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GP 27 September 2006: Dr. Johnson's Stone

The Trouble with Theories Bishop Berkeley held that you and I can only grasp sensations and ideas of an object (i.e., creations of our own mind), not the object in itself. We do not have an untarnished connection to the world outside of ourselves: we just have an accumulation of perceptions about things that are the products of the filters in our consciousness.  Known as “subjective idealism,” his thinking more or less said that we could not know or posit any objective world that subsists outside the mind’s fog.  The great Dr. Johnson, kicking a stone nearby, said, “I refute it thus.”

Common sense has a way of getting in the way of theories, no matter how philosophers, ideologues, and charlatans spin their webs.  The trouble with theories is that they are just that—theories.  A stone always gets in the way.  And yet believers hold to their theories with a fervor and zeal that is normally reserved for religion.  In countries that are over the hill, common sense no longer has a chance to assert itself, and any loony idea can take hold.

Judge Greene.  Back in 1982 Judge Greene broke up AT & T, ending a long standing monopoly upon which America’s universal (and we might add, inexpensive) phone service was built.  Generally it was thought that monopoly was bad and that all sorts of advantages would accrue to our economy and to consumers if it were shattered; marvelous new enterprises would enter the telecommunications marketplace.  A nice theory that, even if most of us then thought our phones worked pretty well and we did not have the foggiest notion of all the marvelous benefits that would ensue from the decision of this novice judge. Our phone service has gone downhill ever since.

Alfred E. Kahn Alfred Kahn, an economist who has recorded stints at both Ripon and Cornell, added ballast to Judge Greene’s decree.  At both the New York Public Service Commission and the Civil Aeronautics Board he floated the thought that if we could put deregulation together with competitive entities, prices would fall, quality would skyrocket, and life would be better for practically everybody. Another nice theory.  The wonderful thing about academic economists, be they Kahn or John Kenneth Galbraith, is that they poke into the marketplace just long enough to create confusion and dysfunction—and then, of course, retreat back to academia.  From their safe roosts, they tell us that things would have been virtually idyllic if we had only done it in their way.  Of course, Con Edison and the New York Power Grid has been a mess ever since, and aviation has become a horrible ordeal for John Q. Public.

Adam Smith and David Ricardo.  Behind all this monopoly busting and regulation shredding lies the economic wisdom of Smith, Ricardo, Mill, Say, and other 18th-century thinkers.  Basically they said that a nation’s economy would work better if it trusted the workings of the marketplace—the invisible hand of the market—rather than the machinations of mercantilist governments that thought they could rule their way to wealth.   But the troubles with all this good theory are legion, two of which we detail here:

  1. There never is any such thing as a truly free market—either then or now.  So it is a bit naïve to depend on its workings.  Mercantilists, fixers, and other clever men are always messing about with the marketplace.  Everybody secretly wants to own 100% of the market: nobody wants the other guy to own it.  Show me a ‘free marketplace,’ and I will show you someone is secretly pulling the strings.  Better theories would advocate free markets but also gracefully incorporate the parries and thrusts of the majority, who don’t like competition that much, into the machinery of trade.

  2. Theories that pretend to be universal usually turn out to most relevant to the time and place where they are put forth.  What was good for 18th-century England is not necessarily the best medicine for the United States or China in the 21st.  In fact, modern communications have changed the cost structure of the world and rendered obsolete some of our older notions of how trade works.  For that matter we now even admit the limits of Newton’s Laws.  By and large, the Asians, who understand the 21st century pretty well,  protect their markets until they enjoy overwhelming market advantage: then they open them up.

Comparative Advantage.  While we worship Adam Smith, it turns out that Ricardo had a better nose for practical affairs.  First off, he made a fortune, showing he had some shrewd instincts for how the world actually worked.  Secondly, he came up with the notion of ‘comparative advantage’ which, in some ways, implies that markets, or at least national markets, have kinks in them.  His Principles of Political Economy and Taxation “introduces the theory of comparative advantage.  According to Ricardo’s theory, even if a country could produce everything more efficiently than another country, it would reap gains from specialising in what it was best at producing and trading with other nations (Case & Fair, 1999: 812-818).  Ricardo believed that wages should be left to free competition, so there should be no restrictions on the importation of agricultural products from abroad.”  In practice, a nation should specialize even if it does a lot of things terribly well.  It is not a foregone conclusion that any one nation should continue in an industry, even if it is more efficient than other nations at the game, especially if a poorer nation has achieved productivity in the same industry that exceeds its national average of all industries.  Put bluntly, the paradox is that the best players on the globe may not survive in a world of comparative advantage.  The marketplace works rather imperfectly.

The Failure of Deregulation.  We calculate that even if there were free markets, they would work imperfectly.  And we would suggest that deregulation in the last quarter of the 20the century, an idea that flows out of free market theory, has not worked out for the United States.  The very industries that have been deregulated—phones, electricity, airlines, railroads, etc.—have only been partially deregulated and the price competition is hardly robust.  Chaos and quality breakdowns have infested each of these markets.  To varying degrees, we have simply substituted unregulated monopolies for regulated monopolies and now enjoy the worst of both worlds—a cruel mixture of unbridled markets and government muckabout.

Falling Behind in Phones and the Internet.  What’s happened instead is that we have fallen behind the rest of the world in our phones, and the same thing promises to happen on the Internet.  These are both strategic building blocks for the so-called Knowledge Economy that we think we have to become.

Mobile Phones. Our mobile phones beautifully illustrate our predicament.  We essentially have a few monopoly players in mobile phones who have built redundant but incompatible networks that underserve certain parts of the country.  Neither the networks nor the phones themselves are durably and correctly built.  We pay too much for the service: we have previously commented that one of our employees has been able to call home to Indiana more cheaply from Germany than he could from any of our offices.  We have too much inefficient competition in network design and construction, and virtually no competition at the point of distribution, such that Cingular and Verizon, the two big providers, today offer you identical plans.

Of the major countries, Japan today offers the most advanced networks, and is early to the party with innovations.  For instance, it did a quick roll out of 3G technology.  We have advised certain of our telecommunication clients to be well placed in Japan in order to keep ahead of the learning curve and not fall behind as has happened in the U.S.  There are today major installations of fiber to the home in Japan.  In the U.S. we are just talking about getting started, with Verizon in the lead.

Internet.  Blazing across the cover of the July 15, 2006 issue of CIO is the news that “China Builds a Better Internet,” which it fleshes out in a cover story on pages 43-45.  China’s Next Generation Internet uses “an emerging communication standard called Internet protocol version 6 (Ipv6).”  This protocol not only supplies enough address capability to keep up with burgeoning demand, but it is more secure and efficient than its predecessors.  (Japan and Korea are also launching initiatives in this area).  “China’s Next Generation Internet could further tighten its control over Internet access and traffic while offering a strategic advantage in foreign intelligence.”  We are advising companies with logistic networks stretching into China to learn about the facileness that the Chinese are demonstrating on the Internet.  In fact, it was Chinese clients who forced us to start using the Internet years ago.

Schumpter.  When starry eyed business writers are not raving about Adam Smith’s perpetual significance for Western economies, they wax purple about Joseph Schumpter’s insight into capitalism. In general, he talks about capitalism’s gift of creative destruction, where the old is demolished, so the new can emerge.  Schumpter, an Austrian, wound up at Harvard so you should take him with a few grains of salt.

That dream of fire in the ashes has not happened with deregulation.  We surely have destroyed a lot, but it’s not clear we have put anything creative or significant in its place.  Phones, the Internet, air transportation, education, electricity—several parts of our economy are probably in shambles.  Moreover, they should be part of the infrastructure of our next economy, so it behooves us to get them right.  Without them, we lack the leverage we need in a global economy.  Right now we’re suffering from ‘unbenign neglect.’

The Venture Proposition.  Smart venture capitalists always bet on the jockey, rather than the horse.  As many have said to us, they want to know that the guy who is coming to them for money can quickly go on to a new idea when his old one does not pan out.  An astute regional investor said, “Can they switch?  Because the initial deal is never the right one.  Can they quickly get on a new horse when they’re flagging in the race?”   As Will Rogers said, “If you find yourself in a hole, the first thing to do is stop digging.’”

That’s the creativity we need now that we have been through this destructive period of capitalism (a.k.a. ‘restructuring’) where we tore down the old.  As we hit stones in the path, like Dr. Johnson, or run into brick walls, we must be looking for people who can cast theory aside and find a course of action that will work.

The Law of Unintended Consequences.  This juicy concept can be explained and expanded upon in all sorts of ways.  It sort of means we can take up a course of action, expecting a benign outcome, but all sorts of other things, we never visualized, actually come to pass.  It can also mean “things never work out” or “never work out in the way we expected.”  We would say that theories, especially theories about governance or social change, when some zealot cons society into taking them seriously, tend to get us in a jam.  Economic theories seem especially pernicious.  We would recommend, in this regard, a look at Robert K. Merton, a.k.a. Meyer R. Schkolnick, who hatched the ‘Law of Unforeseen Consequences,’ ‘self-fulfilling prophecy,’ and lots of other aphorisms about how the notions of social scientists mess up the lives of ordinary mortals.  He knew that irony lurks behind every bush when theory is allowed to become an ideology.

Who would have dreamed that deregulation would lead to monopoly, high prices, falling quality and inferior technology, eroding global competitiveness?  Who would have dreamed that all parts of the political spectrum would have fallen for such daft thinking hook, line, and sinker?  But we ourselves took the hook, albeit with some uneasiness.  To re-coin an old phrase apparently not dreamed up by P.T. Barnum, “There’s a zillion suckers born every minute.”

P.S.  There’s a bright libertarian down in Dallas named Virginia Postrel whose The Future and Its Enemies tells us that dynamic thinkers favor deregulation, which she thinks is part of getting on with the future, and that static types favor government, regulation, and all that holds us back.  Don’t bank on it.  If you tear up the present and don’t replace it with something more benign, most likely you will throw us back into the Stone Age.  Which brings us once again to Dr. Johnson’s ‘stone.’

P.P.S.  Texas is in electricity trouble.  Increased electricity usage, declining reserves, and the elimination of peak power generators is causing trouble across the U.S.  “The problem is especially acute in Texas because the state has almost no ability to import power from neighboring states.”  In other words, it suffers from ‘splendid isolation.’  See “Texas-Size Hunger for Power Worries State’s Grid Boss,” Wall Street Journal, September 25, 2006, p. A2.  State and Federal safety rules mandate a 12.5%  reserve at all times, but it slipped well under 10% on August 17, far below the 16.3% that had been projected this summer.  Humorously enough, the grid is called the Electric Reliability Council of Texas, about as appropriate a name as the Environmental Protection Administration in New York City.

“Californians have held electricity use flat since the 1980s on a per-capita basis through investments in energy-efficiency and conservations programs.  In 2003, California ranked first among all states for lowest per-capita electricity use, at 6,732 kilowatt hours annually.  Texas ranked No. 35 with average annual use that was more than twice as great, at 14,602 kilowatt hours per person.”

None too soon, Texas is climbing on the wind power bandwagon.  See “Texas Blowhard” at Big Ideas.

We suspect there’s a need for developing different rules of governance for our largest states, certainly for California, Texas, New York, and Florida.  They are like little countries, troubled in different ways because we administer them as if they were like their much smaller brethren.  Kahn, of course, thought the remedy for their greater complexity was less governance. Their misgovernance has caused the U.S. economy to lag.

P.P.P.S.  We have previously said that infrastructure investment, properly done, constitutes a vast opportunity for the U.S. in “Investment Outlook: Infrastructure.”

P.P.P.P.S.  Remember when you are wailing about the static influence of state and government, remember that the Internet achieved lift off in Government at the prompting of DARPA, which, in prior times, was a force that very much bolstered America’s competiveness as a byproduct of its activities.

P.P.P.P.P.S.  If you can shake your free market, antigovernment bias, reflect on the fact that employment in our economy is essentially growing in only one sector—healthcare.  Healthcare, of course, is a cancer on the body politic that is simply eating us alive.

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