Alex Cartwright and Dylan DelliSanti
Sears Chairman Eddie Lampert has been experimenting with a new management model at Sears. Essentially, different divisions of the company are forced to compete against one another- supposedly the best Sears division will be the one who gets to use the resource that all divisions are competing for. Of course, competition isn’t ‘good’ in itself and it does not always yield positive results. Productive competition takes place in an institutional environment (under rules or laws) that allows the competitive process to be productive. Lambert’s model may not be the most effective management strategy- we just can’t say without more information about Sears- but we can say that Paul Krugman’s recent blog post criticizing Lampert is a strange and poor attempt at justifying ‘central planning’ in lieu of markets.
In a recent blog post at his New York Times Blog The Conscience of a Liberal, titled “John Galt and The Theory of The Firm”, Paul Krugman writes:
“Of course, that’s not how we do things. We may live in a market sea, but that sea is dotted with many islands that we call firms, some of them quite large, within which decisions are made not via markets but via hierarchy — even, you might say, via central planning. Clearly, there are some things you don’t want to leave up to the market — the market itself is telling us that, by creating those islands of planning and hierarchy.”
Krugman uses this example to suggest that market advocates should be wary of using the market for planning large systems. If competition and decentralization doesn’t work for a big corporation like Sears, then why would it work for a large economy?
Krugman is stumbling onto an insight that economists like F.A. Hayek and Ludwig von Mises stumbled upon several decades ago. Essentially, markets are a web of various planned activities. The popular phrase “spontaneous order” can be misleading, and cause one to think that no planning occurs, but Hayek and Mises realized that planning happens all the time in a market – just on varied and decentralized levels.
In a private firm, the incentives between the planners and the profit earners are aligned (in economists speak, there isn’t a principal agent problem). Those who do the planning have an incentive to do a good job, and as employees in a firm, they are likely to have the local, specialized and tacit knowledge about how to effectively plan and change their plans upon error. Government planners lack all of these characteristics. The issue isn’t the ‘planning’ itself as Krugman suggests; planning is effective depending on who plans for whom.
Krugman’s confusion lies in misunderstanding the difference between a market and a firm. Markets are complex systems that result from the spontaneously coordinated actions of many different individuals and firms, with each acting on their own bit of information. These firms might employ more command-and-control elements or they might take a more decentralized approach like Sears, but it’s up to them to discover the balance. Regardless of which approach they take, they’ll know if they are successful, because of market signals: If, like Sears, they have taken too decentralized an approach, then they’ll see their profits diminish. Firms are the market’s built-in planning units, and testaments to the fact that spontaneous order is not unplanned chaos, but a dense conglomeration of varied plans.
Krugman, of course, wants to use this observation that markets are actually a web of plans to justify greater government planning. What he seemingly fails to understand is that it is not greater complexity that necessitates top-down planning. Essentially, the economic variables known to a firm are tangible and within their grasp – even larger firms like Sears. If the price of a production input rises, the firm can, from their vantage point, search out substitutes that are now relatively cheaper.
However, as Hayek points out in his essay The Economics of Planning, rational planning of an entire economy or industry will face difficulty since the “number of variables which any mind, even with the best assistance, can manipulate is limited.” Many have interpreted Hayek as arguing that planning is too complex, but a bigger and more powerful computer won’t make planning a more realistic possibility. Hayek’s key insight is that the market process is ‘dynamic’ that is, the process itself actually yields results- the competitive market process sends signals to all economic actors (transmitted via prices) that could not possibly be replicated by a planner since the prices are the result of millions of actor’s decisions occurring simultaneously.
Equally as important is that governments don’t receive the same signals as firms. Whereas we know that Sears’ business strategy might have some shortcomings, because their profits are falling. Their falling profits are an indication that they haven’t been able to satisfy consumer demands like they did in the past. They’re being punished for being inefficient. Politicians don’t have comparable signals. Instead, politicians respond to votes; public choice theory and, ideas like rational ignorance, indicate that democracy might be inadequate at punishing bad politicians and rewarding good ones. Furthermore, a firm’s existence depends on its effectiveness that is not at all true to the same degree with government.
Maybe the Sears business model failed to strike the right balance between centralization and decentralization. Not all of the business plans that entrepreneurs try will work out, but those who take a risk and succeed in executing their plan are rewarded with profit for making the consumer’s life better. The virtue of the market is that many different plans and business strategies can compete with each other. We don’t know ahead of time which plans will be most efficient at satisfying consumer desires – especially since the context of this planning is ever-changing.