Innovation Killed Socialism

I’ve never liked top-down economic planning, and after reading Brink Lindsey’s Against The Dead Hand, I know why. Plus, it really changed my perspective of free markets and socialism, especially how the death of liberalism came about in the late 19th century.

Apparently, top-down just seemed logical, given their experiences with large corporations; a single big one could organize the resources for a market better than five smaller. A central economic planning body was preferred to competitive interactions between smaller actors in separate fields. The term “progressive” came about as a result of this ostensible idea that that’s where the world’s heading. Of course, our understanding of it all then was limited and ill-founded – and we’d all pay for it later.

I was reminded of James Surowiecki’s The Wisdom of Crowds, showing how localized decisions aggregated into a broader network yielded better results than top-down. How? According to this social organizing principle, the group itself acts smarter than even the brightest of its members – providing all have access to different information, are making independent decisions, and aren’t influencing each other. It’s not a new phenomenon, first observed by Francis Galton in a county-fair game guessing an ox’s weight over a century ago. The majority missed it while the average of the group’s responses were within 1% of it.

The most noted has to be the wreck of the USS Scorpion – a submarine that went down with all hands in May ’68, the Navy only having its last reported location days before. To help pinpoint the wreckage, a panel was assembled of diverse talent: mathematicians, salvage experts and sub tacticians – each given all available information to best estimate the location. Using Bayes Theorem, a collective determination was calculated; while its discovery proved none had correctly located it individually, the “group guess” was within 220 yards of it exactly.

So, if the broader network is smarter decision-making, why didn’t top-down planning go the way of the dodo when it proved inferior? Okay, let’s do a quick recap on the history of socialism.

It first assumes the marketplace naturally chaotic, which jives with why top-down planning was a local choice to combat it; observers claimed entire industries become consolidated in the hands of a few individuals. Second, it was born during the Industrial Revolution – a really crazy time – with its pioneer, Karl Marx, believing the whole thing a one-off process: the world needed to transition from an agrarian society to an industrialized one. In Das Kapital, he argued all industries would eventually find themselves controlled by only a handful of wealthy leaders, at which point, the process was complete. He seemed hopeful society would lose its dynamism, returning to a more tranquil time, and leaving these industrialists in possession of “the means of production” of the greater society was an injustice.

Of course, history has an ironic sense of humor. In time, Marxist revolutionaries would go on to do just that, as industrialization was proven not a one-off process after all.

Innovation constantly brought a new stream of products and services to market, and a society run by top-down committee (see: the former Soviet Union) just couldn’t effectively allocate resources to produce what the public actually wanted. And, like we know of any bloated bureaucracy, it collapsed beneath the weight of its own inefficiency.

What’s consistently proven to get the job done? Well, for resource-allocation, the free market is tops. If an oil embargo suddenly restricts its nation’s access, we hardly need an army of bureaucrats to refigure society’s production flow. As a commodity’s price rises, people naturally seek less expensive alternatives or use less of it. The free market allows for a resource to be restricted to those who use it best to benefit society; downright unthinkable to the “progressives” of yesteryear. And it’s that free market mindset which allows the “wisdom of crowds” to do its thing.

Oddly enough, socialism has been almost entirely refuted, and yet, it’s still around. We can only hope, like other “great” ideas – flat earth, phrenology, and stagflation – it’ll find its way to the dustbin of history as people become better educated.

Or just tired of wasting time and money – whichever comes first.

Answering Cathy’s Questions

Cathy, good friend and frequent blog commentator, recently left the following comment:

A nice series, even if it doesn’t have a happy ending. For those of us who already live austere debt-free lives yet have no money to invest, how would you suggest we prepare for what is coming?

I am also curious as to how guys like Madoff figure into all of this. If the SEC wouldn’t investigate when told the fund was likely a Ponzi scheme, then the SEC is useless. We should get rid of it. What would be a Libertarian answer to fraudsters like this?

So far, most “Libertarian” answers I have heard (from those who claim to be party members) involve non-answers like, “don’t get fooled, protect yourself”. I call it a non-answer because it means that everyone would have to be superhumanly smart and educated in order to know everything. It means that those unable to care fully for themselves would still be at the mercy of shysters. You’d still need somebody whose opinions you trusted… and Madoff was a very trusted name!

What would be your solution? Cheers!

For your first question, that fact that you are out of debt is very important. You also seem well-prepared for whatever calamities might next befall our society. But, if you’re looking to do more than just survive — and actually prosper — then I’d recommend you pick up a copy of my book. I give some very practical advice in there about how to save money including a section on how to get credit card fees refunded — yes, even if customer service denies you the first time around. In addition, I go over the specifics of how to start and grow a portfolio that’s going to do well over the next few years.

Going forward, America will still have an economy and building wealth will require that you participate in it. So you’re going to need to find that niche in that economy that best pays you for the talents and training you already possess. (If you’re lacking, then this is a good time to acquire it.) That the dollar will eventually default is almost a given in the future, so any student loans you take out to go back to school may end up being a free roll.

In terms of picking out skills for the economy, keep in mind you need to look to the economy of the future — not the present. Language skills will be at a premium. I can think of no language that wouldn’t be useful in some way. Asian languages such as Chinese would suggest themselves, but Europe will remain a training partner of ours as well which means that any of the traditional languages commonly accessed through your local college will be in demand.

Now as far as the SEC goes, I’m afraid I have the same non-answer as the other Libertarians: “Caveat Emptor”, (‘let the buyer beware’). Yes there will be frauds in the areas of finance just as there are frauds and cheats in all walks of life. The individual needs to be very aware of where his money is and how it is being put to work — which, incidentally, is called “transparency” in the field of accounting. Bernard Madoff did not have any transparency to his operation. His operations were a black box into which people out money. In return for it, Madoff would send them statements telling them they had made a profit when they really hadn’t. He didn’t provide any explanations for how their money had grown, just that it had.

Meanwhile, private industry will respond to the investors’ needs for information on where they can safely put their money. Accounting firms will audit records, and those with audited seal of approval from a prestigious accounting firm (which Madoff also did not have) can also go a long way towards keeping the cheats out of the system.

Now, I know this isn’t a perfect answer — in fact, you seem to feel it’s a “non-answer” — but keep in mind that the traditional answer failed, too: the Government’s oversight group, the Securities and Exchange Commission, investigated Madoff twice in the past 4 years and both times came up with nothing. All that did was give people the illusion that Madoff was running a clean ship when, in fact, he was not. Regulatory agencies such as the SEC and the FDA tend to have a horrible record in terms of fulfilling their charter. There have been a number of drugs that made it to market only to kill people under the watch of the FDA just as the largest financial scandals in history have been under the SEC. These agencies do little but chew up taxpayer money and give the organizations they preside over an aura of legitimacy.

In essence, what your question boils down to is, “What can be done about evil in the world?” There is no one answer to that. Evil will always exist and it will never be eliminated entirely. In terms of limiting our exposure to it, there is no substitute for learning the art of skepticism and critical reasoning. Those mental tools will keep most people out of an awful lot of trouble. And, of course, there will always be organizations that will come along and say that they can vouch for various clients of theirs. Then you have to decide whether you want to trust the vouching organization. Sometimes it’s private, and sometimes it’s a government agency.

I haven’t seen any studies to support the notion, but I’m putting my money on the free market to provide better watchdog agencies than the Government.