Sometimes fiction can be used to effectively convey ideas from economics. Other times, the economics you see in fiction don’t make sense. This post is another example of the latter, from a fictional series that I generally enjoy: Star Trek. (For the record, Deep space nine was objectively the best Star Trek series.)
One of the distinguishing features of the Star Trek universe is how, of the most prominent and regularly occurring species, it seems like only humans are versatile. Every other major Star Trek franchise is fundamentally built around a single trait, taken to the extreme. Warrior culture is part of humanity’s culture, but it is the whole of Klingon culture. (How Klingons ever evolved to travel faster than the speed of light is beyond me.) Logic is also part of the way humans work, but it is most important to Vulcans. Both Cardassian and Romulan societies seem to be built entirely around militarism. And Ferengi is supposed to be a society devoted entirely to the ruthless pursuit of profit.
The Ferengi are guided in their behavior by The rules for acquisition. As the name suggests, this is a list of rules that should help a Ferengi gain as much wealth as possible. But in reality the real lines are a terrible guide to how to run a profitable business. To be fair, a few rules are pretty sensible. ‘Small print leads to big risks’ seems like a good rule of thumb. This also applies to ‘Never gamble with a telepath’. (It’s also advice I follow by default, because for me that rule doesn’t end until the second word.) But overall, any real business that tried to adhere to these rules would quickly fail.
The first (and probably most important) of these rules is: “Once you have their money, you never give it back.” According to this rule, the way to maximize profits is to have a strict no-returns, no-refunds policy. But compare that to what we see in the real world. Large – and hugely successful – companies not only don’t adhere to this rule, they often go out of their way to emphasize how accommodating their return and refund policies are. Online brands looking to attract new customers often go to great lengths to reassure customers that trying the product is risk-free. If you don’t like it, you can simply return it, with the company paying the return shipping costs. If you want to buy a product from two different companies, one company says, “Once we get your money, you’ll never get it back,” while the second company says, “If you’re not 100% satisfied, you can a full refund”, what would you choose? Clearly the second is a more attractive prospect. To follow the first rule of acquisition would be shooting yourself in the foot.
The fundamental mistake in the thinking behind most of these rules is the inability to understand the difference between them finite and infinite games. Finite games end with a specific, final ‘winner’. Infinite games are not literally infinite – what sets them apart is that they are open-ended, have no defined end state, and are intended to continue indefinitely. Or, as James Carse put it, the goal of an infinite game is not to end the game, but to keep the game going. In this sense, running a successful business is an infinite game rather than a finite one. A successful business is not one that reaches a predetermined end point after which business activity ceases. A successful company is one that is able to continue operating continuously. Perhaps the first acquisition rule in a finite game consisting of a single interaction could yield better results. But for an infinite game, it is much better to have a generous refund policy.
Thomas Sowell called this mistake “one-phase thinking” in his book Applied Economics:
When I was studying economics with Harvard professor Arthur Smithies, he asked me one day in class what policy I favored on a particular issue of the time. Because I had strong feelings about that issue, I began to answer him enthusiastically, explaining what beneficial consequences I expected from the policy I was advocating.
“And what will happen then?” he asked.
The question caught me off guard. However, as I thought about it, it became clear that the situation I was describing would lead to other economic consequences, which I then began to consider and explain.
“And what will happen next?” asked Professor Smithies.
As I analyzed how further economic responses to the policy would unfold, I began to realize that these responses would lead to consequences that were far less desirable than those in the first phase, and I began to have some doubts.
“And Than what will happen?” The forges continued to exist.
By now I was beginning to see that the economic repercussions of the policies I was advocating were likely to be quite disastrous – and in fact much worse than the initial situation it was intended to improve.
Apart from the few sensible pieces of advice in the Ferengi Rules of Acquisition, these rules all fail immediately if you view business as an endless game, as a constantly ongoing process rather than as a static interaction. If you view the world in static terms and entirely through the lens of finite, single-stage games, you might think that the Ferengi rules would lead to profit maximization, and that corporations will all behave that way if given the chance. But when you stop thinking in static terms and start thinking dynamically, things look very different.
Think of a company that operated with rules like “A deal is a deal until a better one comes along” and “The thinner the product, the higher the price” and “Once you get their money, you never give it back.” ‘ This is a company that will renege on its contracts, sell overpriced junk and refuse all returns and refunds. As soon as you ask: “And Than what will happen?” you can see why any company that wants to be successful and maximize its profits would torch the Ferengi takeover rules.