Sunday, 5 May 2013

What’s wrong with economics

When you take lecture-notes for students with disabilities, you learn all kinds of interesting things. Well, it depends on the subject, of course. Fourth-year dentistry is of limited application, given I have no intention of ever becoming a dentist. But last year I took a first-year Economics paper – OK, I only took half of the lectures for that one, the other half went to some other note-taker, but it has given me considerable insight into how and why Western society is so screwed-up. (I also took several ecology-themed papers, so now I know both what we’re doing to our food supply and why we’re not going to change course until it’s too late.)
Lots of things have been suggested to explain what’s wrong with economics, so first of all let me say what the problem isn’t. The problem isn’t that economics models complex real-world situations with mathematical abstractions. Plenty of sciences do that; simplifying complexity is how we come to understand it. The problem isn’t that economics puts a money value on everything. Money is basically a measure of how much of a crap people really give about things, as opposed to wishing other people gave a crap about them; consider the saying “put your money where your mouth is”. The problem isn’t that economists don’t recognise the “intrinsic value” of natural systems (in the landscape, the biosphere, or the body). Value is about choices, priorities, and meanings, and those are people things, not world things. The problem isn’t that the models require people to act “selfishly”. People do act selfishly quite often – that’s why moralists everywhere have always had to tell us not to – but, more to the point, the logic of making and saving money applies regardless of whether it’s for you or for someone else. The problem isn’t that economists are all bourgeois intellectuals seeking to maintain the class structure that upholds their power. That might explain why errors have been made and not corrected, but not what the errors are. And the problem isn’t that economics assumes rational actors whereas people are in fact stupid – but that’s getting closer, except for the “stupid” part. People don’t behave the way economics presupposes they should. I’m going to have to go into a bit more detail here.

Here’s the foundational principle of economics. Suppose you want to sell your car, and at the same time I’m looking to buy a used car and yours has all the features I want. Now, I’ve decided, in the privacy of my head, that I’m willing to spend up to $4000, but no more. You, meanwhile, in the privacy of your head, decide that you’ll accept $2500 for it, but no less. We don’t tell each other this; instead, I offer $3000 and you accept. Deal done. You now have $3000 where you previously had a car worth $2500 (to you), so you have gained $500 by the sale. I now have a car worth $4000 (to me) where I previously had $3000, so I have gained $1000. In total, $1500 has appeared out of nowhere, the product of our different private valuations of the car and the fact that we were able to make a transaction. We can call this $1500 “surplus value”.
Next, we apply the principle to a whole population, all with different values in their heads for the goods they are buying and selling. Buying a used car from a friend is something you might do half a dozen times in your life at most. Someone selling coffee will certainly be wanting to do it more than once, and to many different people who will all have their own personal idea of how expensive it would have to get before they’d rather keep the money and go without. The seller will have their own private minimum price, but the higher they go above that, the more potential customers will decide it’s too expensive and not buy any. Not only that, but there will be a whole lot of other people selling coffee too, and many of them may have a lower minimum price to sell.
Buying and selling exert “forces” on the market in which they occur. Let’s imagine a free market, where everyone can choose what price they personally like, and no-one can force anyone else’s choice. Suppose there’s more coffee being offered for sale (supply) than people are buying (demand). The first seller to sell below everyone else’s price will net a whole lot of new customers and make a big profit. So the market price will come down. Suppose, on the other hand, people want more coffee (demand) than there is to be had (supply). Sellers will find themselves running low, and put their price up so that they can make a decent profit from the little that’s left; the market price will rise accordingly. At some point in the middle, the amount available for sale will equal the amount people want to buy, the two forces will cancel out, and the price will be more or less stable. This point is called the “equilibrium price” for that market. Because the supply equals the demand, the coffee is neither being wasted nor running short, which is what economists call efficiency.
Now, the whole point of a simplified model is to pick out particular factors and examine their effects one by one. In this case, we vary the price while holding constant all other reasons for drinking or not drinking coffee. We assume that the reason people are choosing to buy or not to buy, to sell or not to sell, is because of the price. Every potential buyer has their own subjective maximum price, above which they won’t buy the coffee; our lecturer called this price the buyer’s “willingness to pay”. If the actual price of coffee is below that, they’ll buy it; if it’s above, they won’t. Likewise, every potential seller has a subjective minimum price – their “willingness to sell” – and they’ll only sell coffee for that or above. So with that in mind, look back up to the used-car example: the total value created by any sale equals the buyer’s subjective price minus the seller’s subjective price. Surplus value is not created by goods sitting in storage past their use-by date, and it’s not created by goods running short. The efficient price, the one which results in no waste and no shortage, is also the one which creates the maximum surplus value. The free market means that those who are most willing to pay are those who end up taking the goods home, or enjoying the services.

I’ve now got about as far as I can get without drawing some graphs. Let’s carry on with the coffee example. Economic graphs always have “price” on one axis and “quantity” on the other, quantity being how much of the good or service gets sold. Since economists are supposedly manipulating prices to see what happens to quantity, price should really be the horizontal axis and quantity the vertical axis, but economists just decided they’d be different, I guess, and now the opposite way is the convention. I have redrawn all these myself, mostly from memory, so plagiarize them at your own risk.
First, we’ll look at individual buyers and sellers. We arrange the buyers from left to right starting with those who have the highest “willingness to pay”. In this instance, Angela would still buy coffee if it were $6 a cup; Barry would quit at $5 a cup; Cathy wouldn’t pay above $4 a cup. As it happens, coffee in their market costs $3 a cup, so all three have bought one. The total surplus value between them is $6: $3 (Angela) + $2 (Barry) + $1 (Cathy).
Sellers, meanwhile, are arranged from left to right starting with those who have the lowest “willingness to sell”. Here, Dave reckons he could still make a profit selling at $1; Ellie’s personal minimum is $2; and Frank is only just happy with the market price of $3. So our sellers here enjoy a combined surplus value of $3: $2 (Dave) + $1 (Ellie) + $0 (Frank).
Next, we want to aggregate the surplus value across a whole population. Basically, we moosh all the buyers together so that their individual “willingnesses-to-pay” become points on a line; then we do the same with the sellers and their “willingnesses-to-sell”; and then we lay the lines on top of each other. In real life the lines will be wiggly, which I suppose is why economists call them “curves”, but straight lines will display the basic logic well enough. All we’re worried about is the areas under them, and as long as the curves don’t go backwards – as long as people don’t start buying more when prices go up or selling more when they go down – the logic will still work. The more people buy or sell, the greater will be the total quantity that changes hands, and the surplus value created.
So what does the graph mean? Where the demand curve and supply curves cross is the equilibrium price (on the vertical axis) and the equilibrium quantity (on the horizontal axis). If the price rises above this, buyers will pull it down; if it drops below, sellers will push it up. In reality of course there’ll be a time delay between price changes and buyer responses, and it will wobble around the equilibrium point. Note that sales happen only to the left of the equilibrium point; to the right of that are the potential buyers for whom the market price is too expensive, and the potential sellers for whom it’s too cheap. Neither of them will be doing any business.
Now, let’s suppose the government puts a $1 tax on every cup of coffee. What happens to our three sellers above, the day the tax comes into effect, if they haven’t changed their prices by then? Dave sells his coffee for $3, but only gets $2 of that. Since his personal minimum is $1, he only gets $1 worth of surplus value. Ellie sells her coffee for $3, and the $2 it nets her is only just acceptable; no surplus value for her. Frank does not sell any at all that day, because $2 is not enough to be worthwhile for him. So of course all the sellers will put their prices up to cover the loss, which means that the buyers are now paying the tax. At first I suppose the price will go up to $4, but that will be too much for a lot of buyers, and they’ll push back. You end up with a new equilibrium price and a new equilibrium quantity, as shown below.
What’s happening here? The government is collecting its dollar for each coffee sold from the sellers, who have passed some of the cost on to the buyers. So far, money is just getting shifted around. But because less coffee is being sold than before, there are fewer sales to collect those dollars from, and some of the value has disappeared entirely. How much, is shown by the grey triangle on the graph. Our lecturer called this a “deadweight loss”.
But the government could compensate for this loss by putting the money into something else, couldn’t it? The opposite of a tax, when the government gives people money to sell a particular product, is called a subsidy. Let’s suppose the government subsidizes coffee at $1 a cup. Again, go back to our three sellers above, on the day before they change their prices. For each coffee, every seller now gets $3 from the customer and $1 from the government, totalling $4. Dave’s personal minimum is $1, so he would now be ready to give coffee away free and fund his business on the subsidy alone. His surplus value from each transaction is now $3. Ellie’s minimum price has now dropped to $1, so she enjoys $2 of surplus value. Frank, in the same vein, is getting $1 surplus value from each coffee. Most of the sellers will now happily lower their prices to bring in those customers whose personal maximum price was below $3. Everyone wins, right? No losses here?
Alas, it is not that simple. Let me introduce a fourth seller, who I’ll call Grace. Grace falls to the right of Frank on the graph. Her “willingness to sell” is $4, so she opens her coffee business only after the subsidy takes effect. Actually, she’ll have to shut up shop again once the others lower their prices to pull in more customers, but there will be other sellers, in between her and Frank, who will still manage to turn a profit. But where is that profit coming from? Somebody has to be covering their costs, and clearly it’s the government. So now the government (and through them, the taxpayer) is suffering a deadweight loss.
Finally, let’s look at what happens if the government tries to regulate the market by setting limits on prices. The logic of maximum prices and minimum prices are mirror images of each other, so I’ll only take you through the minimum one. And yes, the minimum wage was the example our lecturers chose. To market economists, labour is just a particular service that the worker sells and the employer buys, and it generates surplus value by exactly the same logic as the used-car example above. So you use the same kind of maths to figure out what happens. Of course, if the equilibrium price happens to be above the statutory minimum wage, there’s no problem. It’s when it’s below, when employers are being forced to pay more than the market would require, that things go wrong.
The graph below shows what happens. At the left-hand end, a certain amount of value is transferred from the pockets of employers to those of workers. But those firms whose “willingness to pay” falls below the minimum wage simply don’t employ people. As a result, there are fewer jobs around, and a lot of would-be workers end up unemployed. Once again, we have a big deadweight loss to society in terms of potential surplus value.

Have you spotted the problem yet?
I’ve been slightly sneaky. I’ve been talking about “surplus value” so as not to give the show away. In fact in an individual context economists call this “utility”; and, aggregated across a community, the term our lecturer used was “welfare”. Now do you see the problem?
Note-takers are not allowed to ask questions in lectures, and, unbelievably, not one of the students said anything. If I had been a student in that class, I would have had my hand up immediately, and said something like “If you’re going to call this ‘welfare’, shouldn’t you distinguish between ‘willingness to pay’ and ‘ability to pay’? If your weekly income drops (or costs go up) by $100, are you really just as unhappy – is your welfare just as compromised – if that was one hour’s salary, as you are if it was half your benefit?” Most willing to pay, my nostril. The free market means that the rich people end up with all the goods and services.
See, the first ever economic lesson I ever learned wasn’t at university; it was in Sunday School.
And Jesus sat over against the treasury, and beheld how the people cast money into the treasury: and many that were rich cast in much. And there came a certain poor widow, and she threw in two mites, which make a farthing. And he called unto him his disciples, and saith unto them, Verily I say unto you, that this poor widow hath cast more in, than all they which have cast into the treasury: for all they did cast in of their abundance; but she of her want did cast in all that she had, even all her living.
You don’t have to think Jesus was God or the Messiah to see the truth in that. Presumably, the widow had just sacrificed a considerable proportion of her objective ability to purchase the necessities of life; but even if we ignore that, and treat value as purely subjective, the point remains, thanks to two nineteenth-century psychologists named Ernst Weber and Gustav Fechner.
Weber measured how much of an increment to a given stimulus it took to make a “just-noticeable difference” in a subject’s perception, and found that it was proportional to the existing stimulus. That is, if you’re holding a 10kg load in your arms (two bags of flour), the amount of weight you have to add to that load so that you just notice the difference is twice as much as you would have to add if you were only holding a 5kg load (one bag of flour). Fechner, his student, claimed that the same mathematical relationship applied to any change in stimulus, whether it was “just noticeable” or not. So if you start with a 5kg load, and double it to 10kg, you would have to double it again to 20kg before it felt like you had added the same amount. The same applies, roughly, to light, sound, temperature, and various other stimuli. Fechner called these ideas, put together, “Weber’s Law” (they still talked about “laws” in psychology in the nineteenth century). Nowadays it tends to get called the Weber-Fechner law, and is considered to be an approximation that provides a rough estimate in most cases, rather than something you can hang exact predictions on.
What’s this got to do with money? Since the 1970s, the prevailing theory (due to economist Richard Easterlin) has been that money in absolute terms creates happiness only up to a particular threshold, above which it’s all about comparing yourself with other people. Recently this idea has been challenged; it appears that money affects life satisfaction logarithmically – that is, if you’ve just doubled your annual income from $30,000 to $60,000, you’ll have to double it again to $120,000 to experience the same lift in satisfaction. In other words, cash value increases well-being according to the Weber-Fechner law. Jesus was right.
What’s particularly odd is that economists are entirely capable of applying this kind of reasoning to goods and services. They know perfectly well, for example, that going from no car to one car improves your life much more than going from one car to two cars does, and they factor your higher “willingness to pay” into their calculations. They even have a term for this: “the law of diminishing returns”. Yet, for reasons I do not understand, they don’t factor it in when they’re talking about accumulating money instead of stuff.
Why should they? What would happen if they did? Well, it makes our calculations of “welfare” very different, for a start. No more can we conclude that maximizing well-being is merely a matter of filling in all those spaces on the graph. It really matters who gets that surplus value, and how much they were worth beforehand. We can take it as a general principle that creating a given amount of surplus value will be of greater benefit the less the person had to begin with. An after-tax pay-rise of, say, $60 per week will create a lot more welfare if it goes to someone who doesn’t have much (as in a minimum wage increase) than if it goes to someone who’s already rich (as in a tax cut). In many cases, it will more than compensate for the deadweight losses we’ve just seen.

To be fair, one of our lecturers was researching what went wrong in 2008, and he was open to the idea that classical economics was not quite onto it – though, as he said, if you want to criticize the orthodox theory you have to learn it first. He briefly discussed a school of thought called “behavioural economics”, which apparently is generating some interesting alternative theory. In particular, he told us about this study of freelance New York cab drivers, who, it turns out, do exactly the opposite of what rational-actor economic theory says they should.
The standard economic prediction is that a temporary increase in wages should cause people to work longer hours. This prediction is based on the assumption that workers substitute labour and leisure intertemporally, working more when wages are high and consuming more leisure when its price – the foregone wage – is low.
In contrast,
Many drivers told us they set a target for the amount of money they wanted to earn that day, and quit when they reached the target... Daily targeting makes exactly the opposite prediction of the intertemporal substitution hypothesis: When wages are high, drivers will reach their target more quickly and quit early; on low-wage days they will drive longer hours to reach the target.
The field data, recorded from cab meters and drivers’ tip sheets, supported the daily targeting hypothesis. By the standards of classical economics, the cab drivers were behaving irrationally; they were not maximizing the amount of money they could make. The authors suggest that loss-aversion is the underlying motive. That is, the drivers were not too excited about going above their daily target, but they were very concerned about not dipping below it. With the widow’s-mite principle in mind, this begins to make more sense. The less money you’ve made lately, the more difference each dollar lost makes; the more cash you’ve got in hand, the easier it is to decide you’d rather take the afternoon off.
Now, this makes an absolute and utter hash of the last graph I showed you above, about a free labour market being better for workers than a minimum wage. It means the labour market has what’s called “negative elasticity”, which is to say the supply curve slopes backwards: workers will supply more labour the less they get paid. There is no equilibrium price. The employer’s best option is to pay only just enough to be better than unemployment. Granted, if there are other employers offering better, workers may jump ship. But those other employers will not be competitive, because they’ll be pouring money into wages instead of capital and extracting no more labour. The nastier ones will win out, in a rapid race to the bottom. And if you don’t think things would ever work that way, take a few moments to research what labour conditions were like when there wasn’t a minimum wage or an unemployment benefit. Charles Dickens makes it look rather more cheerful than it really was.
Was? Sorry, I forgot about the Third World for a moment there. Is.

You can imagine just how easy it is to save up and start your own business under such conditions. So one major effect of a free labour market is to split society into a business class, who could probably take fairly large losses on the chin really, but why would they want to? – and a working class scraping and struggling for every meal. When you segregate society into classes, people on either side of the boundary tend to dehumanize those on the other side – the ugly aspect of human nature known to popular-science types as “tribalism” and to the trendy-humanities crowd as “othering”. Add to that the psychology of self-deception and cognitive dissonance (nothing is ever my fault); add the fact that health-care and nutritious food are expensive, as is sanitation if the law doesn’t require builders and landlords to provide it; and you end up with the myth of the “undeserving poor”, who prefer being dirty and slovenly to honest toil, and whose best remedy is a good kick up the sacral bone. None of the economics lecturers said anything like this, but my long experience of arguing with people on the internet leads me to expect someone to chip in with a suggestion that we can cancel out the widow’s-mite effect by weighting different people’s well-being according to “how much they’re willing to contribute to the economy” right about... now. My answer is here.
One could argue, slightly more soberly, that large-scale entities with lots of money should still get the benefits of the free market, because they’re better able to put them to use in productive enterprises; that even if we don’t concern ourselves with the welfare of the rich, we should care about their ability to employ other people. The flaw with this reasoning is that concentrating money among a few rich people doesn’t create demand. Henry Ford became the success story that he was because he understood that his workers were also his customers, and paid them accordingly. If that money had gone to a couple of dozen executives instead, let them be as generous and socially aware (or as recklessly spendthrift) as you please, they would not have bought a thousand Model T Fords each. The money would have ended up sitting in their bank accounts instead of stimulating production.

What’s wrong with (orthodox) economics, therefore, is that it ignores individual costs and benefits as long as we’re maximizing surplus value for society as a whole. Free market logic, in a word, is fatally collectivist. Perhaps we might learn some lessons from a theory centred on concern for proprietary rights, namely Marxism. I believe Marxism puts the cart before the horse in making class warfare the cause, rather than the result, of capitalism, but I think its perspective on power relations in the workplace may hold some useful insights. In Marxist analysis, the difference between raw materials and a finished product is that someone has put labour into the finished product. Therefore, the labour is the source of the surplus value (measured as the price of the product minus the cost of the materials), and the labourer is the rightful proprietor of that value. Business owners who take the bulk of that surplus value for themselves and dole out a fraction of it to their workers in wages are neither more nor less nor other than thieves.
I’m going to have to interrupt myself here, unfortunately. Any economics graduate who’s been reading this post with a hostile eye will have just closed the tab in disgust, having pegged me as one of those campus Marxists. Some of my best friends are campus Marxists, but, with all respect, I can’t in honesty take their line. Twentieth-century radicals from Vladimir Lenin to Robert Mugabe tried to improve society through armed revolution. Not one of them, and there were dozens, achieved anything better than a dictatorship. That tells us something, but what?
I was taught – not in my lectures this time, in a Social Studies class at high school – that global communism had collapsed, a few years previously, because it didn’t reward hard work. Perhaps it didn’t, but Dickensian capitalism is not fantastic in that regard either. A better explanation of the chronic shortages in the communist economies is that prices in a market carry information about which commodities are needed and which resources are running low. A central bureaucracy, no matter how benevolent, cannot transmit that kind of information around in time to respond to needs. But the fact that a car won’t move if you weld every part to every other part, doesn’t imply that it will run best if you undo all the bolts and throw them away. There is an optimal amount of state control somewhere between 0% and 100%.
I think the central problem with the Marxist programme began with the rather pedantic point I’ve already mentioned: Karl Marx and Friedrich Engels believed that the class divide was the root of human suffering, and that removing it by any means would abolish power differentials and violence of every kind. After a suitable transition period of mopping up the remaining threats to worker co-operation, of course, and there’s the rub. If all strife arises from class division, then anyone making problems for the transition state must logically be an agent of the deposed regime. Thus legitimate dissent becomes treason.
Usually, however, the problems begin well before the new state is established. A rebel group wishing to wrest power from the government must at some point gain the support of the public, and there are two ways to achieve this: sympathy, or fear. Even before Marxism came on the scene, revolutionary movements that chose fear (the English Civil War, the French Revolution) reliably ended up installing dictators (Oliver Cromwell, the Napoleons) instead of advancing the cause of the people. And it’s not hard to see why. Even well-meaning leaders tend to try and increase their power, so as to be able to do more good. If the people are too afraid of them to restrain them, well, there’s only one way that’s going to go. And if you think it’s your mission to abolish an entire social class, let’s face it, you’re going to scare people. That’s my best guess at why the Communist Party always ends up becoming just another ruling class. Peaceful civil disobedience movements, or those that (like the American Revolution) take up arms only under threat, may not achieve Utopia; but nor do the violent ones, and at least the peaceful ones don’t create Stalins or Pol Pots. If you need to rely on public sympathy, there are firm limits on how much power you can grab for yourself.

But none of that has a direct bearing on the rights and wrongs of wage labour. Marx could have been completely wrong about class, and still right about that. One key question, as you’ll have spotted, is the origin of the surplus value. Is it created by trade, or by labour? The problem with answering it is that value, like I said way up the top, is a people thing, not a world thing. You can’t catch it as it arrives and examine it to see where it came from.
Let’s have a look at the two ends of the spectrum. The used-car example above would be at the “trade” end. Neither one of us has done a smidgen of work on the car, and yet just passing it from you to me, and $3000 cash from me to you, created $1500 of surplus value out of nowhere. At the “labour” end, consider slavery on an eighteenth-century sugar plantation. The slaves’ net gain from the transaction is surely negative, and the owner contributes nothing except the whip. The value here is clearly derived from the slave’s labour. Of the many differences between the two situations, which is the one we’re concerned with?
In the car example, remember that the surplus value represented the difference between your valuation of the car and mine. You were prepared to sell for $2500 or more, I was prepared to buy for $4000 or less. The trade worked because neither of us had the power to force the other’s hand. Suppose now that you were desperate, that you were so behind on rent that it was sell the car or live in it. I could now offer you $2000, and you wouldn’t have much of a choice in the matter; you’d just have to pray that you could find the extra $500 somewhere else before the end of the month. In this situation the money is worth a lot more to you than it is to me – I’m not going to be sleeping under a bridge if I don’t get your car for under $4000. Whether you look at it like that or as a subjective manifestation of the Weber-Fechner law, you’re losing a lot more than I’m gaining. This is no longer a positive-sum transaction. I’m stealing from you.
At the other end of the spectrum, the slaves cannot choose to bow out. The rewards to them could not be considered fair by any sane person. They suffer pain, fear, and privation at their owner’s hands. It all boils down to one thing: the gross imbalance of power. If slaves had fought back on a large scale, things would have changed drastically, immediately. They mostly didn’t, because the owners had the power to beat, mutilate, and kill them if they tried.
Starving slowly, sleeping outdoors, suffering crowd diseases, losing your dignity as a person, are not quite as bad as being beaten, mutilated, or killed (or the slaves would have risked the latter to avoid the former). But they differ chiefly in that they erode your bodily integrity and your capacity for happiness over weeks or months instead of seconds. And these are things that happen to supposedly “free” people under Dickensian conditions, if they lack income. Which, if you’re their boss, is a potent threat to hold over their heads and stifle negotiations. Under such conditions, the concept of employment as a free trade between equal partners is an absurd fiction.

So we can draw a few conclusions. First of all, those right-wing pundits who say that inequality stimulates the economy (our lecturers didn’t) are talking through – I’ll be polite – their hats. You could argue that from Easterlin’s idea that people above subsistence level are only trying to keep up with the Joneses, but, as you’ll remember, Easterlin’s idea has been challenged. I suspect it might apply, to some degree, when very rich people try to get even richer. But people who are very poor, want to get richer because they’re very poor. They don’t need to see other people being very rich to get the idea.
Second, redistribution of wealth from the rich to the poor, even if it results in some loss of cash value in the system, tends to increase human well-being. Further, by increasing the spending power of the majority, it stimulates demand and hence production. When rich people are allowed to indulge their natural inclination to hold on to their riches, the economy suffers. That isn’t to say that central government will necessarily be the best redistributing agent; I came to this job from the sickness benefit, and I’ve seen first-hand the systemic incompetence of my country’s income support system. I believe that the government should make partnerships with community groups on the ground, who know what they’re doing and what’s best for the people they work with. I’d like to see unions involved in finding work for people who are unemployed, for instance.
Third, power in the workplace matters. I’ve mentioned Michael Shermer’s 2008 Scientific American paper, “Do All Companies Have to be Evil?”, elsewhere, but now I’ve discovered it was also published in Nature, so this time I can actually link you to it. Here is the wrong way to do things:
Enamoured of the notion of “survival of the fittest,” [Enron president Jeffrey Skilling] implemented a policy at Enron called the Peer Review Committee (PRC) system, known among the workforce as “Rank and Yank.” PRC was based on the mistaken presumption that people are primarily motivated by greed and fear. Skilling ranked employees on a scale of 1 to 5, with 5s being given the boot. As a result of this strategy, 10 to 20 percent of his employees got axed every six months, leaving everyone on edge and in a state of anxiety over job security. The formal reviews were posted on a company Web page along with a photograph of the employee, increasing the potential for personal humiliation. Those who received a 5 in the relative ranking system – no matter how good their absolute performance may have been – were automatically sent to “Siberia.” From that purgatory the 5s had two weeks to find another position at Enron, after which they were “out the door.”
And here is a way that works:
The Google environment accentuates amity and attenuates enmity by minimizing corporate hierarchy and maximizing cross-pollination among people in different departments. “Because everyone realizes they are an equally important part of Google’s success, no one hesitates to skate over a corporate officer during roller hockey,” explains a statement on corporate culture employees are encouraged to read. Googlers are even expected to devote 20 percent of their time toward exploring new ideas and projects, without hierarchical supervision. A horizontal corporate structure generates an atmosphere of equalitarianism and nonelitism that taps into the environment of our Paleolithic ancestors, who evolved in what are believed to have been largely egalitarian bands and tribes.
We figured out centuries ago that dictatorship doesn’t work for states. Isn’t it about time we applied the lesson to business as well? I don’t think even Google has taken the next step, and afforded employees democratic input into financial decisions. Oh, I can see the objections. They’ll blow the budget on stupidities, they’ll put 100% of the profit into wages, etc. You know what? That’s what people used to say about democracy in the state, too. And yet we found a way that worked. Workers want money today, but they also know they’ll want money tomorrow, so they’ll generally vote enough capital investment to keep the business going. If they don’t, and the business folds, that’s legitimately on their own heads. When we in New Zealand changed our electoral system in 1996 to give minor parties a fairer go, people voted in a three-ring circus exactly once. After that, you learn what works and what doesn’t. I’d give a related answer to the objection that workers would give themselves six-day weekends and three weeks off work every month. Workers who know the connection between profits and wages will be well motivated to keep producing.

Well, that’s about half of what’s wrong with economics. The other half, however – using economic growth as a measure of financial well-being on a finite planet – has been much more thoroughly discussed elsewhere. I may talk about it myself some other time, but as I claim to update this blog “roughly fortnightly”, and it’s now been over a month, it’s time to get this into the aether.


  1. Re: the way Google operates (and might improve) - do you know about Valve? They seem to have taken the Google style of organisational structure all the way out to the level of near-anarchy.

    This is the copy of their employees' handbook they published:

  2. Aargh! Apologies for the weird justification. I dunno why the comment field did that...

    1. I have no idea either. I don't control the CSS on this blog. Maybe I should find out how to do that.

  3. I have a thought. Often the right-wing comments I hear on the radio and so on about how tough things are for small-business owners (probably the same ones who have "mum-and-dad-investors") seem to take the kind of view of these employers that you evoked with your image of trying to sell your car or else live under a bridge - except with labour as the focus of desperation, not cash. These poor employers are desperate, and if you the labourer are not willing to work for them for a 'reasonable' wage, they will have to close down and then their mortgage will be foreclosed on and then they will lose the house and then their families will starve. I am thinking particularly of Christchurch after the quakes and people whose businesses had been literally destroyed, and whose workers had fled or couldn't get to work any more.

  4. BTW I don't seem to be able to follow you on WordPress. Sorry.

  5. I'm not sure what I was meant to get out of this. You try to tackle the problem of what's wrong with economics by showing a first year understanding of the supply/demand model and marginal utility, then you quote the Bible, and pscyhologists, and try to mash different subjects to reach some kind of conclusion.

    The supply/demand model and m.utility is a microeconomic theory that's only ever meant to satisfy basic knowledge of how tiny markets might decide how to allocate resources. You can't really extrapolate this out to apply to the world without additional knowledge, which is where macroeconomic theory kicks in. If you wanted to talk about ability to pay you should have stayed in class and learnt about income theory and the allocation of disposable income to resources.

    1. Well, seeing as I only ever saw half of one first-year paper's lectures, I'd say a "first year understanding" is doing quite well. I wouldn't have minded staying in class and learning about income theory, but I got assigned to a whole bunch of Dentistry lectures this year instead. Them's the breaks.

      I must be a poorer communicator than I thought, though, if all you saw was me "mashing different subjects". Economics is (supposedly) the study of how people allocate resources, yes? Well, then, I'd think that the study of how people behave generally, that being psychology, was perfectly pertinent. The authors of the New York taxicab study seem to have thought so as well, and I'm guessing they had better than a first-year understanding of the supply/demand model and marginal utility. The research discussed in the Atlantic article shows at least that people's economic motivations appear to be consistent with the Weber-Fechner law, as we would expect. But all that is rather dry and potentially hard to follow, so I found a nice quotable quote that makes it seem intuitive, just to make sure the point was clear. That the quote happens to come from the Bible is neither here nor there.

      Since you seem to know about economics, perhaps you would care to enlighten me:
      -- Why do economists call it "welfare" when they haven't distinguished between willingness to pay and ability to pay? (If they reserved that term for when they had made the distinction, I would be much less suspicious of their claim to know what's going on. But our lecturers didn't.)
      -- If the labour market is negatively elastic, what are the implications for the market's competence to set wages? If it's not negatively elastic, what did the New York taxicab study get wrong?
      -- What is the technical economic term for how the law of diminishing returns applies to the value of money, as opposed to the value of goods or services?
      -- My lecturers drew most of their conclusions from a few broad axioms about how ideal rational agents behave. Can you give a few examples of empirical studies supporting free market theories of labour?