Economic Myths and Half-Truths

Although business/economics has become the foundation of western culture, its practitioners have circulated and tend to believe a number of myths and truisms, many of which are in fact half-truths.

You get what you pay for.

No.  You can’t get what you don’t pay for, but between over-inflated prices of certain goods (ranging from luxury products to certain prescription drugs and other aspects of health care), counterfeits, and cheap knock-offs, you often don’t get what you pay for.

 High pay is required to assure competence, especially in upper management.

High pay attracts people who are motivated by money, and higher than average pay is required for people with specialties that require long and expensive training, but there’s an upper limit, and this half-truth varies greatly in different segments of society.  More than a few studies have shown that comparatively lower-paid CEOs who are not “personalities” in general out-perform the highest-paid CEOs.  In addition, a significant percentage of the highest-paid money managers actually lose more money over time for their clients than gain it.  Likewise, money-motivated competence varies tremendously across fields.  A professional academic musician generally has more education than any MBA, but makes a fraction of the income of those MBAs in business and usually at least 30%  less than a business professor with an MBA and more like 50% less than a law professor with a J.D.  The same salary differentials apply to other academics teaching “humanities,” as well as most teachers.

Supply and demand always works better than regulation.

 This is a half-truth because it’s true as far as it goes, but doesn’t consider the implications, or what is meant by “better.”  Supply and demand is indeed the most “efficient” way to determine the allocation of goods and services, but that efficiency doesn’t take into account other values.  In a total free-market economy, in a famine, those who have money will pay higher prices for food… and will survive.  The poorest would not.  In addition, in a high-tech society, as noted above, even the most sophisticated consumer cannot determine the quality of certain goods, such as drugs, some beverages, even some foods, and therefore may well pay more for goods than “true” supply and demand would require. We’ve seen a similar issue in health care, where the “supply” of certain health care services costs more than many people can afford, which is one [but not the only] reason why tens of millions of Americans cannot afford health care.

The greater the risk, the greater the reward.

It is often true, in the case of dividend-paying stocks and bonds, that higher-risk issues have to pay out more than less risky ones, but this analogy truism breaks down in society.  Fire-fighters and police officers certainly face far greater risks than hedge fund managers, but they make a small fraction of the income that financial professionals do.  In professional sports played by both genders, such as basketball or golf, the risks are the same, but the males make more.  Now, this is justified historically by the argument that the demand for watching males is higher, and that can’t be disputed, but that points out that all of these myths/truisms are anything but absolute, even though they’re all too often dragged out as absolutes, especially by business people in pursuit of the bottom line and more of everyone else’s money.

The business model works better.

This half-truth has recently been promoted as the answer to virtually every ill in public institutions ranging from schools and universities, to municipalities, charities, public hospitals, and prisons. And, of course, the question is, again, what is meant by “better.”  In education, the business model has been applied in terms of teacher-pupil ratios or in higher-education, what disciplines are most “cost-effective.”  Unsurprisingly, the hard sciences and the performing arts are the least cost-effective educational disciplines, because the sciences require expensive equipment and additional laboratory sessions and the performing arts require intensive one-on-one training, especially in vocal music. While good financial management is clearly a necessity in any organization handling significant resources, the bottom line of the business model is to cut unnecessary expenses, and services/products which do not cover their costs, and to maximize revenues.  The business imperative is to look out for the business, and only to look beyond the business as necessary to assure its profitability and survival.

Public institutions, by their nature, provide goods and services that society has deemed necessary, even if not “profitable” for the specific institution.  That is why they are public institutions. Public hospitals are mandated to provide health care to people who will never pay their bills.  Schools must handle problem students and disabled students whose education is anything but profitable or cost-effective from the business standpoint.  Fire-fighters will often spend more time and effort putting out a fire than a structure is worth, even when no others are threatened.

So… the next time someone starts spouting these economic “truths,” it wouldn’t hurt to think about just how “true” they are in the case in point, especially if it’s a politician doing the spouting.

 

8 thoughts on “Economic Myths and Half-Truths”

  1. Niko Corulli says:

    Unfortunately, the invisible hand is also deaf, dumb and blind.

  2. William says:

    Your insight on matters like this are the primary reason I read your delightful books (also, as a fairly new manager, I have learned much about effective leadership and politics).

    I am hesitant to say that I have seen an evolution in your thought from one I would (probably unfairly) typify as “Protect the upper middle class, they work for their money” to one that is headed more toward the “left”.

    I am not sure if it is a reflection of our society that your views seem to be drifting “leftward”, (in that society is becoming more fiscally conservative, while yours are staying the same); or if your views are also moving.

    It is delightful to hear a prominent voice talk about the fundamental issues with applying the business model to everything in society.

    I recently read an article where a person spoke about using competition and performance-based pay as a method to boost how much money charities make. Now the gist was, make charities into business, reward high performers with more money and charities make more money with less waste.

    This should be great, but it ignores a fundamental truism of charity workers. Many people work in not-for-profits because they are risk intolerant or unable to take the pay for performance pressure. So, huge numbers of people who do good work would lose those positions. Darwinism many would say, but shouldn’t society work for as many as possible, not just those with aggressive or durable personalities?

    Which brings me back to public institutions. As much as they provide a public good for the people who utilize them, these institutions also provide a public good for the people who work for them, and effectively redistribute wealth from public sources into private ones (by grocery shopping, plumbing services etc). It strikes me that if we head too far in one direction we will lose far more than we gain.

    Anyway, I love your books and hope I will get to keep buying and loving them!

  3. Max says:

    William, I think its a well known effect (its named after someone but the name escapes me), where to a normal person not very interested in politics, the common sense tells them that real situation is somewhere in the middle between the opposing conservative and liberal view points.

    What happens, is that right wing folks exploit this, by intentionally going “full retard” crazy, taking positions that border on insanity, denying the obvious facts, for example see Glen Beck, Michele Bachman and similar politicians.

    But what that does, is that to a person taking a “bird eye view” of the situation, they see really crazy person on the right flank, spouting nonsense about vaccines causing mental retardation, they assume the left flank is equally crazy, and when they “ballpark” the middle, their middle comes much farther to the right then it would have, had there been no crazies on the right wing side.

    So as a result, something that as much as 10-20 years ago been considered moderate/conservative positions, are now being called socialist/liberal.

    1. Steve says:

      Your argument is interesting but false. American society is becoming much more liberal over time, and the evolution is happening quite quickly. In fact, most societies have become more liberal since the Renaissance.

      1. Tim says:

        I will believe the US is getting more liberal when it no longer accounts for almost half of the worlds defence spending. Mind you, perhaps we should reclassify ‘liberal’.

        I remember Jimmy Carter cut the navy back. And I see the there is no aircraft carrier named after him 🙂

        1. Mayhem says:

          Max is right. His comment touches on two concepts.
          The first is now known as the Overton Window – it is the range of ideas which the public consider acceptable, and in which policies can be proposed without risking ones position.
          The job of the various think tanks is to move the Overton window in a particular direction, so that ideas that were once unthinkable become acceptable to discuss, and ideas that were once radical become popular and perhaps even become policy.
          Hence the comments about Glen Beck and the extreme right.

          The second is the philosophical Argument to Moderation, or Middle Ground Fallacy – the idea that the middle ground between two competing ideas is always the better answer. The flaw comes when one idea is true, and one false. No matter where along the ‘line’ between the two you stand, the answer is still false.
          Take for example the ideas ‘Man can breathe on Earth’ and ‘Man can breathe on Mars’. The middle ground would imply something like ‘Man can breathe on the Moon’, yet this is still clearly wrong.

          The key is if everyone says something often enough, it comes to be accepted as true, even if it isn’t. The human brain is clever like that.

          Mr Modesitt gave a good example of the sliding window last month when he contrasted the current Republican party with its forebears, who today would all be considered radical liberals for the proposals that they enacted into law…

          1. Mayhem says:

            Really appropriate set from Dara O’Briain

            http://www.youtube.com/watch?v=uDYba0m6ztE&feature=related

            And a nice article from Cracked on the size of human societies based on how our brains work

            http://www.cracked.com/article_14990_what-monkeysphere.html

  4. Sorwen says:

    1) Even in a literal sense that is true most of the time. Though it isn’t supposed to be about just the literal sense. The quality of something is proportional to what is required to get it. You also kind of defeat your own argument with “counterfeits, and cheap knock-offs”. Those sell because they are cheaper than the originals. So if you pay less your are getting less.

    2) I can agree with this simply because you can’t say something is always anything. As you basically point out that the cost of anything is dependent on how much they thing they can force the customer to pay.

    3) Here again I can’t agree. You are taking the comment to mean only money. Reward doesn’t have to mean money. If you are a Firefighter or Police officer and reward to you is only money then you are in the wrong profession. Simply as that.

    4) Because the statement implies an always, I have to agree to an extent with what you say. Nothing is every really always anything.

    @Max

    That really has nothing to do with left or right wing. Some people are simply crazy and that carries over to the political views no matter what side you are on.

    I don’t like wings anyway, not enough meat on them. I like breast meat. Right in the middle where there is enough to dig into to get what you want out of it.

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