The Hayek and Polyanyi lesson

I learned from this Marginal Revolution post (and its comments) what to call the idea that many successful companies that have emerged in the free market because customers value what they provide would not exist if they had to rely on bureaucrats to approve them.

It’s called the Hayek and Polanyi lesson. Though, this Polanyi is interesting, too.

Advertisements

Why did you buy that?

Art Carden writes that Entrepreneurs Serve Public Better Than Politicians (H/T: Speedmaster at The Pretense of Knowledge).

I agree. I agree.

While on a trip to Vegas, Carden found a profit opportunity. Two nearby Starbucks were selling coffee at different prices. The higher priced Starbucks was busier (sounds like they got their pricing right). Carden bought two cups of coffee at the cheaper (and less busy Starbucks), brought them to the line at the busier and more expensive Starbucks and sold them for a profit to people standing in line.

As Carden sums it up:

The 97 cents I earned was my reward for taking a risk on my hunch that two cups of coffee would be more valuable downstairs than upstairs.

According to Deirdre McCloskey, this is the key to the wealth of the modern world. That we live in a world in which buying low and selling high is at least tolerated encourages economic growth. The great irony of this is that merchants tend to be scorned or otherwise not trusted. But who is the real public servant: the politician deciding he will take more of your money by force so that he can accomplish his goals, or the merchant who decides he wants more of your money and offers you a hot cup of tasty coffee in return?

I have one beef with the column. To make his great point that business folks do more to serve their fellow-man than politicians, he brushed over a key point on value creation.

Most people think of business people as McCloskey put it, someone who buys low and sells high.

That’s too simple.

Why were the folks in line at the more expensive Starbucks willing to pay Carden more than he paid for the coffee?

The answer to that is why business people can “sell high”, if they’re lucky. That is the value creation process.

And the beauty of that process is that it’s sometimes hard to pinpoint the reasons we’re willing to pay what we pay for things.

Perhaps Carden’s buyers were in a hurry, he had what they wanted, so he saved them time. Maybe Carden looks like a trustworthy fellow, had a big smile on his face and his buyers got some value out of his charm. Or maybe, they saw him speak the day before, and thought that he was up to something clever, so they thought they’d play along.

If the reason they bought Carden’s coffee had anything to do with saving time, then Carden had solved what economist Friederich Hayek called the knowledge problem. Carden had knowledge of the particular circumstances of time and place. He knew of a nearby Starbucks with lower prices and shorter lines.

This is knowledge that most of the folks waiting in line at the other Starbucks did not have or did not value enough to act on.

Two people valued it and bought out Carden’s inventory.

Carden took a risk. He could have wound up with no takers, in which case he would have two grande cups of coffee to drink.

Since Carden wasn’t sure whether anyone would buy from him, he didn’t invest much.  He exhibited prudence, as I wrote about in the previous post, by limiting his risk to two cups of coffee.

Business people experiment all the time. They usually don’t know what people will value any more than you or I. They are following their hunches, observing and trying things to find something people value.

It doesn’t always work. Most business owners have experienced failures. They bought two cups of coffee and couldn’t find buyers.

The businesses we trade with every day are the few experiments that worked. For each one, there were likely dozens or maybe even hundreds that failed.

Further, once a business has established its success, we tend to take its success as a given and forget the failures and risk the business owners took to find the success. We have a tendency to question their profits rather than praise the value they bring us.

We forget that even Carden’s customers profited. Most likely, they gained time that was valuable to them.

I was the 301st person to watch this on Youtube

Here’s the second round of the Keynes vs. Hayek.  Enjoy.  I donated $50 to this project.

And here’s Round 1 in case you missed it.

Thanks to Russ Roberts and John Papola for their excellent efforts, great lyrics and high production value!  There’s a lot of depth to both videos in the lyrics, in the folks who are mentioned and the folks who pop up in the video.  These are excellent learning tools.

Retiring Quote of the Week…

“‘Emergencies’ have always been the pretext on which the safeguards of individual liberty have been eroded.” -Friedrich Hayek

…and changing it to Quote of the Month given my frequency in changing it.

It Took This Long?

Greg Mankiw, a well-respected Harvard economics professor wonders if all of the smart economists working for Obama have explained to him that price controls are a bad idea.

I’m certainly no Harvard econ professor, but did it really take Mankiw this long to question Obama’s economics team?

They lost me a year ago with the word “multiplier”.

If they believe their multipliers on the economic impact that results from government spending (i.e. $1 of government spending results in more than $1 of economic activity), that are derived from multiple regressions on imperfectly aggregated and lagging historical economic data from times that might be different than these times and future times, then I think they’re crazy.

True measure: If their models were really that good at predicting the future, they should have been able to prove it by using their models to grow wealthy.

I’m not sure it can be said any better than F.A. Hayek’s character in the Keynes vs. Hayek rap video of such economic models:

I’ll begin in broad strokes, just like my friend Keynes
His theory conceals the mechanics of change,
That simple equation, too much aggregation
Ignores human action and motivation

And yet it continues as a justification
For bailouts and payoffs by pols with machinations
You provide them with cover to sell us a free lunch

Then all that we’re left with is debt, and a bunch