John Kay -- Culture and prosperity: the truth about markets -- why some nations are rich but most remain poor =============================================================================================================== One thing that this book attempts to do is to answer the question: What features enable companies and economies as a whole to succeed and prosper? Kay's answers center around: - Division of labor. - Experimentation and innovation. - High levels of bureaucratic organization. - Flexibility. - Stable, honest government. - Secure property rights. Laws that protect them. Consistent regulation that makes business transactions predictable. And, legitimacy: a sense that rewards and wealth are apportioned fairly. - A sense of community. There must be motivations in addition to and other than personal, financial gain. The system must foster cooperation. - Expensive labor is better than cheap labor. It forces producers to move toward increased productivity, which results in higher compensation for works, which results in a higher level of consumption. - Manufacturing is better than agriculture. Manufacturing produces a higher value product and uses skilled and valuable labor to do it, thereby increasing wealth. The institutions and mind-set needed for a modern, successful economic systems take a long time to produce. It's not likely that anyone can "install" them; these conditions need to evolve through a self-organizing process. Assignment -- Allocation of scarce resources to competing ends. Kay considers examples and problems with both (1) political decisions; (2) market decisions as mechanisms for assigning and allocating goods to those who need them and to where those goods are needed (But, what about the Internet stock boom and bust? Were those companies really winners until they crashed?); (3) allocation decisions made by a single person or by a central controlling authority (that can be huge mistakes also); and (4) picking good people and trusting (yes, but which are the good people? Answer: We don't know until after they've done the right thing.). All of these strategies have problems. We just have to get lucky, I suppose. Spontaneous order (and organization), chaos, etc. -- Many of our problems revolve around the fact that economic systems are large and complex, and, therefore, their formation and change is chaotic. Complex systems are especially subject to sensitivity to initial conditions and path dependence. When initial conditions affect (and determine) subsequent behavior indefinitely and when path dependency is sensitive to small initial conditions, forecasting (prediction) is impossible. One interesting point that Kay makes is that we are fooled in believing that contracts, because we can write them or have them written and signed quickly, are easy. But, the language and the assumptions behind these contracts, as well as the institutions that we rely on to interpret and enforce them were not at all easy to produce. In fact, it took a long time and a huge effort to produce the contract regime that we currently have. Property rights that are stable and understood in common are important in producing prosperity, according to Kay. But, those property rights are not simple. Like the language and assumptions behind contracts, they took years and years to develop and for us to develop a sense of agreement on them. They vary across different societies. And, now that we are contesting ownership of things other than physical property, for example music and movie libraries, the copyrights to books and software, and patents on devices and inventions, not to mention genomes and DNA sequences, those property rights and disagreements over them will become even more complex. All of this affects the legitimacy with which property and its ownership is viewed by a society. A successful economic system must do the following: (1) Allocation: it must allocate scarce resources among competing ends; it must determine what is made (production) and who gets it (assignment). (2) Exchange: the system must enable scarce resources to get to those we need them where they need them, and to do so in an efficient and cost effective way. Centralized control -- Kay provides a number of examples where centralized control of the allocation and exchange of goods, of the production and assignment of those goods, gets it disastrously wrong. Specialization and division of labor are huge magnifiers with respect to prosperity. Corporations do this well. Combine these with the abilities to organize and to cooperate, and this is where prosperity comes from. Some of the later chapters of this book attempt to explain why it is so hard for a poor country to become rich. These chapters discuss problems faced by countries that are poor but resource rich, countries that attempt to use central planning and centrally planned projects, etc. Kay makes the point that those who do the hard and unpleasant work, are more motivated to innovate, to mechanize, and to invest in capital improvements. But, some laborers go on doing unpleasant work for years without innovating. Perhaps Kay means that those who bear the *costs* of that unpleasant labor are motivated to innovate and to improve labor productivity. In particular, they want to remove the costs and reduce their reliance on unreliable labor. Kay critiques the ABM (American business model). He seems to feel that it is too simple. Importantly, he claims that the most important difference between rich and poor states is the quality of their economic institutions. Furthermore, these economic institutions and the qualities that make them better or worse are not simple; and certainly they are complex enough so that they cannot be described as merely strong property rights. It makes a great deal of difference what the exact nature of those property rights are. Also important is that markets function well (or even function at all) only when they are embedded in and can depend upon social institutions. What is wrong with and incorrect about the ABM? (1) The ABM assumes that we have good, or even perfect information; but we do not. (2) Markets for risk do not work as described by the ABM; we handle risks in other ways, e.g. in families and communities that cover us and our risks. In fact the securities markets are more like casinos than like insurance companies. (3) Most economic activity does not happen in anonymous markets with large numbers of buyers and sellers, but rather in corporations and other organizations. (4) Order sometimes does emerge spontaneously, but often it is aided by government, by social institutions, and by agreements between firms. (5) Knowledge and information are produced, most often and more importantly by firms and individuals, not by markets of buyers and sellers. And, most importantly, the ABM is likely to result in a distribution of income and wealth that is so skewed that it and the government and economic system that supports it loses it's legitimacy. We are getting close to that condition here in the U.S. Kay's book is in some sense a study of a particular kind of complex system, specifically an economic system embedded within a political and societal system. It's also an attempt to show just how complex such a system is, and how no simple explanation or simple theory can explain such a system. Systems like this have a number of characteristics in common: they are large, complex, chaotic, deterministic, *not* predictable, decentralized, self-organizing, and adaptive. Given those characteristics, it's easy to see why Kay is skeptical about the ability of a centralized controlling body (e.g. a national government) to plan and control the development of such a system. Why? (1) Because the formation and growth of such systems is chaotic; it's subject to the effect of small changes in initial conditions; it's path dependent, so that small initial differences result in paths and conditions that make other conditions/paths unavailable; it's complex, which means that there are lots of conditions (states); it's subject to outside, unexpected influences; the effect of making a change to the system is unpredictable. (2) These are usually "one-off" systems: each one is "one of a kind". You do not have the option of producing several as practice or as tests and then to make the real one. That means that you have to get it right the first time, and some of us (I'm a computer programmer) know that's not possible. If you are interested in the issues discussed in this book, then you are likely to also be interested in the following: (1) "The origins of political order", by Francis Fukuyama; (2) "The collapse of complex societies", by Joseph A. Tainter; and (3) "Collapse", by Jared Diamond. The problem of how societies and political organizations degrade and fall apart seems as interesting and helpful to me as how they are created and constructed. I wish that Kay (and Fukuyama) had discussed it a bit. 08/04/2011 .. vim:ft=rst:fo+=a: