1. Exploding Worlds and Course Introduction

1. Exploding Worlds and Course Introduction


Prof: I’m going to use
today to actually cover some introductory material.
We will use most of the fifty
minutes. The last part of today’s
lecture will describe the course, its requirements,
and so forth. So let’s begin.
Capitalism–we’re going to
break the subject today into three headings.
Capital, capitalism,
and course, three “Cs”
if you will. The–I’ve chosen,
and I usually do this, I’ve chosen one segment of the
economy as the theme for the day,
and today that segment is revealed in this slide.
Calhoun Athletics XXL,
can you interpret the slide? Student: Green
technology. Prof: Okay what in
particular? Student:
>Prof: Okay,
how about Varic bottled water? Student: Like the crop
circles? Prof: Okay,
they are indeed crop circles. Score one for MBAs.
They are crop circles,
and all of us who travel from east to west across the country
have seen them, but we haven’t seen them quite
in this density because this photograph is taken from space,
it’s a NASA image, and it’s an extraordinarily
elegant display of something very simple.
Now why would center pivot
agriculture interest us from the point of view of capitalism?
The mis-formatted slide here
says capital. This is a definition that comes
down to us through the Oxford English Dictionary from the
early seventeenth century and let me read it in full and then
we’ll boil it down to more manageable terms:
“Capital is the accumulated wealth of an
individual, company, or community used as a
fund to carry on fresh production;
wealth in any form used to help in producing more wealth.”
And there’s a shift between
those two meanings. The first is a very broad
understanding of capital. The second is very close to the
way you would have to think about capital in connection with
an economic system called capitalism.
So, let’s start with the
broader usage, “Capital is accumulated
wealth used as a fund in carrying on fresh
production.” That’s a very broad idea.
It is one which arguably–in
fact I think without much argument,
goes back 10,000 years to the establishment of agricultural
society, and very possibly another
100,000 or 120,000 years to organized hunter gatherers using
weapons and tools. Does this qualify?
Is that not capital?
What do you think?
Second row purple–
Student: >
Prof: It is capital.
Sorry, excuse me,
can you hand her this? Student:
>Prof: Okay,
so the nuts buried in the forest floor are accumulated
wealth, so it meets that test. Does it meet the next test?
You need the mic a little
closer to your mouth. Student:
>Prof: Okay so what is
the squirrel producing with that nut?
Student: Nothing
material. Prof: He’s producing
squirrel, and that’s not really what we mean.
Hand the mic to somebody else
and we’ll just–it’s the hot potato.
Just pass it around and
wherever it is when I ask a question that’s your turn.
That’ll be good.
The nest is producing
nestlings, and it’s a little closer to what we mean.
The beaver dam producing a
working environment for beavers to carry out their business;
it’s closer. Infrastructure if you will.
The honeycomb that bees use.
This one is actually the one
that is closest intuitively to capital.
Right?
The accumulated wealth is the
energy and silk required to weave the nest or weave the web,
and the web is indeed an instrument for the work of
capturing prey, but there’s no external product
beyond it, so even that is not quite what
we have in mind. Now how about seed?
The seeds used in agriculture.
Where’s the–where’s the mic
right now? Fess up.
Come on in guys.
No, no, no.
You’re not passing it off now.
Okay, so do you reckon that
seeds like this constitute capital?
Student: Okay,
I don’t really think so, no.
Prof: Okay and why not?
Student: Well,
I guess that a seed produces a plant,
but it doesn’t really–well I guess yeah,
maybe the seed produces a plant, and then the plant
produces more seeds and it sort of keeps generating more and
more seeds. Prof: Is that capital?
Student: I mean it
doesn’t look like it to me. Prof: Why not?
Be exact.
Student: Well I guess
that capital is sort of a never-ending way of accumulating
more wealth. Prof: Does it have to go
on forever? Don’t capitalists fail?
Student: Yeah
capitalists fail, but good capitalists don’t.
Prof: Take Mory’s,
it’s a pretty good example. It’s a really good example,
actually. Okay, mic please.
In this bucket I’ve got two
kilograms of seed. Would anybody say that it isn’t
enough to count as capital? If–is one seed,
is that enough to make it capital?
Student: What kind of
seeds?. Prof: It’s–
Student: I said what kind of seed is it?
Prof: Okay,
it is for growing safflower. If you elicit information from
me you’ve got to give me something back.
Student: I think seeds
in any quantity can be capital because each–once you plant it
and if there isn’t successful pollination–
Prof: Is the voice loud enough here?
Student:
You can always use plants to produce more seed.
In fact, that’s what a lot of
farms do and that’s what a lot of farms get in trouble for
because other companies want to control those seeds.
Prof: Okay,
so there’s a patent violation issue if I use hybrid seed to
generate more hybrid seed? There may be,
there’s an argument there. Okay, so quantity doesn’t
matter at all? Yes.
Student: I’d say
quantity matters if you’re a subsistence farmer because if
you just have enough seed to feed yourself,
that’s not capital that’s just keeping you alive,
you’re not producing any further wealth from it.
Prof: Okay and if I gave
you just this much seed? Student: Well if I’m
not a farmer, if I have some other means of
supporting myself that could be capital for a side business but
that wouldn’t be for a subsistence farmer.
Prof: You think it’s
really worth having a business over twenty-six safflower seeds?
Student: Well no.
Prof: No,
I don’t think so either. What I’m driving at here is the
notion of minimum efficient scale.
Capital gets–a resource gets
to be capital only when it’s aggregated to a scale where it
can be effectively enough deployed to compete in an actual
economy. Now let’s take–that’s too big
a note, let’s take a dollar. Have I just given you capital
or not? Student: Technically
yes, but probably that wouldn’t allow me to set up a budding
business over here. Prof: Okay,
how might it become a piece of capital?
Student: Well if
somebody else gives me a dollar or more.
Prof: Two dollars is
enough for you to call it capital?
Student: No,
but if I have more investors and they will be giving more
than a dollar. Prof: Okay,
so you need some aggregation or agglomeration.
How do we aggregate capital in
an actual economy? Student: IPOs.
Prof: IPOs are a big way
to do it. In general, the joint stock
corporation is a way to do it. How do banks aggregate capital?
Student: Deposits.
Prof: Thousands of
little deposits make big funds. Okay, so we’re getting there
with capital and what I want to do now is continue the
agricultural theme and see if we can relate what we’re talking
about to the generation of actual wealth in society.
This is called a seed drill.
It is a way of planting
millions of seeds in a very systematic, precise,
and cost effective way. One characteristic feature of
how capital works is combining different factors in the
production of the same thing in an extremely intelligent way.
A way that represents the
accumulated experience of society and when you do it well
you succeed, and when you do it poorly you fail.
You can actually fail even when
you do it well, but you’re very unlikely to
succeed when you do it poorly. Now here I want to compare two
very similar technologies, this is a peasant farming in
Tibet and the mode of power here is a pair of yaks,
and this is a John Deere tractor and the spectacular
difference between these two things is obvious to us all.
It is that one of them
is–constitutes a large investment of capital.
In the case of that tractor and
the gear with it well over $100,000 must be invested.
The yaks, well I don’t know
what yaks cost in Tibet, but less.
We would say that the John
Deere photograph represents something that’s capital
intensive and the yak photograph represents something which is
labor intensive. We would expect a much higher
return in food generated per hour of labor invested from the
highly mechanized capital intensive story.
In the history of the world in
the last thousand years is essentially the history of
substitution of the right hand picture for the left hand;
of capital intensive, highly mechanized means of
production in the place of labor intensive, low capitalization
means of production. Another comparison,
the capital intensivity here, the ratio of that watering cans
capital cost to the center pivot that might be as much as 500
meters long would be measured in the thousands to one,
the tens of thousands, the hundreds of thousands
probably; enormous difference in the
level of investment. Also those of you who are
interested in the environment, and all of us should be,
there is a huge difference in environmental impact.
The labor intensive agriculture
essentially leaves the environment unchanged,
whereas, this kind of agriculture practiced in–
it’s now a world–center pivot irrigation is a worldwide
technology. And in many places it draws so
much water so fast, and so much water is lost to
evaporation, that the underlying aquifer is rapidly being
depleted. Here are two center pivot
photographs, and they too differ in capitalization.
The one on the left is from
Egypt, the one on the right is from Iowa, and the difference
between them in the cost of the land would be dramatic.
The market price of highly
productive loam soil in one of the three or four richest
agricultural zones in the world is much higher than in the
margin of the world’s largest desert.
Here’s another–I kind of got
carried away with center pivot agriculture.
Here’s another slide of the
same kind from the same source, and this is in Southern France.
Who’s been to Southern France?
Pretty great isn’t it?
I have many reservations about
French politics but Southern France is one of the nicest
places I’ve ever been, and this summer–we’ll meet a
guy here in a month named Paolo Zannoni,
who is a robber baron Goldman Sachs partner,
and he just built a villa overlooking Cannes in Southern
France, and I had to be taken away by
security. What’s striking about this
photograph in comparison with the others–
what’s the dramatic difference between this one and the
Egyptian one, and the Iowa one?
Purple?
That’s not what I’m fishing for
guys. Student: There’s other
things in the middle. Prof: Okay you got to
talk really–where’s–do I have the mic?
Here it is.
Would you please pass this over
to him? Student: There’s other
things in the middle of the green and purple circles.
Prof: Push the on button
and it’ll be on. Student: Alright,
there’s other things in the middle of the green and purple
circles. Prof: Okay,
and what are the other things? Student: I can’t tell
if they’re houses or– Prof: Well what are all
these little polygons? Look at the right margin,
for example. They are–take a guess,
they’re not soccer fields. Who wants to take a guess at
this? Yes.
Student: Pasture.
Prof: Pasture?
Okay they might be pasture.
What they are more
generally–you have the–we’ll get better at this microphone
thing as we go. What they are is very small
farms. They’re farms where the leaps
and bounds trace back perhaps 800,1,000,1,200 years.
They were farms which worked
economically when the world was less developed in capital
intensive agriculture, but they have been rendered
marginal by the transformation of world agriculture.
Now the question for you–are
you ready for a policy question? Okay, your name is now Sarkozy,
and the question is, should we increase–let’s
suppose that 20% of these farms are failing a year,
and we’re already subsidizing them pretty heavily.
Should we subsidize them more
so that the rate at which they close down is diminished?
Mr.***Sarkozy?
Student: I would say if
you really want to effectively decrease the rate at which
they’re failing you’d want to encourage consolidation.
It looks like the problem here
is real fragmentation. Prof: Okay,
the problem is fragmentation, that’s a really good start.
Now the person immediately to
your right is your political consultant,
and she’s going to tell you whether what you just said is
going to wash in Lyon or not. How’s the Sarkozy consolidation
program, how’s that going to play?
Student: Can you repeat
the question? Prof: Okay,
Sarkozy just said these little fragments of land are an
extremely inefficient way to do agriculture.
He/she was right on that point.
She goes on to say that we
should try to capture the scale economies of big fields by
consolidating agriculture. Now you are a public official
subject to election. What–how is that going to read
for you, that statement that we should announce the Sarkozy
Agricultural Consolidation Plan? Student: I don’t think
that the public would like it, like the small farmers.
Prof: The small farmers
would hate it, and do the small farmers play a
special role in the life and imagination of France?
Student: Yes.
Prof: Yes.
Okay so probably it won’t
happen and France– this is a characteristic fact
about all the capitalist democracies is that pressure
groups play an enormously important role in actual policy.
The one book,
which is available for purchase at Labyrinth,
but which isn’t actually required, is Christopher
Buckley’s Thank You For Smoking.
How many of you have read this
book? Student: Probably
watched the movie. Prof: Pardon?
Student: The movie.
Prof: Oh, the movie!
How many of you have seen the
movie? Books!
It’s all about the biases of
pressure groups and public relations in the capitalist–in
the largest capitalist democracy, which is our own.
I just couldn’t resist throwing
this one in, this is the Libyan Desert and
center pivot agriculture plus maybe something else that
uncles– observers from the sky found
interesting. Okay so a general theme here,
Strategy A / Strategy B. Strategy A is labor intensive
production. Strategy B is capital intensive
production. The single biggest story,
and I’m repeating myself here because it’s such a big point,
in recent world history is the substitution of Strategy B for
Strategy A, and that happening on an
extremely uneven basis. It’s happening in a big way and
fast some places, and in a little way and slow
other places, and that generates an enormous
vertical dimension to the world. There are income ratios between
households measured in the millions,
millions to one, and that provides some of the
interest in the functioning of capitalism which brings us to
the subject. Now comparing labor intensive,
the red arrow, with capital intensive,
the blue arrow, we have here a very simple
production function where labor expended is on the horizontal
axis, and units produced is on the
vertical. For those of who are actually
taking this course, these slides I posted them just
before class and so if you– you can just–you don’t have to
write this stuff down. If you project differences in
rates of return over long periods,
here I’ve put 100 production cycles,
and one curve is increasing at 1%, the red one,
the other is increasing at 4% per cycle,
and by the end of the period there is a monstrous difference
in the rate at which they are accumulating.
In actual fact very small
differences, I’ve greatly overstated them in the
production function here. The difference between 4% and
3%, or between 2.5% and 1%, are enormously consequential
when projected over time. And at a given moment in time,
are enormously consequential from a competitive point of
view, because if you are not the low
cost producer, the low cost producer is in a
position where if she has sufficient scale of operation,
she can drive you out of business.
Now everything we’ve said so
far could be true of almost any economic system.
I put the grass here to suggest
Tang, China. This was one of the great
periods in Chinese cultural and economic history,
ending more than a thousand years ago.
The use of capital,
not necessarily in the highly intensive form,
but the use of capital in this economic cycle we’re talking
about was a perfectly normal practice which the Tang Dynasty
would have understood easily. They were, by the way,
just as inventive as we have been in the last couple of
hundred years. What they didn’t have was the
ability to go to scale. Or it could have been as
suggested in this Bruegel painting,
we could be thinking of Europe in the fifteenth century or the
sixteenth century before the capitalist revolution because
there was always the reliance on capital.
Lower levels of intensivity
because there was less capital in total.
And it could even have been,
we could even be talking about an agricultural cooperative in
the Soviet Union, which used capital in the form
of tractors and land, and seed, and so on,
but used it in a very different way than it is used in market
economies. Two: capitalism.
Let’s switch now to the lower
usage here. It is the use of accumulated
wealth to produce more wealth. Marx makes a big point of this
wealth, commodity, wealth–WCW–and sees this as
pathological, as a distortion of human
values. And we’ll talk through Marx in
about a week or ten days. The great man–how many of you
have read as many as ten pages of Marx’s writing?
Where do we read Marx at Yale
these days? Student: Philosophy.
Prof: Philosophy
department. Where else?
Student: Sociology.
Professor Douglas W.
Rae: Directed studies.
What is directed studies read
of Marx? Student:
>Prof: “Communist
Manifesto”; that’s great,
you’re well prepared for this class because we’re going to
read it next week. What would you say of Marx as a
writer? First of all he wrote in
German, but who’s got an editorial opinion about Marx’s
writing? Yes.
Student: I think–
Prof: You’ve got to shout without the mic.
Student: A very
talented writer. Prof: A very talented
writer. I agree;
a very smart guy. If you were marking a Marx term
paper up, what would you find fault with?
Student: A bit
long-winded. Prof: Very windy and a
little overwrought, right?
He really wants to hit you in
the face five times with each thought.
But what we’ll discover is
interesting is that Marx, in the Manifesto,
Marx and Engels, look at capitalism in a way
very similar to the way we look at it today.
They emphasize its enormous
productive capacity and they also emphasize that it is always
on the edge of being out of control.
Capitalism, as a word,
comes into the English language in the middle of the 1800s,
and it comes in because of Marx and people like Marx.
It is a pejorative used to
attack the existing economic system.
Capitalism is seen not as a
highly productive system but as an unjust system,
and it’s criticized in other ways which I’ll tick off in a
moment. Anybody recognize this fellow?
Yes.
Student: J.P.***Morgan.
Prof: It’s J.P.
Morgan and does anybody know
who took this photograph? That’s a little hard;
Steichen. And it’s a very famous
photograph. What’s famous about it?
What does–what’s striking
about this image? Student: His face.
Prof: Does he look
friendly, warm and fuzzy? No, and he wasn’t.
I mean this was a very hard
edge guy. What seems to be in his left
hand? Student: A chair.
Prof: It is a chair–it
is the arm of a chair, but the reflection makes it
look like he’s holding a dagger. It was no accident.
Steichen was not a fan and this
has been used–this photograph’s been used thousands of times in
a polemical way. Okay, capitalism as seen in the
nineteenth century. A disease for which scientific
socialism, that’s Marx’s term for Marx, is the cure.
Of course there were twenty or
thirty other brands of socialism that Marx regarded as
unscientific. It is a method by which to
steal the labor from the exploited masses.
The reasoning,
which we’ll review in ten days time,
is that capital can never make money except by using either
labor now or the accumulated fruit of labor from the past,
and if capital ends up with a profit,
that profit must be extracted from either living or fossilized
labor. This is not a thought which I
share. It is a system which undermines
traditional society in all its forms, and undermines
traditional skill sets, and that’s a perfectly true
statement. When it happens it is very
coercive. It is indeed a trademark of the
way capitalism works. That a skill set which was
competitive and au courant in 1980 may not
command as much as the minimum wage in 2009.
This is the kicker for Marx;
it is the claim that capitalism inevitably will destroy itself.
It will undermine its own
foundations and ultimately disappear.
We’ll evaluate that view.
This slide has cut off the main
part of the–of what’s here so I’ll have to remember it for
you. Capitalism is the name given to
an economic system by its enemies;
point one by its enemies. Point two a system which relies
heavily on the private use of capital;
heavily on the private use of capital combined with the profit
motive founded on self interest or family interest.
There are hundreds of
variations on the capitalist system,
but the essentials are private deployment of capital,
open acknowledgement of profit as a motive,
and a sympathetic understanding of self or household interest.
Another frequent part of the
package is a tolerance for innovation.
One of the characteristic facts
about historical society is a resistance to innovation.
And the temptation to resist
change is always there. It is absolutely always there
and as people grow older they grow more set in their ways and
expectations and less tolerant of fresh innovation.
This course.
We’re going to start with some
excerpts from the Wealth Of Nations.
It is available on Class V2
posted under resources. How many of you have read at
least a chapter of Wealth of Nations?
Okay, the rest of you are in
for a treat. Smith is not only a great
writer but a great thinker. He is a much more complex
thinker than we usually imagine him to be.
He was not a believer that it’s
just fine for the poor to starve in the streets.
He actually had very
complicated news about that which are broadly analogous to
the philosopher John Rawls, and Rawls’ difference principle
about what inequalities are justified,
namely those which>
ultimately in some way to the
benefit of the least favored stratum in an economy.
The Manifesto,
already mentioned, and in both cases we’ll leave
out a good bit. Smith is a very old book.
I recommend to you the Bantam
paperback, $7.95 of Smith because it has
wonderful little summaries of each paragraph in italics which
allow speed reading, which is actually a very useful
thing when a book would take a week to plow through in a
careful reading. We’ll focus on just three or
four points there, three or four arguments in
Smith, but they are really powerful and important readings.
The Constitution of
Liberty is by F.A. Hayek and we’ll just read two
chapters that will be in a packet, which you will get.
Hayek is the arch-conservative,
a market conservative from whom most of the conservative
movement– not not concerned with social
authority– but the libertarian side of
American conservatism relies primarily on Hayek,
actually. Farewell to Alms,
this book, by a guy named Gregory Clarke,
is a book which says capitalism: more and better;
pour it on. As capitalism increases its
reach the world will grow wealthier and better.
It is a polemical work,
written by an economist, and you will find things to
argue with even if you more or less agree with him you will
find many things to argue with him about and that will be an
important book in the course. The Mystery of Capital
by Hernando DeSoto is an argument about why the less
developed countries in the world are less developed,
and the gist of it is that formal and enforceable property
rights are a precondition to capital development.
It’s a very powerful piece of
work. Richard Posner,
The Failure of Capitalism,
Posner–anybody know who Posner is?
Tell us loud and clear.
Student: A judge.
Prof: He’s a judge and
he’s a judge of what persuasion, would you say?
He’s a very conservative judge,
teaches at The University of Chicago Law School,
and he has written a very penetrating analysis of the
current crisis. It is–I read maybe 20 books
and picked one on this subject, and this is the clearest and
most honest, I think, and he doesn’t–he
does no ideological distortion here that I can detect.
It is just a penetrating and
straightforward analysis of what happened, and for that reason
very useful. The Bottom Billion by
Paul Collier, who is a World Bank economist
who teaches at Oxford, and in this maps out a
diagnosis and a strategy for using market mechanisms and
capital development to alleviate most of the world’s poverty.
Finally, The White
Tiger, this is fiction, but there are times when
fiction is better at describing the real world than nonfiction.
This is a brutally penetrating
novel written from the point of view of a very poor,
very smart, and in many ways flawed young man in South India.
It won the Man Booker prize
last year for fiction. It is, for our age,
it is as good as Dickens and Zola were for the nineteenth
century. It’s just a brilliant book.
I couldn’t put it down.
Ten people told me I had to
read it, and I kept shrugging my shoulders and that’s when I
started, and I read it front to back in one long day.
It is–if you want to
understand why there are a billion or two billion people
out there for whom capitalism looks not like a powerful
mechanism of production but like an extremely coercive system.
The White Tiger is a
great way to do that. Chris Buckley’s,
Thank You For Smoking, is optional.
We will also use the case
method and the case method occupies about a third of the
course. We will use–the ones in white
are straightforward cases, the ones in gold we’ll have the
people in the room or some of the people.
Polaroid is the story of the
land camera and a brilliant technology which ultimately
crashed and burned, and it’s–the case is a hard
business school case about the attempt to get that business
through its crisis at the time that it went broke.
Goldman Sachs IPO
terrifically–it’s a good HBS case,
and better yet we’ll have Paolo Zannoni with us to tell the
story from the inside of the Goldman system.
Wanda Rapaczynski is the story
of getting a business going in Poland just after the death of
communism. A Yale-trained business woman
who created something called Agora S.A.,
which is the largest publishing company in East Europe,
and how she coped with the toxic environment,
the toxic business environment, left over by communism.
Selco India is a microfinance
story. Cardiothoracic Systems is a
tech story and I’m going to have the Dean of SOM come and do it
as a business case with you, which means you’re going to
need to wear helmets. She is an aggressive cold
caller. By the way, I’m going to make
two kinds of calls in this course,
cold calls are the kind of thing I did today where you get
no warning, and warm calls I’ll send you an
email and say heads up about, and in the second case you’ve
really got to have something to say.
Some of the fun in this stuff
is the back and forth between you and me, and you and you.
The Enron case,
Jim Alexander is an important guy in this course.
Jim would you just stand up and
wave? Jim was–Jim is a good friend
of mine who had a career in investment banking and then at
Enron, and he was Chief Financial
Officer of Enron, Global Pipeline & Power,
and he saw what was happening and got out.
He is referred to as the fly in
the ointment in Smartest Guys in the Room,
which is the popularized story of Enron’s crash.
He then went on and co-founded
Spinnaker Exploration whose operating principle was:
think what Enron would do and do the opposite.
Spinnaker became a public
company and was extremely successful.
Medley Global Advisors,
this is a case about gathering business intelligence and
selling it at high prices. Medley is another Yale-trained
person. He founded the company and the
case is about his attempt to sell the company,
which he did, so he’s selling a company
that– which is posthumously his,
and he actually sold it for fifty seven million bucks,
and it’s a no venture medley story and he’s a very
interesting guy. Then maybe we’ll talk about
Mory’s. I’m chair of a workout
committee which is trying to put more effective business and it
turns out to be a really interesting hard case.

Leave a Reply

Your email address will not be published. Required fields are marked *