February 16, 2013

The Costs of Efficient Thinking

I have posted previously about problems associated with simplification. This post continues that discussion looking at more specific problems.

One way economists simplify things is with an archaic tool known as mathematics. Economists use math to measure things and relate them to each other. Math helps make things easier to think about by creating new, simplified ways to understand them. For example, once you understand the concept of elasticity, it is easier to think about “elasticity of demand” than “the amount that demand will change in response to a change in price.” It is likewise easier to think about productivity than it is to think of “the ratio of output per person.”

It is good when terms are precisely defined with equations, but even well-defined concepts can be problematic. First, complex concepts may fall victim to a sort of "sanitizing conflation", when a concept made up of other concepts takes on a simplified meaning that ignores one or more of its constituent factors. Concepts may be bundled into packages that distract us or focus our attention in different ways than the individual concepts might. Another way to think of this problem is that even when a model (or even an even simpler definition of an economic concept) is accurate, the way it represents the world may be misleading.

Misleading representations can be seen everywhere when you start looking. Even in such a field as accounting, where relatively rigorous and standardized quantification exists for most everything, simple headline concepts such as “profit” can obscure important details about internal costs. In economics, the idea of productivity suffers from sanitizing conflation when we focus on the beneficial effects of increased output and competitiveness instead of the possibility of job losses.

Santizing conflation is particularly likely when the different factors in a derivative concept have different levels of quantifiability. For example, economists generally agree that both technology and education levels are important determinates of productivity, but education is relatively quantifiable while culture is a nebulous concpt that is difficult to fit in an equation. Education therefore shows up in far more studies as a relevant variable.

The second problem that concepts even very precisely defined by other concepts may face is that the original concepts themselves may not be coherent or exactly defineable. If you are enjoying the fancy labels we can call this "indefinite origination". Indefinite origination is a huge problem in economics because even the most exact data on something as straightforward as, say, unemployment may in fact be problematically defined. In the USA there are six different measures of unemployment! The question of which one to use has enormous influence on anything you might use the concept of unemployment for.

But one does not always need math to simplify things—if you do it right you can get along fine with hand-wavey obfuscations. Economists are often guilty of this, certainly, but economics also does a decent job in many instances of making assumptions explicit. A good economist is far better equipped to understand the full details and implications of an economic concept than, say, your average journalist or voter.

One common hand-wavey simplification is “efficiency”. Efficiency has several exact mathematical definitions in economics, but those definitions do not have much to do with everyday usage in business or politics. Efficiency is generally assumed to mean cost reduction or increased speed or output, but it is silent on how those reductions or increases come about. Much like productivity, effiency gains can stem from improved processes and eliminated waste, or they can come from reduced pay and benefits (scroll down to section II).

Instead of efficiency, I have tried to start thinking more directly in terms of costs. This is helpful because costs—even costs that are eliminated—are easier to see than “efficiencies”. It is also clearer that many costs are two-sided: my employer’s cost is my salary, whereas efficiency for an employer does not necessarily have anything to do with me. Costs are also clearer to think about in both monetary and non-monetary terms, because they are “something” instead of “a reduction in something or an increase in something else.”

I plan on writing more about efficiency and costs in a subsequent post, but for now I think I have made the points I want to make. Be careful with complex concepts because we have a hard time comprehending them in their full complexity. Math is an powerful and essential tool to help your thinking, but it structures your ideas in a rigid framework that may or may not be appropriate to the real world. And beware the multitude of these concepts that have already entered your thinking and understanding of the world.

February 7, 2013

Production as Privilege: A Toaster

This post is part of a series trying to breathe new life into the connection between production and distribution. We veer off a bit here from standard economic theory, using a recent art project as a jumping-off point.

Conceptual Tool #9: A Toaster

(You should probably visit at least one of these links for this post to make sense.)

This toaster, something of an absurdist take on the modern economy, is a striking example of the interdependent nature of production. Econ professors particularly enamored with capitalism enjoy pointing to such examples (a simple pencil, designed in the Germany, assembled in Vietnam, made with South American graphite and African cedar--miraculous!) as proof of the amazing organizing power of trade and free markets. That power is pretty cool, but there is another lesson to be learned from this complexity.

The flip side of these miracles is that, on our own, we are incredibly inefficient. This was the lesson of Adam Smith's Pin Factory, where workers can produce far more pins if they work within a coordinated division of labor and each concentrate on a single task.

But where does a pin factory come from? Or more generally, how do we achieve the organizational sophistication and capital concentration required to make pin factories work? Factories do not simply spring up spontaneously--they must be planned and built, workers must be hired and managed, and capital must be purchased. In order to create these efficiencies due to specialization we have to organize ourselves, work with others, and pool risks and resources. Our ability to do these things does not derive wholly from ourselves or from some anarchic state of nature--instead we rely on an institutional framework that renders our economic actions coherent.

The case of the toaster is illustrative. To create a modern, efficient toaster--and to create the market networks that have facilitated its creation--we have built an almost incomprehensibly complex web of national and international laws enforced by armies and set by political processes. These laws enable specialization and help minimize the cost of resources, including labor.

To be sure, there has been trade around the world for centuries and even millennia. But it was not hunter-gatherers or subsistence farmers producing or distributing these goods--it was complex systems of city-states, empires, and other hierarchies of power. Today, where laws do not bound and regulate markets, other forms of power do.

Exactly how much and what type of power is required for organization and efficiency is a major economic debate of modern times, although it is rarely framed in these terms. Political ideologies from communism to libertarianism make explicit or assumed arguments as to the most efficient levels of organization and how much that efficiency is worth when weight against other values, such as individual liberty or environmental sustainability.

These arguments manifest themselves in the laws, the enforcement, and structures of power governing the organization of our economy. Conservatives in the USA, generally trusting of the market and distrustful of government, take a bare-bones approach to economic policy. Their professed preference is for a smaller fiscal footprint of the government in the economy and limited government regulatory influence as well. Liberals (in the American sense) are more critical of private forms of power, such as corporations, and view the use of government power to actively shape market outcomes more favorably. These differences are substantive but nevertheless dwarfed by differences between the US system and other economic systems seen in the past century, such as Soviet-style communism or the vast variety of economic systems found in the developing world.


What was it again that these political perspectives and associated market-shaping policies had to do with making bread brown and crispy?

Presumably, the exorbitant price tag on the homemade toaster ensures that it will never be sold (at least not to be used as a normal toaster). Perhaps upon further attempts the artist/producer would improve his toaster production and bring down price somewhat, but we can assume it would never be able to compete on price or quality with the typical goods it would sit next to on the shelf at Wal-Mart or Tesco. In effect, the artist will not be able to make money producing normal toasters on his own because he is unable to produce enough value that people will pay him for. His labor costs too much, and therefore he does not possess the requisite productivity to effectively compete.

Like any producer, requisite productivity for a toaster maker derives from two things. First: the costs relative to how much people value his toaster—it is unlikely he will find many buyers for £3,000 toasters. And, second: the costs for his toaster relative to his competition’s costs—if there was no-one making a cheaper toaster, he would perhaps have been able to sell one or two to rich people. As it stands, however, there are clearly classier toasters available for less price.

The existence of value that people will pay someone for is a function of scarcity, which in turn is a function of both supply and demand. This is another way to think about who can sell toasters: individual producers of toasters are unable to supply goods at market prices because large, highly organized producers integrated with the world market are able to produce much more cheaply, bringing down the costs.

But is it not a good thing if specialized production brings down costs? What is the problem here?

One potential area for problems arises from the interaction between power and cost structures. Like power, cost is often a zero-sum game: "there's no such thing as a free lunch." Organizational power leads to economic power, but this economic power may leave weaker players with the shorter end of the stick. The organizational power of corporations allows us to achieve impressive economies of scale in many markets (including the breakfast food preparation appliance market). But it also tends to concentrate economic power at a level far above the individual.


We cannot make toasters from scratch for a living. If browning bread is our true passion, we can join the specialization chain at some point, designing electrical toasting circuits or stylish new chrome shapes to sit on our countertops. This chain is brilliantly inexpensive and can benefit consumers, but the organizational power required to maintain specialization also concentrates economic power within the production process.

Hopefully I am being somewhat clear. The problem is not that people are getting more productive and therefore costs are going down. That is good. If you are more productive you can just sell more and make more money.

The problem is also not that we have to specialize. Specialized producers could still trade their production for a fair market value.

The problem is when the only way to be more productive is by through organization, and that organization itself exerts power in the market (or over the part of the market it shelters). This power can shape the way costs (and I am talking particularly about labor and social costs here) are distributed, squeezed, or eliminated within the chain of production.