Mises on Homo Economicus

Ludwig von Mises describes homo economicus as fictitious and hypothetical. It pictures a being driven exclusively by economic motives, i.e. solely by the intention of making the greatest possible material or monetary profit. The homo economicus image of classical economics is certainly not an ideal type, but it helped classical economists explain the formation of market prices.

However, the classical economists failed to provide a satisfactory theory of value that traced the phenomena of market exchange and production to their ultimate source, the behavior of consumers.

Source: Human Action, 3rd revised edition 62-64.

Economic Man and Parenting

The title of Beyond Self-Interest, edited by Jane Mansbridge, intrigued me enough to borrow it. One chapter by Virginia Held describes the mother/child relation as follows. I put parenting in the title because much of it applies to fathers, too.

1. To a large extent the relation is not voluntary, and for this reason among others, not contractual. Deciding to have children is voluntary, but the relation is not so after the child is born. The child certainly does not enter the relationship voluntarily.

2. The relations between mother and child are largely permanent and not replaceable.  The market makes of everything, even human labor and artistic expression and sexual desire, a commodity to be bought and sold, with one unit being replaceable by another of equivalent value. No child and no mothering person is to the other a mere replaceable commodity.

3. The relation between mothering parent and child provides insight into our ideas of equality. Equality is not equivalent to having equal legal rights.

4. The relation between mothering parent and child makes it clear that we do not fulfill our obligations by merely leaving people alone.

5. The relation between mothering parent and child provides an understanding of privacy very different than among adults.  In the former each party making demands on the other is the normal state. A mother is subject to the continual demands and needs of the child. A child is subject to the continual demands and expectations of parents and other authorities.

6. The mother-child relation provides an understanding of power different than something that can be wielded by one person over another. The mother seeks to empower the child to act responsibly and become independent.

Held contrasts this relation with that of “economic man”, or homo economicus, whose relations are voluntary and largely contractual. Concepts of rationality typically assume that human beings are independent, self-interested or mutually disinterested, but that it is rational for humans to enter into contractual relations with each other. To see contractual relations between self-interested or mutually disinterested individuals as constituting a paradigm of human relations is to take the idea of “economic man” as representative of humanity.

She doubts that morality should be based on any one type of human relation. She even wrote a book, Rights and Goods, to argue for moral approaches for different contexts and try to map out which approaches are suitable for different contexts.  The different contexts she names in the BSI chapter are law, economic activity, and the family. I agree that context matters, but will say no more since I have not read her book.

The Nature of the Firm #5

The Nature of the Firm says nothing about the make or buy decision in regard to computer software. However, I suspect it arises quite often in today’s world, and it did during my own work career. Both ways have their advantages and disadvantages.

The following observations are based on my work experience. Developing one’s own software gives maximum control, but it may be slower and cost more. Buying software from a vendor may be quicker and cheaper, but it provides less control. When the buyer later wants changes to the software – which is nearly always true in a workplace – the buyer is subject to the vendor’s and its other customers’ priorities, not merely its own.

On second thought, there is a third option, which I will call hire.  That is, hire a consulting firm or independent contractor that specializes in the kind of software needed.  This way seems to blend characteristics of make and buy. The hirer has a strong degree of control as long as the hired is under contract. Once the contract period is over, the situation for the hirer is much like having bought the software. That is, until the hirer wants changes, a very likely occurrence.  Then it’s probably hire again.  

Cleveland Celebrates

The Cleveland Cavaliers NBA Champs victory celebration parade is happening today in downtown Cleveland.  It’s pandemonium in the metro area. An estimated more than a million people are amassed downtown. The public transportation system is swamped. The outermost station of one commuter train line is at the airport. The airport parking lots are full due to people parking there to merely try to catch a train to get downtown. There are long lines of people waiting to board at every train station in the area, and many bus stops.

My wife and I went to the train station one stop from the airport towards downtown. The scene was much like described above. It might have been a good idea if we had attempted it about three hours earlier. We will experience it from home via television.  The local CBS station is providing live coverage, probably most of the day. 

The Nature of the Firm #4

What is the essence of a firm? The Nature of the Firm (NF) gives two views, one the “orthodox” view and the other of Ronald Coase.

The orthodox view is that firms are “repositories of productive knowledge” (NF 184). Like consumers, producing firms are unitary actors and are economically rational. They maximize profit or present value.  There are spot markets for inputs and outputs. Contractual arrangements and other supports for the firm’s business are implicitly assumed to be flawless and costless. The focus is on decisions made about resource allocation for production. It is about inputs and outputs and how they relate to the given technology, to each other, and to market forces (NF 180). The orthodox view recognizes both interfirm and intrafirm aspects. Markets offer answers to the interfirm aspect. The intrafirm aspect when addressed is subsumed by the role of the entrepreneur.

According to Ronald Coase a firm’s essence is the coordination of a team of inputs.  Such coordination is a result of both interfirm and intrafirm aspects, and Coase’s theory gives far more attention to the latter than the orthodox theory and tradeoffs between the two aspects. He emphasized the firm not as an owner of assets but the control and coordination of cooperating inputs. “[T]he economic question regarding institutional form involves a comparison of the costs of coordinating the activities of the factors of production within the firm with the costs of bringing about the same result by market transactions or by mean of operations undertaken within some other firm” (NF 220-21).

The Nature of the Firm #3

Market transactions can take many forms ranging from simple, one- time (“spot”) transactions to sequential transactions by the same parties to complex long-term contracts, including those between employers and employees. Contracts range from specific and complete to nonspecific and very incomplete, with different degrees of flexibility. Incomplete long-term contracts may be more attractive than sequential spot market trades, but such contracts require monitoring. Long-term contracts often include or permit different remedies if plans aren’t met or are modified.

Specific institutional arrangements emerge in response to various transactional considerations in order to minimize the cost of making transactions. The boundary between a firm and a market provides a rough distinction – make versus buy or lease – for resource utilization. (The Nature of the Firm, 119-122).

Sometimes a firm will utilize futures contracts to reduce risks from transactions for which price fluctuations or currency values are significant risks. An example of the former might be an oil refiner that hedges the price risk of buying crude oil and selling gasoline, aviation fuel, etc. The term crack spread – no, it has nothing to do with cocaine – describes a kind of contract used as a tool to hedge this kind of risk. An example of the latter would be an importer buying goods/commodities from a foreign supplier with the goods/commodities priced in the manufacturer’s country’s currency different than that of the buyer.  

The Nature of the Firm #2

The capital theory of Austrian school economists focuses on the elements of time and entrepreneurship. While I thought much of it was informative, I found trying to tie the Hayekian Triangle to reality (to specific examples) very difficult. In my experience, Austrian school economics says very little about the organization of firms (other than existence of the division of labor) and finance (other than by banks and governments).

This book shed light on some of the missing, mostly the former. Large and durable capital investment is not the only issue. Other issues are (1) whether large and durable capital investments are re-deployable or not, and (2) if not, the need for and ease of adapting to changing market and technological circumstances.

This has ramifications for a firm borrowing as well. If everything goes well, the lender will be paid principle and interest as scheduled. In the event of default, however, how much lenders can recover depends on the degree to which assets are re-deployable. In the extreme case, of course, equity holders get nothing and lenders get what it can, which may be much less value than the loan. Since the value of a preemptive claim by the lender(s) declines as the degree of assets specificity increases, the terms of debt financing is adjusted adversely.

This triggered my own thoughts about what makes good collateral for obtaining a loan. For example, if a car dealer borrows to buy new cars to add to its inventory, the new cars are excellent collateral. Selling them provides the money to repay the loan and interest. Also, if the car dealer defaults on the loan, the lender can gain possession of the cars and sell them.

A firm’s accounts receivable is even better collateral for getting a (short-term) loan. This is money owed the firm by its customers/clients that comes due soon, e.g. in 90 days or often much less. A firm might so borrow to obtain cash, like meeting its payroll.

The Nature of the Firm #1

I have been reading The Nature of the Firm edited by Oliver E. Williamson and Sidney G. Winter.  The book derives from a 1987 conference to commemorate the 50th anniversary of Ronald Coase’s 1937 article “The Nature of the Firm.” The book includes that article, three more by Coase, and eight more by others. There is a summary of Coase’s article on Wikipedia. Both Coase and Williamson won a Nobel Prize.

Coase’s 1937 article was pioneering for two reasons. First, it asked the make or buy question. Does a firm itself make something that’s needed on the way to offering its final product for sale or does the firm buy it in the marketplace? For example, does an auto maker buy parts from a supplier or make the parts itself?  Prior to 1937 economic theory focused on marketplace transactions and price theory. The theory assumed the direction of resources was directly dependent on the price mechanism. Also, the theory focused on one- time (“spot”) market transactions and overlooked the reality of a wide variety of kinds of contractual relationships, including recurring transactions. Second, the article also considered the internal structure of a firm. Businesses are organized in many ways – sole proprietors (with or without employees), partnerships, corporations (from one to millions of stockholders, from one to a few to many employees), mutual companies, franchises, joint ventures, etc.  There are various kinds of contracts, such as compensation for employees (set wages, bonuses, commissions, etc.). What determines how a firm is organized? Make or buy decisions and the varying nature of transactions and contracts are factors. 

Wages and Profits

On pages 478-9 of Capitalism George Reisman says that profits, not wages, are the primary form of income. He argues against the Marxist position, and even Adam Smith's, that profits are deducted from wages. "Thus, in the precapitalist economy imagined by Smith and Marx, all income recipients in the process of production are workers. But the incomes are not wages. They are, in fact, profits."

"In order for wages to exist in the production of commodities for sale, it is first necessary that there be capitalists. The emergence of capitalists does not bring into existence the phenomenen of profit. Profit exists prior to their emergence."

I would go further. Qua money, wages or net wages are profits to an employee even in a capitalist society. I will show this with algebra, all variables denoting money. Revenue - Costs = Profit is a standard formula for a business. For an employee, wages are revenues from selling one's labor. Hence: Wages - Costs = Revenue - Costs = Profit.  If Cost = 0, then Wages = Profit. Even if Cost > 0, Net Wages = Profit. Therefore, Revenue - Costs applies equally well to wages from the employee's perspective. (To an employer wages paid to others are costs, not revenue or income.) Therefore, by algebraic transitivity, qua money, and to the recipient, wages are profits!

The reader might object that wages aren't profits because Revenue - Costs = Profit applied to a business and to wages are different situations. I disagree qua money. 1 + 1 = 2 applied to coins versus toothpicks are different situations, but 1 + 1 = 2 in either case. Also, imagine a worker who switches from being self-employed (with zero employees) to working for an employer for wages, or vice-versa, doing the same kind of work in each case. Wages doesn't apply or fits poorly in the self-employed case. Yet in both cases the worker gets paid for the same kind of work performed. In effect wages are revenues and profits. The income from the customer in the self-employed cases is often more direct than for many employees, but I consider that a minor difference outweighed by there being income in both cases.