A Lattice of Insights from Charlie Munger

In a previous post I mentioned the "Latticework of Models" espoused by Charlie Munger, Warren Buffet's partner. I found this transcript of a rare Charlie speech. It's an MBA-in-a-PDF!!

No, really. It's one of those pieces that changes your world view forever. For the better.

He takes a hard science look at the soft science of Economics. Guess what? It turns out that a hard science view is the smart money view. And his criticisms of Economics can easily be translated into criticisms of current business management practices.

"at a very young age, I absorbed what I call the fundamental full attribution ethos of hard science...Under this ethos, you've got to know all the big ideas in all the disciplines less fundamental than our own. You can never make any explanation, which can be made in a more 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 say you're using biology...I could early on see that 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 sciences as well as hard sciences. That was a very lucky idea for me."

To give you a flavor of his comments and to whet your appetite to read the whole thing, here are Charlie's nine points of criticism of economics:

1) Fatal Unconnectedness, Leading to "Man With A Hammer Syndrome," Often Causing Overweighing What Can Be Counted

"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...And 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..."

...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."

2) Failure to Follow the Fundamental Full Attribution Ethos of Hard Science

3) Physics Envy

"I want economics to pick up the basic ethos of hard science, the full attribution habit, but not the craving for unattainable precision that comes from physics envy...Economics involves too complex a system. (Emphasis mine)

4) Too Much Emphasis on Macroeconomics

"My fourth criticism is that there's too much emphasis on macroeconomics and not enough on microeconomics. I think this is wrong. It's like trying to learn medicine without knowing anatomy and chemistry."

He proves his point by citing some very interesting examples and challenging you to understand why certain business thrived when logic says they shouldn't. And he discusses his lattice of factors for extreme success in a business category.


5) Too Little Synthesis in Economics

...people take four courses in economics, go to business school, have all these IQ 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 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."

In this section Munger challenges the audience to tell him why in some cases raising prices also raises sales volume, and other situations in which synthesizing two ideas leads to a successful outcome that's a paradox to the original principles.


6) Extreme and Counterproductive Psychological Ignorance
Another challenge: why does one slot machine in 50 consistently outperform the others in terms of profits?

"If you want to go through life like a one legged man in an ass-kicking contest, 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."

Beware of one-legged men swinging hammers.


7) 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. When I was a meteorologist I found this stuff irritating. And economics makes meteorology look like a tea party."

He discusses why U.S.-China policy is a new form of the Tragedy of the Commons.


8) Not Enough Attention to the Concept of Febezzlement

"I asked the question 'Is there a functional equivalent to embezzlement?' I came up with a lot of wonderful alternatives. 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 market goes up, the guy who's wasting all this money doesn't feel it, because he's look 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."

9) Not Enough Attention to Virtue and Vice Effects

"The cash register did more for humman morality than the congregational church...A system that's very hard to defraud, like a cash register, helps the economic performance of a civilization by reducing vice, but very few people within economics talk about it in those terms."

If directors were significant shareholders who got zero pay, you'd be amazed what would happen to unfair compensation of corporate executives as we dampened effects from reciprocity tendency.

Paging Dr. Robert Cialdini...he also talks about why it's in civilization's best interest that some system are deliberately made unfair. He also discusses the inevitability of paradox in economics, and business in general, and the fact that this inevitability of paradox is a source of opportunity:

"Well, if mathematicians can't get the paradox out of their system when they'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."

He concludes by saying: "If you skillfully follow the multidisciplinary path, will will never wish to come back. It would be like cutting off your hands."

Do read the whole thing.

Related Post: Miscellaneous Munger