Chapter 1. The Economic Way of Thinking 30 restaurants have depended upon the quality of their burgers and the cleanliness of their rest rooms. Some firms have failed not because they have done anything “wrong,” but rather they have not done as much “right” as have their competitors. Many textile firms in the southeast part of the country have folded over the last two decades in spite of their substantial efforts to improve their productivity and increase quality. The failing firms closed their doors simply because they were not able meet the competition from lower- priced textile imports and from textiles produced by even more aggressive (and successful) domestic textile firms. 29 Many firms have failed because they did not pay attention to their costs or because their managers were not very smart in setting their firms’ product and service strategies to meet the changes in their markets. Even the 9/11 ctatrophy, several major airlines (and scores of smaller ones) have folded their wings over the last two decades because their planes and personnel were too expensive relative to the value of the service they provided and therefore relative to the prices they could charge in deregulated skies. We agree that a lot of things are important to success in business, not the least of which are the leadership of managers, worker skills and character, firm strategies, and cost-control methods. One of the more important points managers must remember is that incentives can be very powerful forces within a firm—for good and bad! This means managers must pay attention to the art and logic of getting incentives right. In the “Manager’s Corner” sections that are included in every chapter, we will examine a large number of different questions related to the organization of production within firms, most of which relate to incentives in one way or another: How large should firms be? Do workers want tough bosses? Why don’t more firms pay piece rate? What difference does debt make? What good are corporate raiders? At the most obvious level, these questions are concerned with widely different problems firms have to face. But underneath all that is written about firm structure or piece-rate pay or corporate raiders in the “Manager’s Corner” sections is an important theme: Develop incentives so that everyone in your firm or connected to it—owners, executives, managers, workers, suppliers, and customers— win from your firm’s operation. It is all too common for people to think that the only way for one group of “stakeholders” in a firm to gain is for some other group to lose. The search is all too frequently for ways to cut costs for one group of stakeholders (owners or managers) by skewering another group (line workers or customers). In this book we seek incentive arrangements by which everyone profits. That means that we seek incentives that are mutually beneficial, which necessarily means incentives that promote cooperation between everyone with an interest in the firm. Devising mutually beneficial incentives is a tough order, but we think it is the only way to ensure a viable business. Business arrangements that do not benefit all parties involved are arrangements that are not likely to survive for long. 29 Indeed, many textile firms have failed because the expanding nontextile economies of their regions have pushed up labor costs, outcompeting some textile firms for the resources they need for continued production. Chapter 1. The Economic Way of Thinking 31 As noted, we typically think of firms competing with each other by producing better products at lower costs and making them more conveniently available to consumers at lower prices. But underlying this competition that we can observe in the marketplace is a more fundamental struggle taking place within firms to organize production in the most efficient manner, which necessarily requires an understanding of the incentives that face firm stakeholders—owners, managers, workers, and suppliers. The “Manager’s Corners” have been written with one central proposition in mind: In the competitive marketplace, the firms that survive and thrive are the ones that recognize that incentives matter—and they matter a great deal. Successful firms play to the power of smart incentives (those that drive firm and worker incomes upward) and avoid perverse incentives (ones that undermine firm and worker incomes). And managers have good reason to make incentives a major focus for their firms: They can reduce their chances of being replaced. 30 Why Incentives Are Important But such facts beg a critical question, Why are incentives important? Why do they work? Admittedly, the answers are many. One of the more important reasons that incentives matter within firms is that firms are collections of workers whose interests are not always aligned with the interests of the people who employ them, that is, the owners. The principal problem facing the owners is how to get the workers to do what the owners want them to do. The owners could just issue directives, but without some incentive to obey the directives, nothing may happen. Directives may have some value in themselves; people do feel a sense of obligation to do what they were hired to do, and one of the things they may have been hired to do is obey orders (within limits). However, directives can be costly. Firms may use incentives simply as a cheaper substitute for giving out orders that can go unheeded unless the workers have some reason to heed them. Firms may also use incentives to clarify firm goals, to spell out in concrete terms to workers what the owners want to accomplish. As every manager knows all too well, it’s difficult to establish and write out the firm’s strategy that will be used to achieve its stated goals, and it is an even more difficult task to get workers to appreciate, understand, and work toward those goals. The communication problem typically escalates with the size of the organization. Goals are always imperfectly communicated, especially by memoranda or through employment manuals that may be read once and tossed. Workers don’t always know how serious the owners and upper managers are; they can remember any number of times when widely circulated memos were nothing but window dressing. Incentives are a means by which owners and upper managers can validate overall company goals and strategies. They can in effect say through incentives, “This is what we think is important. This is what we will be working toward. This is what we will be trying to get everyone else to do. And this is where we will put our money.” Even if 30 According to econometric research, those firms in the lowest decile of industry performance measured by profit and stock price increases were about 1.5 times as likely to have a change of top executives as firms in the best decile of profit and stock price performers. See M. Weisback, “Outside Directors and CEO Turnover,” Journal of Financial Economics, vol. 20 (1988), pp. 431–60; and J. Warner, R. Watts, and K. Wruck, “Stock Prices and Top Management Changes,” Journal of Financial Economics, vol. 20, pp. 461– 92. Chapter 1. The Economic Way of Thinking 32 workers were not sensitive to the pecuniary benefits of work, but were only interested in doing what their companies wanted them to do, incentives, because of the messages they convey, can have a valued and direct impact on what workers do and how long and hard they work. 31 But there is a far more fundamental reason that incentives matter: Managers don’t always know what orders or directives to give. No matter how intelligent, hard working and well-informed managers are, they seldom know as much about particular jobs as those who are actually doing those jobs. Knowing about the peculiarities of a machine, the difficulties a fellow worker on the production line is experiencing at home, or the personality quirks of a customer are just a few examples of the innumerable particular bits of localized knowledge that are crucial to the success of a firm. And this knowledge is spread over everyone in the firm without the possibility of its being fully communicated to, and effectively utilized by, those who are primarily responsible for managerial oversight. The only way a firm can fully benefit from such localized knowledge is to allow those who possess the knowledge—the firm's employees—the freedom to use what they know. Management theorists are increasingly recognizing this simple fact—that a great deal of knowledge is widely dispersed throughout the firm. In doing so, they are turning away from the approach to management recommended by Frederick Taylor. 32 At the beginning of the twentieth century, Taylor had popularized the time-and-motion approach to management in which experts, or managers, determined the most efficient way to do particular jobs and then required employees to work accordingly. Instead of the top- down or command style recommended by Taylor, the management profession is now sympathetic to a more participatory managerial approach, under which the management hierarchy is flatter, with authority for particular decisions dispersed throughout the firm, residing with those who are in the best position to exercise it. As noted, in varying degrees, all firms are necessarily involved in participatory management with practically everyone having some management authority over some firm resources. The principal difference between those workers at the top and bottom of the firm hierarchy is the scope of authority over resources. But the benefits from participatory management can only be realized if employees have not only the freedom but also the motivation to use their special knowledge in productive cooperation with each other. The crucial ingredient for bringing about the requisite coordination is incentives that align the otherwise conflicting interests of individual employees with the collective interests of all members of the firm. Without such incentives, there can be no hope that the knowledge dispersed throughout the firm will be used in a cooperative and coordinated way. The only practical alternative to a 31 This perspective on incentives is developed by Harrison C. White, “Agency as Control,” Principals and Agents: The Structure of Business, edited by John W. Pratt and Richard J. Zeckhauser (Boston, Mass.: Harvard Business School Press, 1991), pp. 187–12; and James A. Robins, “Why and When Does Agency Theory Matter? A Critical Approach to the Role of Agency Theory in the Analysis of Organizational Control” (Irvine, Calif.: Graduate School of Management, University of California, Irvine, working paper, 1996). 32 Frederick Taylor, The Principles of Scientific Management (New York: Harper, 1929). Chapter 1. The Economic Way of Thinking 33 functioning system of incentives is, again, a top-down, command-and-control approach that, unfortunately, can never allow the full potential of a firm's employees to be realized. Managers must heed the words of social philosopher Friedrich Hayek, “The more men know, the smaller the share of knowledge becomes that any one mind [the planner's mind included] can absorb. The more civilized we become, the more relatively ignorant must each individual be of the facts on which the working of civilization depends. The very division of knowledge increases the necessary ignorance of the individual of most of this knowledge.” 33 That insight applies within the firm. With the growing complexity and sophistication of production, knowledge becomes ever more widely dispersed among a growing number of workers. Hence, the importance of incentives has grown with modern-day leaps in the technological sophistication of products and production processes. Incentives will continue to grow in importance as production and distribution processes become ever more complex. Seen in this light, the problem of the firm is the same as the problem of the general economy. As did Hayek, economists have argued for years that no group of government planners, no matter how intelligent and dedicated, can acquire all the localized knowledge necessary to allocate resources intelligently. The long and painful experiments with socialism and its extreme variant, communism, have confirmed that this is one argument that economists got right. But the freedom for people to use the knowledge that only they individually have has to be coupled with incentives that motivate people to use that knowledge in socially cooperative ways—meaning that the best way for individuals to pursue their own objectives is by making decisions that improve the opportunities for others to pursue their objectives. In a market economy these incentives are found primarily in the form of prices that emerge out of the rules of private property and voluntary exchange. Market prices provide the incentive people need to productively coordinate their decisions with each other, thus making it not only possible, but desirable, for people to have a large measure of freedom to make use of the localized information and know-how they have. A perfect incentive system would assure that everyone could be given complete freedom because it would be in the interest of each to advance the interests of all. No such perfect incentive system exists, not within any firm or within any economy. In every economy there is always some appropriate mix of both market incentives and government controls that achieve the best overall results. The argument over just what the right mix is will no doubt continue indefinitely, but few deny that both incentives and controls are needed. Similarly, for any firm made up of more than one person, there is some mix of incentives and direct managerial control that best promotes the objectives of the firm; i.e., the general interests of its members. Granted, incentives may not seem to matter much at any point in time, but even so, the power of incentives can accumulate with time. For example, suppose that without improved incentives firm profits will grow in real-dollar terms by 2 percent a year. Suppose that with more effective incentives firm profits can grow by 2.5 percent a year. The difference is not “much,” just a half of a percentage point per year. However, the compound impact of the higher growth rate will mean that after 30 years, real profits will 33 F. A. Hayek, The Constitution of Liberty (Chicago: University of Chicago Press, 1960), p. 26. Chapter 1. The Economic Way of Thinking 34 be 33 percent higher with the improved incentives (a fact that is likely to be reflected in current stock prices). Furthermore, the firm may be able to achieve the relatively higher profits with little or no cost. “Good” incentives may be no more expensive than “bad” incentives. Good incentives are the proverbial “free lunch” that economists typically dismiss. Of course, if a given firm doesn’t pay attention to its incentives, it may lose more than its lunch; it may be forced out of business by those firms that do recognize the importance of incentives. Seen from this perspective, incentives can be a critical component of firm survival, perhaps just as critical as product development or technological sophistication. The problem is in getting the incentives right and using the full range of potential incentives. Unfortunately, we can’t say exactly what incentives your firm should employ. The exact incentives chosen depend on local conditions that can vary greatly across firms. You would not want us to write about particular incentives for your particular circumstances, mainly because we can be assured of only one constant fact about business: Particular circumstances will change with time and markets. Here, we offer a way of thinking about incentives that, if employed with diligence, will enable managers and owners to get their firms’ incentives more in line with their desire for increased productivity and profits. Why Designated Hitters Get Hit Admittedly, there is no way that managers can ever know for sure what the best set of incentives is. The problems of determining the proper incentives are many. And one of the main problems is not the dearth, but the great variety of incentives that can be used. Under the “Manager’s Corner” sections, we necessarily focus on monetary incentives. This is mainly because such incentives have been well tested, but monetary incentives should be expected to be effective for the broad sweep of managers and workers: Most people can usually find some reason to want more money, given that it can be used to buy so many things that people want. But our emphasis on monetary incentives doesn’t mean that money is all that matters to people at work, and managers should realize that simple fact. Managers need to know what counts. We know money should count for most people at work simply because money can be used to buy so many things that are valued by workers. But what attributes of work can count? That’s not always an easy question to answer. Not recognizing the question, however, and not looking for answers can have incentive consequences that are not expected. To see this point, we take a sports example that involves people at work, albeit baseball players. Starting in 1973, the American League allowed “designated hitters” to bat for pitchers (who are, generally, poor at batting). What would you expect to be the consequence of such a workplace change? Three economists have reasoned that given that American League pitchers would not come up to bat, we should expect that more batters would be hit by errant pitches in the American League than in the National League. This is because the American League pitchers would not have to fear being hit themselves in retaliation. Hence, American League pitchers could be expected to deliberately hit more batters or to take more chances of coming closer to batters than Chapter 1. The Economic Way of Thinking 35 would be the case in the National League. Using sophisticated statistical methods, the economists found what they expected: since 1973 (after adjusting for other relevant factors that might affect hit batters), 10 to 15 percent more batters in the American League have been hit than in the National League. 34 We remind you that “hits” and “pats” on the back can be important ways of increasing firm profits. However, there is a problem in talking about “hits” and “pats,” or any other nonmoney attribute of the work environment, that must be kept in mind: Are “hits” and “pats” goods (something workers want) or bads (something they don’t want)? Clearly, most people might want to avoid being hit by a baseball going 90 miles an hour, but what about “hits” that come close to being “pats”? Some workers might consider a “pat” on the back as a valued form of encouragement, whereas others might consider them to be an unwanted form of patronization or sexual overture (depending on exactly how and where the “pat” is given). As complicated as these issues are, we can’t avoid them, and managers would not get the pay they do if all such problems of “what counts” in the workplace were easily and readily solved. Psychology will always be a part of management precisely because it helps identify workers’ likes and dislikes. Economics will always be a part of management because it can guide managers in making money by instituting and adjusting on the margin the combination of money and nonmoney incentives set out for workers. You can bet that we, the authors, also can show how the workers’ willingness to trade off money for other attributes of the work environment (for example, common courtesies and respect) can increase firm profits and, at the same time, enhance worker welfare. That means that an unheralded job of managers is to stay attuned to what their workers want and then try to figure out how much they are willing to pay for what they want. Another problem in the management of incentives is that no set of incentives is ever perfect, nor could it be. But even if managers knew the best incentive structure and how best to implement it, a serious incentive problem would remain, What incentive should managers have to find the best set of incentives? That’s a tough but interesting question. An understanding of the structure of firms requires that we recognize the need to subject managers, as well as other employees, to the proper incentives. The need to impose the proper set of incentives on managers is also necessary for understanding firms’ financial structure. For example, the question of what combination of debt and equity instruments is best for financing a firm cannot be answered properly without a consideration of managerial incentives. Concluding Comments Economics is a discipline best described as the study of human interaction in the context of scarcity. It is the study of how, individually and collectively, people use their scarce resources to satisfy as many their wants as possible. The economic method is founded in a set of presuppositions about human behavior on which economists construct theoretical models. 34 Brian L. Goff, William F. Shughart, and Robert D. Tollison, “Batter Up! Moral Hazard and the Effects of the Designated Hitter Rule on Hit Batsmen,” Economic Inquiry, vol. 35 (July 1997), pp. 555–61. Chapter 1. The Economic Way of Thinking 36 A major purpose of this book is to describe the analytical tools economists use and in that way show how they study human behavior in general. However, we stress how this method of thinking can be used to understand the ways people act business. After all, MBA students want (or should want) to know how economic methods can help them become better managers. Throughout the book, we use these methods of thinking in our search for improved incentives within firms. Almost everyone understands that firms can turn substantial profits by building the proverbial “better mousetrap.” We intend to stress how money can be made from careful thinking about business issues, including how people are rewarded for their work and investments. Review Questions 1. In the prison camp described on pages 4-6, rations were distributed equally. Why did trade within and among bungalows result? 2. Recall the priest who traded the cigarettes for cheese, and cheese for cigarettes, so that he ended up with more cigarettes than he had initially. Did someone else in the camp lose by the priest’s activities? How was the priest able to end up better off than when he began? What did his activities do to the price of cheese in the different bungalows? 3. Theories may be defective, but economists continue to use them. Why? 4. A microeconomics book designed for MBA students could include theories more complex than those in this book. What might be the tradeoffs in dealing with more complex theories? 5. Most MBA students study in “groups.” If you are not in a study group, imaging yourself in one. What incentive problems do these groups have to overcome? How has your group sought to overcome the incentive problems? Chapter 1. The Economic Way of Thinking 37 READING: “I, Pencil” Leonard E. Read 35 I am a lead pencil—ordinary wooden pencil familiar to all boys and girls and adults who can read and write. (My official name is “Mongol 482.” My many ingredients are assembled, fabricated and finished by Eberhard Faber Pencil Company, Wilkes-Barre, Pennsylvania.) Writing is both my vocation and my avocation; that’s all I do. You may wonder why I should write a genealogy. Well, to begin with, my story is interesting. And, next, I am a mystery—more so than a tree or a sunset or even a flash of lightning. But, sadly, I am taken for granted by those who use me, as if I were a mere incident and without background. This supercilious attitude relegates me to the level of the commonplace. This is a species of the grievous error in which mankind cannot too long persist without peril. For, as a wise man, G.K. Chesterton, observed, “We are perishing for want or wonder, not for want of wonders.” I, Pencil, simple though I appear to be, merit your wonder and awe, a claim I shall attempt to prove. In fact, if you can understand me—no, that’s too much to ask of anyone—if you can become aware of the miraculousness that I symbolize, you can help save the freedom mankind is so unhappily losing. I have a profound lesson to teach. And I can teach this lesson better than can an automobile or an airplane or a mechanical dishwasher because—well, because I am seemingly so simple. Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn’t it? Especially when you realize that there are about one and one-half billion of my kind produced in the U.S. each year. Pick me up and look me over. What do you see? Not much meets the eye—there’s some wood, lacquer, the printed labeling, graphite lead, a bit of metal, and an eraser. Innumerable Antecedents Just as you cannot trace your family tree back very far, so is it impossible for me to name and explain all my antecedents. But I would like to suggest enough of them to impress upon you the richness and complexity of my background. My family tree begins with what in fact is a tree, a cedar of straight grain that grows in Northern California and Oregon. Now contemplate all the saws and trucks and rope and the countless other gear used in harvesting and carting the cedar logs to the railroad siding. Think of all the persons and the numberless skills that went into their fabrication: the mining of ore, the making of steel and its refinement into saws, axes, motors; the growing of hemp and bringing it through all the stages to heavy and strong rope; the logging camps with their beds and mess halls, the cookery and the raising of all the foods. Why, untold thousands of persons had a hand in every cup of coffee the loggers drink! The logs are shipped to a mill in San Leandro, California. Can you imagine the individuals who make flat cars and rails and railroad engines and who construct and install the communication systems incidental thereto? These legions are among my antecedents. Consider the millwork in San Leandro. The cedar logs are cut into small, pencil-length slats less than one- fourth of an inch in thickness. These are kiln-dried and then tinted for the same reason women put rouge on their faces. People prefer that I look pretty, not a pallid white. The slats are waxed and kiln-dried again. How many skills went into the making of the tint and kilns, into supplying the heat, the light and power, the belts, motors, and all the other things a mill requires? Are sweepers in the mill among my ancestors? Yes, and also included are the men who poured the concrete for the dam of a Pacific Gas & Electric company hydroplant, which supplies the mill’s power. And don’t overlook the ancestors present and distant who have a hand in transporting sixty carloads of slats across the nation from California to Wilkes-Barre. 3535 The late Mr. Reed was the founder of the Foundation for Economic Education. Permission for use in this volume granted by Donald Boudreaux, President, Foundation for Economic Education (May 4, 1999). Chapter 1. The Economic Way of Thinking 38 Complicated Machinery Once in the pencil factory—$4,000,000 in machinery and building, all capital accumulated by thrifty and saving parents of mine—each slat is given eight grooves by a complex machine, after which another machine lays leads in every other slat, applies glue, and places another slat atop—a lead sandwich, so to speak. Seven brothers and I are mechanically carved from this “wood-clinched” sandwich. My “lead” itself—it contains no lead at all—is complex. The graphite is mined in Ceylon. Consider the miners and those who make their many tools and the makers of the paper sacks in which the graphite is shipped and those who make the string that ties the sacks and those who put them aboard ships and those who make the ships. Even the lighthouse keepers along the way assisted in my birth—and the harbor pilots. The graphite is mixed with clay from Mississippi in which ammonium hydroxide is used in the refining process. Then wetting agents are added such as sulfonated tallow—animal fats chemically reacted with sulfuric acid. After passing through numerous machines, the mixture finally appears as endless extrusions—as from a sausage grinder—cut to size, dried, and baked for several hours at 1,850 degrees Fahrenheit. To increase their strength and smoothness the leads are then treated with a hot mixture, which includes candililla wax from Mexico, paraffin wax and hydrogenated natural fats. My cedar receives six coats of lacquer. Do you know all of the ingredients of lacquer? Who would think that the growers of castor beans and the refiners of castor oil are a part of it? They are. Why, even the processes by which the lacquer is made a beautiful yellow involves the skills of more persons than one can enumerate! Observe the labeling. That’s a film formed by applying heat to carbon black mixed with resins. How do you make resins and what, pray, is carbon black? My bit of metal—the ferrule—is brass. Think of all the persons who mine zinc and copper and those who have the skills to make shiny sheet brass from these products of nature. Those black rings on my ferrule are black nickel. What is black nickel and how is it applied? The complete story of why the center of my ferrule has no black nickel on it would take pages to explain. Then there’s my crowning glory, inelegantly referred to in the trade as “the plug,” the part man uses to erase the errors he makes with me. An ingredient called “factice” is what does the erasing. It is a rubber- like product made by reacting grape seed oil from the Dutch East Indies with sulfur chloride. Rubber, contrary to the common notion, is only for binding purposes. Then, too, there are numerous vulcanizing and accelerating agents. The pumice comes from Italy; and the pigment that gives “the plug” its color is cadmium sulfide. Vast Web of Know-How Does anyone wish to challenge my earlier assertion that no single person on the face of this earth knows how to make me? Actually, millions of human beings have had a hand in my creation, no one of whom even knows more than a very few of the others. Now, you may say that I go too far in relating the picker of a coffee berry in far- off Brazil and food growers elsewhere to my creation; that this is an extreme position. I shall stand by my claim. There isn’t a single person in all these millions, including the president of the pencil company, who contributes more than a tiny, infinitesimal bit of know-how. From the standpoint of know-how the only difference between the miner of graphite in Ceylon and the logger in Oregon is in the type of know-how. Neither the miner nor the logger can be dispensed with, any more than the chemist at the factory or the worker in the oil field—paraffin being a by-product of petroleum. Here is an astounding fact: Neither the worker in the oil field nor the chemist nor the digger of graphite or clay nor anyone who mans or makes the ships or trains or trucks nor the one who runs the machine that does the knurling on my bit of metal nor the president of the company performs his singular task because he wants me. Each one wants me less, perhaps, than does a child in the first grade. Indeed, there are some Chapter 1. The Economic Way of Thinking 39 among this vast multitude who never saw a pencil nor would they know how to use one. Their motivation is other than me. Perhaps it is something like this: Each of these millions sees that he can thus exchange his tiny know-how for the goods and services he needs or wants. I may or may not be among these items. No Human Master-Mind There is a fact still more astounding: The absence of a master-mind, of anyone dictating or forcibly directing these countless actions that bring me into being. No trace of such a person can be found. Instead, we find the Scottish economist and moral philosopher Adam Smith’s famous “Invisible Hand” at work in the marketplace. This is the mystery to which I earlier referred. It has been said that “only God can make a tree.” Why do we agree with this? Isn’t it because we realize that we ourselves could not make one? Indeed, can we even describe a tree? We cannot, except in superficial terms. We can say, for instance, that a certain molecular configuration manifests itself as a tree. But what mind is there among men that could even record, let alone direct, the constant changes in molecules that transpire in the life span of a tree? Such a feat is utterly unthinkable! I, Pencil, am a complex combination of miracles; a tree, zinc, copper, graphite, and so on. But to these miracles that manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies—millions of tiny bits of know-how configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human master-minding! Since only God can make a tree, I insist that only God could make me. Man can no more direct millions of bits of know-how so as to bring a pencil into being than he can put molecules together to create a tree. That’s what I meant when I wrote earlier, “If you can become aware of the miraculousness that I symbolize, you can help save the freedom mankind is so unhappily losing.” For, if one is aware that these bits of know-how will naturally, yes, automatically, arrange themselves into creative and productive patterns in response to human necessity and demand—that is, in the absence of governmental or any other coercive master-minding—then one will possess an absolutely essential ingredient for freedom: a faith in free men. Freedom is impossible without this faith. Once government has had a monopoly on a creative activity—the delivery of the mail, for instance—most individuals will believe that the mail could not be efficiently delivered by men acting freely. And here is the reason: Each one acknowledges that he himself doesn’t know how to do all the things involved in mail delivery. He also recognizes that no other individual could. These assumptions are correct. No individual possesses enough know-how to perform a nation’s mail delivery any more than any individual possesses enough know-how to make a pencil. In the absence of a faith in free men—unaware that millions of tiny kinds of know-how would naturally and miraculously form and cooperate to satisfy this necessity—the individual cannot help but reach the erroneous conclusion that the mail can be delivered only by governmental master-minding. Testimony Galore If I, Pencil, were the only item that could offer testimony on what men can accomplish when free to try, then those with little faith would have a fair case. However, there is testimony galore; it’s all about us on every hand. Mail delivery is exceedingly simple when compared, for instance, to the making of an automobile or a calculating machine or a grain combine or a milling machine, or to tens of thousands of other things. Delivery? Why, in this age where men have been left free to try, they deliver the human voice around the world in less than one second; they deliver an event visually and in motion to any person’s home when it is happening; they deliver 150 passengers from Seattle to Baltimore in less than four hours; they deliver gas from Texas to one’s range or furnace in New York at unbelievably low rates and without subsidy; they deliver each four pounds of oil from the Persian Gulf to our Eastern Seaboard—halfway around the world—for less money than the government charges for delivering a one-ounce letter across the street! . operation. It is all too common for people to think that the only way for one group of “stakeholders” in a firm to gain is for some other group to lose necessary for understanding firms’ financial structure. For example, the question of what combination of debt and equity instruments is best for financing