The Total Uncertainty of Markets: Richard Cantillon and the Failure of Market Plans
I don’t believe in patents. I don’t believe in ‘scale’. The value of innovation lies in scarcity and addressing a need.
Conformists (e.g. Zuckerberg, Bill Gates, Thomas Edison, Larry Page, Larry Allison) start ‘valuable’ companies and become their own slaves; anarchists create and trade extremely-scarce assets (e.g. Richard Cantillon, Nicola Tesla, Howard Hughes, Elon Musk, Kanye West, John D. McAfee).
Richard Cantillon is largely regarded as the founder of the modern discipline of economics. His ‘Economic Theory’ essay was written 40 years before Adam Smith’s ‘Wealth of Nations’. Most students of Economics mostly know a lot more about Adam Smith, than Cantillon. But that’s because Englishmen in general (and academics in particular) like praising themselves too much…
“But no matter what he [Adam Smith] actually learned or failed to learn from predecessors, the fact is that the Wealth of Nations does not contain a single analytic idea, principle, or method that was entirely new in 1776.” (Schumpeter 1954)
Cantillon was Irish, and spent most of his time, unlike almost all economists after him ‘in the streets’ of trade in France. Cantillon was not just the world’s first economist, he was also the world’s first ‘self-made’ millionaire from trading in the markets.
Basically, if you feel the need to simultaneously learn about both market economies and how to make millions, Cantillon is the first, the best and the most practical.
Cantillon’s market hypotheses, entirely unlike those later postulated by many economists, was based on his extensive experience of the phenomenon of market uncertainties.
He was the first to show the relationship of price, to supply and demand (independent of production costs). Since he is largely regarded as belonging to a class of the ‘Austrian’/capitalist school of economics, his market price theory has been widely discussed by Adam Smith (cf. market competition theory), David Ricardo (cf. market price as an indication of labour quantities), Ludwig Von Mises (cf. economic calculation problem), Hayek (cf. knowledge in society) and Milton Friedman (cf. demand and supply in quantity theory of money) in various forms. These latter theorists propounded various forms of the theory of market price ‘equilibrium’; which states that price approaches production cost as more competitors and substitutionary alternatives enter the supply market.
But Cantillon’s thesis was much more nuanced and in many ways much further ahead of his latter students. His ‘supply and demand’ market price thesis was entirely predicated on the assumption that markets are constantly fluctuating and have irrevocable uncertainty.
For Cantillon, there could never be an ‘equilibrium’ of price, any more than there could ever be an equilibrium of supply. The markets, according to Cantillon are driven by many unforeseen uncertainties that render any calculation: whether regarding ‘equilibrium’, production ‘costs’, or market price, entirely irrelevant.
The enterpreneur, according to Richard, must price as the market dictates as per the supply and demand analysis; any other ‘consideration’, no matter how critical to the profitability, viability or sustainability of the business is totally irrelevant to the equation.
His “market price” hypothesis then, is much simpler and ‘abstracts’ many factors that modern economists, who are far removed from actual economic activity, usually obsess about.
For Cantillon, the supply component in pricing is the most paramount. A commodity or product that is widely available, loses its value. He is fixated on establishing a market demand and managing or limiting the supply of a commodity than on ‘looking out’ for other factors that may influence his price.
On the surface, Cantillon’s approach may seem simplistic and naive. But that is because he was more interested in ‘making the most of uncertainty’ (and becoming a millionare!), than in being ‘accurate’.
Some may argue that his hypothesis applies more to commodities such as money (since he was a banker himself), and not so much to utilities or market consumables.
That is simply not true, as it will be seen below.
Hey, What About the ‘Price Equilibrium’ Theory?
It is total BS.
Let’s take an example of someone supplying, let’s say… rocket engines!
Clearly, the entrepreneur behind such a product is a genius (Musk, anyone?). Let’s assume the demand of these engines is going up (R. Branson, Jeff Bezos, China, India, and Russia; aren’t they all interested?).
The assumption behind the ‘price equilibrium’ theory is that if many other companies (Boeing, Lockheed Martin, etc) start making and selling their own engines, the price of a rocket engine will eventually turn toward ‘equilibrium’… it will reduce to the point of converging towards its ‘production cost’.
The problem with this hypothesis is that for Cantillon, once again, everything is in flux; including the production costs! The production input costs are also in flux because of their own supply and demand mechanisms, which are always changing.
Cantillon, then, did not foreshadow the classical equilibrium theory that cost of production constituted the long-run, and presumably therefore the most important, determinant of market price. On the contrary, for Cantillon cost of production had a very different function: deciding whether a business could make profits or else have to suffer losses and go out of business. Murray N. Rothbard
Another element usually ignored by proponents of the ‘price equilibrium’ theory is the likelihood of a newcomer using material or machinery from an existing incumbent; in some sense, this might make the input costs ‘stable’ (assuming one supplier) but in many ways it makes the input costs extremely unstable, as the supplier is likely to invent various ways to increase the price (=due to being the sole or one of the few suppliers of the material or machinery/tools).
What It All Means
Since the markets are unpredictable, it makes sense for the entrepreneur never to have a ‘market plan’. A market plan wastes a lot of invaluable time in actual trading and related activities, and it becomes invalid the hour, the day the week, the month and the year after it was written.
What matters, is for the entrepreneur to determine what the market requires that is in short supply. By definition, there will exist no ‘blueprint’ for how and what to do to execute such a trade mission. There will be no past ‘data’ to base a ‘plan’ off. This also means that the entrepreneur has to have a very good understanding of the market conditions before embarking on the mission for producing or distributing a new ‘entity’ in the markets.
The market ‘conditions’ do NOT mean a ‘feasibility study’, as that would imply stable and static market conditions for both consumers and producers. The market condition primarily entails a fair understanding of the ‘subjective value’ or price that the customer would be willing to pay for. These market ‘conditions’ form a critical component of the ‘demand’ analysis.
In short, the entire cost of production, all the labor and effort that went into the production and transport of beaver skins, means nothing unless the product satisfies the consumer enough to pay for the costs, and to enable the product to compete with another commodity made more cheaply at home. It is consumer demand that determines sales as well as price. Murray N. Rothbard (emphasis mine)
After the demand has been established, what is required is an even deeper foray into the supply landscape. The entrepreneur either has to make or invent the ‘entity’, or he has to buy it or its material from somewhere at a profitable price.
O’Mahony has commented that:
For Cantillon then it is not so much that intrinsic values exist automatically and spontaneously and that market prices are drawn towards them, as that the prices offered in the market determine whether or not it is worth producing things. In other words, it is the prices offered that determine what production costs can be incurred not that production costs determine what the prices must be. (emphasis mine)
Which is remarkably similar to David Ricardo’s definition of ‘production costs’ as ‘inclusive’ of profits.
In a nutshell, production costs are not constant! The market determines the production costs, the ‘costs’ of which are the price (as they include profits); and since the price is determined not only by the ‘subjective’ market interests that drive the demand up or down, and the unpredictable supply which may increase or decrease, the entire market-value-chain is at the mercy of customers! So much for the business plan!
“It often happens that many things which actually have this intrinsic value are not sold in the market at that value: That will depend on the humors and fancies of men and on their consumption.” Richard Cantillon
But such an entrepreneur still has no clear guarantee on whether the customers will actually buy, and if they do, how many they will actually buy. He’ll either sink himself into abject poverty (or debt) or become an overnight success!
The Certainty of Supply and Demand
To have some sanity, the entrepreneur either needs a ‘plan’ (which clearly will never work), or he needs a strategy for staying sane and committed to the mission.
Lessons for business, from Richard Cantillon, are therefore the following:
The entrepreneur’s objective is,
- To supply rare goods that are needed (or in demand), and
- To sell them at subjective market value, and
- To ‘limit’ the supply in order to avoid a decrease in subjective market value.
The ‘creation of demand’ does not mean advertising, it means visibility of a market good.
When an entrepreneur fails to limit the supply (by legal and acceptable means, of course) he will either fail to know why customers did not buy (if no one bought); or why he succeeded (i.e. for future replication or market scaling). The customers will also start demanding reduced prices, and competitors will notice soon enough and also start supplying the same good; which will not only reduce the entrepreneur’s percentage sales, but is bound to force the entrepreneur to reduce the price even further due to the increased market supply of a market good.
The good side effect of limiting supply is that the entrepreneur will know sooner if and why customers are not buying. When the entrepreneur has made enough sales (up to the pre-determined limit) he/she will provide himself/herself enough leverage to provide maximum value to existing customers (i.e. upselling, cross-selling, etc). Customers will tell others; and the price of the good being sold is likely to go up due to an increased demand, the added serendipitous ‘value’ and the restricted supply.
It must be noted that my conjectures above are mainly based on my experiences in making and selling a particular market ‘good’, software. But this method would have obvious application in many other related ‘non-perishable’ technology products.
Limit supply (by market design). Never write a market plan.
