The Knowledge Problem: Pictorial

See it here. (HT: Marginal Revolution)

If you build it, they won’t necessarily come.


The Knowledge Problem in Jim Manzi’s words

Just a paragraph later from the previous quote, Manzi writes:

These deep commonalities across activities such as science, markets, common law, and representative democracy at least indicate the plausibility of a common underlying structure. Each is a noncoercive system for human social organizations to increase material well-being in the face of a complex environment.

They are all methods for obtaining and exploiting practical knowledge through action, and all commingle abstract knowledge and action to various degrees; hence, so-called tacit knowledge. If the environment were simple–if determining the course of action were obvious and relatively static across time–then the complexity and waste of a scientific/market/judicial/democratic process of discovery would not be justified, and central authority would more efficiently impose a common answer.

Later, Manzi reminds us that we should be humble about our knowledge, even if we have what we think are foolproof models to help us predict what might happen (p. 67):

By (unverifiable) tradition, a Roman general who received a triumphant parade upon returning from a conquest had a slave stand just behind his shoulder, whispering over and over again into his ear, “Remember, you are mortal.” When using a probabilistic forecast, we should always hear a whisper in our ears remind us: The model is never the system.

I agree. I often tell my statistician buddies that to create a model that factors in everything in a complex system they would first need to create the universe.

I think the models they create are like the artist’s rendering of a subject. With a great artist, his or her rendering may be good to hang on the wall, but it tells us very little about the true workings of the subject’s world.

The rendering of a mountain landscape, for example, will not give us any information about how weather fronts move over those mountains or how universal forces combined to create the majestic landscape. The artist’s rendering is nothing more than well placed brush strokes on a canvas that merely represent the landscape from one particular point of view at one particular point in time. A statisticians model is much closer to that than it is a living model of the real world.

Of course, some folks entertain the thought that our universe is a simulation. Perhaps we live in a model of a statistician that took my advice to heart.

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.