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Charlie Munger: Academic Economics — Strengths and Weaknesses, after Considering Interdisciplinary Need - Notes

My personal history is interesting because it's deficiencies and my peculiarities eventully created advantages. For some odd reason, I had an early and extreme multidisciplinary cast of mind. I couldn't stand reaching for a small idea in my own discipline when there was a big idea right over the fence in somebody else's discipline. So I just grabbed in all directions for the big ideas that would really work. Nobody taught me to do that, I was just born with that yen. I was also born with a huge craving for syntheses. And when it didn't come easily, which was often, I would rag the problem, and then when I failed I would put it aside and I'd come back to it and rag it again. It took me 20 years to figure out how and why the Reverend Moon's conversion methods worked. But the psychology departments haven't figured it out yet, so I'm ahead of them.

But anyway, I have this tendency to want to rag the problems. Because WWII caught me. I drifted into some physics and the Air Corps sent me to Caltech where I did a little more physics as part of being made into a meteorologist. And there, at a very young age, I absorbed what I call the fundamental full attribution ethos of hard science. And that was enormously useful to me. Let me explain that ethos.

Under this ethos, you've got to know all the big ideas in all the disciplines less fundamental than your own. You can never many any explanation, which can be made in a more fundamental way, in any other way than the most fundamental way. And you always take with full attribution to the most fundamental ideas that you are required to use. When you're using physics, you say you're using physics. When you're using biology, you said you're using biology. And so on and so on. I could early on see that ethos would act as a fine organizing system for my thought. And I strongly suspected that it would work really well in the soft sciences as well as the hard sciences, So I just grabbed it and used it all through my life in soft science as well as hard science. That was a very lucky idea for me.

Let me explain how extreme that ethos is in hard Science. There is a constant, one of the fundamental constants in physics, known as Boltzmann's constant. You probably all know it very well. And the interesting thing about Boltzmann's constant in that Boltzmann didn't discover it. So why is Boltzmann's constant now named for Boltzmann? Well, the answer was that Boltzmann derived that constant from basic physics in a more fundamental way than the poor forgotten fellow who found the constant in the first place in some less fundamental way. The ethos of hard science is so strong

What’s Wrong with Economics

The nature of this failure is that it creates what I always all, “man with a hammer syndrome” And that's taken from the folk saying: To the man with only a hammer, every problem looks pretty much like a nail. And that works marvellously to sum up all professions, and all departments of academia, and indeed most practical life. The only antidote for being an absolute klutz due to the presence of a man with a hammer syndrome is to have a full kit of tools. You don't have just a hammer. You've got all the tools. And you've got to have one more trick.

You've got to use those tools checklist-style, because you'll miss a lot if you just hope that the right tool is going to pop up unaided whenever you need it. But if you've got a full list of tools, and go through them in your mind, checklist-style you will find a lot of answer that you won't find any other way. So limiting this big general objection that so disturbed Alfred North Whitehead is very important, and there are mental tricks that help do the job.

A special version of this “man with a hammer syndrome” is terrible, not only in economics but practically everywhere else, including business. It's really terrible in business. You've got a complex system and it spews out a lot of wonderful numbers that enable you to measure some factors. But there are other factors that are terribly important, yet there's no precise numbering you can put to these factors. You know they're important, but you don't have the numbers. Well practically everybody 1) Over-weights the stuff that can be numbered, because it yields to the statistical techniques they're taught in academia, and 2) doesn't mix in the hard-to-measure stuff that may be more important. That is a mistake I've tried all my life to avoid, and I have no regrets for having done that.

My fifth criticism is too little synthesis in economics. Not only with matters outside traditional economics, but also within economics. I have posed at two different business schools the following problem. I say “You have studied supply and demand curves. You have learned that when you raise the price, ordinarily the volume you can sell goes down, and when you reduce the price, the volume you can sell goes up. Is that right? That's what you've learned?” They all nod eyes. And I say “Now you tell me several instances when, if you want the physical volume to go up, the correct answer is to increase the price?” And there's this long and ghastly pause. And finally in each of the two business school in which I've tried this. Maybe one person in fifty could name one instance. They come up with the idea that occasionally a higher price acts as a rough indicator of quality and thereby increases sales volumes.

This happened in the case of my friend Bill Ballhaus. When he was head of Beckman Instruments it produced some complicated product where if it failed it caused enormous damage to the purchaser. It wasn't a pump at the bottom of an oil well, but that's a good mental example. And he realized that the reason this thing was selling so poorly, even though it was better than anybody else's product, was because it was priced lower. It made people think it was a low quality gizmo. So he raised the price by 20% or so and the volume went way up. But only one in fifty can come up with this sole instance in a modern business school, one of the business schools being Stanford, which is hard to get into. And nobody has et come up with the main answer that I like. Supposed you raise the price, and use the extra money to bribe the other guy's purchasing agent? Is that going to work? And are there functional equivalents in economics, microeconomics of raising the price and using the extra sales proceeds to drive sales higher? And of course there are a zillion once you've made that mental jump. It's so simple.

Berkshire had this former savings and loan company, and it had made this loan on a hotel right opposite to the Hollywood Park Racetrack. In due time the neighbourhood changed and it was full of gangs, pimps, and dope dealers. They tore copper pipe out of the wall for dope fixes, and there were people hanging around the hotel with guns, and nobody would come. We foreclosed on it two or three times, and the loan value went down to nothing. We seemed to have an insolvable economic problem, microeconomics problem.

Now we could have gone to McKinsey, or maybe a bunch of professors from Harvard, and we would have gotten a report about 10 inches thick about the ways we could approach this failing hotel in this terrible neighbourhood. But instead, we put a sign on the property that said For sale or rent“ and in came, in response to that sign, a who said “I'll spend $200,000 fixing up your hotel, and buy it at a high price on credit if you can get zoning so I can turn the parking lot into a putting green.”

“You've got to have a parking lot in a hotel” we said.

“What do you have in mind?” he said.

“No my business is flying seniors in from Florida, putting them near the airport, and then letting them go out to Disneyland and various places by bus and coming back. And I don't care how bad the neighbourhood is going to be because my people are self contained behind walls. All they have to do is get on the bus in the morning and come home in the evening, and they don't need a parking lot they need a putting green.” So we made the deal with the guy. The whole thing worked beautifully and the loan got paid off, and it all worked out.

Well I've taken you part way through the synthesis. It gets harder when you want to figure out how much activity should be within private firms, and how much should be within the government, and what are the factors that determine which functions are where, and why do the failures occur, and so on and so on.

It's my opinion that anybody with a high IQ who graduated in economics ought to be able to sit down and write a ten page synthesis of all these ideas that's quite persuasive. And I would bet a lot of money that I could give this test in practically every economics department in the country, and get a perfectly lousy bunch of synthesis. They'd talk about transaction costs. They'd click off a little something that their professors gave them and spit it back. But in terms of really understanding how it all fits together, I would confidently predict that most people couldn't do it very well.

By the way if any of you want to try and do this, go ahead. I think you'll find it hard. In this connection, one of the interesting things that I want to mention is that Max Planck, the great Nobel laureate who found Planck's Constant, tried once to do economics. He gave it up. Now why did Max Planck, one of the smartest people who ever live, give up economics? The answer is he said “It's too hard. The best solution you can get is messy and uncertain” It didn't satisfy Planck's craving for order, and so he gave it up. If Max Planck early on realized he was never going to get perfect order, I will confidently predict all of the rest of you are going to have exactly the same result.

Extreme counterproductive psychological ignorance in economics. Here I want to give you a very simple problem. I specialize in simple problems. You own a small casino in Las Vegas. It has fifty standard slot machines. Identical in appearance, they're identical in function. They have exactly the same payout ratios. The things that cause the payouts are exactly the same. They occur in the same percentages. But there's one machine in this group of slot machines, no matter where you put it among the fifty, in fairly short order, when you go to the machines at the end of the day, there will be 25% more winnings from this one machine than from any other machine. Now surely I'm not going to have a failure here. What is different about the heavy winning machine? Can anybody do it?

Male: More people play it.

Charles Munger: No, no, I want to know why more people play it. What's different about that machine is people have used modern electronics to give a higher ratio of near misses. That machine is going bar, bar, lemon. Bar, bar, grapefruit, way more often than normal machines, and that will cause heavier play. How do you get an answer like that? Easy, obviously there's a psychological cause: That machine is doing something to trigger some basic psychological response.

If you know the psychological factors, if you've got them on a checklist in your head, you just run down the factors, and boom! You get to one that must explain this occurrence. There isn't any other way to do it effectively. These answers are not going to come to people who don't learn these mental tricks. If you want to go through life like a one-legged man in an ass-kicking contest, why be my guest. But if you want to succeed, like a strong man with two legs, you have to pick up these tricks, including doing economics while knowing psychology.

My ninth objection. Not enough attention to virtue and vice effects in economics. It has been plain to me since early life that there are enormous virtue effects in economics, and also enormous vice effects. But economics get very uncomfortable when you talk about virtue and vice. It doesn't lend itself to a lot of columns of numbers. But I would argue that there are big virtue effects in economics, and also enormous vice effects. It doesn't lend itself to a lot of columns of numbers. But I would argue that there are big virtue effects in economics. I would say that the spreading of double-entry bookkeeping by the Monk, Fra Luca de Pacioli was a big virtue effect in economics. It made business more controllable and it made it more honest. Then the cash register. The cash register did more for human morality than the congregational church. It was a really powerful phenomenon to make an economic system work better, just as, in reverse, a system that can be easily defrauded ruins a civilization. A system that's very hard to defraud, like a cash register, helps the economic performance of civilization by reducing vice, but very few people within economics talk about it in those terms.

Religion. I say economic systems work better when there's an extreme reliability ethos. And the traditional way to get a reliability ethos, at least in past generations in America, was through religion. The religions instilled guilt. We have a charming Irish Catholic priest in our neighbourhood and he loves to say, “Those old Jews may have invented guilt, but we perfected it” And this guilt, derived from religion has been a huge driver of a reliability ethos, which has been very helpful to economic outcomes for man.

When I was young, everybody was excited by Godel who came up with proof that you couldn't have a mathematical system without a lot of irritating incompleteness in it. Well, since then my betters tell me that they've come up with more irremovable defects in mathematics and have decided that you're never going to get mathematics without some paradox in it. No matter how hard you work, you're going to have to live with some paradox if you're a mathematician.

Well, if the mathematicians can't get the paradox out of their system when the're creating it themselves, the poor economists are never going to get rid of paradoxes, nor are any of the rest of us. It doesn't matter. Life is interesting with some paradox. When I run into a paradox I think either I'm a total horse's ass to have gotten to this point, or I'm fruitfully near the edge of my discipline. It adds excitement to life to wonder which it is.

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