The Fatal Conceit #3

What is the fatal conceit that gives the book its title? I saw only two meanings clearly given:
             - The idea that the ability to acquire skills stems from reason (p. 21).

- That man is able to shape the world around him according to his wishes (p. 27).

The first exaggerates. While reason may help to acquire skill, perception and other interactions with the external world have huge roles. The second is true to a significant degree. Whenever humans make any machine or construct a building, they shape the world around them according to their wishes. 

On the other hand, the theme of the book is that some humans believe they can via government design and control a large society according to their wishes, achieving what they intend and without unintended consequences. This is the same theme Hayek expressed elsewhere without Bartley being an editor.

Content like this and that noted in my previous post add to my suspicion that Bartley had a heavy hand in the writing of The Fatal Conceit.

The Fatal Conceit #2

The section following Hayek’s saying that the morality of markets (or the extended order) is between instinct and reason is titled in part “the impossibility of observing the effects of our morality.” Therein it says:

- unintended consequences are paramount in the marketplace, and

- the distribution of resources is guided by an impersonal process that individuals acting for their own ends do not and cannot know what will be the net result of their interactions

- constructivist rationalism requires that the purposes and effects of a proposed action must be known in advance and be fully observable.

As I said in my previous post, it seems that Hayek created another, different false dichotomy – that reason has no role in the morality of markets. The first two points exaggerate ignorance and nearly obliterate actors using reason in markets. “Paramount” means more important than all other things. I don’t buy the notion that unintended consequences are more important than intended consequences.

Why is knowing the distribution of resources important? Individuals acting for their own ends do know something about the results of their interactions – such as on a production team or obtaining a job – despite their not knowing every consequence.

Economic theory usually assumes that humans make rational choices, .i.e. they use reason. Putting the morals of the market between instinct and reason is problematic in two ways. It equates reason with constructivist rationalism. It goes against a basic assumption of economic theory.

With regard to morals more specifically, is following the golden rule – negative or positive version – irrational or arational? Moreover, how is it possible to observe none of the effects?

The Fatal Conceit #1

I have been reading The Fatal Conceit by Friedrich Hayek. Perhaps that should be by Hayek and the editor W. W. Bartley. According to Wikipedia, there is much debate about how much was written by Bartley rather than Hayek. Here is a far more extensive article about the matter.

However much of it was written by Hayek, it repeats themes in Hayek’s other, earlier works. The spontaneous order of markets and constructivist rationalism are key themes. The other key theme seems to be captured on page 70 as follows.

“How then do morals arise? What is our ‘rational reconstruction’? We have already sketched it in the foregoing chapters. Apart from the constructivist contention that an adequate morality can be constructed afresh by reason, there are at least two other possible sources of morality. There is, first as we saw, the innate morality, so-called, of our instincts (solidarity, altruism, group decisions, and such like), the practices flowing from which are not sufficient to sustain our present extended order and its population.

Second, there is the evolved morality (savings, several property, honesty, and so on) that created and sustains the extended order. As we have already seen, this morality stands between instinct and reason, a position that has been obscured by the false dichotomy of instinct versus reason.

The extended order depends on this morality in the sense that it came into being through the fact that groups following its underlying rules increased in number and in wealth relative to other groups. The paradox of our extended order, and of the market, [is that it was and is more successful] than would be possible by a personally directed process.”

The morality of markets is thus the “middle ground” between instinct and reason obscured by the false dichotomy of instinct versus reason. It seems to me that Hayek in the process created another, different false dichotomy – that reason has no role in the morality of markets.  I will have more to say about this in my next post. 

On The Trader Principle

Ayn Rand wrote on page 31 (1964 Centennial Edition) of The Virtue of Selfishness: “The principle of trade is the only rational ethical principle for all human relationships, personal and social, private and public, spiritual and material.”

I think the trader principle is an excellent moral guide with wide application, but believe that her use of "only" and "all" overstate the case. In a typical trade each party provides the counter-party with something that can be called a cost to the said party. For example, I buy a new car from a dealer. The cost to me is the money I pay. The cost to the dealer is what he paid for the car plus some overhead.

I challenge her use of "only" and "all" for three different sorts of actions -- raising children, teamwork, and charitable giving.

When parents feed, clothe, educate, and otherwise provide the basics of life to their young children, what do the children trade, or give up, in return that is of equal or roughly equal value? In other words, what is the child’s cost that is the counterpart of the car dealer’s cost? 

Suppose two men use a two-man saw to cut down a tree and further cut it into smaller pieces. Far more examples of teamwork are easy to imagine, and occur frequently in work situations. Each worker does his or her part, which may or may not be the same, to achieve a common goal.  How is such teamwork a trade like my buying a car?

Suppose I contribute some money to disaster relief or to benefit military veterans. Another party X, unknown to me, benefits from the money contributed. How is that a trade like my buying a car?

By the way, I reject the notion that a trade-off implies a trade.

History of the Internet

Brief History of The Internet at The Internet Society. Some of the co-authors were key pioneers.

Government Did Invent the Internet, But the Market Made It Glorious. The Mises Institute.

What was Al Gore's involvement?

Economic Organization #5

The classic capitalist firm could be either a sole-proprietorship or a corporation with one person having dominant control and owning 100% of the stock. In economic analysis there is little or no difference.

Most business partnerships are sort of in between the classic capitalist firm and the publicly-traded corporation. The partners share both control and ownership. It need not be on an equal basis but it is preset. Call this a general partnership, and the partners general partners, to distinguish it from the following.

Some partnerships have both general partners and limited partners. A limited partnership is similar to a general partnership, except that where a general partnership has two or more general partners, a limited partnership has at least one general partner and at least one limited partner.

The general partners are much like partners in a conventional/general partnership. They have management control, share the right to use partnership property, share the profits of the firm in preset proportions, and have joint and several liability for any debts of the partnership. They have authority, as agents of the firm, to bind the partnership in contracts with third parties in the ordinary course of the partnership's business.

Like shareholders in a corporation, the limited partners have limited liability. They have no management authority, and (unless they obligate themselves by a separate contract such as a guaranty) are not liable for the debts of the partnership. The limited partnership provides the limited partners a return on their investment (similar to a dividend), the nature and extent of which is usually defined in the partnership agreement. General partners thus bear more economic risk than do limited partners, and in cases of financial loss, the general partners may become personally liable.

Although a corporate shareholder's liability for the company's actions is limited, some shareholders may still be liable for their own acts. For example, persons who are directors and major shareholders of small companies are often required to give personal guarantees of the company's debts to those lending to the company. They will become liable for those debts in the event that the company cannot pay, although the other shareholders will not be so liable. This is known as co-signing. The same goes for general partners and sole-proprietors.

The idea of limited liability is widely accepted and generally acknowledged but some people are critical of it on moral grounds. They ask why shouldn’t somebody be able to sue a firm for damages and those with limited liability be subject to pay damages from assets not invested with said firm? In other words, responsibility should not be limited like that. Limited liability is far more criticized than defended. One rare defense of it is in Robert Hessen’s Defense of the Corporation. Hessen argues that unlimited liability should only apply to those shareholders who play an active role in managing an enterprise or in selecting and supervising its employees and agents. The tort liability of inactive shareholders, likewise limited partners, should be limited to the amount invested because they do not participate in management and control. In other words, responsibility is aligned with control.

I believe that without limited liability, the benefits of large-scale economic cooperation would be greatly limited. Also, pursuit of unlimited liability when there are many, many shareholders (changing more frequent than daily for large publicly-traded companies) would likely entail prohibitive discovery costs. The extra discovery cost might easily exceed the additional collections, resulting in a net loss to the litigants compared to limited liability.

Economic Organization #4

This continues the topic of control of a corporation with many owners-stockholders and day-to-day decision-making delegated to professional managers.

Rather than try to control the decisions of management, which is harder to do with many stockholders than with only a few, selling provides a much easier way for a stockholder to exit from management with which he disagrees. Nevertheless, restricted salability is not uncommon, e.g. minimum holding periods for insiders, especially after an initial public offering and stock grants.

In addition to competition from outside and inside managers, more control may be temporarily gained via voting blocs owned and/or controlled by one or a few contenders. Proxy battles or stock-purchases concentrate the votes required to displace the existing management or modify managerial policies.

Without capitalization of future benefits, there would be less incentive to incur the costs required to exert informed decisive influence on the corporation's policies and managing personnel. Temporarily, the structure of ownership is reformed, moving away from diffused ownership into decisive power blocs, and this is a transient resurgence of the classical firm with power again concentrated in those who have title to the residual.

The benefits obtained by the new management are greater if the stock can be purchased and sold, because this enables capitalization of anticipated future improvements into present wealth of new managers who bought stock and created a larger capital by their management changes. In contrast, nonprofit corporations, colleges, churches, country clubs, mutual savings banks, mutual insurance  companies, and "coops," the future consequences of improved management are not capitalized into present wealth of stock-holders.

Economic Organization #3

This post is about ownership and control, with substantial credit to the Alchian and Demsetz article.

In the classical capitalist firm one person is sole owner and dominates control. While there are joint inputs – by employees and suppliers – the owner (a) contracts for all inputs and does any renegotiation of said contracts, (b) holds the residual claim, and (c) has the right to sell his central contractual residual status to a new owner.

  

Ownership and control of most large corporations is largely separated.  The corporation acquires command over resources primarily by selling promises of future returns to those who -- as creditors or owners -- provide financial capital. The amount of capital is too large and risky for one or few persons, so it is obtained from many individuals. Risk is also thereby spread among numerous individuals.

Broad oversight is provided by a board of directors. Control of day-to-day operations is delegated to professional managers. If every stock owner were to participate in every decision for the corporation, not only would large bureaucratic costs be incurred, but many owners aren’t well-informed on the issues to be decided. Stockholders often even assign their proxy voting rights to the board of directors.  More effective control of corporate activity is achieved for most purposes by transferring decision authority to the smaller group of professional managers, whose main function is to negotiate with and manage (renegotiate with) the other inputs of the team. The corporate stockholders retain the authority to revise the membership of the management group and over major decisions that affect the structure of the corporation or its dissolution.

Consistent with outside stockholders’ lack of control is limited liability for blame. It protects them from any losses that are larger than the amount they invested.

Economic Organization #2

Some of the terms in the list in Economic Organization #1 -- centralized contractual agent, monitor, and residual claimant -- aren’t commonly used in business to my knowledge. They probably came from a seminal article by Armen Alchian & Harold Demsetz, published in 1972, which is in the book’s references. I quote the following from the article:

"Two important problems face a theory of economic organization -- to explain the conditions that determine whether the gains from specialization and cooperative production can better be obtained within an organization like the firm, or across markets, and to explain the structure of the organization." - Production, Information Costs, and Economic Organization, American Economic Review 62: 777–795 (link).

“Usual explanations of the gains from cooperative behavior rely on exchange and production in accord with the comparative advantage specialization principle with separable additive production. However, as suggested above there is a source of gain from cooperative activity involving working as a team, wherein individual cooperating inputs do not yield identifiable, separate products which can be summed to measure the total output. For this cooperative productive activity, here called "team" production, measuring marginal productivity and making payments in accord therewith is more expensive by an order of magnitude than for separable production functions“ (ibid.)

This blog article relates the Alchian-Demsetz article to Austrian economics.

Economic Organization #1

The book The Philosophy and Economics of Market Socialism lists the following business roles.

1. laborers

2. capital providers

3. other input suppliers, such as raw materials and intermediate goods

4. monitors, who decide on the deployment of inputs and evaluate performance

5. central contracting agents, those in charge of negotiating contracts with all input suppliers

6. directors of the firm’s output, those in charge of deciding what is produced, its characteristics, and price

7. ultimate decision makers, those with authority about deployment of the firm’s assets

8. residual claimants, those with a claim on the residual income of the firm, what is left over after other claims have been satisfied.  (p. 98)

It goes on to describe who has these roles in different kinds of organizations – the classical capitalist firm, an open corporation, and a cooperative. In the classical capitalist firm the same individual, the boss, occupies all but #1 and #3. The “open corporation” is what would more typically be called a publicly-traded corporation, a large firm in which management and ownership are mostly separate.

Marketing is included in #6 a bit later. Some finance fits #2, #5, and #7. Maybe accounting and legal are considered auxiliary; they would be less so in a large firm.