This post is by naval from Startup Boy
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Our brains aren’t evolved to comprehend new forms of leverage
Nivi: Why don’t we talk a little bit about leverage?
The first tweet in the storm was a famous quote from Archimedes, which was, “Give me a lever long enough and a place to stand and I will move the Earth.”
The next tweet was, “Fortunes require leverage. Business leverage comes from capital, people and products with no marginal costs of replication.”
Naval: Leverage is critical. The reason I stuck in Archimedes quote in there is… normally I don’t like putting other people’s quotes in my Twitter. That doesn’t add any value. You can go look up those people’s quotes. But this quote I had to put in there because it’s just so fundamental. I read it when I was very, very young and it had a huge impression me.
We all know what leverage is when we use a seesaw or a lever. We understand how that works physically, but I think what our brains aren’t really well-evolved to comprehend is how much leverage is possible in modern society and what the newest forms of leverage are.
Society overvalues labor leverage
The oldest form of leverage is labor, which is people working for you. Instead of me lifting rocks, I can have 10 people lift rocks. Then just by my guidance on where the rock should go, a lot more rocks get moved than I could do myself. Everybody understands this because we’re evolved to understand the labor form of leverage, so what happens is society overvalues labor as a form of leverage.
This is why your parents are impressed when you get a promotion and you have lots of people working underneath you. This is why when a lot of naive people, when you tell them about your company, they’ll say, “How many people work there?” They’ll use that as a way to establish credibility. They’re trying to measure how much leverage and impact you actually have.
Or when someone starts a movement, they’ll say how many people they have or how big the army is. We just automatically assume that more people is better.
You want the minimum amount of labor that allows you to use the other forms of leverage
I would argue that this is the worst form of leverage that you could possibly use. Managing other people is incredibly messy. It requires tremendous leadership skills. You’re one short hop from a mutiny or getting eaten or torn apart by the mob.
It’s incredibly competed over. Entire civilizations have been destroyed over this fight. For example, communism, Marxism, is all about the battle between capital and labor, das kapital and das labor. It’s kind of a trap.
You really want to stay out of labor-based leverage. You want the minimum amount of people working with you that are going to allow to use the other forms of leverage, which I would argue are much more interesting.
Capital has been the dominant form of leverage in the last century
The second type of leverage is capital. This one’s a little less hardwired into us because large amounts of money moving around and being saved and being invested in money markets, these are inventions of human beings the in last few hundred to few thousand years. They’re not evolved with us from hundreds of thousands of years.
We understand them a little bit less well. They probably require more intelligence to use correctly, and the ways in which we use them keep changing. Management skills from a hundred years ago might still apply today, but investing in the stock market skills from a hundred years ago probably don’t apply to the same level today.
Capital is a trickier form of leverage to use. It’s more modern. It’s the one that people have used to get fabulously wealthy in the last century. It’s probably been the dominant form of leverage in the last century.
You can see this by who are the richest people. It’s bankers, politicians in corrupt countries who print money, essentially people who move large amounts of money around.
If you look at the top of very large companies, outside of technology companies, in many, many large old companies, the CEO job is really a financial job. They’re really financial asset managers. Sometimes, an asset manager can put a pleasant face on it, so you get a Warren Buffet type.
But deep down, I think we all dislike capital as a form of leverage because it feels unfair. It’s this invisible thing that can be accumulated and passed across generations and suddenly seems to result in people having gargantuan amounts of money with nobody else around them or necessarily sharing in it.
That said, capital is a powerful form of leverage. It can be converted to labor. It can be converted to other things. It’s very surgical, very analytical.
If you are a brilliant investor and give $1 billion and you can make a 30% return with it, whereas anybody else can only make a 20% return, you’re going to get all the money and you’re going to get paid very handsomely for it.
It scales very, very well. If you get good at managing capital, you can manage more and more capital much more easily than you can manage more and more people.
You need specific knowledge and accountability to obtain capital
It is a good form of leverage, but the hard part with capital is how do you obtain it? That’s why I talked about specific knowledge and accountability first.
If you have specific knowledge in a domain and if you’re accountable and you have a good name in that domain, then people are going to give you capital as a form of leverage that you can use to then go get more capital.
Capital also is fairly well understood. I think a lot of the knocks against capitalism come because of the accumulation of capital.
More: See all posts on How to Get Rich.