A Country Is Not a Company

What is a Firm? One Woman's Journey To Answer The Question of A Generation

do NOT look up what this sculpture is called

It’s election season in Argentina, which means I’ve been hearing one of the most common politician lines out there: “we need to run the government like a company”. A good line for sure, but what exactly does it mean? Nobody knows. Likewise, you see proposed nationalizations, and you hear businessmen (successful ones, at that) giving their judgment on the economic state of the country (easy one, because it’s bad) and also proposing solutions.

Is there anything to such statements? No, obviously. But why?

Making your mark-et

To understand companies, first you need to understand where they operate - the market. Let’s start with what the market is, before moving onto the why. 

As a generalization, people have things they want to buy and things they have for sale, so they can exchange things for money, leaving both parties better off. Of course, there’s an issue that immediately comes to mind: multiple people sometimes want the same things - I might want a plot of land to build a house, but someone else wants to build a golf course. The way to solve this issue is through competition - everyone makes a bid under equal conditions (big if) and whoever has the most appealing offer wins. This process can usually work, but it functions mostly if everyone has the same information, and if the costs and benefits accrue to the people partaking in the transaction - no things such as pollution, which can’t be priced because the people who suffer from it aren’t buyers or sellers. 

Information, therefore, is key for “the market” to function. Around the world, everyone knows different things - especially, how to make certain products or do certain services, and all the related changes to different conditions. So how to do a haircut, how to do it to curly hair or straight hair, how to dye, what to use for dry and oily hair, wash hair, etc. This information is not public, and usually people don’t want to share it - if I’m a chef, and I give away all my recipes, anyone can copy me. What the market system does, and does well, is to get people to share that information with others - not directly, but as changes in prices. Sharing is important because, going back to the hairdresser example, it’s not easy knowing what kind of hair everyone has, to correctly apportion shampoo for straight and curly and dry and oily hair (sidenote: if you have curly hair, use less shampoo and more conditioner, but not on the roots). So instead of going around doing a census of hair types, or some other equally time-consuming process, you simply observe prices for each type of hair product: if one is more expensive, all things being equal, then it has to be more in demand, meaning that hair type is more common. Nobody knows how to make a pencil - they know how to do parts of the task at hand, and prices and their own self interest keep the gravy train rolling. 

The sharing of information is important because it would not be otherwise accessible, and because it helps coordinate how to use resources better - how much and of what to make. Prices both have all the information available, and give out the bare minimum - how, exactly, is a whole thing. The point isn’t really that prices convey information by themselves, but rather, that knowing prices is an efficient shorthand for knowing the information - it’s not especially important if more people have curly hair or if curls are in fashion or if the straight hair shampoo is wack; it only matters how many people are buying each shampoos and how that reflects on their prices.

But additionally, I’d say, prices also provide incentives to share information that is accurate. When you have a system to share information, you have two things people can do if you want it to work well: participation, i.e. it has to be worth a damn, and incentive compatibility, i.e. they have to have reasons to tell the truth. Think about dating apps: people need to be able to find dates, so they log in at all, but they also need to be incentivized to tell the truth about themselves, so they actually get good dates - and if there’s a big penalty on being short, people will lie, making height-based selection harder. If there’s money on the line, people tend to be less honest and more selfish (I read this on Thinking Fast and Slow seven years ago so don’t blame me if the state of the art has changed), so asking someone “how much of this do you need” to give it to them for free is going to end up with a very different amount than if they had to pay for it. Prices, it seems, bridge the gap between the two parties - they give incentives to ask for the correct quantity of things, and provide (more or less) reliable information about it. 

Quiet quitting?

Knowing why there’s a market - efficiently using information - still doesn’t mean anything about how production is structured; in fact, many believers in “the market” don’t believe in privately owned corporations at all. There’s the issue of “the firm” (firm is just nerd-speak for company): how do companies work, actually?

The first step is why economic activities take place in companies at all, and not just through individual people going by prices. There’s obviously things that are more efficient at higher scales - for example, it’s not very reasonable for everyone to have a small coal mine in their back yard, better to have one really big one. But the thing is, going by prices has costs for the people involved too. The first cost is discovery: finding prices, comparing them, and figuring out what the signals say. There’s also costs to negotiating and for contracts; having all your interactions be haggled extensively every time is just too much of a pain. To avoid all of these headaches, groups of workers agree to take orders from a business owner in exchange for money, and the owner manages the firm - i.e. takes care of handling relationships with suppliers and distributors, choosing who to hire, etc. The nexus of the firm, though, is labor - the relationship between employer and employee, which is basically obeying orders in certain contexts in exchange for pay. 

The natural follow-up is why there’s more than one firm, if the firm is so good. An initial reason is that management ability might not scale - fundamentally, at larger scales, decisions are more complex, and giving orders is harder - it’s just not clear how well people understand what you’re telling them to do, or if you understand how to give them orders. It’s just the problem that led to markets, but at a slightly smaller scale.

But another reason is probably simpler: people are lazy. Remember, the core of the firm is employer-employee relationships. On a team, there are people who pull their weight, people who slack off, and people who go beyond what’s required. If it was possible to measure how much each person contributed, then you’d just pay them a share of profits proportional to their effort, and fire the slackers. However, it’s not really possible, and a lot of the time it’s actually very difficult to tell how much work actually went into something. Instead, you have to monitor your employees, so you can figure out who’s slacking and who’s working. If he (or she or they, this is a woke publication after all) who does not work shall not eat, then they pretend to work and you pretend to pay them. 

Potentially, you can hire a foreman to look over their shoulders, or threaten to fire them and replace them - unemployment, in a lot of ways, functions as a way to discipline workers. The surplus army of labor and whatnot. Therefore, out of the need to keep a lot of working relationships under one roof, a firm emerges: it needs to have team production be more productive than individual production, but also for it to not be possible to measure how much each individual contributes to the team - though it has to be feasible to measure how many inputs each person is using (such as how much time they’re working). This results in a “classic capitalist firm”, which sounds like a leftist insult, but is basically just an organization with a team of workers, multiple users and owners for resources, a single person (the owner or manager) who is a party to all contracts, and this person who receives the profits and can sell this share to someone else.

There are many types of firms based on how ownership works: there’s co-ops, where the team owns the firms; there’s corporations, where they borrow money to fund activities, and there are multiple owners. There’s partnerships, with few owners. And some companies separate being the manager from owning, which can result in problems - getting more pay versus making the firm more valuable. 

MAXIMUM PROFIT

So now we know what a company is and why they exist, and the oceans they swim in, we can understand their purpose. Normally, it’s assumed that firms maximize profits. But what does this actually mean? Well, profits are revenue minus costs. Maximizing profits means, broadly speaking, that companies choose how much to produce and at what price to sell it such that their costs are lowest and revenue is highest; there’s usually some level at which selling more generates more costs than it does revenue. There are, of course, complications and nuances, but in general it’s assumed that companies solve a problem to chase maximum profits.

This seems like a tall order; companies would just have to be run unrealistically well for profits to be optimal. Saying that companies merely want to chase higher benefits is more reasonable - making more money than otherwise, rather than the most money possible. Because the world is uncertain, and because success in business strategies is not guaranteed, companies choose sets of possible market outcomes, not certain scenarios. The role of profits, then, isn’t to signal the right choice of actions, but rather, to distinguish viable companies from non-viable ones - i.e. companies that can make good choices from companies that make bad ones. In a marathon, the winner is who runs the fastest of the runners, not of everyone on the planet ever, and the same goes for a market - survival is based on receiving positive profits over time, and success is just receiving more profits than everyone else involved.

Importantly, companies don’t need to make the most rational choices or even the best ones, just the ones that succeed often - no matter the reason. Luck and randomness play a huge role, since the world is unpredictable. Thus, firms that consistently succeed can be the ones that make the best choices, the ones that make good choices while others err, or the luckiest ones. Of course, given that the companies that remain profitable in different conditions all made similar decisions (produce more or less, etc) then it’s possible to predict and verify behavior using profit maximization - who is acting as if they were chasing the maximum profit possible, rather than focusing on realism. 

Given that companies are supposed to chase higher profits for their survival, some would say earning more is their sole responsibility - the managers of a company are tasked, fundamentally, to keep it going. The people who run companies are chosen to run them in the interest of the owners, and normally the owners want them to run the company in a way that chases the most profit - not some lofty social cause. The social responsibility of the firm is profit; the common good should be left to whomever ideology behooves you to leave it to, provided they’re not traded in the stock market. 

As they say in Wall Street (1987): “The point is, ladies and gentleman, that greed - for lack of a better word - is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms - greed for life, for money, for love, knowledge - has marked the upward surge of mankind.”

Cells interlinked within cells interlinked within cells

Something you can glean quite clearly is that business owners, successful as they are, don’t succeed by developing the most accurate theories about the nature of supply and demand - they succeed by responding adequately to market conditions. A corporate leader succeeds by finding the right strategies, not by developing a theory of the corporation.

The first problem is, quite simply, that countries are much bigger than companies. The largest company in the United States, Walmart, has 2.3 million employees and revenue of 572 billion dollars. The US civilian labor force has 170 million people, and US GDP is 26 trillion dollars (that is, 26,000 billions). Companies tend to focus on one thing, while national economies can’t do that. And all the problems listed above with scaling up in firms (incentives, shirking, etc.) are leagues more complicated for an economy.

That people will simply lie about resource use is such a big problem that central planning, can’t really work - not even with computers. This is something the late Hungarian economist Janos Kornai saw very clearly: socialist economies tended to have constant shortages of everything, since everyone just hoarded inputs they didn’t pay full cost for. Market systems are mostly constrained by demand, because they leave people behind, while non-market ones are constrained by the fact that everyone exaggerates how much they’ll use, and then underutilizes what they asked for.

This leads us to a second problem: an economy is a closed system, while a company is an open system. Imagine a parking lot (omg A Serious Man reference) that fills up by 9 am. If you get there at 8:30, you’ll get to park. But if everyone gets there by 8:30, it’ll just fill up earlier. From the perspective of a single driver, the lot is an open system; but from the perspective of all drivers, it’s a closed system - there are capacity constraints. A firm can grow in every market and hire more people for each division, but every single company in a nation can’t do that because there’s so much demand and so many workers. International trade is the same: either you sell less at home, or you use more and make more. There’s not infinite demand or infinite inputs.

This is probably the biggest gap between business thinking and economic thinking, or macro and micro if you will. Because an economy has a countless number of firms, and many complex interrelations between them, then there are many feedbacks between them - higher sales of Coca Cola mean different things to Pepsi Co than to the entire economy. Higher imports mean lower employment for manufacturers, but might mean cheaper prices, more spending, and overall higher employment for the economy as a whole. Firms have ties to other firms which have ties to other firms which have ties to other firms.

Babysitter’s club

But the fact that so many activities are intercorrelated means that they can just all get out of whack. Let’s start with a simple parable. Imagine a club of parents who babysit for each other. The club works thusly: every parent has a number of tokens they can trade with each other for hours of babysitting. Parents with more tokens are the ones who either babysit more, or demand less babysitting, and those with fewer either babysit less, or need their kids looked after more. Under normal circumstances, the number of tokens would even out - parents who have fewer tokens would look for opportunities to babysit, and parents with more would go out more often.

But imagine if there were too few tokens going around: then it wouldn’t really be possible for parents to build up too many tokens, so many more parents would be interested in babysitting than those who would be interested in asking for those services. In other words, there would be too many parents who aren’t “working”, and too few that are “hiring”. If the number of tokens were to magically go down, then a lot of parents would cancel their plans to not lose out on an important resource, and a therefore people who want to build up their token stockpile would be out of opportunities to do so.

This analogy is pretty close to the real world. In the economy, businesses (or the government, but acting “business-like”) hire people to do things. This depends, crucially, on the amount of spending in the economy - if people didn’t have enough money to spend, then they would cut back, impacting businesses and forcing them to cut back on future hiring, and perhaps to fire workers. A decline in spending, known as a recession, is usually accompanied by layoffs, because businesses are unable to cut wages - sometimes it’s illegal, and usually employees won’t like it.

This is generally known as a coordination failure and it’s something that simply cannot happen in a business. It’s certainly possible for a company to operate below full potential, to make less than it can, but it’s not because all its parts are feeding into each other - it’s because it’s badly run. If people are not buying its products, it can just lower its prices - but if all firms in the economy lower prices, they simply make less revenue and hire fewer workers, maintaining a depressed demand. A recession, which is a demand shortfall, is usually caused by the very demand shortfall that it produces - and it happens throughout the entire economy. “Nobody goes there, it’s too crowded” can actually happen for a national economy.

This means that the economy needs a babysitter - normally monetary policy, as well as fiscal policy. The government actually needs to make sure that the aggregate of demand and supply is where it needs to be. Without intervention, it is very much possible that business logic works - more competition equals lower employment, etc. But with a stabilizing force out there, tough luck - to quote Paul Krugman:

… the Federal Reserve Board actively manages interest rates, pushing them down when it thinks employment is too low and raising them when it thinks the economy is overheating. You may quarrel with the Fed chairman's judgment (…) but you can hardly dispute his power. Indeed, if you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what [Powell] wants it to be, plus or minus a random error reflecting the fact that he is not quite God.

Conclusion

So, a country isn’t just a big company because it can simply go bad on its own, rather than going bad because it is badly managed - outside of tech, streaming, social media, banking, or Hollywood, even.

The big lesson here is that being a businessman doesn’t necessarily make you better at the economy because a government policymaker doesn’t have the same level of control over output that a business leader has - you can’t just tell the country to make more steel, for instance, because it has to have both enough coal, iron, workers, factories, and buyers for it to make an actual profit. And having more employment in the steel mills might just mean the same amount of overall employment, and some other industry having to go with less. These things are just hard.