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New economics, new management

Mon, 28th Feb 2011

Management takes such legitimacy as it has from economics, just as economics, equally misguidedly, has modelled itself on the ‘hard’ sciences such as physics.

It should matter to managers, then, that conventional economics, the kind that has shaped the thinking of policymakers and corporate leaders in both public and private sectors for the last 30 years, is in deep, deep disarray.

To put it bluntly, the events of the last three years have dealt it a blow from which it can’t recover. Luminaries as different as as Alan Greenspan, Nobel laureates Paul Krugman, Joe Stiglitz and Paul Samuelson, Larry Summers and Willem Buiter have all lined up to say publicly the same thing: market fundamentalism is dead, and whole swathes of economics needs to be rethought along the lines of what is, not what economists think it ought to be.

Three recent books do a good job of stating the revisionist case. Ha-Joon Chang is a Cambridge economist working within the traditional frameworks, and the finding of his excellent 23 Things They Don’t Tell You about Capitalism (Allen Lane, 2010) is admirably clear: ‘The last three decades have shown that, contrary to the claims of its proponents, [free-market capitalism] slows down the economy, increases inequality and insecurity, and leads to more frequent (and sometimes massive) financial crashes’.

Among the myths he takes on are rationality (the foundation of coventional economics) – since we can’t predict distant or sometimes even immediate outcomes, we need safety standards for financial instruments just as we do for cars, planes and drugs; self-interest – companies run for the benefit of shareholders do worse than those that aren’t; pay as an objective measure of performance – the poor tend to be more entrepreneurial than the rich, and a juster society would level the playing field to allow them to prove it; the obsolescence of manufacturing, which has misdirected investment towards problematic ‘thin air’ targets such as formal education and the spread of the internet; and finance as a source of growth and innovation.

Chang concludes that governments need to get better at crafting a more dynamic, stable and equitable economic system – which means ‘building a better welfare state, a better regulatory system (especially for finance) and better industrial policy’.

Chang’s subject isn’t the crash itself, but it certainly reinforces his findings. In his entertaining and provocative Zombie Economics: How Dead Ideas Still Walk Among Us (Princeton, 2010), on the other hand, the Australian economist John Quiggin deals with the GFC (global financial crisis) head on, showing how the implosion of the financial system fatally undermines both economists’ most cherished axioms – efficient markets, general equilibrium, trickle-down, privatisation – and the policies based on them.

He shows that the ‘great moderation’ was a sham, providing soothing camouflage for the reversal of the long-term trend towards social protection and a ‘great risk shift’ from corporations and governments to individuals and households. This is the imbalance that now needs to be corrected, by policies and by economics that ‘focus more on realism, less on rigor; more on equity, less on efficiency; more on humility, less on hubris.’

Exactly the same, of course, applies to management – as proved, if proof were needed, by the third of the book trio, Dan Ariely’s Predictably Irrational (Harper, 2009). Ariely is among the most prominent of the new breed of behavioural economists shaking up the profession by taking the injunction to realism seriously, not least by taking the unheard-of step (for an economist) of testing his hypotheses with empirical experimentation.

From these experiments come some remarkable reappraisals, which conspicuously support the revisionist conclusions of Chang and Quiggin. Thus, Ariely’s experiments suggest that human preferences are so manipulable that our choices and trades in the marketplace are unreliable guides to our real utility; so unreliable, in fact, that ‘market prices’ themselves become arbitrary and suspect. Demand and supply aren’t separate things.

Momentous consequences flow from that. If, reasons Ariely. we can’t rely on market forces to set optimal market prices, and nor can we expect choice to be an accurate reflection of individual preference, the market’s claim to be an infallible allocator of resources falls away. For society’s essentials such as healthcare, medicine, education and the utilities, judicious governments must have at least a regulating role, ‘even if it limits free enterprise’.

The conclusion is underlined by other significant experiments with social and market norms. If the efficiency claim falls, and if, as it seems, money turns out to be the most expensive (and not very effective) motivator, then we need to protect the areas (healthcare, medicine, the professions) where cash is not king; where, to paraphrase Herzberg, people do a good job because they are given a good job to do.

As for management, the things that some of us have been banging on about for years turn out to be completely compatible with, indeed vindicated by, the new economics.

Reality demands that since human beings are malleable and neither all good nor all bad, we need to build organisations that bring the best out of them, not the worst. Equity demands that we build organisations that share risk and reward collectively, instead of heaping it on some constituencies to the benefit of one alone. And humility requires people think about the job rather than the reward, the whole rather than the part, the social as well as the commercial, and the planet alongside shareholder value.

If traditional economics is a zombie that needs garlic, a cross and a stake through its heart, then that goes for traditional management too.

 


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