Coordination Problem

Institutions and Creativity in Israel Kirzner’s Work

Nicolai Foss recently posted a comment (see here) on my latest paper with Israel Kirzner (see here). I have always been a fan of Nicolai’s work. He was on my dissertation committee back in 1998 (along with Pete Boettke and others). He belongs to a rare breed of scholars who look across schools of thoughts and disciplines. He can also turn out a paper in the time it takes me to write the title. We had a “revise and resubmit” at JEBO together back in 2000, but I refused to change the passages about Kirzner’s work and we didn’t get the paper published. I probably would revise the paper today but at the time I was not willing to. I think Nicolai has been mad at me since then...

Nicolai is right to point out that my latest paper with Kirzner includes a whole discussion on institutions, culture, and policy, which is not very common in Kirzner’s work. This was why I wanted to write the paper with him in the first place. This said, I do think that scholars often underestimate how much Kirzner is interested in institutional and policy issues. As I argued in my paper, “Kirznerian Economics: Some Policy Implications and Issues” (published as part of the special issue on Kirzner in the Journal des Economistes et des Etudes Humaines in 2002), Kirzner’s work is very rich in policy issues, even if he doesn’t always draw the implications himself. The main policy themes in his work are: government regulations (including monopoly and antitrust) and tax policy. One should not forget that policy issues are also institutional issues.

While there is less material in Kirzner's work (besides our latest paper) on the issues of institutions and culture (as they are usually discussed), there is enough to understand his view. The role of property rights is very present, especially in so far as they affect entrepreneurial discovery. Kirzner has done a lot of work on ethics—probably more than the average economist. He explains the importance of meta-rules and belief systems that frame the market, and he developed the “finder-keeper” principle. Kirzner says that entrepreneurship requires a moral and institutional framework to take place. It cannot operate in a vacuum. This means that entrepreneurship must take place against (at least) a shared ethics. It is true that if one defines institutions as rules and their enforcement, it is not entirely clear whether Kirzner thinks entrepreneurship can take place at this level or not.

I disagree with Nicolai about the role of creativity in Kirzner’s work. The Kirznerian discovery process is fundamentally a creative process. It is about the introduction of new knowledge in the world. The act of discovery is a new understanding of causal relations, as the entrepreneur perceives them. Kirzner’s work rests on two fundamental tenets: subjectivism and uncertainty. By marrying these two concepts, he elaborated the role of the entrepreneur more than any other economist before him. Discovery became relevant as an economic concept because of subjectivism in a situation of uncertainty. Creativity is just another word for discovery. In my view, Kirzner’s work encompasses Schumpeter’s.

Pete and I will be in New York next week to meet with Israel Kirzner. We will be interviewing him and my goal is to ask him all the hard questions about his work—and the role of institutions and culture will be one of them.

Value Investing NBA Style

Upcoming this week is the NBA draft.  The HS players will not be in the draft this year -- a big departure from the recent trend -- due to a minimum age requirement.  I am not in favor of this rule not because I like to see the kids skipping college but because I believe the unintended consequences will actually generate problems with elite youth basketball which will be more detrimental in terms of exacerbating the hypocrisy already evident in the NCAA, prep schools, etc.  But that is not what I want to address in this post.

College Hoops lists the projections for the 2006 NBA draft.  Rudy Gay of UConn is the no miss prospect.  And who can doubt the experts -- at 6'9" and with guard skills, Gay is a special athlete.  (Though those who followed GMU's great run to the Final Four will know that Will Thomas has beaten Gay throughout HS and now in college when they faced each other in championship situations).

But the real question is where will the surprises come in this draft.  The top college players from last season, JJ Redick is projected to go to the Utah Jazz around 14th in the first round though Adam Morrison is expected to go 4th to Portland Trailblazers.  But still these guys are not candidates for surprise.  Instead, the principles of value investing suggest that markets are to a considerable extent efficient --- as the saying goes $20 bills will not lay there forever, they will be picked up.  But that doesn't mean that there never is a $20 bill to pick up.  Finding them is what entrepreneurship is all about.  My candidate for the $20 bill in this years draft --- Mike Gansey of West Virginia University.  Gansey could perhaps evolve into a player like Jeff Hornacek, who was instrumental in the Jazz's success during the Stockton and Malone era.  If so, he could be the best find.  Of course, a lot depends on what team drafts a player and how does he fit into the system.

Successful Transitions: Individuals, Organizations and Societies

This week I had the great opportunity to do an interview for a TV documentary on the calling of the entrepreneur on Monday, and to visit Wichita, KS and speak to a group of businessmen on Tuesday on lessons from transition economies for organizational learning.  I find the opportunity to discuss economic affairs with non-academics extremely refreshing (even if at times it is frustrating).   In an earlier post from October 2005 I discussed the role of non-academic mentors in my own inellectual development.  Businessmen, policy makers, and journalists often have a sense of relevance which unfortunately is missed in some academic discourse.  But relevance, it should always be stressed, is a virtue, not a vice, in our attempt to make intellectual progress in the sciences of man.  In our attempt to understand ourselves and others we must avoid both free floating abstractions as well as momentary concretes.  Instead, we must develop concepts that enable us to address the practical problems that businessman and policy makers are called upon to solve.  If we don't, our intellectual exercises in conceptual analysis fail the relevance test.  Theories can be rejected, I have argued, based on logical inconsistency, and lack of relevance for understanding the empirical issue under examination.

My talk on Tuesday emphasized the following lessons we have learned from transition societies that are relevant for the study of organizations: (a) adaptability, and (b) resiliency.  Success requires a level of creative adaptability to constantly changing circumstances, and resiliency in the face of crisis.  The societies that were the most successful were the ones that were the quickest to adapt to the changing situation, and the ones that developed quickly resilient institutions to replace the fragile institutions the defined the system prior to the current crisis.  I contrasted this concept of creative adaptability with the more standard notion of creative destruction.  Creative destruction normally starts in a settled equilibrium, and then an exogenous shock is introduced which destroys the old equilibrium and then individuals adjust their behavior until a new equilibrium is obtained.  In contrast, creative adaptability speaks to a world of ceaseless change and uncertainty in which actors are constantly adjusting on various margins to realize opportunities for mutual cooperation and gain.  To illustrate my points I reached into the sports world -- tennis and then basketball.

The first rule of competitive tennis -- introduced as far as I know by the great tennis coach Harry Hopman -- who told his players to never change a winning game, but always change a losing game during the course of a match.  The great matches in history exhibit a sort of chess match with racquets in which the players are constantly adapting their natural talents and style of play to gain a competitive advantage over their opponent.  The game of basketball perhaps illustrates even better the organizational principles of creative adaptability and resiliency.  Basketball is a team game played by individuals and as such it requires both teamwork and creative individual initiative.  There are three basic principles for success in the game.  First, recognize capabilities of your team --- know who you are, know who your teammates are, and know who your team is playing.  Successful teams would not have Shaq shooting 3s rather than posting up.  In other words, both individuals and teams must avoid shooting themselves in the foot.  Second, offense is spacing, and spacing is offense.  Spacing creates opportunities.  It creates room for individual creativity within the disciplined setting of the offensive system.  This creativity within discipline is the key.  Great basketball (like great jazz) relies on improvisation.  Consider Dwayne Wade's wonderful NBA finals performances, great individual skill was utilized within the boundaries of the team.  Wade not only slashed to score, but also when needed found teammates open for key shots. Third, demand excellence and accountability from each other.  During GMU's run to the final four it was revealed that Coach Larranaga emphasized to his players Aristotle's comment that excellence is not a single act, but a habit.  Individuals and teams must dream big in order to achieve big, but in order to achieve they need to put in the hard work to achieve that goal.

Back to organizations and societies, failure is a fact of life.  Being afraid to fail results in failing to try.  So you cannot create an atmosphere where failure is not built in.  Constant adaptation change and resiliency in face of crisis is the name of the game.

So what have we learned from transitions over the past decade and a half?  I argue that there is an amazing amount of similarity between the lessons we learn from the experience in East and Central Europe, and the principles of successful organizations.  Societies and organizations must create space for their members to be creative in a discplined manner.  At the society level the number 1 priority is to reduce the threat of predation from both private and public actors so that individuals will be willing to bet on their ideas and find the financing to bring those bets to life.  As Adam Smith put it, the only things required to move from poverty to prosperity is peace, easy taxes and a reaonable administration of justice.  At the individual and organizational level, the creativity within discpline required for success needs: (a) specified goal, (b) adaptability to changing circumstances to seize opportunties for gain, (c) resiliency against crisis, and (d) feedback and accountability.

It is all about strategizing within disequilibrium.

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Note to readers: John A. Mathews, Strategizing, Disequilibrium and Profit (Stanford University Press, 2006) is a wonderful work that everyone interested in market process analysis needs to read carefully.

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Weathering Corruption

Could bad weather be responsible for corruption in the U.S.?

In a new paper, Russ Sobel and I provide evidence that the answer is 'yes' and explain why.

Check it out here.

A Billion Here and a Billion There, and Pretty Soon You Are Spending Real Money

On Wednesday newspapers across the US were filled with reports of a government audit which showed that an estimated $1.4 billion in FEMA emergency funds for Katrina and Rita was lost in fraud over the past 9 months. FEMA was attacked for mismanaging the crisis in New Orleans and now for poor accounting of the use of funds. My favorite headline on this is from today's Philadelphia Daily News: "Many Got Aid and Played" (see here).

As discussed before, the Mercatus Center is conducting a research project on Katrina and one of the branches of this projects headed up by Russ Sobel in collaboration with Peter Leeson is in fact addressing the problems of corruption in disaster relief.

Another branch of this research focuses on the economic and sociological dimensions. In yesterday's Wall Street Journal Emily Chamlee-Wright and Dan Rothchild published an article entitled "Government Dines on Katrina Left-Overs" (see here).

Mercatus’ fellows have already published articles in newspapers and magazines on various aspects of the post-Katrina reconstruction of the Gulf Coast. Some of the more substantial academic work will be appearing this summer. An easy way to describe the general thrust of the different branches would be to see:

• the sociological wing as exploring Tocqueville's idea of the art of association and the resiliency of communities as a function of social networks,
• the economic wing as exploring the ideas of Jane Jacobs on commerce and cities in the natural redevelopment, and
• the political wing as exploring the power of Gordon Tullock's idea of rent-seeking and the politics of bureaucracy in the government management of crisis.

I find the entire project to be intellectually exhilarating, and a great opportunity to work with wonderfully insightful and dedicate scholars who are committed to the proposition that ideas do and must have consequences in the real world of practical policy.

A New Exposition of a Powerful Theory: Israel Kirzner’s Latest Paper on Entrepreneurship

The fans of Israel Kirzner out there have reasons to rejoice. Israel Kirzner and I collaborated on the publication of a new piece: “The Nature and Role of Entrepreneurship in Markets: Implications for Policy,” published as part of the Mercatus Policy Series.

The piece is a highly accessible and illuminating exposition of Kirznerian entrepreneurship. It is principally aimed at policy makers around the world who are interested in the topic. It should also attract the attention of economists and other social scientists who want to know more about the cognitive understanding of entrepreneurship.

Indeed, policy makers and others often associate entrepreneurship with the creation of new businesses. While this is an accurate description of one of the many outcomes of entrepreneurial activity, entrepreneurship fundamentally is not about business start-ups. It derives from the creative power of the human mind and consists of the discovery of profitable ideas that enable market actors to exploit new, socially beneficial gains from trade. As such, entrepreneurship is the driving force of the market, and it makes progress and sustained prosperity possible.

Israel Kirzner and I explain that entrepreneurship matters more to individual wellbeing than resources. As long as entrepreneurial activity is free to operate, economic systems are very resilient; they can adjust to all sorts of problems. However, when entrepreneurial discovery is stifled, resilience disappears and poverty increases. It follows that economic policy should focus on the institutional (and cultural) context that fosters socially-beneficial entrepreneurial activity. The quality of institutions, especially as they impact monetary profits, is crucial to enabling individuals to bet on the future and reap the profits they have discovered.

A Nation in Debt

In 1986 I worked with Rich Fink and Jack High to put together an edited book dealing with the public debt crisis in the US.  Jerry Ellig and I have a paper in that volume entitled The Business of Government and Government as a Business that attempted to dispel the myth that government could act on the basis of business principles when in fact profit and loss incentives are absent.  In that paper we showed that in the post WWII era every time that government raised taxes (except 1 year) to pay down the debt the debt wasn't paid down because spending increased.  In short, we argued that only binding rules that constrain spending and limit taxation, and more importantly streamline what we ask governments to do, will get the fiscal house in order.

Naill Ferguson, the brilliant Harvard historian, has a nice article in the New York Times Magazine June 11th edition (subscriptions might be required) on the reasons why we should be worried in the US given our public debt.  As Ferguson puts it:

When the National Debt clock in Times Square was turned on in 1989, the federal debt amounted to around $2.7 trillion. Eleven years later, on Sept. 7, 2000, the clock read: "Our national debt: $5,676,989,904,887. Your family share: $73,733." That's when the clock was turned off, because, in those innocent days, it seemed as if the $5.6 trillion debt was set to decline, perhaps to disappear altogether. On that same date, CNN reported, "Vice President and Democratic presidential nominee Al Gore . . . outlined a plan that he says would eliminate the debt by 2012." The proposal was uncontroversial. Economic advisers to the Republican candidate, George W. Bush, were said to have "agreed with the principle of paying down the debt," but their candidate had "not committed to a specific date for eliminating it."

That should have set the alarm bells ringing. (And, in fact, the National Debt Clock started running again in 2002.)

Since becoming president, George Bush has presided over one of the steepest peacetime rises ever in the federal debt. The gross federal debt now exceeds $8.3 trillion. There are three reasons for the post-2000 increase: reduced revenue during the 2001 recession, generous tax cuts for higher income groups and increased expenditures not only on warfare abroad but also on welfare at home. And if projections from the Congressional Budget Office turn out to be correct, we are just a decade away from a $12.8 trillion debt — more than double what it was when Bush took office.

I am generally an optimist, given advances in technology and openning up of new trading opportunitiies the gains from trade and innovation will off set stupid government policies so that tomorrow's trough will still be higher than today's peak.  But I do believe there are serious reasons to worry.  Deficit financing fuels the natural proclivities of politicians to spend to please special interests, and the monetization of debt will risk distortionary inflation that can cause extreme discoordination that will undermine any gains from trade and innovation we might realize and tomorrow's trough will actually be lower than today's --- we will be worse off in the future than we are today.  And my problem is that I cannot see how we can possibly get the political-economic system back on the right track absent an ideological change that tames the desires of the voters and constrains the politicians.

Why Have Kiwis Not Become Tigers?

I know I have been promoting my publications quite a lot lately, but I must tell you about this new one (there is actually one more coming soon). Today the New Zealand Business Roundtable released the NZ version of my paper: “Why Have Kiwis Not Become Tigers?” (see here), which was published two months ago in the Independent Review (see here). I am very pleased this publication is now directly available in NZ. I hope it will contribute to the policy debate down under and will entice NZ policymakers to pay more attention to entrepreneurship.

Simultaneously, I have published today an article in the New Zealand Herald entitled: “Kiwis into Tigers: Hardly Likely” (see here; the title is not from me but from the editor). The article stresses the issue of entrepreneurship in NZ policy and, following the paper, argues that NZ governments have neglected in the recent past the conditions for entrepreneurial activity (in the Austrian sense of course). If Kiwis are to become tigers, they should focus more on the institutional conditions for entrepreneurial discovery: low taxes, small government, and (a return to) light-handed regulation.

The Ups and Downs of Athletic Endeavors

Today Rafael Nadal won his 60th consecutive clay court tennis match and in so doing stopped Roger Federer from achieving his goal winning four consecutive Grand Slam tournaments in tennis.  Nadal's ability to scramble and fight so hard on clay is a testament to his physical and mental toughness, and the emerging rivalry between Nadal and Federer is great for the game ---- hopefully lasting much longer than Borg vs. McEnroe and producing even more high profile matches than Aggassi vs. Sampras.   A quick footnote on the Grand Slam today versus yesterday.  At one point 3 of the tournaments were played on grass (Wimbledon, US Open and Australian Open) and only the French was played on a different surface.  However, today's players face a different surface at each of the major championships.  Borg's 6 French and 5 Wimbledon championships is perhaps still the most impressive achievement in the modern era given the quick turnaround between the clay court and grass court championships.

I am currently watching the NBA Finals, I would like to see Miami win, but I am not confident that will be the result.  I am cheering for both Shaq and Wade, but Walker has always been a player that I doubt and that is true for Payton and Williams due to their style of play.  The NYT has a nice op-ed on the NBA finals and the leagues secret superstars by John Berri.  There is also a nice interview with Skip Sauer and his work on the economics of sports available from the Richmond Fed, read especially his discussion on page 39-40 of the Moneyball hypothesis concerning undervalued attributes in baseball.  See there are constant entrepreneurial moments in sports as a player, a coach and a general manager that must be exploited to realize success.

Speaking of which, my 9th grade team won the BRYC East Coast Tournament of Champions this weekend going 4-0 against teams from Virginia and Maryland.  The Maryland team will be heading to the AAU Nationals for Division 2 later this summer, and the team from Vriginia that we beat in the finals (65 to 62) was the top ranked team in VA in USSSA basketball.  The team played well throughout the weekend, but in the final game we never led until the last minute of the game.  Clutch play by several players helped the team win in a tough final.  We haven't always been so fortunate this season as we have lost 8 games this season by less than 4 points.  Anyway congratulations go the players for competing throughout and pulling out the victory.

What does IKEA have to do with the law of association?

When people ask me what Mises's greatest contribution to social theory was I ultimately pinpoint his work on the Law of Association.  Mises generalized Ricardo's law of comparative advantage into a general principle for social cooperation and in doing so provided the economic rationale for civil society.

Tom Palmer has a nice discussion of liberty, the law of association, and civil society here.