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When groups of people come together for a common purpose, great things can happen. The corporations, businesses, and individuals that compete in the global agora bring us goods and services that enrich us in unprecedented ways. But as in the jungle, cooperation and symbiotic relationships are just as important as competitive ones. The combination of cooperation and competition requires the coordination of billions of human hands and minds. These actors coordinate their efforts primarily through a singular communication mechanism: pricing. Here, we examine how markets and pricing information form the data inputs that transform all of humanity into one global problem-solving machine.
I, Pencil
Decades ago, Leonard E. Read wrote a famous short piece from the perspective of the humble pencil. Though the individual actors have likely changed since then, his essay illustrates the beautiful complexity of a symbiotic supply chain. He describes how the wood that encases a pencil is sourced from a specific kind of cedar tree grown in America’s Northwest, which is harvested and transported over rail. The logs of wood are then shipped to a distant mill, organized by a complex system of communication and logistics. Upon arriving at the mill, the wood is cut by machine into pencil-length slats that are tinted and dried in a kiln.
Specialized machinery then cut eight groves into each slat, after which another lays the “lead” in every other slat, before applying glue and sandwiching the opposing pieces together. This “lead,” of course, is not lead at all, but graphite mined by people somewhere else on the planet, mixed with clay mined from another part of the planet. Lacquer, which must be applied six times to every pencil, requires the added coordination of castor bean growers and their refiners from other distant locations. Metal ore must also be mined and refined to make the small piece of metal that holds the “eraser” in place. The erasure being a rubber-like product made by reacting rapeseed oil from Indonesia with sulfur chloride.
Every step in this process requires specialized machinery, skills, and knowledge where the total is greater than the sum of its parts. The deeper we look into the supply chain the more complex it becomes. Think of an auto manufacturer, which uses large machines made of steel to build cars. The machines themselves are powered by electricity, possibly generated via natural gas sourced from fracking. They may have been designed on a computer that was assembled in China, using microchips made in Korea. The software that designed those chips may have been written in the United States and chips manufactured using lithography machines assembled in Denmark, which themselves use extremely high-precision lasers, lenses, and other parts fashioned by dozens of manufacturers spanning the globe.
The pencil factory, like any other today, is a wonder of coordination, a symphony of efficiency, requiring millions of dollars to build and teams of men and women to maintain and operate. But its function ultimately depends on an inception-like “factory within a factory within a factory” of upstream suppliers that involve countless numbers of actors working together to provide you with an affordable writing utensil. Yet, what is most remarkable is that these actors are not working under the direction of any central coordinator; they do not know each other and perhaps don’t even speak the same language.
The Invisible Hand
They communicate using the universal language of pricing. Sometimes called the “invisible hand,” economists view pricing data as ‘signals’ that economic actors use to coordinate their actions. Prices contain within them information on both supply and demand. If supply is low and demand is high, prices rise, signaling scarcity. If demand is low and supply is high, prices fall, signaling abundance. If, as
argues, that a correctly arranged society is akin to one “vast problem-solving network,” prices are among the most important data inputs into that network.This matters because when the price of something signals scarcity, it encourages governments, individuals, families, and corporations to find ways to minimize its usage. When, for example, the price of cobalt and nickel soared in the wake of Russia’s 2022 invasion of Ukraine, electric vehicle manufacturers quickly pivoted to using LFP batteries that do not require the “scarce” materials. The subsequent fall in demand for cobalt and nickel led prices back to a more reasonable level shortly thereafter.
Pricing information feeds drives innovation with data that aids in the endless search to do more with less, the hallmark of progress. That is, more computing power with less energy, more soda cans with less aluminum, more food grown from less land…etc. This sometimes results in, as Andrew McAfee calls it in his aptly-named book, More From Less, the “evaporation” of entire products and parts, whereby our economies grow using less and less physical resources. As we will soon discuss, many of the world’s most developed countries have long since passed peak usage of steel, copper, aluminum, fertilizer, farmland, timber…etc. as price pressures drove innovations that made more efficient use of finite Earth’s matter.
In addition, prices also tell us what is working and what is not. The key distinction between invention and innovation is that the latter gains market acceptance. An invention will remain just a fanciful idea if people do not find it worth paying for. We “vote,” in essence, with our wallets, if an innovation is worth the price needed to ensure a profit for the innovator, we reward that innovator and his/her investors when buying that good or service. If the idea is not worth the price charged for it, the business risks going under and so must improve its efficiency (innovate more) or go out of business.
The data contained within prices is so important that attempts to hide these signals works to our detriment. When something deemed “essential” becomes expensive, the knee-jerk reaction of many governments is to subsidize it with taxpayer money to make it affordable. Doing so, however, merely papers the problem over and is ultimately harmful because it interrupts the ability of the market to find better and more efficient means of providing those goods and services.
Prices Are Imperfect
Now, some might ask, if prices are such useful signals and government intervention so detrimental, why have government at all? Why not allow the marketplace to self-regulate? We should be under no illusions, as powerful as price data is; the free market alone cannot create a functioning and prosperous society. Markets cannot create the conditions that sustain them, they cannot create courts, central banks, police, or armies, for example. The government must still build the agora and allow the jungle to thrive within its confines.
Nor should we be under the illusion that pricing data is flawless. In the real world, markets do not operate perfectly. There are a myriad of issues, from monopolies to negative externalities/internalities, to other flaws that can systemically distort the data contained within prices. For example, the pricing of coal-generated electricity does not naturally contain within it the cost of the pollution required to generate it. That cost is borne externally by third parties unless we impose regulations and/or taxes on coal energy. Garbage in, garbage out, as they say. When flawed data gets fed into our ‘problem-solving machine’ we get flawed outputs. Thus, when and where we can, we must correct the data transmitted by prices; only a sovereign government is positioned to do this.
When the system is functioning optimally, data contained within prices are fed into the ultimate supercomputer: human society. There, billions of minds collectively coordinate to find answers, from the simplest to the most challenging of problems. Poverty is alleviated as productivity grows, incomes rise, and prices are compressed. This process is self-reinforcing; as growth continues and human capability expands, more people on this Earth are given a greater opportunity to contribute. Even if his or her contribution began with a sheet of paper and a humble pencil.
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Thanks for the shout out!
Your article brings to mind the Brit who tried to build a toaster from scratch.
https://www.youtube.com/watch?v=5ODzO7Lz_pw
Oh, and here is a better story about pencils:
https://engines.egr.uh.edu/episode/339
We get a hard-on for the complexity of the world financial and trade system, and conveniently forget the folks who actually made pencils possible.