Tuesday, March 25, 2014

Free Enterprise Is Always Managing Change

"It is not the strongest or most intelligent who will survive but those who can best manage change."

Charles Darwin (1809 - 1882)

Darwin carved a niche for himself as someone who is respected and someone who is reviled.

The above quote, typically associated with his thinking about "natural selection," could very easily be applied to economics, and capitalism, as well.

Darwin was a reader and fan of Adam Smith.  He understood how economics creates change.  Applying this thinking to his other studies he posited the above quote.

Just as he applied his thinking of random variation and selective survival to various species, it can be applied also to economics.

Markets are complex and creative.  Markets change all the time.  Markets destroy to recreate.  Joseph Schumpeter called that "creative destruction."

It could be said that nothing is really invented, but is a recombination of what came before.  The much-read historian L.T.C. Rolt once said that the automobile was "sired by the bicycle out of the horse carriage."  If you look at the first car designs, that is very true!

Consider technology.  How long do new things survive?  How long is a program of software, for example, used before it is changed, improved, modified, magnified, or whatever?  How often do apps update on your phone?

But consider any product.  If I go to buy tires for my car, do I contact the synthetic rubber manufacturer, the vulcanizer, the tread designer, the tire producer, the shipper, the wholesaler, et al, before I make my way to a retailer to select and have my tires installed?  I don't have to!  The market does that for me.

It is exceptionally unlikely that the chemist altering the formula for synthetic rubber to make a longer-lasting tire has personal involvement with the clerk or tire installer where I purchase my tires.  He might!  But it is exceptionally unlikely.  And the chemist, or the shipper, do not do what they do to satisfy anyone in particular, but to satisfy the general demand for what they are participating in out of self interest.

These individuals in the chain of events operate entirely out of self interest.   THAT is the invisible hand of the marketplace at work.

The marketplace is exceptionally complex.  And very destructive.  Tires popular just 10 years ago have given way to the newer design, longer-tread wear, quieter, smoother-riding tires that I purchased just a couple of months ago.

And when I chose my tires, I had my pick of many characteristics and prices to choose from!

Tire manufacturing and distributing and selling companies have managed to deal with change.  And have survived.

It is all chaos to be sure.  But exceptionally-managed chaos.  Something no gubment, institution, law writer, council or overlord could ever, ever manage.

Managing change happens invisibly, naturally, continuously and necessarily -
when free markets are in charge.
Creative destruction is the natural order of free enterprise.

Tuesday, March 18, 2014

What Happens When Super-Successful Capitalists Fail?

"We will get our men in Brazil.  We are not going to South America to make money, but to develop that wonderful and fertile land ... We'll train the Brazilians and they will work as well as any others."

Henry Ford (1863 - 1947), regarding Fordlandia

"The Ford Motor Company in Brazil is said to be one of the best equipped and most liberally funded expeditions that ever entered the region."

Unknown author of "The Ford Motor Company of Brazil." The Inter-American Review, July 1929
What happens when a very successful capitalist is thwarted by other capitalists and warlord dictators in other parts of the globe?

Have you ever heard of Fordlandia?

In the early 20th century a huge majority of the world's rubber supply was held by a cartel made up of British and Dutch "rubber barons."  The only source of rubber at that time was from a South American rubber tree called havea brasiliensis.  Its sap was the fount of natural latex.  Brazil was the largest producer.  In the 1870s smugglers, capitalists all, privily carted seeds from this South American tree to various large plantations in the Far East.  Production from these plantations eventually overtook and crushed Brazilian production, and their control by the above "rubber barons" strangled the world's rubber supply, becoming the largest producers.

In the 1920s, Ford's business was booming and he needed rubber!  He had only one source for rubber to make his zillions of needed automobile tires.  He decided to do what every bona fide capitalist does - HE DECIDED TO COMPETE!

He competed by integrating vertically.  He would produce his own rubber!  Where would a very nice place to grow havea brasiliensis be?  Very good - Brazil.  In 1929 Ford contacted the Brazilian gubment, who graciously provided him a specialist named Villares to look over the Amazon for a suitable location for Ford's desired rubber plantation.  The hope was to bring the rubber business back to Brazil.

(Side note here:  it turned out later that the Brazilian gubment did not trust foreign investors and Villares was actually the landowner of the property he "found" for Ford.  Villares knew it was hilly and rocky and unsuitable for a rubber plantation.  Not knowing all this Ford went along with the deal because the Brazilian gubment conceded him up to 2.5 million acres.  Ford's part of the deal was a 7% kick back of future profits to the gubment.  Ford actually purchased the useless land from Villares.)

A location was found along a tributary of the Amazon called the Tapajos River.  The 15,000 square miles of land was to produce enough rubber annually to supply 8 million tires a year.  Feverishly Ford began building his new utopia in 1930.  In addition to factory buildings, a town flourished with as many as 10,000 residents.  A host of other businesses grew up as well - restaurants, barber shops, shoemakers, butchers, you name it.  There was a hospital, library, and a hotel!  Fordlandia was established.

Ford's first mistake was to get his best engineers and factory supervisors to work, instead of hiring horticulturalists, to manage the plantation.  Razing thousands of acres of land he planted thousands of saplings.  And all very close together.  To Ford's thinking more was better.  However, heavy rains washed the rich topsoil away, so Ford razed more land and planted more saplings!

An acre of Brazilian jungle naturally contains an average of 7 rubber trees per acre.  They mingle with the other plant species, but are not too close together.  This is for a reason - drought, insects and a deadly leaf fungus.  Too close together the trees' leaves pass this fungus easily from tree to tree.  Nature knows what it is doing.

In addition, there was much disaffection among workers, who did not want to work 9-5 (the heat of the day) or eat American cuisine.  Ford also wanted them to participate in American cultural activities like square dancing and sing-a-longs (in English).  The prohibition on alcohol was a big downer for the workers as well,  and they eventually rioted.  The workers were paid twice the going daily wage, but that was not enough.

The lack of sapling growth and worker unhappiness caused Ford to do two things - he hired a plant pathologist, Dr. James Weir, and moved to another location in 1933.  Finding Belterra, about 80 miles away, he began again.  Weir brought thousands of saplings from the Far East to plant at Belterra.  By 1940 only 500 workers remained at Fordlandia while some 2,500 worked at Belterra.

In 1942 only 750 tons of latex was produced at Belterra, far short of the 38,000 ton goal Ford had set.  And something else happened.  The Japanese during World War II virtually shut off the rubber supply from the Far East.  Anticipating this, the United States had previously begun a large program to develop synthetic rubber.

Ford's rubber plantation failed in a big way.  Two economic principles combined to doom him - 
1.  Product differentiation and 
2.  Substitution.

By 1945 synthetic rubber was indeed developed and there was no longer the desperate need for Ford's latex.  He finally abandoned his dream, selling his interests to the Brazilian gubment for $250,000, after losing today's equivalent of $200 million!  As recently as 1987 Belterra  was producing latex, but not at a commercially-viable rate.  Fordlandia is abandoned today, and a tourist stop.

Ford's capitalist attempt ended in a complete failure.  It started with a land scam and ended in a huge financial loss.  Free enterprise makes no guarantees.  He did proclaim Fordlandia to be a "sociological success," however!   That was probably a disaster too, but having not ever visited, Ford never saw this for himself.


Tuesday, March 11, 2014

Improving Lives, Or Trampling On Them? Invisible Hands Don't Trample.

"The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it." 

Adam Smith (1723 - 1790)

This 18th-century quote is so appropriate today!  And accurate!

Why is it that gubments worldwide, and statesmen worldwide, think they can control the private sectors in their countries to the degree that their "control," as they hope, can shape economic policy positively?

Notice Adam Smith's use of the word "capitals."  Capital is one of the factors of production, which is defined as also including land, labor and entrepreneurs.  Capital comes in many forms.  Certainly a big part of the capital I bring to my job as a home inspector is my education and its application by virtue of my experience.  A "trained eye" is just that.  But that's not all.  I have tools, and a camera, and software, and the like, and the ability to use those factors of my production to create reports that inform home buyers of what my experience has determined pertains to their purchase.  All of those things, and more, make up my business capital.

Why is it that gubments, and statesmen in those gubments, or councils, or senates (to use Adam Smiths' words) worldwide think they can control the private sector, and that sector's various capitals, to the degree that these factors of production can be manipulated and controlled to create economic growth?

Of course they have no hope of controlled economic improvement.  IT IS IMPOSSIBLE!

Impossible you say?  Of course!  Nobody anywhere even knows how to make a pencil, so how can any gubment, person or council know how to most efficiently direct the trillions of combinations of activities that make up every day's activities in any market place?

Adam Smith, in his famous book The Wealth of Nations, from which the above quote was taken, proposed that what most efficiently guides and directs any market place is an Invisible Hand overall.  Each of those trillions of combinations of activity is trying every day to bring to the market their good or service.  Most do their small part without any knowledge of the majority of what the market place is also bringing to pass to aid them!  It took zillions of people, and the employment of factors of production, to bring you that shoelace that you tie on your shoe.

As regards gubment involvement in the marketplace's Invisible Hand, Milton Friedman suggested there is also an Invisible Foot.  He said, "When government attempts to substitute its own judgments for the judgments of free people, the results are usually disastrous.  In contrast to the free market's invisible hand, which improves the lives of people, the government's invisible foot  tramples on peoples' hopes and destroys their dreams."  (emphasis mine)

This perfectly complements the Adam Smith quote above.  We have come full circle.  What Adam Smith called "folly," Dr. Friedman called "trampling."

What's the difference?

When markets are manipulated and controlled, economic growth is IMPOSSIBLE.

Gubment manipulation and control stultifies, tramples and destroys.  Invisible Hands don't trample.

Wednesday, March 5, 2014

Everyone Has A Place

"Those who were adept and brave fellows I have made military commanders. Those who were quick and nimble I have made herders of horses. Those who were not adept I have given a small whip and sent to be shepherds."

Genghis Khan (1162 – 1227)

Of course, not thinking economic principles at all, Genghis Khan was merely trying to create a conquering army that was more efficient in every regard.

And the economic principle would be?  The division of labor.

Everyone in his army had a place.  And a place that suited him and his abilities.  An army is made up of many component parts, each with its own function and contribution.

Many centuries later, in 1776, the Scottish economist Adam Smith published his famous book The Wealth of Nations.

One of the many concepts the book treats is the division of labor.  Smith, of course, related it to economic growth.  The division of labor implies the assignment of jobs to each person in a company or factory that best suit him.  We all have our proclivities, skills and abilities.  Smith's proposition was that each person's strengths get best utilized.  As the labor is divided into smaller parts each working person becomes more expert in his job, his efficiency would improve and his productivity would increase.

Smith realized that the possible downfall of division of labor was in people being stultified mentally, eventually getting bored and dissatisfied.  To him, for labor to be productive, it had to fulfill two goals:

1.  it had to "lead to the production of tangible objects," and
2.  it had to "create a surplus that could be reinvested into future production."

His thinking was employed by businesses, however, and factories in the Victorian Era of Europe grew in size and productivity, and they propelled economic growth.  Standards of living improved generally.

Apparently everyone in the Khan army enjoyed his contribution.  Although no new surplus was created, there were tangible rewards to the ransacking, but only for the Mongols!  Conquering comes with built-in benefits.  But only for the conquerors.  For everyone else we are talking about the broken window fallacy.

Genghis Khan was obviously not entirely on board with the division of labor concept, thinking that some jobs should not be delegated out or divided into smaller parts.  A National Geographic study on DNA determined in 2003 that some 8% of the 4 billion Asians share the Genghis Khan y chromosome.  It was determined that he has some 16 million male descendants!  If his army was divided up into everyone's most important contribution, that y chromosome progeny is quite an individual contribution!