What does an economy do?
Modern economics suggests it is about [production] efficiency, and develops models for assessing the degree to which it is achieved and predicting outcomes assuming it. This is a fundamental misunderstanding that, when scratching on the surface, clearly is as impossible as it is undesirable.
Economy is about value creation: about getting more out of less.
Efficiency is backward-looking and lacking of progress, while value creation is future-oriented and aspirational. What I mean by that is that efficiency is about tinkering with processes and mechanisms that already exist, with the goal of making them run faster, smoother, and with less waste. It is about management, about reducing costs and cutting overhead. But one cannot cut costs unless there is already an established process for which costs can be cut.
In other words, efficiency is not a matter of figuring out other things to do, but only how to do things already underway in other ways.
Consider any production process, either within a firm or the economy overall, which is either already efficient or nearing such a state. Every step on the way toward increasing output at lesser per-unit cost is an improvement in terms of efficiency. Why, in this situation, would you take resources and speculate on producing something else? You wouldn’t, because it is inefficient and makes the overall undertaking less efficient.
But this is exactly what an economy does through entrepreneurship: it attempts numerous new types of production, new types of goods, and so on. And a first attempt is never efficient. Very often, it is rather outrageously inefficient and wasteful. But where it turns out to be successful, new value is created. And then, through competitive discovery and skillful management, the production process can be improved toward (whether or not it reaches) efficiency.
With a little luck, this process — even though it’s approaching efficiency — is disrupted by, relatively speaking, a more inefficient process. But one that creates more value. More wasteful in terms of resource usage given the valued outcome, but more valuable in the outcome!
Schumpeter addressed this as ‘creative destruction’,1 arguing that this process of discovery and creation will always beat a system that is ever maximized. It is because there is slack/available resources that the open economy’s ‘essential element’ (entrepreneurship), through inefficient innovation and attempted value creation, creates immense value.
All of those actions are future-oriented, as already Menger stressed, whereas efficiency is about management of that which was already established. One can only improve processes that already exist, and one cannot demand that something new is efficient from scratch.
Consequently, efficiency necessarily leads us astray if our goal is increased standard of living and well-being, and saving humanity from poverty.
Focusing on efficiency instead of value creation (and one cannot have both), because it relies on historical rather than future value, also augments previous structures.
There is no assurance that those owning capital in the past will be the ones creating value in the future. In fact, it is often the other way around: disruptions are brought about by small and seemingly insignificant players and innovators.
But if our aim is efficiency, then whatever differences were will be augmented: those who already own existing production structures are those benefiting from making them more efficient/less costly. And the difference between capital owners and non-capital owners is thus strengthened. Not because of power or influence, though the State tends to provide them with that too, but because the past is not disrupted by new value creation.
In this sense, efficiency should not be a goal, but should be avoided.
Edited for clarity from Twitter @PerBylund
- 1. See ch. 7 of Capitalism, Socialism, and Democracy.
Per Bylund is assistant professor of entrepreneurship & Records-Johnston Professor of Free Enterprise in the School of Entrepreneurship at Oklahoma State University. Website: PerBylund.com.
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