 Welcome to the Mises Academy Podcast. I'm Danny Sanchez, Director of Online Learning at the Mises Institute. In this episode, I talk with Peter Klein about his upcoming online course, Austrian Economics for Managers, which is available for enrollment at academy.mesis.org. So Peter, in a lot of neoclassical economics courses, it can seem really dry for practical people who are planning on going into business, can't it? Oh, absolutely. I think a lot of that is the way economics is taught. So it's typically taught in a way that's pretty dull and unengaging. And there are a lot of charts and graphs that don't seem particularly relevant to real world decision makers. There's also the substance of neoclassical economics itself, which Bill is centered on these highly abstract and artificial models with deliberately false assumptions, equations and curves that are supposed to represent production or marketing or whatever that don't really have any real world analog. And I think business students and other people trying to get practical insight from application of economics, if that's what they think economics is, they quickly get frustrated and think they need to go with just their intuition or their gut feeling or, you know, some guru books they pick up at the airport. And there are some things that neoclassical economics take as given that economics is supposed to be able to answer how that comes about in the first place, isn't it? That's right. I mean, even the phenomenon, basic phenomenon such as the business firm, why do we have firms? What do firms do? How are firms organized? What kinds of strategies do they use? These are mostly questions that are uninteresting to neoclassical economists trying to build, you know, competitive equilibrium models of the economy and so on. So they stick in little abstract representations of things called firms and plug them into their models and off they go. But if you're really interested in what a firm is, what a firm does, or as a practitioner, how to set up a firm, how to run a firm, how to organize a firm, how to strategize, those kinds of models, those kinds of theories are not likely to be very useful. And Austrian economics can shed light on these kinds of questions, can't it? I think so. I mean, Austrian economics, because it takes a different approach, it emphasizes causality, cause and effect. It's very realistic. It focuses on real phenomena. Austrians do, of course, employ abstraction as a way of, you know, sort of reasoning about how one kind of mechanism might work or how one kind of action might affect, some might bring about some particular result. But Austrians are always interested in developing their theories and applying their theories in a realistic, real world context. The purpose of employing abstract economic theory to the Austrians is to explain the real world, not to build little models that amuse ourselves and get us published in scientific journals and so forth, but to explain the world around us, how things work, why things are the way they are, how we can change things, how we can make them better. Could Austrian economics help someone to become a better manager? Oh, I think absolutely. Austrian economics helps us to understand how people behave, how people act in different circumstances, how they respond to different kinds of incentives, what kind of information they need to make good decisions. And of course, this is basic management, right? Management is about people working with people, understanding what makes them tick. Why does a person tend to choose A rather than B? How can a manager set up the environment, provide appropriate incentives, feedback and so forth to get people to, you know, cooperate and work together? Austrian economics provides a lot of insight into these kind of interpersonal relationships. Yet theoretical knowledge isn't a substitute for judgment, correct? No, that's absolutely right. And no one would claim, I certainly wouldn't claim, that taking a few courses in Austrian economics or even mastering Austrian theory is a sufficient condition for success in the real world. Austrian economics, like other kinds of economics, deals with abstract situations, how you apply the theory to one particular context or another, takes some intuition, it takes some common sense or to use a more technical word, it takes some judgment and experience. So of course, there are lots of successful entrepreneurs who have not studied Austrian economics. And there are a lot of Austrian economists, you know, for whom I would not want to work in a business setting. But I think that knowing a little bit of basic economics from the Austrian point of view gives the manager a lot of insight into how to set things up and how to do things. And that insight is complementary to the kind of intuitive judgment that a successful manager will have. Do you think some people go into their management career after having taken neoclassical courses with the mistaken belief that what they've learned about production functions will help them to just be sort of like a technocrat just plugging in for certain variables and then making decisions based on that? Yeah, I think that's probably true. I mean, related to that is the whole credentialing function of higher education in a lot of established companies, big companies, Wall Street companies and so forth, you know, having an MBA degree from a good university is almost an entry requirement. And there's lots of lore about experienced managers and other professionals who have not, you know, gone to gotten a Harvard MBA, how they react to these, you know, young Turks who come in freshly minted out of business school with a whole bunch of wildly unrealistic theories and models and jargon words and techniques and so forth that really aren't very useful to business. So I think one of the reasons that, you know, mainstream business programs that are founded on neoclassical economics are so popular is because, you know, of the value of the degree, at least as perceived by people on the market. But there's a lot of backlash against that, particularly MBA programs, a lot of skeptics who think that the kind of knowledge you get going to, you know, Harvard or Stanford and getting a professional business degree is really not very useful for some fields, for many fields. And I think that's why studying, you know, sort of a more rigorous foundational knowledge that's based on the Austrian school, you know, we're not focusing on trendy jargon and buzzwords and cute diagrams that you might read, you know, in a magazine. We're looking at real business and looking for real solutions. Do you think people who are hiring, who come across MBA holders like that, will be refreshed to meet someone who has an Austrian perspective and who takes a course like this? Oh, I would think so. Most of the students that I've taught in many years of teaching business students and executives find that the language and the way of thinking that Austrians employ, you know, makes a lot of sense. It's congenial. It's intuitive for them. It seems to be realistic. It seems to apply. And so I think, yeah, the more students who are trained in Austrian economics or have some exposure to Austrian economics who are going out and getting experience as entrepreneurs and managers, I think that's going to help to bring more people, you know, to attract more attention to the Austrian school. Now, the first week, you're going to be covering microeconomics. And what use, how is it useful, do you think, to really start with fundamental principles first before you go into managerial economics? Right. Well, like any, you know, Austrian style course, we do things in a sequential and structured manner. So we're going to start with some basics, you know, basic economic concepts about scarcity and opportunity cost and thinking on the margin and so forth. Students who have already had, you know, economics courses will be familiar with those concepts already, but some will not. And, you know, before we can talk about things that managers want to do inside the firm, we need a little bit of basic knowledge of how market works, right? Where do market prices come from? How does consumer demand constrain what the entrepreneur wants to do? Right entrepreneurship, whether in a small enterprise setting or in a large company, is ultimately about producing goods and services that consumers will want to buy. So understanding how consumers express their preferences in a monetary economy through demand, what determines the characteristics of demand, like elasticity, for example. Those are building blocks that managers need to start with before they can get into more specific strategies about, you know, insourcing or outsourcing or how they want to design their compensation programs, how they want to evaluate employees and so on. One of the early readings that you've assigned is by H. Edward Rapp. It's called Good General Managers Are Not Professional. Could you briefly summarize what the title means? Sure. This is a classic article from the 1960s that sort of circulated underground for a long time. Rapp was a professor in the business school at Chicago for many years. And the title is a little bit obscure, but what he meant by professional managers was those who have been to a place like the University of Chicago Graduate School of Business, like we were talking about before, who know a lot of jargon, who know a lot of buzzwords, who know these sort of, you know, mathematical models that they learned in school, but don't have any good judgment. They don't have sound instincts. They don't have experience. What Rapp calls a general manager is someone who really knows how to motivate people, knows how to make decisions, can rely on gut instinct when necessary, knows how to get sort of an overall understanding of the data. What he calls a professional manager is, you know, sort of younger person who's fresh out of business school, who knows how to collect data and do some quantitative analysis, but doesn't know what the data mean, doesn't know how to interpret, is not good at making actual decisions that have to be made day to day, moment by moment. So the pamphlet, I like to assign it as an introductory reading for a managerial course. It's a little bit of a polemic, but it's sort of a fun read to give us a sense of the proper limits of kind of formal technical analysis in dealing with real problems. Over the Christmas break, I took my kids to see the new Walter Mitty movie with Ben Stiller, which is an okay movie, not great, but there is a particular character, a set of characters in the film. The main character, Ben Stiller, is a mid-level employee at Life Magazine, which is being shut down in the movie, and the company has brought in a cadre of young sort of restructuring consultants whose job is to make some changes and to fire people and to help to sort of bring closure to the print version of the magazine. And they're portrayed as smug, arrogant, you know, uninformed about how anything in the magazine actually works, and they make the movie makes fun of their appearance, their manner of dress, their manner of speech, and so forth. It's really sort of good fun, but I think in many ways that those obnoxious consultants represent the kind of thing that H. Edward Wrapp is talking about when he refers to a professional manager. He means somebody like that who's sort of all about style over substance, is trying to make himself look good. With jargon. With jargon and so forth, and it doesn't really care about the performance of the organization itself. Now in the third week, you're covering competitive strategy. Would you like to talk a little bit about what you're going to be discussing in that week? Right. Strategy is, of course, you know, managers have always employed a strategy, but kind of the formal analysis of business strategy is a very, very hot area in the field of management. It really took off in the 1980s with some important work by Michael Porter, a professor at Harvard Business School. We'll read one of Porter's articles. What's interesting from our perspective here, the way Porter approached strategy for business was to start with neoclassical microeconomics very explicitly and say we can use this as our analytical framework, but just sort of flip it around and tell it from the firm's point of view rather than the regulator's point of view or society's point of view. So for example, in a traditional industrial organization course, students learn that competition means lots and lots of little tiny firms. Monopoly means a few big firms. The antitrust authorities have to step in to reduce barriers to entry to eliminate reduced concentration rates to allow for, you know, a greater number of firms in the industry, et cetera. Supporter said, well, that's right, but from the point of view of the incumbent firm, you want to limit competition, right? You want to erect barriers to entry. You want to increase the concentration ratio, and here are some different tricks and tips that you can use to try to keep other firms out of your industry. I mean, there's a lot of interesting potential insight that can come from thinking about that way, but several scholars and many practitioners have thought, well, that's the wrong way to look at competition, right? Austrians look at competition as a dynamic, rivalrous process of entrepreneurship and innovation. It's not a static thing where you look at the number of companies in the industry right now. Rather, we're interested in the conditions by which new firms could potentially enter in the future. We're interested in how firms innovate to stay ahead. The whole dynamics of the constant flux of a market economy. If we take that perspective, we get a very different view of strategy that what a firm needs to do to be successful is not to try to increase concentration in a static sense, not to rest on its laurels, but rather firms have to innovate. They have to experiment. They have to be aware of the threats of potential competition from rivals in the future. Sort of implicit competition. Oh, sure. And so, again, I think thinking of it as static versus dynamic competition is a useful framing. Now, some scholars began to look to Austrian economics as a way to get new insight on strategy. There's a very famous article which will read, which is published in the Academy of Management Review, the most prestigious theory journal in management studies in the early 90s called the Austrian School of Strategy, which is a very explicit attempt to take concepts from Austrian economics and use them to help managers make more money. And they have sort of a very limited view of what entails competition, don't they, that they sort of don't realize how products that aren't exactly the same can still be competition. No, that's exactly right. And just as the neoclassical antitrust approach and industry studies approach, you know, mistakenly thinks that if a firm like Walmart, for example, is large and has a large share of the market for discount retail, you know, that by itself is an undesirable outcome. That is an anti-competitive phenomenon. Austrians and others have pointed out, well, now you have to look at how did Walmart get to be large if a company is large because consumers prefer to patronize it rather than some more expensive rival then that is a very competitive situation. It's the outcome of competitive behavior. Likewise, from the manager's point of view, if you think that being large equates to being successful, you know, that Walmart has market power, no one can effectively compete with it. If you have that mentality and you're running Walmart, well, then you're just going to rest on your laurels. You think all we need to do is stay big. We need to try to crush any little guys who come in. But if you don't understand how you got to be big, in other words, by being efficient, by cutting costs, by being more innovative and adopting information technology and so forth, Walmart, by the way, is extremely innovative company in adopting all the sort of logistics, innovations, supply chain management innovations that allow it to get its cost down. If you forget about all that and just look at your market share numbers, well, then you don't know how to innovate and you're not likely to persist in your, you know, strong market position. You're going to be outcompeted by somebody who is more aware of how firms get to be big. In the Pixar movie WALL-E, there's a sort of, going back to Walmart, there's sort of like a Walmart equivalent that eventually grew to become the one company in the whole world and basically like almost like a one world government, but it was a corporation. In your fourth week, you're going to be discussing firm boundaries. Is that conceivable? Can Walmart eventually not only, you know, take over Target, but just basically take over every company and become the only producer in the whole world? Yeah, well, not only is that highly unlikely, there are sound theoretical reasons to think that that could never happen. In fact, that's one of Murray Rothbard's great contributions to the study of industry structure and not one of his best known contributions, but Rothbard shows in man economy and state and a couple of other places how Mises' concept of socialist economic calculation, how Mises' argument about the need for private property, the need for private ownership of resources and competition among owners of resources from which come market prices that are needed to allocate resources effectively. Rothbard shows how Mises' argument is not just about socialist countries, but it's really a more general statement about the need for private ownership and competition among factors. And Rothbard showed that if the kind of thing you describe were to happen, if a company were to acquire other companies and keep expanding and growing and growing at some point, if it found itself the only firm in a particular sector, if it found itself the only user of particular resources, then it too would face the economic calculation problem faced by the socialist manager. It would not be able to price its inputs appropriately. It would not be able to know what's the most efficient means to produce goods and services, and it would find itself becoming less efficient, less profitable, and it would be outcompeted by smaller rivals. So this is a good example of how theoretical and practical insights developed in one context, Mises' analysis of socialism, actually have very powerful application to a very different context, namely, you know, mergers and acquisitions, whether a firm should acquire a competitor or not, whether a firm should be vertically integrated or not. It's a good illustration of how we can use core Austrian theory to gain insight into a very important and very practical managerial problem. So that is a upper limit for firm size. Are there theoretical lower limits as well? Sure. I mean, one of the things that we learn from the study of cooperative human action, right, is ways in which people sometimes find it better to coordinate on a voluntary basis rather than engage in all kinds of interactions sort of at arm's length. So the reason that we have companies in the first place, and I've addressed some of this in my own theoretical research, the reason we have organizations is because in many cases it's easier to produce things, it's more cost effective to produce things in tightly coordinated teams where we designate people into different roles and we give particular individuals some kind of supervisory capacity. We call them managers or call them the boss and many of us find that if we sort of work together and we allow the boss to assist us with our coordination, we can get more stuff, we can produce more stuff and we can individually be better off than we would if we try to associate with each other in a more distant kind of relationship. Now some on the left, they really criticize corporations and they say that really it's not the shareholders that really control and own the company on a fundamental level that it's the managers and that there's this conflict mostly between managers and workers. And so are there Austrian insights that sort of show that that's not really true? There are small companies in a mixed economy like we have today that also get some of these benefits. So I don't agree with the point of view that the large hierarchical company is automatically or necessarily the product of some kind of artificial state regulation or intervention, though in some cases it clearly is. Mostly what, I mean we'll talk about some of these legal restrictions in the course. Interested listeners might want to take a look at the archives of a course that Art Cardin and I did a couple of years ago. I believe it was called Big Business Friend or Foe where we got a little bit more explicitly into some of the politics of big business. So I think our course is going to cover most of that ground and I think it will be very interesting to people who are curious about that debate who want to know if corporations per se or private hierarchies are consistent with competition and the free market, etc. But we won't focus explicitly on the political or legal aspects in this course. Well, another aspect of the debate, of that debate is the principal agent problem. And so that's what the people on the left are saying is that the shareholders, they're only principals in name, but really it's the managers who are controlling things. And doesn't Mises kind of shed some light on that? That's really a misconception. Yeah, absolutely right. This is an old argument that goes back to the 1930s. It's a famous book by Adolf Burley and Gardner Means that articulated what we now call the separation of ownership and control, right? That the kind of principles that we've been talking about up to this point might apply to smaller organizations but not to larger ones where you have shareholders owning stocks and you have professional managers who are kind of running the firm on a day-to-day basis. Then the true owners of the firm are not getting their wishes. Their wishes are being frustrated because they're not actually operating the firm. There are too many of them. They have other things to do. They don't devote all of their time to this company and you have professional managers who are really sort of running the show. Mises has some really insightful remarks in bureaucracy and in human action about the role of financial markets, how the stock market disciplines and constrains managers of large companies who might want to act against their shareholders' interest. And so we will cover later in the course the more general topic of compensation. So that includes not only compensation for executives, how shareholders can design the CEO's compensation plan to make it less likely that the CEO will engage in the kind of discretionary behavior that Berlin means we're worried about. But also we'll look at compensation throughout the organization, how entry-level workers are paid, how mid-level managers are paid and evaluated. Do you use bonus systems? Do you pay hourly rates or do you pay based on output? What kind of evaluation systems can be used? Are there ways that employees can try to game the compensation system? How can managers design compensation practices or human resource practices more generally to get the best performance out of the firm as a whole? So people who are interested in labor markets might enjoy this course as well because there's certainly a big labor aspect to the running of any large organization. So at the beginning of the interview we talked about what potential future managers or present managers might get out of this course. How about academics or future academics, someone who is interested in studying this kind of thing at a university, would this be useful for them too? Oh, I think it would absolutely for students who are interested in of course learning more Austrian economics and getting a better and sort of more rounded perspective on Austrian economics. I think they would benefit. Also researchers, scholars who are interested in sort of domains or applications of Austrian theory might find this material interesting as well. One thing that I've said for a number of years is that while the economics profession remains at least to some degree closed to Austrian insights, not entirely, but certainly not as friendly to Austrian theorizing as we would like, research and scholarship in management, both in entrepreneurship and strategic management, human resource management, corporate strategy, et cetera. In those academic disciplines, there's a lot of receptivity to Austrian thinking, to Austrian style analysis, to the great Austrian books and articles and so forth. Management as an academic discipline tends to be a lot more kind of eclectic from a theoretical point of view. It's, you know, you maybe call it multi-paradigmatic. There's not one dominant paradigm. They're open to a number of different insights, not only from economics, but also from sociology or psychology, anthropology and so forth. So Austrian economics is a viable player, you know, in that game of sort of influencing that profession. So Austrian scholars, graduate students, professional scholars, researchers, private researchers who are interested in, you know, where, what are some areas where Austrian economics is having influence and can have even more influence might be interested in looking at the managerial sciences as a very potentially fruitful area for applying Austrian insights. And even more open to Austrian insights than other realms like macroeconomics. Oh, I think so, absolutely. Like other people, you know, outside of mainstream economics departments, management scholars and people in business schools are increasingly, you know, dissatisfied with or disenchanted with the kind of stuff that, you know, they hear from Paul Krugman and that they might read, you know, the American Economic Review. And so I think they're very receptive to the Austrian school and we should look to build, you know, to look for allies there and try to build some relationships there. Well, thank you so much, Peter. I encourage everyone to sign up for your course. It sounds fascinating. Thanks a lot. Thank you for listening to the Mises Academy podcast. To enroll in online courses, to access other episodes of this podcast, or for more information, visit academy.mesis.org.