Micro sense... Macro madness

Why are we so good at understanding companies and yet so bad at understanding the economy?  After all, surely no one can disagree that any economy is merely an aggregation of companies.  Output, investment, employment and all the other macroeconomic metrics we like to focus on, originate from the company.  Companies make investment decisions.  Companies decide where, what and how much to produce.  Companies provide employment opportunities for the majority of us not engaged in entrepreneurial capitalist ventures.

However, in the world we live in today, it seems that understanding what makes a company successful at the micro level bears no relation to understanding what makes the economy successful at the macro level.

This should not be so.  In fact, once we understand the basics of what makes companies successful and growing, and these really are basics, all we need to do is aggregate that model to the macro level and we have a blue-print for a successful economy.

Unfortunately, economists have so confused us all that, while we understand the core elements of what is good for a company, we have all but given up trying to know what is good for an economy.

Economists tell us that we need to read thick textbooks printed in small font and obtain masters and doctorates before we can really understand economics like they do.  They invent erroneous theories with fancy but nonsensical terms like ’liquidity trap‘, ‘paradox of thrift‘, ‘fiscal multipliers‘, and ‘perfect competition’, and in the end we’re so lost we just accept them at their word, tell ourselves they know what they’re doing, and leave all the big economic decisions to ‘those in the know’.

This needs to stop.  Economics is not rocket science.  In fact, there is no good reason why all people, ‘educated’ or not, cannot gain a useful and working knowledge of economics and be able to hold the average ivory towered economics professor to account for most or all of their theoretical bloviations.

The reason why academia has, in the main, served economics so poorly is a deep discussion beyond the scope of this post.  However, what we do know is that the average economic theoretician tends to live a life completely disengaged from real economic processes.  Most economic theory originates from career academics living in a state-subsidised bubble.  For them life is about leafy campuses and tweed jackets and canteen coffee breaks and standing on the shoulders of intellectual dwarfs giving seminars to other academics living in the same bubble.

This is why some of the best economists we know and pay attention to are not academic economists, but hail from all walks of life and have simply applied their minds in logical and consistent ways.  The best economists are usually accountants or doctors or entrepreneurs or engineers.  Very seldom are they professional, full time economists.

This is not to say that full time academic endeavour has not provided us with some of the most profoundly brilliant and sound economic theory, but it is to say that this tiny islet of worthwhile academic work is drowned in a sea of pontificatory nonsense originating from the mudspring of academia.

The water level is receding however as every year the global economic policy model, directed by mainstream economists, proves to be increasingly bankrupt, both intellectually and, well, actually.

The only men and women that saw the credit crisis years before it happened, the guys who went long gold in 1999 and have consistently diagnosed correctly the heart of our economic problems, is the small band of Austrian School disciples and others who think according to core Austrian school principles.

People are waking up to the fraud foisted upon us by the Keynesians.  Their intellectual currency, like paper money, is losing value fast.

So, back to our company-economy story.  Below we provide a brief framework for how to think clearly about the economy and how to stop a rampant Keynesian/Statist in his/her tracks when they put forward some or other wacky theory.

Here is a list of 10 basic signs of a healthy company.  Because an economy is simply made up of many companies, what is good for a company is good for an economy.  So, this is also really a list of 10 basic signs of a healthy economy.  Any policy that runs counter to these factors is bad for the economy, and don’t let a head-in-the-clouds economist tell you otherwise.

1. Minimising employment

Employment should always and everywhere be minimised to get a job done.  Any company worthy of the title does not seek to maximise employment but to minimise it.  The goal of economic policy should be the same.  Companies aim to maximise production with available resources.  An economy functions best when it maximises production using the available capital and resources.  The key to this is not maximising employment, but maximising the production of value.  What’s the difference?  If we maximise the production of value we will necessarily have full employment, but if we maximise employment we do not necessarily create maximum value.  We could easily ‘create’ thousands of jobs by destroying street lamps and paying people to hold lamps along the road at night.  We’ve created jobs but destroyed value.

Rigid labour laws, government make-work programmes, and any other state-imposed means of ‘maximising’ employment or reducing companies’ ability to minimise employment, is bad for companies and bad for the economy, period.

2. Minimising costs

Hand in hand with minimising labour costs, successful companies will always minimise all production costs in the creation of desired value output.  A successful economy does the same, but government inefficiency retards this cost minimisation programme.  High tax rates take money away from cost minimising (economising) entities and places capital in the hands of entities with little or no incentive to minimise costs.  As a result, less value is produced for the resources expended.

3. Good cash flow

Any healthy business has a good cash-flow.  Anything that hinders cash flow hinders business and value.  Economic policy can hinder cash flow.  High and onerous provisional taxation can hit company cash flow severely, especially when earnings projections by the government revenue service far exceed the actual earnings of the business.  Onerous regulatory compliance, petty fines, and a poor monetary and banking system can all hinder cash flow and are therefore a detriment to the economy.

4. Healthy balance sheet, strong asset base, and adequate reinvestment

Strong companies are well capitalised and have sound and stable asset bases.  Undercapitalised companies that consume too much capital become weak and scupper their growth potential.  Policies that create disincentive for companies to be well capitalised relative to liabilities are bad for companies and bad for the economy.  This includes policies that promote capital consumption such as excessively loose monetary policy and artificially low interest rates.  Inflationary money policies also undermine accurate asset pricing and create asset price volatility.  High taxes also undermine return on investment and therefore create a disincentive to invest.  Monetary inflation, artificially low interest rates, asset price volatility, and high taxes on production all undermine company balance sheets and are bad for the economy.

5. Minimal decision making constraints on the entrepreneur

A successful entrepreneur is one that can respond quickly and effectively to a changing market.  Business leaders need flexibility in order to remain as productive and innovative and responsive as possible.  A company saddled with resource constraints is a less successful company.  Government rules and regulations create barriers to entrepreneurial flexibility.  Labour laws create rigidities in responding to market dynamics, as do higher tax rates as they diminish discretionary capital allocation decisions.  In addition, the myriad of red tape and regulations companies must adhere to create parameters that ultimately diminish flexibility.  Zoning laws restrict companies from positioning their business to service their market as best as possible, raise logistics costs, and are bad economic policy.  All such restrictions that limit the freedom of the entrepreneur are bad for the economy.

6. Freedom of association, acquisition, merger, partnering, deal-making

In similar vein to point 5 above, companies thrive when they are free to associate, transact, acquire and partner with other companies.  Laws that restrict this freedom are bad for companies and therefore bad for the economy.  Competition law aims to restrict collusion, industry concentration, oligopoly and monopoly.  While these laws appear to protect the public, they do nothing of the sort and merely act as restraints to doing business freely.  Company’s that, within the bounds of natural law in respect of property rights and individual liberty, are forcefully disallowed from freely associating, acquiring, merging, partnering, colluding, monopolising and dominating in their respective markets are worse off for it, and so is the economy.

7. Low debt levels funding production, not consumption

Company’s that get into debt to fund current expenditures are in big trouble.  Incurring debt to pay staff for example is a sure sign that a company is not far from folding.  However, governments are forever funding current expenditures with debt.  When governments do this we term it “fiscal stimulus”, but when companies do this we term it “suicide”.  National deficit spending that funds current expenditure destroys capital and is unsustainable.  Excessive state debt is bad for the economy and debt-financed current expenditure makes the economy poorer.

8. Access to liquidity within a stable banking/capital allocation system

The other side of the coin to a company having a healthy cash flow situation is a company having good access to liquidity and working capital.  In this regard companies thrive best in jurisdictions with a healthy and stable banking system and with healthy savings rates.  Real capital comes from savers, and good liquidity comes from confidence in the banking system.  Policies that undermine saving and banking system confidence are bad for companies and therefore bad for the economy.  High inflation chokes off savings and is bad for companies and the economy.  Fractional reserve banking backed up by the lender of last resort, the central bank, creates moral hazard, bad loans, runs on banks and capital crunches.  It undermines liquidity and is bad for companies and the economy.

9. Low trade barriers

Companies that face trade barriers are worse off.  Import tariffs raise the cost of production, where sourcing locally produced or imported inputs, meaning more resources must be committed to produce the same value.  This is the exact opposite of economising and makes us collectively poorer.  Some companies benefit from import tariffs, but all the consumers of their products are worse off because they pay higher prices than they would otherwise have to pay, and income is in turn diverted from other goods and services produced by other companies.  Some companies benefit, but all consumers and all other companies are worse off.  Trade barriers make the economy worse off, period.

10. Freedom from IP laws

Companies thrive when intellectual property laws are abolished.  This is controversial but true nonetheless.  The competitive advantage in any business invention or idea is in having special knowledge and first mover advantage.  In some instances that special knowledge is impossible to copy, while in many other instances it can be copied easily.  Legal protection of the IP is an additional privilege that entrepreneurs have sought from the state.  While these entrepreneurs benefit from these laws, other companies are worse off for not being able to replicate and improve these ideas, and consumers are worse off because production is restricted and therefore prices are higher than they otherwise would be, diverting income away from other goods and services.  Like trade barriers, IP laws protect a minority while making the majority worse off.  The incentive for a company to invest in an idea and benefit commercially from it is inversely proportional to the replicability of the special knowledge.  The better the invention or idea, the harder to replicate that knowledge, meaning a longer period of time of exclusive commercial benefit for the inventor.  If something needs IP laws to have any commercial benefit, it is a weak invention.  IP laws are bad for companies and bad for the economy. 

So, there you have it.  This is by no means an exhaustive list, but hopefully it can get you thinking more clearly about what makes good or bad economic policy.  As a general rule, policies that restrict individual or corporate freedom are bad for companies, and by implication, bad the economy as a whole.

Cheers.