Why our desire for simplicity is often misguided

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Image credit: Ratiocinativa

The human brain craves simplicity. This is because an active brain can consume thirty percent of the body’s blood glucose and for most of our evolutionary history we needed that energy to power muscles to (i) escape from predators, and (ii) secure food supplies. So we are naturally predisposed to avoid thinking wherever possible. As simple ideas are far easier to cope with than complex ideas, we naturally gravitate to whatever is easiest to grasp.

Unfortunately, in our complex post-industrial world, this hardwired preference for the simple over the complicated very often leads us to poor decisions which in turn lead to poor outcomes. Today the triumph of populism is a direct consequence of our desire for simple answers to complex questions — no matter how abjectly inadequate those supposed answers obviously are.

But we don’t have to look far back in history to see many other examples of how our desire for simplicity has led us astray. This article is going to focus on the Great Political Trend that was dominant in many countries between 1980 and the end of the century: privatization.

For those too young to have lived through it themselves, the 1970s were pretty dire in Europe and in several other parts of the world. In the late nineteenth century and more or less until World War II, companies held all the power. This meant they could abuse their employees by requiring long working days, poor conditions, and modest pay. Naturally this resulted in a counter-movement led by organized labor. Unfortunately the pendulum always swings past the center-point and by the late 1960s in most European countries organized labor was a bigger problem than exploitative organizations.

Labor unions ensured that workers needed to do little, and not do it with any degree of care, because any attempt to discipline or fire unproductive workers would be met with strikes that at times could paralyze entire nations. Not surprisingly, productivity collapsed, manufactured goods were shoddy, and civil strife was frequent as unions brought entire sectors of the economy to a standstill. In the UK in the early 1970s everyone was without electricity for four out of every seven days; by the end of the decade garbage was rotting in the streets and people were dying as they waited for ambulances that never arrived.

Meanwhile the Technocratic Dream of a planned economy was falling apart in the Soviet Union, a place in which even the basics of life such as toilet paper and shoes were frequently unavailable and, when present on the shelves of State-run shops, always of dramatically inferior quality.

A few economists looked at these phenomena and realized one important thing: in the absence of any reliable mechanism to promote innovation and high quality, stagnation and massive free-riding was inevitable. Marx’s infantile notions about “from each according to their ability” simply didn’t match the reality of human nature which was better summed up by the saying common among Soviet workers: Они делают вид, что платят нам, а мы делаем вид, что работаем (“they pretend that they pay us and we pretend that we work”).

Contrast this with the private sector in the West in which innovation was far more pronounced and inefficiencies far fewer.

The difference? In most private-sector situations there was plenty of competition.

The absence of competition leads to complacency which in turn results in low productivity and shoddy outputs. It was the absence of competition (thanks to import restrictions) that allowed Detroit to go on turning out land barges with atrocious safety and horrible fuel consumption. It was the absence of competition that enabled UK unions to eviscerate the UK automobile industry. The list of disasters arising from the lack of competition is long and inglorious.

For economists and then for politicians it seemed that if private-sector organizations had greater efficiency, innovation, and productivity then the answer to the problem of stagnation surely was to privatize State-run concerns and monopolies! What could be simpler?

Unfortunately, the simple answer wasn’t the correct answer.

The economists and the politicians who subsequently absorbed the basics of the academic papers all failed to grasp that the distinction was not in fact between private and public entities but between sectors of the economy where competition could genuinely exist and sectors of the economy where competition would be practically infeasible.

To see why this matters let’s look at a few different sectors, beginning with manufactured goods. We’re going to consider filing cabinets because a quirk of history enables us to look at three distinct economic environments.

First we’ll take the Soviet Union: in this environment filing cabinets are of poor quality because the only metric was the number produced per year; no one even thought about quality because by definition Soviet filing cabinets were the finest in the world and any attempt to create quality metrics would have been a crime against Soviet thinking which would have resulted in a very bad outcome for anyone stupid enough to make such a suggestion.

Furthermore, the output of filing cabinets is patchy because the workers have secure jobs for life so even if the production quotas aren’t met, the workers don’t suffer (the managers do, but the workers don’t care about the managers).

Now we’ll look at India, which in the 1970s and 1980s was stuck between a Soviet model of State control and a quasi-Western model of private corporations. Here there were plenty of filing cabinets but most were of very poor quality indeed, having for example huge holes ripped in various places because of the defective steel used in their manufacture. The government mandated the price of filing cabinets and had the right to purchase a fixed number per year; furthermore they handed out the licenses to produce filing cabinets and in consequence only a handful of Indian companies were in the filing cabinet manufacturing business.

As the price the government would pay was below the cost of producing the filing cabinets, the small number of private companies making filing cabinets had to mass produce using the cheapest inputs possible, in this case defective steel. After the government had taken its quota each company was free to sell the rest of its output at more realistic prices and thus stay in business. So the result was dangerously defective output by private corporations responding rationally to government regulations.

Finally we come to a market economy in which the State does not own the means of production nor does it determine which companies are permitted to produce which items nor at what price items shall be sold. In this situation companies will enter the market if they see a viable opportunity; in the case of filing cabinets there’s enough business to support perhaps a dozen companies worldwide. Each company is in competition with two or three other companies in its region and thus each must ensure that its products are of sufficient quality at a competitive price. The need to achieve these ends results in continuous improvement of processes and techniques which over time reduce cost per unit (the so-called “learning curve” effect) and increase output.

If we were to consider this example and stop here it could seem obvious that the way for governments to combat the natural lethargy and inefficiency of State-run organizations would be to privatize them because, as per the example above, the privatized companies yielded the best overall economic results even when, as is the case in India, the government is doing its best to make a mess of everything.

And wholesale privatization is precisely the incorrect conclusion that economists and governments drew. In the twenty years between 1980 and 2000, governments around the world privatized vast swathes of their economies.

The result? Mostly a bunch of very poor outcomes.

The problem was that the economists and the politicians had failed to understand that it is the presence of competition in a market economy that drives efficiency and innovation. If there’s no real competition, there won’t be any improvements. All that privatization will achieve is to hand unwarranted profits (called “rents” in economic jargon) to some lucky executives. And that’s precisely what happened.

Let’s take a look at some of the UK’s most catastrophically inept privatizations to see just how misguided this policy was.

The UK decided to privatize utilities. Water, sewage, electricity, and gas would all be privatized and the world (or at least the UK) would be a better place. But… if we have a house in Bristol and there’s one set of water pipes and one local reservoir, it’s physically impossible to have competition. What are we supposed to do if we think our water company is price-gouging us? Sell our house and move? What other option do we have? None whatsoever.

So privatizing a natural monopoly is brain-dead stupid though it does, from a politician’s perspective, have the sole merit of enabling the government to reap one-time cash windfalls from companies buying the right to “privatize” State-owned assets. And money is always important because politicians have to bribe voters in order to stay in power, so more money is always good and never mind the consequences. Consequences will be someone else’s problem.

The British privatized the railways. Here they made a desperate, pathetic attempt to be clever. Any company could buy trains and carriages and run whatever schedules they wanted, but… the track would be privatized too, and the track company would charge the train companies to use the track. Which is precisely the same problem as we have just seen with water. There’s no alternative. There are not dozens of parallel tracks the train companies can choose between; there’s only one set, and that’s it.

By now it should be obvious that there are some inevitable monopolies and when these are privatized the consumer loses out and a few executives gain handsomely. But there’s no increase in competition and so there’s no increase in efficiency. Prices don’t fall and quality doesn’t improve; indeed the reverse is all too frequently true.

The real lesson here is that economies aren’t amenable to simple-minded ideas that can be applied thoughtlessly across a wide range of different conditions. Privatization is no more a generic panacea for bureaucratic inertia and labor unresponsiveness than is a prescription of leeches or waving a burning mulberry branch in the air while chanting a ritual incantation.

Competition in a market economy is what drives down cost and improves quality. Whenever governments interfere to upset this equation, consumers suffer.

Yet markets are very far from perfect. Adam Smith, in his seminal work The Wealth of Nations was no laissez-faire free market enthusiast. He knew perfectly well that the role of government is to stand in the way of companies creating monopolies or forming oligopolies in order to price-gouge their customers. Unfortunately this lesson has been entirely forgotten, especially in the USA where politicians are permanently looking for campaign contributions. Large, profitable, oligopolistic corporations can hand over much larger contributions than companies operating in genuinely competitive market segments.

And so when we look around the world we frequently see not competitive markets but de facto oligopolies: Airbus and Boeing, Apple and Samsung, GE and Rolls-Royce. Locally, automotive markets are also usually oligopolies: in the USA GM and Ford, in Europe VW and the French-directed combos of Nissan-Renault and now PSA-FCA.

As tariffs and import quotas fell in Western nations, automotive competition increased to the point where these local oligopolies could no longer rely on exploiting captive customers; hence Ford and GM had to improve quality dramatically (though it’s still lower in the USA than in their European operations where competition is more fierce). But for the most part mergers and acquisitions and additional privatizations have over the last 20 years resulted in increasing concentration of power to a handful of corporations which, naturally, use this dominance to exploit their customers.

And yet: these non-innovative slow-moving inefficient high-charging organizations are private companies! The very sort of organization the economists and politicians claimed would always yield lower prices and higher quality.

As should be obvious by now, natural monopolies such as supply of potable water, sewage disposal, and any other form of public good or service for which there is a natural physical constraint on supply should best be operated by government agencies for which benchmarks and targets can be a pale substitute for meaningful competition. Under such circumstances, inefficiency and lack of innovation are inevitable but at least we avoid the disgraceful sight of a handful of executives paying themselves handsomely for sitting on their overstuffed backsides and profiting from a natural monopoly that a dim-witted group of politicians handed them on a plate.

Where there genuinely can be real competition, privatization is a very good way to boost productivity, increase innovation, and reduce costs. But these opportunities are few and far between because in general governments undertook infrastructure tasks only when it became evident that markets could not do the job adequately because market mechanisms were diminished or entirely absent.

If we humans spent less time self-identifying with trendy political labels and more time analyzing fundamentals we might be a little less prone to error. Unfortunately that generally doesn’t happen because we’re hardwired to go straight for the simple answer: “free market or central planner?” “capitalist or socialist?” Reality doesn’t fit into neat little boxes and there’s no single prescription for complex issues.

Which brings us to one of my favorite observers of social folly: H. L. Mencken.

He wrote: for every complex human problem, there is a solution that is neat, simple and wrong.

It’s a shame we haven’t learned this particular lesson, especially as it’s really quite simple…

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