn me into a socialist but that's exactly what it has done. I'm impressed with how most fields of business focus on the customer and on treating employees as an asset, and even more by the focus on the system, rather than individuals, as the source of a company's problems. Deming's 14 points in particular strike me as a good way to run anything.

However, as one of my professors has said regularly most companies are badly managed (and some research has backed up his statements) and we will be spending most of our careers pointing out common sense. Most owners and managers remain bound up in cognitive biases, fundamental attribution error appears to be particularly rife in business types.*

Yet, our system has developed a broad set of institutions that serves to increase the power of owners and managers at the expense of other stakeholders. Companies should be focused on their primary stakeholders, employees and customers, but instead they are beholden to their owners who are continuously draining off funds that could be more productively put to use by the company or distributed to the employees who contributed to the company's success and have a far more direct stake in a company's mission than its owners do. The one field taught in my MBA program that diverges from the focus on customer and employees is finance, which explicitly endorses the purpose of the firm as maximizing the current value of the firm's stock.

This results in the most important institutions in our society, private corporations, having a goal that is often at odds with the health and wealth of society as a whole. Companies focused on their customers and employees will have interests that line up very naturally with those of society as a whole, this is far less likely with owners. The malaise effecting America, and much of the rest of the world, has at least some of its origins in the fact that the conflict between owners objectives and companies' missions was decided in favor of the owners; with predictable impacts on corporate success and on income inequality.

Reforming this doesn't seem overly difficult, though it is in direct conflict with the increase in shareholder power which has been occurring since the 1980s as a result of the Friedman doctrine.** All that is really necessary is to change the rules governing corporations so that firms can purchase themselves through stock buybacks. As it stands, buybacks do nothing but concentrate ownership, but there is no good reason the stock should become inactive. A cultural change is also necessary, we are biased in believing companies should be owned, but there is no real need for a company to be owned by anyone.

Rules for composing corporate boards of unowned companies would have to be drafted, but this should be easy enough since their primary stakeholders, customers and employees, are readily identifiable. Boards composed this way would result in companies that have their interests aligned with society as a whole, and incidentally matching up with modern business best practices of having a focus on the customer and on their own personnel. This would also resolve the conflict between stockholders and other stakeholders how it should have been resolved decades ago, in favor of the other stakeholders.

None of this is to say that capital should be shut out. Capital does add value, where I find it problematic is in mature companies where the stock price has become disassociated from any need to raise further capital. Where capital plays a role is in financing start ups and long term projects. The life cycle I imagine is one where venture capitalists and other investors primarily play a role in the early phases of corporate growth. As a company matures it returns the initial investment to stockholders through the form of share buybacks, eventually getting a 51% stake and freeing itself from outside ownership. Provided this becomes an explicit corporate goal it should be easily achieved.

While this is a utopian pipe dream, it's unlikely for cultural and not institutional reasons. For whatever reason Americans have powerful beliefs about ownership and don't seem to be able to shake out of these beliefs even when performance is lackluster. Institutionally, we know that finances tend to shift powerfully in response to even small relative incentives. To achieve corporate independence on a national scale all that would be necessary would be a fairly small tax advantage to encourage firms to compensate their investors through share buy backs rather than through dividends and other means. Most investors are fairly neutral in the form their returns take so provided they don't object on cultural and ideological grounds (which is likely) it shouldn't be difficult for firms to free themselves of the tyranny of ownership.

Unfortunately, other than a very small movement in favor of employee owned firms*** I haven't heard much on this subject. However, like Deming, I believe that systems matter and that systems are responsible for the majority of faults in any organization. Treating the world economic system as this kind of organization I believe that 3rd party ownership is one of the fatal flaws at the heart of many of our social problems. Ending this problem wouldn't be difficult but it would take a revolution in how we think about our economic system. Perhaps momentum will build, this is perfectly congruent with everything I have been reading outside of finance texts with modern business thinking.

[Lest it need be added, while I think freeing firms from ownership is clearly socialistic I see even more problems with state ownership than I do with ownership by investors. Organizations function best when they are independent, while this is a socialist program the state has no role other than in changing institutions to allow for this. I'm going on a tangent but I am very frustrated at how often socialism is confused with the state when the state has nothing to do with socialism in theory or often in practice.]