Recently in Just Plain Interesting Category

Not every day do we get a new Nobel Prize winner in Economics, not to mention one whose name, Paul Krugman, might actually be familiar to more Americans than the few of us who are poor closet economists. Krugman is of course not only a Princeton professor (we pause to take pride here in the home team), but a regular op-ed columnist in The New York Times where he is known for wielding a hatchet against all things touching or concerning the Bush Administration.

As for his Times op-ed columns, we are, as you know, resolutely apolitical here at "Adam Smith, Esq." Perhaps the best that can be said of those is that we come not to praise but to bury them in the context of his winning the Prize. Or, as was said more pungently in Australia's National Post, "You don't get the Nobel Prize in Economics for writing newspaper columns (as I've been trying to explain to my mother the last couple of days). So the prize awarded Monday to Paul Krugman should not be read as an endorsement of Krugman's uber-Democratic newspapering."

Actually, I'll give the last word on his Times op-eds to his fellow columnist Maureen Dowd:

"I'm not sending Paul Krugman Champagne.

He won the Nobel prize in economics this week, and while I'm sure that's delightful for him, it has raised the bar to an impossible height for his fellow columnists at The Times. We used to strive for Pulitzers, or simply regional awards, or even just try to top each other on the paper's most e-mailed list.

Now we're supposed to compete for Nobels?"

We're here to take a brief interlude, a detour, if you will, into economic theory and into what Krugman's Nobel is all about.

Classic models of trade between countries, stemming from David Ricardo's shockingly brilliant concept of "comparative advantage," predicted, in theory, that trade flows would depend on such things as ratios of capital to labor, with capital-rich countries exporting capital-intensive goods and importing labor-intensive goods from labor-rich countries.

But that's not what the data showed. In reality, most international trade takes place between countries with very similar capital:labor ratios.

Krugman sought to, and succeeded in, explaining this. His explanation was based on economies of scale and on transaction costs across distances. What does this mean?

Economies of scale mean that producer incentives are to concentrate production in a limited number of locations. Too abstract? Let's make it concrete: There's a reason Silicon Valley is a self-reinforcing hub of high technology and innovation in general. An engineering and entrepreneurial culture combined with venture capitalists combined with a world-class research university (Stanford) combined with a very start-up friendly business ecosystem has made it a hotbed for new companies.

Similarly, New York and London are likely to remain global financial centers as far as the eye can see. They both have the infrastructure that sophisticated financial professionals depend on. Permit me to state the obvious ones:

• English
• Entrepreneurial cultures
• The Anglo-Saxon common law tradition, and the rule of law
• An indigenous infrastructure of banks, law firms, marketing professionals, and all the multifarious support professions.

And the less obvious:

• Workable, if not Asian-clean-slate, physical infrastructures
• Terrific international air connections
• Fabulous stores, restaurants, museums, parks, and schools
• Great, and highly diverse, residential and commercial real estate

But back to Krugman.

He described his basic findings in the 1992 "Geography & Trade:"

"Because of economies of scale, producers have an incentive to concentrate production of each good or service in a limited number of locations. Because of the cost of transacting across distance, the preferred locations for each individual producer are those where demand is large or supply of inputs is particularly convenient -- which in general are the locations chosen by other producers. Thus [geographical] concentrations of industry, once established, tend to be self-sustaining."

An example he used was that the auto industry in capital-intensive Sweden exports cars to capital-intensive America while also importing cars from America.  The logic is that both Volvo and GM can reduce costs by producing a relatively large output (sufficient to satisfy worldwide demand) in particular geographic niches where the requisite inputs are concentrated. 

Krugman, of course, was building on the theory of comparative advantage, which he explained perhaps most famously in "Ricardo's Difficult Idea." Comparative advantage is a theory at once powerful and notoriously elusive, which--although beloved by economists, including yours truly--seems to inspire incomprehension even by those who loudly retort that while they subscribe to it, they only happen to see certain exceptions applying, which are only visible to those with a particularly subtle intellect.

At that point you know you're in the company of someone whose fellow intellectual travelers include those who proclaim their belief in evolution while demanding equal time in the schools for "intelligent design." They say they believe, but they don't believe.

Here's where Krugman's brilliant "Ricardo's Difficult Idea" comes into play. Permit me to quote at some length (my own Cliff's Notes version is here at the bottom):

My objective in this essay is to try to explain why intellectuals who are interested in economic issues so consistently balk at the concept of comparative advantage. Why do journalists who have a reputation as deep thinkers about world affairs begin squirming in their seats if you try to explain how trade can lead to mutually beneficial specialization? Why is it virtually impossible to get a discussion of comparative advantage, not only onto newspaper op-ed pages, but even into magazines that cheerfully publish long discussions of the work of Jacques Derrida? Why do policy wonks who will happily watch hundreds of hours of talking heads droning on about the global economy refuse to sit still for the ten minutes or so it takes to explain Ricardo?

[...]

At a deeper level, comparative advantage is a harder concept than it seems, because like any scientific concept it is actually part of a dense web of linked ideas. A trained economist looks at the simple Ricardian model and sees a story that can be told in a few minutes; but in fact to tell that story so quickly one must presume that one's audience understands a number of other stories involving how competitive markets work, what determines wages, how the balance of payments adds up, and so on.

[...]

I believe that much of the ineffectiveness of economists in public debate comes from their false supposition that intelligent people who read and even write about world trade must grasp the idea of comparative advantage. With very few exceptions, they don't -- and they don't even want to hear about it. Why?

[...}

[I]f one tries to explain the basic model to a non-economist, it soon becomes clear that it really isn't that simple after all.

There are, I believe, at least three implicit assumptions that underlie the most basic Ricardian model, assumptions that are justified by the whole fabric of economic understanding but are not at all obvious to non-economists. Here they are:

- Wages are determined in a national labor market: The basic Ricardian model envisages a single factor, labor, which can move freely between industries. When one tries to talk about trade with laymen, however, one at least sometimes realizes that they do not think about things that way at all. They think about steelworkers, textile workers, and so on; there is no such thing as a national labor market. It does not occur to them that the wages earned in one industry are largely determined by the wages similar workers are earning in other industries. This has several consequences. First, unless it is carefully explained, the standard demonstration of the gains from trade in a Ricardian model -- workers can earn more by moving into the industries in which you have a comparative advantage -- simply fails to register with lay intellectuals. Their picture is of aircraft workers gaining and textile workers losing, and the idea that it is useful even for the sake of argument to imagine that workers can move from one industry to the other is foreign to them.

Not is it obvious to non-economists that wages are endogenous. Someone looks at Vietnam and asks, "what would happen if people who work for such low wages manage to achieve Western productivity?" The economist's answer is, "if they achieve Western productivity, they will be paid Western wages" -- as has in fact happened in Japan. But to the non-economist this conclusion is neither natural nor plausible.

- Constant employment is a reasonable approximation: The standard textbook version of the Ricardian model assumes full employment in both countries. But in reality unemployment is constantly a concern of economic policy -- so why is this the usual assumption? There are two answers. One -- the answer that Ricardo would have given -- is that international trade is a long-run issue, and that in the long run the economy has a natural self-correcting tendency to return to full employment. The other, more modern answer is that countries have central banks, which try to stabilize employment around the NAIRU ["Non-Accelerating Inflation Rate of Unemployment"--Bruce]; so that it makes sense to think of the Federal Reserve and its counterparts acting in the background to hold employment constant. This is not at all the way that non-economists think about the issue.

- The balance of payments is not a problem: The standard textbook presentation of the Ricardian model assumes balanced trade -- indeed, it is usually a one-period model in which trade must be balanced. Yet the news is full of stories about the balance of payments, of complaints about trade surpluses and deficits. Why are these absent from the story?

Again, economists have good reasons for thinking that it is a good approximation to separate balance of payments from real international trade issues. In Ricardo's case, the essential ingredient was the argument by David Hume that trade imbalances are self-correcting: a surplus country will acquire specie, leading to rising prices that price its goods out of world markets, while a deficit country will correspondingly find its goods increasingly competitively priced. In the modern world, again, the channels involve less Invisible Hand and more government intervention: when monetary policies target the unemployment rate, exchange rates do the adjusting. Economists are also aware that even persistent trade imbalances are not necessarily a problem, and certainly that surpluses are not a sure sign of health or deficits one of weakness.

Permit me to try to summarize the virtues of comparative advantage.

The benefits of trade do not depend on countries' having absolute advantages over other countries, but only on having comparative advantages. This means that a country that is absolutely disadvantaged in producing all relevant goods and services can still benefit from trade. The secret is opportunity costs, not absolute costs.

Consider two hypothetical countries, North and South, which produce only two goods, food and clothes. If each country devoted its entire economy to producing food, North would produce 100 tons and South 200 tons. Similarly, if each devoted everything to clothes production, each would produce 100 tons of clothes. South appears absolutely advantaged, so where's the benefit from trade?

First, let's pretend that each country is equally predisposed to consumption of food and of clothes, so that each devotes 50% of their productive capacity to each. This produces:

	Food	Clothes
North	50	50
South	100	50
Total	150	100

Now let's assume trade barriers are lifted and each concentrates entirely on its preferred output in anticipation of being able to trade. This yields:

	Food	Clothes
North	0	100
South	200	0
Total	200	100

Of course, this "production" leaves North starving and South naked.

So if we introduce actual trade and imagine some arbitrary preference "price" of one ton of Food for 2/3 ton of Clothes, we get:

	Food	Clothes
North	75	50
South	125	50
Total	200	100

Everyone is better off.

---

Now, if you still don't believe me, consider the famous "attorney/typist" example.

Suppose you're the best lawyer in town and also the fastest typist in town; you have an absolute advantage in both.

Q1: Are you going to go to work as a secretary? Obviously not. You put your absolute advantage as a lawyer to its highest use.

Q2: Are you going to type your own documents? Obviously not. You put your comparative advantage as a lawyer to its highest use.

You are now a subscriber to the doctrine of free trade.

My friend Professor William Henderson at Indiana University School of Law—Bloomington just sent word of a new initiative the law school is launching in conjunction with the American Bar Foundation. 

Called the "Law Firms Working Group," the project includes no fewer than 14 research teams comprising 38 scholars in all, who will have access under a special license to the archival data of American Lawyer Media, which "includes cross–sectional and longitudinal information on law firm structure, financial performance, lawyer demographics, branch office size and location, lawyer mobility, associate satisfaction, relative law firm prestige derived from lawyer surveys, practice group prominence, and other facets of modern law firm practice."

What precisely are they researching, and what makes this initiative different from yet another set of academic papers on our complicated profession?

First, what promises to make it different is that the "LFWG" researchers will actually be working with data.  In other words, their work will be far more empirical than the usual armchair-observing and abstract-pontificating (and no, I'm not naming any names, thank you).

Second, their proposed projects include several that promise to be of genuine interest to those of us who are long since out of the academy and into the actual nitty-gritty of management and leadership.  Here are a few that struck me as particularly "real world" in focus:

• Lawyer Mobility:  "The investigators will study the volume of lawyer lateral mobility, and the and factors influencing it. They will explore the importance of a strong firm culture in the quality of client service, firm profits, firm stability, employee satisfaction, and associate attrition. After this analysis has been completed, Marc Galanter and William Henderson will utilize this dataset to study the relation of mandatory retirement policies to lawyer mobility."
• Interaction Between Law Firm Structure, Hiring, and Partner Promotion:  "John Gordanier will study the empirical relationship between the structure of law firms and the characteristics of associates and partners. His focus will be on whether a multi-tiered partnership structure [with equity and non-equity partners] changes the composition of a firm's associates and whether it affects the quality of the partners."
• Globalization Strategies of U.S. Law Firms:  "Carole Silver and Nicole DeBruin will combine Law Firms Working Group data with their own prior research into non-U.S. offices of U.S. law firms to analyze the consequences of different approaches to global expansion. They will examine a variety of factors, including the ways that offshore offices reflect or differ from their domestic counterparts, and the relationship between offshore office growth and financial success."
• The Professionalization of Large Firm Management:  "Elizabeth Chambliss will track the emergence of full-time ("professional") managers in law firms, focusing on the managing partner and law firm general counsel positions. Her research will examine the relationship between professional management and the economic success of the firm, and the sources of managerial authority for full-time versus part-time/practicing managers."

Other projects will look at the relationship between firm performance and a commitment to pro bono, the changing geographic footprint of global law firms, career trajectories of young lawyers, and race and gender in large law firms.

For some time now, Bill Henderson has been one of the rare law professors with a dominant "quant" gene and I for one will be fascinated to see the fruits of these various research projects.

And of course, you know that "Adam Smith, Esq." will be one place where you can read about those results as they materialize.

The College of Law Practice Management was formed over a decade ago to "honor and recognize distinguished law practice management professionals, to set standards of achievement for others in the profession, and to fund and assist projects that enhance the highest quality of law practice management."  To date, over 200 practitioners have been inducted, from the US, Canada, and eight other countries.  The College is governed by a Board of 15 Trustees, and annually it sponsors the "InnovAction Awards," designed to identify innovation by lawyers and law firms.  The criteria for selecting among entrants are:

• Absence of precedent (never been done or done quite this way before)
• Evidence of action (the innovative idea was transformed into action and not merely reflective of best intentions)
• Effectiveness of innovation (there is some measurable outcome that would indicate that the innovation is accomplishing what it was intended to do)
• Action must have taken place within no more than three years prior to this entry.

Information about the InnovAction Awards is here, and I invite you to check out the inaugural issue of the online publication celebrating last year's awards.

So:  Have you or any of your good friends done something wonderfully innovative recently?  Nominations are open; what are you waiting for?

At "Adam Smith, Esq.," we don't talk about Adam Smith himself very much, but at year-end it seems appropriate to pay a moment's homage to this site's intellectual godfather and, I hope, provide those of you who may not have studied him closely a slightly more nuanced perspective of his views.

To start, there could be no better introduction than this discussion of the interplay between his most famous work, obviously, The Wealth of Nations, and its predecessor by 17 years, the relatively unsung Theory of Moral Sentiments.   The piece takes off from Adam's Fallacy: A Guide to Economic Theology, written by Duncan Foley of New School University in New York, which is described as "a beautiful little book. It contains some of the most lucid exposition of the core ideas of economics that I have ever read."  (The reviewer is David Warsh, author of Knowledge and the Wealth of Nations, which I will soon be reviewing here; Warsh is a former Boston Globe columnist.)

The "fallacy" of "Adam [Smith]" is this:

"So what exactly is Adam's fallacy? According to Foley, it's "the idea that it is possible to separate an economic sphere of life, in which the pursuit of self-interest is guided by objective laws to a socially beneficent outcome, from the rest of social life, in which the pursuit of self interest is morally problematic and has to be weighed against other ends." This abstraction of an economic sphere from the messy complexity of real life is indeed the kernel of present-day economics.

But this entirely overlooks Moral Sentiments (for the 18th-Century phrase "moral sentiments," substitute today's more apt "conscience," and your understanding will increase), which opens thus:

"How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.... The greatest ruffian, the most hardened violator of the laws of society, is not altogether without it."

And Adam Smith is astutely attuned to the inability to cabin human beings into the rigor of the model of homo economicus, without attending to

the social and psychological realities of free will, choice, and impulse:

And here he describes "the man of system," who "seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces on a chess-board; he does not consider that the pieces on a chess-board have no principle of motion besides that which the hand impresses on them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own altogether different from that which the legislature might choose to impress upon it."

Indeed, these extra-homo economicus considerations are not just competitive with rational, gimlet-eyed, calculating analytics, at times they overwhelm "reason" altogether:

"What is it that prompts the generous, on all occasions, and the mean, upon many, to sacrifice their own interests to the greater interests of others? Is it not the soft power of humanity, is it not that feeble spark of benevolence which Nature has lighted up in the human heart, that is capable of counteracting the strongest impulses of self-love?"

Now, for some reason, the received wisdom handed down over 200 years later about Adam Smith is that he abandoned these views with publication of The Wealth of Nations.  Well, I'll spare you the academic arguments, but suffice to say there's not a scintilla of evidence that was the case.  Indeed, the better reasoned side of the debate, able to marshal far more evidence in support of its view, is that Smith intended a third and possibly even a fourth volume (cut short by his death, and his mandated destruction of all his unpublished manuscripts) reconciling and extending Moral Sentiments and Wealth of Nations by adding to the mix a treatise on the theory and impact of law and another on science and the arts.

So where are we left here in the 21st Century? 

Economics, a somewhat feckless discipline for the last few decades (there you have, in a nutshell, why I never entertained the notion of pursuing a Ph.D. in economics), has opted to "model what it can at the expense of ignoring what it cannot," and "moral sentiments" are famously unsusceptible to modeling.

One of my fonder, if milder, hopes is that my beloved discipline of economics will come to grasp more strongly the world as it really is with all its human complexity and contradiction, and return from its exile in the arid, mathematically intricate "blackboard economics" domain of homo rationalis economicus.

Happy New Year.

As the legal blogosphere goes from childhood to adolescence to (eventually) full-throated adulthood, I've enjoyed not just contributing my own small efforts to that process, but also being able to be an armchair observer of other developments having nothing whatsoever to do with me. 

Partly this stems from my endless fascination with the proliferation of business models the online world has spawned, and with luck will continue to spawn.   Partly it stems from my wanting to vindicate—or invalidate—a theory of mine to the effect that any new media channel begins life by imitating the closest analogous old-media channel, and that it takes an explosion of experimentation before the new media understands "what it wants to be when it grows up."  Thus radio began by staging plays and running vaudeville acts years before discovering its real home in news, talk, and music.  Likewise, TV began by imitating radio before it found its strength in late-breaking news, sports, and series. 

And yes, thus the web began imitating print and has evolved roughly as follows:

• Web 1.0
  • revolution = hyperlinks
  • static content ("brochure-ware")
  • activity = surfing
• Web 1.5
  • revolution = self-contained portals
  • dynamic content (Salon, Nerve, Slashdot)
  • activity = search
• Web 2.0
  • revolution = collaboration
  • user-generated content
  • activity = share

Today I'm here to report on an emerging category of legal sites targeting micro-communities with micro-focused content. 

The best example I've seen, which I just learned of this week, is Drug and Device Law, which is—yep!—about pharmaceutical and medical device product liability.  Its founders and co-hosts are Jim Beck, with Dechert in Philadelphia, and Mark Herrmann, with Jones Day in Cleveland.  (Careful readers will recognize mark as the author of The Curmudgeon's Guide to Practicing Law.)  Their goal for the site?  As Mark put it to me, "Jim and I would be quite happy with a "fit audience, though few": inside counsel at drug and device companies and sophisticated lawyers who act as outside counsel for those companies."

Why is this different than, say, a three-ring binder treatise on the same subject?

Look back up at my bullets under "Web 2.0:"  The potential is for "Drug and Device Law" to become essentially home-base for a community of practice, exchanging ideas, analyses, and even briefs (well, OK, we could start with string cites).  Now imagine trying to replicate the robust functionality of that same potential community in the off-line world.

I rest my case. 

So Happy Zero Birthday to Drug and Device Law.

Those of you who know or have worked with me are aware that I'm pleased to have a "best friends" relationship with the principals of Edge International, founded over twenty years ago, and a group of wonderfully talented people who are also fun and deeply edifying to be around.  (I also am proud of my strong relationships with individuals at Hildebrandt, at Altman-Weil, and elsewhere in the industry, but those are not topics for today.)

The announcement:  As of December 1, an outstanding group of people from Edge have combined with Alan  Hodgart, based in London, and with Tim Leishman, based in Toronto, to form Kerma Partners. 

I wish the best of luck to both the new venture and to Edge, both populated by good friends of long standing. 

From the Journal of Economic Education (hat tip to "Truth on the Market") comes the first study I'm familiar with examining whether the choice of undergraduate major has any effect on a lawyer's career earnings.  And guess what?  If you major in economics, it helps; majoring in anything else makes no difference.

Here's the abstract, in full (emphasis supplied):

"Using nationally representative data, the authors examine the effects of preprofessional education on the earnings of lawyers. They specify and estimate a statistical earnings function on the basis of well-established theory and principles. Along with standard control variables, categorical variables are included to represent graduate degrees in addition to the law degree and an assortment of undergraduate major fields. Holding a Ph.D. or M.B.A. degree, with the law degree, is associated with significantly higher earnings in some sectors. Lawyers with undergraduate training in economics earn more than other lawyers, ceteris paribus, and economics is the only undergraduate field associated with earnings that differ significantly. The available evidence supports the hypothesis that economics training increases a lawyer’s human capital compared with other undergraduate majors."

That still doesn't mean Adam Smith would become a lawyer were he alive today; but I know in my heart that he would have an active and energetic blog.

"The dismal science?"  You won't be surprised to hear that that's about the last way I'd describe the art and discipline of economics, and a new book, Knowledge and the Wealth of Nations, reviewed by Paul Krugman in yesterday's Sunday Times Book Review sounds like a wonderfully exciting intellectual exploration of why I believe economics retains its ability to fascinate as it attempts to explain how people, ideas, and things interact to try to produce value.

 The author, David Warsh, a former economics correspondent at the Boston Globe, Forbes, and The Wall Street Journal, writes the online weekly, "Economic Principals."  The book tells the story of how academic understanding of increasing returns to scale, and indeed of growth itself, was revolutionized in the past few decades by introducing the concept of knowledge itself as a factor of production, at long last joining the classical triumvirate of land (a/k/a tangible resources), capital, and labor.

When a book gets advance praise like this, the reason I continue to adore economics should be clear:

“Romer’s understated but earth shattering work deserves our attention and a Nobel prize in economics.”
— John Doerr, partner, Kleiner Perkins Caufield & Byers

As loyal readers know, I had a nasty brush with copyright law and the ALM Media inhouse law department this past Monday. 

In a nutshell, after spending part of the weekend generating four pieces on the 2006 AmLaw 100 (released last Friday)—here, here, here, and here—first thing Monday I returned a phone call from an assistant general counsel at ALM Media who proceeded to tell me that everything I'd written violated their copyright in the AmLaw 100 and that I must take it all down forthwith.

I did not, and I did what any lawyer with himself for a client would advise:  Call in the experts.

The good news is I learned a lot about copyright and fair use thanks to the superb counsel and advice I was able to draw upon, ranging from nearly a dozen readers, many of whom I'd never heard from, who offered their thoughts in personal emails (which were without exception generous and supportive) to a few friends who happen to be IP lawyers, to another friend who's the heaviest hitter of all in this area, as General Counsel of a major publicly-traded media organization.  (You know who you are.)

Consider what follows, then, a small effort to repay the collective efforts of the blogosphere, and an attempt to memorialize what I learned in hopes it might be useful in future to someone finding themselves in a similar situation.

One motivation for doing this is the remark of an IP practitioner and friend who, unsolicited, volunteered the opinion that "There are entire in-house law departments devoted to sending out legally unjustified cease and desist letters." And the truly bad news is not that dismaying commentary on the paucity of ethics, but his additional observation that far more than half the time, threats work.

David Maister, who knows his way across the management/leadership landscape so much better than almost anyone else that he seems to have been GPS-enabled while the rest of us were relying on 15thC. parchment maps, has taken off from my post of a few days ago about leadership.   Here he is getting warmed up:

"I keep getting asked about this topic, so here goes my ten cents worth. I think more rubbish has been written about ‘leadership’ than almost any other business topic. A lot of it is patently false, and even more of it is dangerous."

And I bet you didn't know that "manager" derives from medieval French or Italian meaning, roughly, "holder of the horses," while "leader" is of Chaucerian-era origins and means one who chose the expedition's route, a model "that won't work," David states flatly.

Enough; just go read the whole thing right now.