Friday Warrior: Incentives
Sorry this is late and potentially bad. It’s been one of those weeks.
Image: Victoriano Izquierdo
“Show me the incentive and I will show you the outcome.”
— Charlie Munger
There is a reason that capitalism works better than socialism and communism. It leverages incentives, and extremely well at that.
When you dig a little further, you begin to understand why.
An economy is a massive system that has resources and activities that need those resources. The problem is deciding where those resources go. Relying on the government to decide is a bad solution. But it’s not bad because governments typically have lazy, overpaid employees, even though that is sometimes (LOL) the case. It’s a bad solution because of the information. Or the distribution thereof.
Frederick Hayek explains it in detail in this essay.
Governments rely on scientific (technical) knowledge too much. They focus on theory. But, as important as theory is, it’s often not what makes things efficient. Rather, time and circumstance do that. When someone is fresh out of university, their technical knowledge is usually fresh and sound, but the application of that knowledge, and its growth, is a function of experience.
It is through experience that an engineer knows that one should avoid making even small changes to a software project on a demonstration day. The theory states that if it’s a small inconsequential change, it should be fine. Experience, on the other hand, shows that sometimes one thinks it’s a small inconsequential change, but it ends up being something more complex and the demo is a fail.
This information, garnered from experience, lies with experienced people in disparate industries and fields within society. These pockets of information are exactly the type that the state needs in order to plan efficiently. Which is why it has experienced and knowledgeable special advisors.
Unfortunately, when experts are working for the government, they are not gaining, or gaining limited experience in their field—and that field is constantly changing. And systems changes. Information can quickly become redundant.
It is the same with any large organisation. Decisions often come down from the executive that are often out of touch with what is happening on the ground. In the business world, this results in poor performance. In the military, however, it results in death. This fact led to decentralised command. Commandos or managers, on the ground, are given the authority to make decisions independently.
It makes senses too. They are close to the actions —the data source— and have the most information to make the best decision in any given moment. Not only is that information less accurate when it arrives at HQ — ever played broken telephone?— it takes time to get there.
Looking back at society, the same principle applies. People, in their respective industries, are best equipped to understand where resources should go. The problem, then, is disseminating that information across the system.
But what information is relevant to whom? This is why pricing is important.
A manufacturer using tin doesn’t need to know why tin is scarce. It doesn’t matter that it’s because of a new innovation that requires a lot of that specific metal, or if a large mine shut down. All the manufacturer needs to know is to use it sparingly.
Pricing does this and does it well.
When tin is more scarce, the price will go up. This one change quickly informs the behaviour of potentially thousands of people. Part of the reason it’s so efficient is that relevant information is accessible by those who need it.
And it all boils down to incentives. If something is scarce, the price goes up. More work is required to obtain it. If something is in surplus, the price goes down. Less work is required to obtain it. This is a very important point.
Often in central planning models, there is price-fixing or manipulation in order to send resources to where the central party believes it should go. It corrupts incentives. If something is scarce, but the price is kept down, what incentive does the producer have to produce it?
A few radical things
Here are a few radical things I discovered this week:
A 12v UPS power bank for Wifi. They are sold out now from TakeAlot. But I got one. Loadshedding can suck it.
Pavarotti. A re-discovery, sure, but the bro has pipes.
The Hayek essay linked to in the post. Unbelievable.
The Subscriber Challenge 5000
I’ve set a goal to grow to 1,000 subscribers before the end of August. I’d really appreciate it if you helped me get there.
Thank you for taking the time to read this.
RM