Making Connections

December 22nd, 2005

In my career, and especially in my dad’s 30-plus years as a business advisor, the recurrent question from clients or curious onlookers has been variations on this theme: “What do you do?” The obvious answer–that an advisor (or consultant, pick your label) provides important information that the persons seeking advice have not the resources to discover themselves, where the desired outcome is better decisions leading to some combination of lower risk and higher reward–is commonly met with the restated question.

At this point question is not easily answered because the “other” answer is deeply metaphysical, whether the person asking it realizes it or not. The difficulty is compounded if the inquirer is still hoping for some “practical” answer.

I don’t have the mental equipment to tackle the epistemological underpinnings of this question-and-answer. Most people who have devoted a good part of their careers to starting and developing their own business don’t have the time to understand that answer if I could give it.

It is easily within our mental grasp, though, to understand that information changes what we do. Even in the most basic modes of production–say, in a tribe of hunter-gatherers—knowledge gains an advantage.* People who know when, where, and what to hunt will thrive. Those who lack such knowledge will run around finding nothing and starve, if they don’t get themselves killed first.

It should be easily apparent that on their own, blood, sweat, and tears, accomplish nothing. People could as easily work up a sweat digging holes in the ground one day and filling them the next, in endless succession. The fact that we know this won’t sustain life, however entertaining the project sounds, redirects our efforts to more productive ends.

So knowing things makes a positive difference. Over the years, the accumulation of practical knowledge has facilitated massive improvement in the quality and length of human life–and contrary to some ideologies, not by merely mining the planet of non-renewable resources. Consider that mass extinction of large animal species tended to coincide with the first appearance of hunter-gatherer societies, not the first oil rig or smokestack. Consider that the land under cultivation in the United States has decreased in the past century, even as production has increased dramatically. Consider that re-forestation of the U.S. during the same time period. Finally, consider Alan Greenspan’s observation, a few years ago, that the GNP of the U.S. by physical weight is no greater now than it was 100 years ago.

Knowledge both led to, and has in turn been enhanced by, two economic realities. The first reality is the division of labor,** an important driver of wealth that has been widely acknowledged by all comers since Adam Smith wrote The Wealth of Nations. The second is an idea that permeates the Austrian school’s economic analysis. It is the idea of time preference: the fact that people will defer consumption now for some greater good that is expected if they orient their efforts to consumption later. Most of us intuitively recognize the concept in practice in all walks of life. Bound up in the time preference idea is an inherent assumption that people can effectively identify such present-for-the-future trades, and that the means of supporting those trades exist.

On the topic of time-preference, let me try a simple example. Consider a farmer who holds back a portion of the crop for seed (this in the days before hybrids, mind you). The decision assumes that a) he knows how to plant seeds so they grow, b) he knows how to store them so they don’t spoil over the winter, and c) he has access to such a storage facility. A great deal of knowledge, as well as the capital accumulated from past discoveries, is required to complete this transaction successfully.

Our economy connects vast numbers of people in accomplishing things over variable, and often considerable, lengths of time. All are vital to the preservation of the capital we enjoy and the creation of new wealth. It has proven difficult to simplify for the sake of analysis or planning on the grand scale. It is true that many outcomes in business, taken individually, seem inscrutable or even perverse. But historical attempts to “rationalize” the economy, to direct it more centrally and avoid such irrational missteps (as they are characterized) have resulted in considerable destruction of wealth, with little improvement in predictable outcomes–except that the outcomes under centralized decision-making, whatever they are, are predictably bad.

The point of all this, rather than to advance an economic framework, is to gain greater context for this question of what we do, which given its expression I take to mean “How does ‘your’ knowledge work?” The modern economy on which our wealth depends is complex, so it does not reliably submit to our sense of cause-and-effect. The usefulness of new knowledge, which in business is to say its applicability to cause-and-effect, is not automatically apparent. There is a sense in which any small business, to the extent it has thrived, has done so because of the owner/entrepreneur’s mastery of cause-and-effect in his or her own tiny corner of the world. It is a ship on the ocean; the seasons and weather are beyond control or influence, so the only thing is to run a tight ship.

Of course, the metaphor-as-argument collapses on itself, when, keeping with the metaphor, you consider the impact of advances in communication, navigation, or meteorology on the rate of maritime disasters.

Similarly, new knowledge in the realm of business has positive impact. However, it is often not possible in advance to say how it will be used; the only relevant question is whether the area under research has some regular contact with the firm.

For example, a manufacturing firm dealing with new competition from China will be concerned with exchange rates and the cost of international shipping. What shades of difference will this knowledge make in decisions? We do not know in advance, but how could we know until we understand the nature and magnitude of the challenge? Fundamentally, it is apparent that our competitors’ prices as our firm’s current and potential customers receive them–that is, modified by the strength of the dollar and the cost of getting the goods to the U.S.–is very, very relevant.

It is possible to establish useful logical connections between new information and action where none were apparent. This is the nature of economic growth. In this sense, entrepreneurs take the leap, not of faith but of reason, in the face of incomplete empirical evidence, when they start a firm. Similarly, the discovery and application of new knowledge is an extension of the original entrepreneurial effort on which the firm is built.

* I say advantage not as compared to competing tribes, but as compared to a more “natural” state, where existence is less pleasant and more tenuous, by leaps and bounds, than what is preferred.
** A more comprehensive term, applicable in Adam Smith’s day but even more apropos today, would be the division of knowledge. This shows a certain kinship with Freidrich Hayek’s argument that economic knowledge by its nature is local and decentralized.