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.
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