Basic Economics Read online

  In short, although corporations may be thought of as big, impersonal and inscrutable institutions, they are ultimately run by human beings who all differ from one another and who all have shortcomings and make mistakes, as happens with economic enterprises in every kind of economic system and in countries around the world. Companies superbly adapted to a given set of conditions can be left behind when those conditions change suddenly and their competitors are quicker to respond. Sometimes the changes are technological, as in the computer industry, and sometimes these changes are social or economic.

  Social Changes

  The A & P grocery chain was for decades a company superbly adapted to social and economic conditions in the United States. It was by far the leading grocery chain in the country, renowned for its high quality and low prices. During the 1920s the A & P chain was making a phenomenal rate of profit on its investment—never less than 20 percent per year,{126} about double the national average—and it continued to prosper on through the decades of the 1930s, 1940s and 1950s. But all this began to change drastically in the 1970s, when A & P lost more than $50 million in one 52-week period.{127} A few years later, it lost $157 million over the same span of time.{128} Its decline had begun and, in the years that followed, many thousands of A & P stores were forced to close, as the chain shrank to become a mere shadow of its former self.

  A & P’s fate, both when it prospered and when it lost out to rival grocery chains, illustrates the dynamic nature of a price-coordinated economy and the role of profits and losses. When A & P was prospering up through the 1950s, it did so by charging lower prices than competing grocery stores. It could do this because its exceptional efficiency kept its costs lower than those of most other grocery stores and chains, and the resulting lower prices attracted vast numbers of customers. Later, when A & P began to lose customers to other grocery chains, this was because these other chains now had lower costs than A & P, and could therefore sell for lower prices. Changing conditions in the surrounding society brought this about—together with differences in the speed with which different companies spotted these changes, realized their implications and adjusted accordingly.

  What were these changes? In the years following the end of World War II, suburbanization and the American public’s rising prosperity gave huge supermarkets in shopping malls with vast parking lots decisive advantages over neighborhood stores—such as those of A & P—located along the streets in the central cities. As the ownership of automobiles, refrigerators and freezers became far more widespread, this completely changed the economics of the grocery industry.

  The automobile, which made suburbanization possible, also made possible greater economies of scale for both customers and supermarkets. Shoppers could now buy far more groceries at one time than they could have carried home in their arms from an urban neighborhood store before the war. That was the crucial role of the automobile. Moreover, the far more widespread ownership of refrigerators and freezers now made it possible to stock up on perishable items like meat and dairy products. This led to fewer trips to grocery stores, with larger purchases each time.

  What this meant to the supermarket itself was a larger volume of sales at a given location, which could now draw customers in automobiles from miles around, whereas a neighborhood store in the central city was unlikely to draw customers on foot from ten blocks away. High volume meant savings in delivery costs from the producers to the supermarket, as compared to the cost of delivering the same total amount of groceries in smaller individual lots to many scattered and smaller neighborhood stores, whose total sales would add up to what one supermarket sold. This also meant savings in the cost of selling within the supermarket, because it did not take as long to check out one customer buying $100 worth of groceries at a supermarket as it did to check out ten customers buying $10 worth of groceries each at a neighborhood store. Because of these and other differences in the costs of doing business, supermarkets could be very profitable while charging prices lower than those in neighborhood stores that were struggling to survive.

  All this not only lowered the costs of delivering groceries to the consumer, it changed the relative economic advantages and disadvantages of different locations for stores. Some supermarket chains, such as Safeway, responded to these radically new conditions faster and better than A & P did. The A & P stores lingered in the central cities longer and also did not follow the shifts of population to California and other sunbelt regions.

  A & P was also reluctant to sign long leases or pay high prices for new locations where the customers and their money were now moving. As a result, after years of being the lowest-price major grocery chain, A & P suddenly found itself being undersold by rivals with even lower costs of doing business.

  Lower costs reflected in lower prices is what made A & P the world’s leading retail chain in the first half of the twentieth century. Similarly, lower costs reflected in lower prices is what enabled other supermarket chains to take A & P’s customers away in the second half of the twentieth century. While A & P succeeded in one era and failed in another, what is far more important is that the economy as a whole succeeded in both eras in getting its groceries at the lowest prices possible at the time—from whichever company happened to have the lowest prices. Such displacements of industry leaders continued in the early twenty-first century, when general merchandiser Wal-Mart moved to the top of the grocery industry, with nearly double the number of stores selling groceries as Safeway had.

  Many other corporations that once dominated their fields have likewise fallen behind in the face of changes or have even gone bankrupt. Pan American Airways, which pioneered in commercial flights across the Atlantic and the Pacific in the first half of the twentieth century, went out of business in the late twentieth century, as a result of increased competition among airlines in the wake of the deregulation of the airline industry.

  Famous newspapers like the New York Herald-Tribune, with a pedigree going back more than a century, stopped publishing in a new environment, after television became a major source of news and newspaper unions made publishing more costly. Between 1949 and 1990, the total number of copies of all the newspapers sold daily in New York City fell from more than 6 million copies to less than 3 million.{129} New York was not unique. Nationwide, daily newspaper circulation per capita dropped 44 percent between 1947 and 1998.{130} The Herald-Tribune was one of many local newspapers across the country to go out of business with the rise of television. The New York Daily Mirror, with a circulation of more than a million readers in 1949, went out of business in 1963.{131}

  By 2004, the only American newspapers with daily circulations of a million or more were newspapers sold nationwide—USA Today, the Wall Street Journal and the New York Times.{132} Back in 1949, New York City alone had two local newspapers that each sold more than a million copies daily—the Daily Mirror at 1,020,879 and the Daily News at 2,254,644.{133} The decline was still continuing in the twenty-first century, as newspaper circulation nationwide fell nearly an additional 4 million between 2000 and 2006.{134}

  Other great industrial and commercial firms that have declined or become extinct are likewise a monument to the unrelenting pressures of competition. So is the rising prosperity of the consuming public. The fate of particular companies or industries is not what is most important. Consumers are the principal beneficiaries of lower prices made possible by the more efficient allocation of scarce resources which have alternative uses. The key roles in all of this are played not only by prices and profits, but also by losses. These losses force businesses to change with changing conditions or find themselves losing out to competitors who spot the new trends sooner or who understand their implications better and respond faster.

  Knowledge is one of the scarcest of all resources in any economy, and the insight distilled from knowledge is even more scarce. An economy based on prices, profits, and losses gives decisive advantages to those with greater knowledge and insight.

  Put differently, know
ledge and insight can guide the allocation of resources, even if most people, including the country’s political leaders, do not share that knowledge or do not have the insight to understand what is happening. Clearly this is not true in the kind of economic system where political leaders control economic decisions, for then the necessarily limited knowledge and insights of those leaders become decisive barriers to the progress of the whole economy. Even when leaders have more knowledge and insight than the average member of the society, they are unlikely to have nearly as much knowledge and insight as exists scattered among the millions of people subject to their governance.

  Knowledge and insight need not be technological or scientific for it to be economically valuable and decisive for the material well-being of the society as a whole. Something as mundane as retailing changed radically during the course of the twentieth century, revolutionizing both department stores and grocery stores—and raising the standard of living of millions of people by lowering the costs of delivering goods to them.

  Individual businesses are forced to make drastic changes internally over time, in order to survive. For example, names like Sears and Wards came to mean department store chains to most Americans by the late twentieth century. However, neither of these enterprises began as department store chains. Montgomery Ward—the original name of Wards department stores—began as a mail order house in the nineteenth century. Under the conditions of that time, before there were automobiles or trucks, and with most Americans living in small rural communities, the high costs of delivering consumer goods to small and widely-scattered local stores was reflected in the prices that were charged. These prices, in turn, meant that ordinary people could seldom afford many of the things that we today regard as basic.

  Montgomery Ward cut delivery costs by operating as a mail order house, selling directly to consumers all over the country from its huge warehouse in Chicago. Using the existing railway freight shipping services, and later the post office, allowed Montgomery Ward to deliver its products to customers at lower costs that were reflected in lower prices than those charged by local stores in rural areas. Under these conditions, Montgomery Ward became the world’s largest retailer in the late nineteenth century.

  During that same era, a young railroad agent named Richard Sears began selling watches on the side, and ended up creating a rival mail order house that grew over the years to eventually become several times the size of Montgomery Ward. Moreover, the Sears retail empire outlasted the demise of its rival in 2001, when the latter closed its doors for the last time under its more recent name, Wards department stores. One indication of the size of these two retail giants in their heyday as mail order houses was that each had railroad tracks running through its Chicago warehouse. That was one of the ways they cut delivery costs, allowing them to charge lower prices than those charged by local retail stores in what was still a predominantly rural country in the early twentieth century. In 1903, the Chicago Daily Tribune reported that mail order houses were driving rural stores out of business.{135}

  More important than the fates of these two businesses was the fact that millions of people were able to afford a higher standard of living than if they had to be supplied with goods through costlier channels. Meanwhile, there were changes over the years in American society, with more and more people beginning to live in urban communities. This was not a secret, but not everyone noticed such gradual changes and even fewer had the insight to understand their implications for retail selling. It was 1920 before the census showed that, for the first time in the country’s history, there were more Americans living in urban areas than in rural areas.

  One man who liked to pore over such statistics was Robert Wood, an executive at Montgomery Ward. Now, he realized, selling merchandise through a chain of urban department stores would be more efficient and more profitable than selling exclusively by mail order. Not only were his insights not shared by the head of Montgomery Ward, Wood was fired for trying to change company policy.

  Meanwhile, a man named James Cash Penney had the same insight and was already setting up his own chain of department stores. From very modest beginnings, the J.C. Penney chain grew to almost 300 stores by 1920 and more than a thousand by the end of the decade.{136} Their greater efficiency in delivering goods to urban consumers was a boon to those consumers—and Penney’s competition became a big economic problem for the mail order giants Sears and Montgomery Ward, both of which began losing money as department stores began taking customers away from mail order houses.{137} The fired Robert Wood went to work for Sears and was more successful there in convincing their top management to begin building department stores of their own. After they did, Montgomery Ward had no choice but to do the same belatedly, though it was never able to catch up to Sears again.

  Rather than get lost in the details of the histories of particular businesses, we need to look at this from the standpoint of the economy as a whole and the standard of living of the people as a whole. One of the biggest advantages of an economy coordinated by prices and operating under the incentives created by profit and loss is that it can tap scarce knowledge and insights, even when most of the people—or even their intellectual and political elites—do not have such knowledge or insights.

  The competitive advantages of those who are right can overwhelm the numerical, or even financial, advantages of those who are wrong. James Cash Penney did not start with a lot of money. He was in fact raised in poverty and began his retail career as just a one-third partner in a store in a little town in Wyoming, at a time when Sears and Montgomery Ward were unchallenged giants of nationwide retailing. Yet his insights into the changing conditions of retailing eventually forced these giants into doing things his way, on pain of extinction.

  In a later era, a clerk in a J.C. Penney store named Sam Walton would learn retailing from the ground up, and then put his knowledge and insights to work in his own store, which would eventually expand to become the Wal-Mart chain, with sales larger than those of Sears and J.C. Penney combined.

  One of the great handicaps of economies run by political authorities, whether under medieval mercantilism or modern communism, is that insights which arise among the masses have no such powerful leverage as to force those in authority to change the way they do things. Under any form of economic or political system, those at the top tend to become complacent, if not arrogant. Convincing them of anything is not easy, especially when it is some new way of doing things that is very different from what they are used to. The big advantage of a free market is that you don’t have to convince anybody of anything. You simply compete with them in the marketplace and let that be the test of what works best.

  Imagine a system in which James Cash Penney had to verbally convince the heads of Sears and Montgomery Ward to expand beyond mail order retailing and build a nationwide chain of stores. Their response might well have been: “Who is this guy Penney—a part-owner of some little store in a hick town nobody ever heard of—to tell us how to run the largest retail companies in the world?”

  In a market economy, Penney did not have to convince anybody of anything. All he had to do was deliver the merchandise to the consumers at lower prices. His success, and the millions of dollars in losses suffered by Sears and Montgomery Ward as a result, left these corporate giants no choice but to imitate this upstart, in order to become profitable again. Although J.C. Penney grew up in worse poverty than most people who are on welfare today, his ideas and insights prevailed against some of the richest men of his time, who eventually realized that they would not remain rich much longer if Penney and others kept taking away their customers, leaving their companies with millions of dollars in losses each year.

  Economic Changes

  Economic changes include not only changes in the economy but also changes within the managements of firms, especially in their responses to external economic changes. Many things that we take for granted today, as features of a modern economy, were resisted when first proposed and had to f
ight uphill to establish themselves by the power of the marketplace. Even something as widely used today as bank credit cards were initially resisted. When BankAmericard and Master Charge (later MasterCard) first appeared in the 1960s, leading New York department stores such as Macy’s and Bloomingdale’s said that they had no intention of accepting bank credit cards as payments for purchases in their stores, even though there were already millions of people with such cards in the New York metropolitan area.{138}

  Only after the success of these credit cards in smaller stores did the big department stores finally relent and begin accepting credit cards. In 2003, for the first time, more purchases were made by credit cards or debit cards than by cash.{139} That same year, Fortune magazine reported that a number of companies made more money from their own credit card business, with its interest charges, than from selling goods and services. Sears made more than half its profits from its credit cards and Circuit City made all of its profits from its credit cards, while losing $17 million on its sales of electronic merchandise.{140}

  Neither individuals nor companies are successful forever. Death alone guarantees turnover in management. Given the importance of the human factor and the variability among people—or even with the same person at different stages of life—it can hardly be surprising that dramatic changes over time in the relative positions of businesses have been the norm.

  Some individual executives are very successful during one era in the country’s evolution, or during one period in their own lives, and very ineffective at a later time. Sewell Avery, for example, was for many years during the twentieth century a highly successful and widely praised leader of U.S. Gypsum and later of Montgomery Ward. Yet his last years were marked by public criticism and controversy over the way he ran Montgomery Ward, and by a bitter fight for control of the company that he was regarded as mismanaging. When Avery resigned as chief executive officer, the value of Montgomery Ward’s stock rose immediately. Under his leadership, Montgomery Ward had put aside so many millions of dollars, as a cushion against an economic downturn, that Fortune magazine called it “a bank with a store front.”{141} Meanwhile, rivals like Sears were using their money to expand into new markets.