Charlie Munger: Academic Economics

Talk 9 of the eleven in Chapter Four of Poor Charlie’s Almanack. See The Eleven Talks of Poor Charlie’s Almanack for the full collection.

Key Takeaways

Economics should be more like physics in becoming practical, but not try and be as concise as physics by turning all these human elements into equations.

Highlights & Notes

Kyle’s reading layer from Poor Charlie’s Almanack, preserved verbatim. Munger’s text and pulled-in source quotes appear as bullets; Kyle’s own annotations appear as Kyle: callouts.

• Benjamin Franklin’s observation in Poor Richard’s Almanack, “If you would persuade, appeal to interest and not to reason.” The man changed his silly view when his incentives made him change it and not before. #Incentives
• Well, Berkshire’s whole record has been achieved without paying one ounce of attention to the efficient market theory in its hard form. And not one ounce of attention to the descendants of that idea, which came out of academic economics and went into corporate finance and morphed into such obscenities as the Capital Asset Pricing Model (CAPM), which we also paid no attention to. I think you’d have to believe in the tooth fairy to believe that you could easily outperform the market by seven percentage points per annum just by investing in high-volatility stocks.
• For one year at the Harvard Law School, I was ranked second in a very large group, and I always figured that, while there were always a lot of people much smarter than I was, I didn’t have to hang back totally in the thinking game. #PKP
• Economics was always more multidisciplinary than the rest of soft science. It just reached out and grabbed things as it needed to. And that tendency to just grab whatever you need from the rest of knowledge if you’re an economist has reached a fairly high point in N. Gregory Mankiw’s new textbook. I checked out that textbook. I must have been one of the few businessmen in America that bought it immediately when it came out l because it had gotten such a big advance. I wanted to figure out what the guy was doing where he could get l an advance that great. So this is how I happened to riffle through Mankiw’s freshman textbook. And there I found laid out as principles of economics: opportunity cost is a superpower, to be used by all people who have any hope of getting the right answer. Also, incentives are superpowers. #Multidisciplinary Thinking

  Kyle: Interesting side note: decide what books to read based on how much the author got paid

• The big general objection to economics was the one early described by Alfred North Whitehead when he spoke of the fatal unconnectedness of academic disciplines, wherein each professor didn’t even know the models of the other disciplines, much less try to synthesize those disciplines with his own. I think there’s a modern name for this approach that Whitehead didn’t like, and that name is “bonkers.” This is a perfectly crazy way to behave. Yet economics, like much else in academia, is too insular. #Multidisciplinary Thinking #Multidisciplinary Thinking
• Well, practically everybody (1) overweighs 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.

  Kyle: Intangible variables often left to be measured by “gut” and therefore become undervalued

  • “When performance is measured, performance improves. When performance is measured and reported, the rate of improvement accelerates” Thomas S. Monson
• “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.” (Charlie Munger) #Big Important Ideas #Multidisciplinary Thinking
• Thomas Hunt Morgan banned the Friden calculator from the biology department. And when they said, “What the hell are you doing, Dr. Morgan?” he said, “Well, I am like a guy who is prospecting for gold along the banks of the Sacramento River in 1849. With a little intelligence, I can reach down and pick up big nuggets of gold. And as long as I can do that, I’m not going to let any people in my department waste scarce resources in placer mining.” And that’s the way Thomas Hunt Morgan got through life.
  • Far less efficient than Munger’s preferred approach of simply “reaching down and picking up big nuggets of gold,” placer mining (pronounced “plass-er”) is an open-pit or open-cast form of mining in which miniscule amounts of valuable minerals are extracted from great volumes of earth using water pressure or surface excavating equipment. The name derives from the Spanish word, “placer,” meaning “sand bank” and refers to precious metal deposits (particularly gold and gem stones) found in alluvial deposits.

  Kyle: You can spend as much time, effort, and money chasing big ideas, so why worry about the flecks? Kyle: A big idea can come from a small $ amount:

  • https://twitter.com/awilkinson/status/1262449756686540801?s=20
• I want economics to pick up the basic ethos of hard science, the full attribution habit, but not the craving for an unattainable precision that comes from physics envy. The sort of precise, reliable formula that includes Boltzmann’s constant is not going to happen, by and large, in economics. Economics involves too complex a system. And the craving for that physics-style precision does little but you in terrible trouble, like the poor fool from McKinsey.
• So, economics should emulate physics’ basic ethos, but its search for precision in physics-like formulas is almost always wrong in economics.
• Well, how did I solve those problems? Obviously, I was using a simple search engine in my mind to go through checklist-style, and I was using some rough algorithms that work pretty well in a great many complex systems, and those algorithms run something like this: Extreme success is likely to be caused by some combination of the following factors: #Checklists
• I think my experience with my simple question is an example of how little synthesis people get, even in advanced academic settings, considering economic questions. Obvious questions, with such obvious answers. Yet, people take four courses in economics, go to business school, have all these I.Q. points, and write all these essays, but they can’t synthesize worth a damn. This failure is not because the professors know all this stuff and they’re deliberately withholding it from the students. This failure happens because the professors aren’t all that good at this kind of synthesis. They were trained in a different way. I can’t remember if it was Keynes or Galbraith who said that economics professors are most economical with ideas. They make a few they learned in graduate school last a lifetime. #Multidisciplinary Thinking
• It’s my opinion that anybody with a high I.Q. 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 give me Ronald Coase. 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.
• 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 problem-solving methods. 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 methods, including doing micro- and macro-economics while knowing psychology. #Checklists
• This has been attributed to Samuel Johnson. He said, in substance, that if an academic maintains in place an ignorance that can be easily removed with a little work, the conduct of the academic amounts to treachery. That was his word, “treachery.”
  • The ethical rule is from Samuel Johnson, who believed that maintenance of easily removable ignorance by a responsible officeholder was treacherous malfeasance in meeting moral obligation. The prudential rule is that underlying the old Warner & Swasey advertisement for machine tools: “The man who needs a new machine tool and hasn’t bought it is already paying for it.” The Warner & Swasey rule also applies, I believe, to thinking tools. If you don’t have the right thinking tools, you, and the people you seek to help, are already suffering from your easily removable ignorance. #Roam Research #Personal Knowledge Management
• Too Little Attention to Second- and Higher-Order Effects
• This defect is quite understandable because the consequences have consequences, and the consequences of the consequences have consequences, and so on. It gets very complicated.
• Extreme economic ignorance was displayed when various experts, including Ph. D. economists, forecast the cost of the original Medicare law. They did simple extrapolations of past costs. Well, the cost forecast was off by a factor of more than one thousand percent. The cost they projected was less than ten percent of the cost that happened. Once they put in place various new incentives, the behavior changed in response to the incentives, and the numbers became quite different from their projection. And medicine invented new and expensive remedies, as it was sure to do. How could a great group of experts make such a silly forecast? Answer: They oversimplified to get easy figures, like the rube rounding pi to 3.2! They chose not to consider effects of effects on effects, and so on. #Forecasting #Incentives
• Usually, I don’t use formal projections. I don’t let people do them for me because I don’t like throwing up on the desk, but I see them made in a very foolish way all the time, and many people believe in them, no matter how foolish they are. It’s an effective sales technique in America to put a foolish projection on a desk. And if you’re an investment banker, it’s an art form. I don’t read their projections either. Once Warren and I bought a company, and the seller had a big study done by an investment banker. It was about this thick, We just turned it over as if it were a diseased carcass. He said, “We paid $2 million for that.” I said, “We don’t use them. Never look at them.” #Forecasting
• That’s what’s wrong with the workers’ comp system in California. Gaming has been raised to an art form. In the course of gaming the system, people learn to be crooked. Is this good for civilization? Is it good for economic performance? Hell, no. The people who design easily gameable systems belong in the lowest circle of hell. #Incentives

  Kyle: Some scripture about “causeth a man to sin” - why people should study psychology, to understand how people will react to different incentives #Find the Quote

• Frequently overlooked is that Ricardo’s comparative advantage in “delegating” tasks among nations is equally applicable for managers delegating work. Even if a manager can perform the full range of tasks better himself, it is still mutually advantageous to divide them up. #Management
• This happened after I asked the question, “Is there a functional equivalent of embezzlement?” I came up with a lot of wonderful, affirmative answers. Some were in investment management. After all, I’m near investment management.** I considered the billions of dollars totally wasted in the course of investing common stock portfolios for American owners. As long as the marker keeps going up, the guy who’s wasting all this money doesn’t feel it because he’s looking at these steadily rising values.** And to the guy who is getting the money for investment advice, the money looks like well earned income when he’s really selling detriment for money, surely the functional equivalent of undisclosed embezzlement. You can see why I don’t get invited to many lectures.
• “Few things are harder to put up with than the annoyance of a good example.” Mark Twain
• Many bad effects from vice are clear. You’ve got the crazy booms and crooked promotions-all you have to do is read the paper over the last six months. There’s enough vice to make us all choke. And, by the way, everybody’s angry about unfair compensation at the top of American corporations, and people should be. We now face various crazy governance nostrums invented by lawyers and professors that won’t give us a fix for unfair compensation, yet a good partial solution is obvious: If directors were significant shareholders who got a pay of zero, you’d be amazed what would happen to unfair compensation of corporate executives as we dampened effects from reciprocity tendency. #Incentives #Compensation
• This is the system Benjamin Franklin, near the end of his life, wanted for the U.S. government, He didn’t want the high executives of government to be paid, but to be like himself or the entirely unpaid, well-off ministers and rulers of the Mormon Church, And when I see what’s happened in California, I’m not sure he wasn’t right. At any rate, no one now drifts in Franklin’s direction. For one thing, professors-and most of them need money-get appointed directors.
• Keynes said, “It’s not bringing in the new ideas that’s so hard. It’s getting rid of the old ones.” And Einstein said it better, attributing his mental success to “curiosity, concentration, perseverance, and self-criticism.” By self-criticism, he meant becoming good at destroying your own best-loved and hardest-won ideas. If you can get really good at destroying your own wrong ideas, that is a great gift. #Self-Criticism
  • In so behaving, the University of Chicago is imitating Charles Darwin, who spent much of his long life thinking in reverse as he tried to disprove his own hardest-won and best-loved ideas. And so long as there are parts of academia that keep alive its best values by thinking in reverse like Darwin, we can confidently expect that silly educational practices will eventually be replaced by better ones, exactly as Carl Jacobi might have predicted. #Self-Criticism
• “Capitalism works best when there is trust in the system.” Charlie Munger
• “No matter how smart you are, there are smart people out there who can fool you if they really want to. So, be sure you can trust the smart people you work with.”