Wednesday, February 17, 2010

Who Can and Does Are Entrepreneurs

Shikha Dalmia writes (12 February) in Reason.com (HERE):

“The Fable of Market Meritocracy”

“Markets don't reward smart people. They reward value ... Most advocates of markets have failed to fully make this distinction, perpetuating a cult of market meritocracy—something that has hindered, not helped, the cause of free markets.

With the notable exception of Nobel laureate F.A. Hayek, market theoreticians have to a large extent employed the equivalent of the Great Man theory of history to explain what makes markets tick. According to this theory, the course of history is shaped not by the convergence of multiple, unpredictable events but by the intervention of great men. Likewise, in the conventional thinking about markets, economic progress depends not on the labors of infinite economic actors but on the select few, the brainiacs, who rise to the top and generate innovations from which ordinary mortals benefit through a kind of trickle-down effect.

English sociologist Michael Young noted in his influential 1958 fable, The Rise of the Meritocracy: "Civilization does not depend on the stolid mass, the homme moyen sensuel, but upon the creative minority, the innovator ... the brilliant few … the restless elite who have made mutation a social as well as a biological fact." Less elegantly, Ayn Rand evinced a "pyramid of ability" in capitalism under which "the man at the top contributes the most to all those below him." What's more, this Nietzsche of capitalism opined: "Man at the bottom who, left to himself, would starve in his hopeless ineptitude, contributes nothing to those above him, but receives the bonus of their brain."

What's good about markets in this line of thinking is that they identify the incandescent geniuses among us and catapult them to the top where their innate brilliance is harnessed to improve the lot of mankind. At once, then, markets yield economic progress and what Rand (and others) regard as justice—the biggest rewards to the best.

The only problem with this neat little formulation is that it is wrong at every level. For starters, the idea that value creation is a one-way street from the top to the bottom is not just offensive, but it ignores the principle of comparative advantage, a key breakthrough in market theory. Put simply, this principle holds that everyone benefits by exchanging goods and services with everyone else, regardless of anyone's inherent capabilities. It's in the interest of even the most annoying "all-rounder" (as we say in India), who is better than me at everything, to specialize in those tasks in which our gap is the biggest and trade with me for those in which our gap is smaller. Under the elaborate division of labor that ensues, both the less-endowed and the better-endowed contribute to each others well being.

But is it the case that this division of labor necessarily directs the biggest rewards to the most gifted by putting them at the highest end of the value chain? No.
The beauty of the market, Hayek brilliantly pointed out, is that it allows people to use knowledge of their particular circumstances to generate something valuable for others. And circumstances, he emphasized, are a matter of chance—not of gift. Furthermore, since no two people's circumstances are ever identical, every producer potentially has something—some information, some skill or some resource--that no one else does, giving him a unique market edge. "[T]he shipper who earns his living from using otherwise empty or half-filled journeys of tramp-steamers, or the estate agent whose whole knowledge is almost exclusively one of temporary opportunities, or the arbitrageur who gains from local differences of commodity prices, are all performing eminently useful functions based on special knowledge of circumstances of the fleeting moment not known to others," noted Hayek.”

Comment
Follow the link and read the rest of Shikha Dalmia's article.

It’s an excellent exposition of markets and what makes them work better than the alternatives on offer, and better than those designed on a scribble pad somewhere by some “man (or woman) of system” that Smith warned us about in Moral Sentiments (and which Lost Legacy gets plagued with from time to time).

Like many students I read Ayn Rand in paperback many years ago – I still have her books – but like most other readers, I grew out of her ‘exceptional men of destiny’ characters.

Most enterprising small traders I came across were not John Galt figures of genius. Their ordinariness was their common denominator.

In short, they supplied value to sufficient customers who need a service or something and who were willing to pay for it at least up to the figure the suppliers could make a living from and did. The last bit separated them from the people with great ideas and little else.

People who need ‘fail-safe’ guarantees before they take their ideas to market are not entrepreneurs, and never will be until the penny drops – they usually become state bureaucrats, instead (many teach in business schools, er, there are notable exceptions of course!).

I remember representatives of the type when the state-funded Scottish Enterprise ‘companies’ were formed in the 1980s who, faced with an initial funding of £126 million to promote local private enterprises, immediately declared that their “company” was “under-funded”.

Fortunately, these companies were also peopled by a few real entrepreneurs, giving up some of their time to sit with the civil-servant bureaucrats and trade union leaders in the ‘local enterprise’ teams, and readily declared that “nobody in the private sector had ever given them £126 million to do anything they had ever done in the private sector” and they suggested that they all got on with their work without delay, in case the government withdrew their capital realizing they had made a mistake.

Markets are about creating value and selling it to customers. Unless that is understood, markets become mysterious, other-wordly, even godly, in fact everything but complex clearing-houses for creating and distributing value-added.

As 'Meerkat', the cartoon character in the TV-ad would say: Simple!

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