The Whitehall Effect

As regular as bonfire night, last week saw the UK’s ritual annual outsourcing row. In 2013 the Institute of Government urged a halt to central outsourcing pending a review on the grounds that Whitehall lacked the management skills to make it work. Last week it was the turn of the Public Accounts Committee to charge that departments were overreliant on a handful of ‘quasi-monopoly’ contractors, two of them under investigation by the Serious Fraud Office for gross overcharging. The ‘markets’ being created by this kind of privatisation, charged the IG, were reducing competition and choice rather than enhancing them.

This is a fail in its own terms: but beyond that choice and competition are in themselves wrong-headed and self-defeating goals. These assertions run so counter to the authorised version that Whitehall simply blanks them out, which is why the outsourcing juggernaut rolls on regardless. This is one of the central themes of John Seddon’s important new book, The Whitehall Effect – How Whitehall Became the Enemy of Great Public Services and What We Can Do About it, which takes as its invaluable task the deconstruction of the current public-service paradigm (which is what it is) and the substitution of a better one.

Disclosure is in order here – while the ideas are distinctively Seddon’s, developed in Vanguard’s hands-on consultancy work across public- and private-sector organisations – I did some editing work on the book. I am proud to have done so, because while, as one Amazon reviewer puts it, Seddon’s narrative will certainly ‘make any rational person angry’, it fulfills a larger ambition. It puts in place a hard evidence base for a replacement offering hope and even (not a word to use lightly) inspiration for those who believe that management and public service have more to offer than cost-cutting, rationing and increasingly intrusive individual performance management.

To my knowledge, no one before has put together a satisfying intellectual pedigree of UK public services explaining both how they have come to assume their current form and why the latter is so dysfunctional. Seddon shows how the computerised call-centre/front-and-back-office/shared service model derives from – and suffers all the disadvantages of – traditional batch manufacturing, with its emphasis on standardisation, economies of scale and unit costs. This model, although still largely followed, was already obsolescent even in manufacturing by the late 1980s. In services, where the nature of demand is infinitely variable, the adoption of standardisation has been predictably disastrous.

As citizens, what we now get are shrink-wrapped, mass-produced service packages designed for lowest cost by commissioners and specifiers. They do such a poor job of meeting real need that they generate more demand (more contacts, more explanation, more referrals and assessments, more useless activity) than they satisfy.

Here in a nutshell is the whole slow-motion nightmare of everlasting austerity: public services that generate demand rather than meet it, apparently justifying more cuts that make matters grindingly worse. As Seddon explains, the ‘choice’ people really want is having their individual needs met; deciding between competing suppliers of similar bog-standard, ill-fitting packages, the Whitehall version of ‘choice’, is a bad joke, a travesty that delivers the worst of both worlds: a kind of market Stalinism in which product and cost are centrally planned and (see the PAC report) contracting is weighted in favour of the largest, cheapest and most cynical suppliers who care most about their shareholders and least about customers and workers.

One by one, Seddon picks off all the current public-service nostrums: as well as choice, personal budgets, commissioning, managing demand (aka rationing), risk management and lean have nothing to do with the purpose of a service in the only way that matters, as a citizen would define it. They are just activity. Some chapters (for example on procurement, aptly subtitled ‘how to ensure you don’t get what you want’) make you want to cry, laugh and smash up the furniture at the same time. As he reminds us, in the absence of real purpose the management measures used – in targets and standards, inspection and regulation and performance management (managing individuals rather than the system) – fill the void, distorting priorities and diverting effort and ingenuity into self-defeating attempts to do the wrong thing righter. The result is degraded services, disengaged citizens and demoralised public-service workers.

By definition, a paradigm is monolithic; at some point, it can no longer be incrementally force-fitted to the emerging evidence and has to be replaced. In other words, you can’t get to where we want to be by altering targets and standards. Getting over this hump is hard – ‘it is difficult,’ as Upton Sinclair noted, ‘to get a man to understand something when his livelihood depends on his not understanding it’ – which is why the careful dismantling of the monolith is essential part of Seddon’s project. But as important is the positive element, ‘the principles and practice’, to quote Lord Victor Adebowale’s foreword, ‘of how public services could empower citizens, could be exciting (yes, exciting) to deliver, and could genuinely add value to the lives of the public who pay for them’.

They could also return lost legitimacy to politics and Whitehall. ‘Politicians don’t know much about management,’ writes Seddon. But nor should they. Their mandated role is not to micro-manage but to focus on the purpose of public services for the people they represent. This ‘puts politicians where they need to be: connected to [their voters], able to appreciate the value of public services in their terms… but also to understand how better services build stronger communities, resolve social problems and lower costs’. Leaders of public services should be freed up to determine the measures and methods they use to meet these ends, with the role of ‘intelligent’ inspection and regulation restricted to testing whether the methods (whatever they are) really do drive improvement against purpose.

One of the ironies is that, when people can break the straitjacket of the dominant paradigm, such an agenda transcends considerations of right and left. Thus, in the US it is gaining traction in avowedly hard-right states like Texas and Utah, where politicians and technocrats are flocking to see how officials are respectively slashing prison populations (Texas of all places has closed three prisons so far) and dramatically reducing homelessness by resolving the issues that threw individuals off course and getting them on their feet again. The motivation is simple: it costs the taxpayer too much to keep people in prison or in homeless shelters, much less to do whatever it takes to get them off the state’s books, permanently. One state’s ‘financial rectitude’ is another’s ‘enlightened treatment of social problems’; whatever, it’s a result.

Under the radar, many similar initiatives in the UK public sector are producing the same kind of results, which Seddon has documented in a number of previous books and articles. This, though, is the most important and authoritative. In the run-up to the election, it has a direct message for every voter and politician as well as service leader: this is a set of ideas whose time has surely come.

How measures make (and unmake) management

One of the emerging sub-themes in debates on the ‘great transformation’ at the engrossing Global Peter Drucker Forum a couple of weeks ago was measures. Everyone agreed that measures were important (‘what gets measured gets managed’, etc), but there was less clarity about what in the transformed world they should look like.

‘What are the metrics for the new economy?’ pondered one Silicon Valley entrepreneur. In a plenary on the same subject, along with junking shareholder value (MSV) and top-down hierarchical management practices, speakers and audience debated whether ‘creative companies’ should abandon narrow financial metrics for broader, more inclusive ones.

My observation that the three items the plenary was questioning (purpose, measures and method) were systemically linked brought a gratifying name-check from the platform. Actually, I claim no credit for the idea: that belongs to John Seddon, who along with his colleagues at consultancy Vanguard have observed and tested the link in hundreds of service improvement assignments in both public and private sectors.

Seddon’s insight is that this invisible link is not just important: whether managers know it or not, it is what makes the organisation tick.

Here’s how it works. When measures are derived from purpose (what the organisation is there to deliver from the customer’s point of view), they guide method, in a good way. Thus, when Taichii Ohno, architect of the Toyota Production System, was asked near the end of his career what he was working on, he replied: ‘Shortening the time between receiving a customer’s order and taking his cheque’. The purpose of the TPS is to deliver to the customer exactly the car ordered as fast as possible. The metric of end-to-end time drives quality (there’s no point delivering a manual if the buyer wants an automatic) and all the methods, from kanban to factory layout to near-instant machine set-up times, that managers and front-line production workers have devised to get delivery times for some Toyota vehicles down to one or two days. Apple uses similar principles and measures in building computers to order.

End-to-end time and quality put the emphasis on flow rather than quantity, and are the secret of high-performing customer service and service delivery systems too. One of the key functions of measures is to connect actions with consequences. They foster self-knowledge and learning. If this is our purpose, as defined by the customer, what is our capability and how reliably do we meet it? Knowing our real capability (often a wake-up call to managers who have never posed the question before), what methods do we use to improve against the purpose? If we do this, what are the consequences in terms of desired outcomes?

By contrast, look at what happens when purpose goes by default or is set by a manager or, as is usually the case in public services, by an inspector or regulator. Measures still drive practice and method – but not in a good way. In both public and private sectors, for example, customer contact centres use measures that reflect top management’s view of service. Based on the desire to control cost and achieve economies of scale, they usually measure functional performance and activity (time to pick up the phone, call-handling time, number of calls per day) and instead of learning and improvement are used to secure compliance and manage performance through targets, standards and league tables. In relation to real customer purpose (‘solve my problem as quickly as possible’) they are arbitrary and irrelevant; in the absence of connection to the customer, meeting them becomes the purpose – ie satisfying the manager or inspector rather than the customer. Because they ignore the hidden thread that links them to purpose and method, managers using such measures are, in systems guru Russ Ackoff’s immortal phrase, condemned to ‘do the wrong thing righter’, which actually makes them wronger, worsening service and driving up cost.

Why does customer service by banks, phone companies and public services never get better? Because what managers and politicians and managers view as great service – that is, meeting all their targets and standards – has no bearing on quality as experienced by the customer. Hence the phenomenon of MP’s surgeries full of constituents complaining loudly about lousy service by departments or services officially rated as five-star, or top-ranked units suddenly being placed in special measures as they are hit by scandal. As Vanguard’s Andy Brogan puts it, ‘It’s not simply a case of defining the right measures – that’s a hygiene factor. What’s critical is what the measures are used for. The problem is not just that we end up doing the wrong things, it is that they keep us blind to the impact on the true purpose.’

The relationship between purpose, measures and method also helps explain performance at corporate level too. Drucker said that the sole valid purpose of a business is to create and keep a customer. Toyota and Apple have internalised this insight, and their measures and methods are all geared to support it. In this vision profit is not the purpose but a function of how well they are meeting it. Chiming with this, Jim Collins and Jerry Porras in their research found that companies defining their purpose directly in terms of maximising shareholder value did less well for shareholders than comparators that focused on doing right for customers.

It’s not hard to see why. If you use measures that cause you to do the right thing better, then you’re driving in the opposite direction from those that are doing the wrong thing, however well, and customers reward you accordingly. The other way round, as has been said many times, no one gets out of bed in the morning itching to make money for shareholders. Workers have to be incentivised and dragooned into doing so with measures using budgets, targets and standards focused on the financials (what the manager wants, not the customer), all of which can be and frequently are gamed as people strive to meet their de facto purpose.

The tighter the linkages in such perverse couplings, the more likely they are to end in tears. At the extreme, the dynamic so corrupts the original goals that outcomes turn into their linguistic opposite, a process that John Lanchester in his recent How To Speak Money terms ‘reversification’: ‘enhancements’ that make service worse, ‘securitisation’ as risk, ‘credit’ as debt and HR as sacking people. At the far end of this road lie whole organisations that are negative versions of themselves: benefits offices whose job is to refuse applicants, banks that make people poorer, medical practice as at Mid Staffs that kills patients rather than cure, shareholder-value maximising companies that destroy value. These pathologies then drive ever tighter compensating rules and regulations until they end up reversifying management itself: a technology that, as Drucker pointed out, all too often makes it harder for people to work, not easier, a creator of problems rather than solutions.

So yes, measures are more important even than people think. While good measures foster learning and improvement, bad measures do the reverse, not only causing people to do the wrong things but also blinding them to the effects. The tests of a good measure are the same in the new economy as in the old: they are related to purpose and what matters as defined by the customer; they are used by people doing the work, in the work, to understand and improve the work; and they make visible to the people who do that work the consequences of their actions for the achievement of their purpose.

Rebooting management

J D Wetherspoon is a successful pub group with a long-term view. In contrast to the rest of the industry, sales are buoyant, and the company has opened 40 new pubs this year. But the news in its recent quarterly results that it had awarded its employees a 5 per cent pay rise sent its shares tumbling. On the other hand aeroengine maker Rolls Royce, which has had a poor couple of years, was rewarded by a boost to the share price after it announced it was cutting its workforce by more than 2,000, many of them in the UK.

Welcome to the new normal. Perhaps not surprisingly, Wetherspoon CEO Tim Martin is an exception in his willingness (and ability) to raise two fingers to the City. Most others are less brave. The cumulative effect of 30 years of of diminishing corporate courage and increasingly overweening finance is that the UK in 2014, the 13th most prosperous nation in the world, now has 5.28 million people, or one-sixth of the employed population, working for less than a living wage (currently defined as £7.85p an hour). Unemployment is falling, but the slack is being taken up by the self-employed, now numbering 1.7m, and more likely to be cab drivers than entrepreneurs. In today’s hour-glass shaped jobs economy, cab drivers, carers and pittance-earners in the ironically named sharing economy is all they’ll ever be. Real wages have been falling for seven straight years; as a share of GDP they have lost 10 percentage points since 1973. Only one in seven people in the UK (one in 18 in the north of England) says that they have felt the effects of the ‘recovery’; more than half believe the UK’s best days are gone. More austerity – much more – is in the pipeline, and the climate of antagonism, tacit or overt, against immigration, Europe and the poor is the ugliest in my lifetime.

The underlying truth is: for most people there isn’t going to be a recovery. This is pretty much as good as it gets. As Paul Mason notes in his piece, it is financialisation – companies dancing to the tune of the insatiable capital markets – that is the primarily cause of widening inequality, not technology or globalisation, the two other usual suspects. In other words, business as usual has become the problem we need to solve. Capitalism UK (and US) style is broken, unable to provide not only luxuries but the basics: proper livelihoods for the employed, pensions for those retired, or reliable investment returns for all but a handful of CEOs and hedge-fund activists who thrive on market volatility.

This is the backdrop against which academics, managers and commentators (including this one) will meet this week in Vienna for the 2014 Global Peter Drucker Forum. The theme of the Forum, set up to commemorate the man who was one of the first and most influential of all management thinkers, this year is the ‘great transformation’: what it will take in management terms to get beyond today’s stasis and trigger a real recovery. It’s a worthy cause, and one that measures how far the discipline has diverged in the last 30 years from the human-centred ‘liberal art’ (his words) that the Viennese-born Drucker espoused.

‘We have arrived at a turning point,’ says the Forum’s launch abstract. ‘Either the world will embark on a route to long-term growth and prosperity, or we will manage our way to economic decline’. This puts managers in an unaccustomed and uncomfortable position. As the FT’s Andrew Hill put it in a penetrating piece, what has come to be management’s default mode – internally focused, often detached from purpose, numbers- rather than people oriented, with scant appetite for change – will suddenly no longer do. Quoting Henry Mintzberg, who pointed out that east Europeans pushed through obstacles to change 25 years ago because they ‘understood full well how enslaved they were by their system of governance’, Hill notes that not only have default managers lost sight of their part in perpetuating today’s failing system, ‘more worryingly they fail to recognise they have the potential to change it’.

One plenary forum session takes the bull by the horns to pose three questions: Should firms shift their focus from maximising shareholder value to adding value for customers and citizens? Should they change from narrow financial to more inclusive metrics? Should they abandon traditional hierarchical management for approaches that encourage initiative and creativity rather than compliance? To all of which the answer is yes. Drucker always insisted that the company was a social institution that could only harness the potential of its people if it fully respected them. If not a noble calling, management was a central resource of society whose ‘very survival … is dependent on the performance, the competence, the earnestness and the values of their managers’. As usual he was ahead of his time. Never was that more true, or a reset of the management default more urgent.

But where are the jobs?

In its October 4 edition, The Economist ran a special report with accompanying leader on ‘The the third wave’ – the ‘modern digital revolution’ now breaking and its consequences for the world economy. This being The Economist, the overall conclusion, adduced from the historical evidence of the first and second industrial revolutions, is cautiously optimistic: ‘this newspaper believes that technology is, by and large, an engine of progress’. Yet despite the proviso that the favourable results could on past precedent take many years to feed through, or more desperately that the technological revolution could ‘create vast numbers of jobs nobody has yet imagined, or boost the productivity of less-skilled workers in entirely novel ways, perhaps through robotic exoskeletons or brain implants’, the interesting thing is how little the positive conclusion is supported by what has gone before. The evidence simply doesn’t justify it. A truer flavour of the piece is given by the title of the accompanying leader, ‘Wealth without workers, workers without wealth’.

Briefly speaking, the report notes that ubiquitous computing driven by Moore’s law (which predicts that computing power per chip doubles every two years while halving in cost) is about to unleash a tsunami of economic disruption which upends all established ideas about the job split between humans and computers. Nearly half of all US jobs could be automated away in the next 20 years, according to one estimate. The income distribution is being hollowed out, with many fewer jobs in the middle tier, many more at the bottom and a very, very few soaring away at the top. In the developing world, the change threatens traditional routes to development through ‘premature deindustrialisation’. As the author concedes, whether the digital revolution will bring mass digital job creation to make up for the mass job destruction – or as I would put it, whether it represents progress or a step backwards for human civilisation – remains to be seen.

As you would expect, the report is well written and thought-provoking. But all the sources, references and thinking here are economic. In this analysis everything is down to economic determinism, and nothing to human decisions and motivations. This is a common failing in neo-liberal economics, and it substantially undermines even the report’s hesitant techno-optimistic conclusions

There is no mention here, for example, of the rise of big data, giant computing ‘clouds’ and National Security Agency pointing ‘to a future in which technology’s ability to set mankind free is far from guaranteed’, as a recent FT book review mildly puts it. No mention either of the point (made in the same review) that the new digital reality looks suspiciously like the old one before PCs, a world of centralised computing but this time concentrated in the hands of a few giant companies and governments. It ignores the ‘winner takes all’ tendencies this enables, brilliantly illustrated by the woefully-misnamed ‘sharing’ economy, which crunches up real jobs and spits out the remains as pitifully paid micro-jobs – all this at a time when, as the survey does acknowledge, computers are having no mitigating effects at all on the costs of living basics such as housing, healthcare and education, which are soaring everywhere. There is no mention of the issue of power – the fact that the US banks at least, and some of the internet companies, now far outstrip the ability, or willingness, of the authorities to regulate them.

Most glaring of all, comparisons with previous technological upheavals – the first Industrial Revolution in the late 18th century and the second a century later that brought in electricity and the internal combustion engine – are vitiated by the fact that in neither of those cases were the outcomes influenced if not determined by an ideology that dictates that the sole beneficiaries of corporate activity are shareholders. There were of course plenty of immediate losers both times round, and it took time for the cumulative benefits to spread through the economy. But even though capital emerged dominant over labour, by the early 20th century there were sufficient countervailing forces in the shape of trade unions and enlightened employers to ensure that until well after the mid-century the labour share of GDP remained robust and stable.

Is it coincidence that the decline of the labour share, the hollowing out of the Anglophone economies and widening income inequality all began in the late 1970s and 1980s with the advent of the shareholder value movement and have picked up pace ever since? As just one example, Thomas Piketty has identified the emergence of corporate ‘super-managers’ as an important element in increasing wealth and wage inequality. While the Economist author assumes that pay differentials are simply the market reflection of different levels of talent, no one who has looked at it in detail can doubt that soaring pay for CEOs and collapsing pay for everyone else are two sides of the same coin, driven in different directions by the incentives created by governance based on maximising shareholder value. Here is not the place for a description of the multiple pathologies associated with shareholder primacy (there is an impressive list compiled by the consistently excellent Steve Denning on his Forbes blog here and a more academic statement of doubts here) – but as I have argued before, at the very least they are shaping the way the digital revolution plays out in practice, and not in a good way.

The Economist’s leader on the subject warns that governments will have to react faster than they did last time, when it took 100 years to make the education investment that enabled workers to benefit from the original industrial revolution. But while no one would quarrel with better education per se, it’s an illusion to think that this time it can solve a problem that’s posed on a wholly different plane. The big issue this time round isn’t levels of education, it’s the investment behaviour of CEOs. To echo city economist Andrew Smithers, if we can’t change the incentives that govern CEOs’ allocation of corporate resources, all the rest is whistling in the wind.

The doctor’s dilemma

Last week (after a three-week wait) I went to see my GP, a senior member of a very busy and ethnically diverse central London practice. Knowing the surgery was scheduled soon to relocate to a big new redevelopment nearby I asked when the move would happen.

Usually brisk and businesslike, this time she sighed. She looked knackered. ‘We don’t know,’ she said. The practice needs to move, she explained, because it is running out of space in the grand but inconvenient Georgian townhouse it currently inhabits, where in any case the lease runs out in eight years’ time.

The reasons it is running out of space are twofold and very much of our time. The first is that more and more medical care is moving out of hospitals and into the community, and extra space – not to mention GPs, nurses and support staff – is needed to accommodate it.

The second is that another local practice, unable to cope with the mounting pressures, recently closed down (which it is perfectly entitled to do, since GPs are private contractors to the NHS, not employees). Its patients have to re-register somewhere else, and there are financial penalties for a surgery that chooses not to take them on. In effect, our surgey is in a cleft stick: it suffers if it doesn’t take the new patients on, and if it does it needs more GPs and space.

The snag with moving, however, is that rents in the new development are sky high – and the current landlord will invoke a penalty clause if the centre vacates the premises early. To sum up: the cost of the move is £500,000, which the practice doesn’t have. So relocation, and with it the future of our harassed but functioning and proactive practice, is in limbo. In the meantime, the pressures grow: ‘This is why you have to wait a month to see me’. (My sister tells me that her practice, also in London, books no more than a month ahead, so if that month is full, you can’t make an appointment at all.)

‘Anyway, in eight years’ time it will be someone else’s problem,’ the doctor said. ‘I never thought I’d say this, because I love seeing patients! But I’m 54, and there’s no way I shall stay a day after I’m 60. I’m already doing a four-day week, because of the pressure’ (she uses the other day to catch up on paperwork and read the medical journals). ‘My colleagues of my age are all the same.’ The NHS is doing nothing to induce senior GPs to stay on, she says, and fewer and fewer students are choosing to go into general practice – not because it is unattractive in itself, but because of the pressures and diktats raining down from all sides that make it impossible to do the job with any kind of satisfaction.

This is the moment – with the NHS’s stresses and strains all over the front pages and its deficit predicted to rise £30bn by 2020 – that David Cameron chooses to decree that by the same date all GP practices will open seven days a week. My doctor concedes that better out-of-hours access and possibly Sunday working are desirable, but their arbitrary imposition without discussion or any idea of the demand or resources needed fills her with despair. For many, like the closed neighbouring surgery, it will be the last straw.

In Out of the Crisis, W. Edwards Deming wrote: ‘If you have a stable system then there is no use to specify a goal. You will get whatever the system will deliver. A goal beyond the capability of the system will not be reached. If you have not a stable system, there is no point to setting a goal. There is no way to know what the system will produce: it has no capacity.’ Poor NHS. It’s not just that it has no capacity. Constantly tampered with by ministers and civil servants who have no idea how systems work, or people within them, it is being made almost daily more unstable, more difficult to manage. They are making matters worse.

It takes some doing, but we have somehow managed to contrive a situation where UK public services instead of pointing forward simultaneously unite the worst features of Soviet-style central planning and unreconstructed market capitalism: on one side detailed ministerial micro-management (dictating details of how services should be set up and run – wrong in principle as well as method chosen, since it stifles desperately-needed innovation and locks in today’s Kafkaesque inefficiencies), to the profit of private outsourcers and IT consultants whose priority is not citizens but shareholders.

It is a system riddled with waste, inefficiency and conflict of interest bordering on corruption that harassed and dedicated professionals like my doctor manage to make work, more or less, in spite of itself. They have to fight the system to do the right thing. Given the constraints of these system conditions the wonder is not that there are so many lapses and scandals, but so few. ‘There may not be an NHS in eight years’ time,’ my doctor said quietly as I left.

The power of an idea

[The High Pay Centre is running a series of events looking at the political power of business in the UK. This is the text of my presentation at a lunch on 10 September 2014]

I want to say a few words about the power of ideas – even mistaken ones, even especially mistaken ones. It’s only by understanding how they arose that we can demystify and debunk them.

I’m going to trace the story of why we’re here, why the High Pay Centre exists and why there’s still an unresolved problem with high pay back to 1970, and more precisely 13 September 1970. That’s the date, according to Dominic Barton, global managing director of McKinsey, that capitalism started veering off track, and it was the day that the New York Times published an essay by Milton Friedman called ‘The Social Responsibility of Business is to Increase its Profits’.

‘In a free-enterprise, private-property system,’ Friedman wrote, ‘a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to their basic rules of the society.’

As it happens, this is actually wrong in almost every particular. In law, managers aren’t employees of shareholders, who don’t own the business. Firms are separate legal entities that own themselves, it’s they that employ directors and executives, and they to whom the latter owe fiduciary duty.

It’s hard to credit, but at the time the idea that the purpose of the firm was to maximise returns to shareholders was novel, even revolutionary. Yet by the turn of the century it had the status of ‘holy writ’, more religion than science, as one writer put it. The purpose of the corporation, it was claimed, had been settled once and for all, and it was only a matter of time before the rest of the world fell in line with the US.

It is a truly remarkable story, even more so since how it happened has nothing to do with whether it was right or not, and all to do with institutional ambition, opportunism and unintended consequences. As Rakesh Khurana wrote in his wonderful book on US business schools, From Higher Aims to Hired Hands, ‘The development of economic institutions… is not simply a function of their efficiency; rather it often results from the outcome of contests in the legal, political, social, and cultural realms’. It’s about the play of different interests, including those of class. It’s political, not technocratic.

Six years after Friedman, another article, another milestone on the road to hegemony, this one called ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’, by Michael Jensen and William Meckling, published in 1976 in the Journal of Financial Economics. It’s full of graphs and equations which make it a tough read for non-specialists, but it is the single most cited article in the business literature.

In fact, the graphs and equations are part of the point. Management at that time was desperate to establish academic and scientific legitimacy, and in that context the idea of optimising the firm around a single measurable point, shareholder value, was a heaven-sent opportunity for academics to do just that. Of course what had to be left out of all this was anything to do with the human side of business, notably ethics and intentionality (not to mention things like luck and power) which can’t be mathematically modelled, so what the theory gained in ‘scientific validity’ it lost in common sense, but that’s a whole other, if fascinating, byway of the story.

Jensen and Meckling’s main assertion was that the fundamental problem in corporations was ensuring that self-interested managers focused on maximising value for shareholders rather than attending to their own concerns. It triggered a wave of scholarly theorizing which soon came to dominate the business-school research agenda in the US and UK.

Unlike most management theories, however, shareholder primacy had obvious appeal to other important constituencies as well. Not too surprisingly, the corporate raiders then on the prowl (they’d now be termed ‘activists), loved the idea because it seemed to justify their restructuring activities, which they accordingly redoubled. Institutional investors approved too, and so did the most powerful constituency, company CEOs, who soon discovered, and readily acquiesced to, the warming material benefits of having their interests aligned with those of shareholders by tying their pay to the performance of the share price.

The interlocking pieces were then fixed in place by governments and regulators as they proceeded to reshape governance and company law to give shareholders more influence over company boards and make managers more attentive to the share price.

In this way, an ideologically-based programme, purely abstract and with no empirical backing, has wormed its way into every crevice of management, to the point where it, and its assumptions, are not only unchallenged but have become invisible to the naked eye. Even now it’s rare to pass a week without reading in the FT or hearing on the BBC – for example during the Pfizer-AstraZeneca merger talks – someone starting a response, ‘of course shareholders own companies, so it comes down to them in the end.’

(I’m told that in the last review of UK company law, one or two bolder members of the review panel were firmly told that they could come up with any organising principle so long as it was shareholder value. The answer came out as ‘enlightened shareholder value’, a typically British compromise, which still leaves the UK as the most shareholder-friendly jurisdiction in the world.)

Ironically, the review took came out in 2006, just when the negative consequences of the four-decade-long practical experiment with shareholder value were beginning to emerge, and just two years before all the worst fears in that regard were confirmed by the financial crash.

It’s now clear that shareholder primacy doesn’t work even in its own terms.

Shareholders are suffering their worst returns since the great depression, and Roger Martin has shown that over the whole period since 1970 they have done worse than they did in the post-war years when their interests weren’t put first. The regime doesn’t seem to do companies much good either. The longevity of publicly-quoted companies has tumbled, and their number is dwindling fast. Astonishingly there are now 50 per cent fewer British and US listed companies than there were 15 years ago.

One particular group has consistently benefited from the shareholder primacy regime, however – short-term shareholders comprising activists (hedge funds) and what Thomas Piketty calls the ‘supermanagers’, the corporate elite who since the 1970s (note the date) have come to constitute the largest part of the 1 per cent.

The mechanism that put them there, of course, was shareholder value and agency theory. That was what triggered the ‘revolution in management pay’ that we heard Andrew Smithers describe here a few months ago. Crudely, the revolution consisted in paying them in shares and options to make them think like shareholders, a wheeze that was instantly successful. Shares and options now make up 83 per cent of total top management pay in the US and somewhat less here.

Paying executives like this changed their behaviour, exactly as it was supposed to do. Instead of ‘retaining and reinvesting’ corporate profits, in William Lazonick’s phrase, benefiting all stakeholders, they started to use them primarily to ‘distribute and downsize’, prioritising shareholders. That did indeed push share prices up (and thus their own rewards), but at the cost of R&D and capital investment – with the consequences for corporate health and mortality that I’ve mentioned.

It’s the link with shareholder value, driven by the idea that shareholders own and control companies, that is the hidden mechanism that continues to pull executive pay upward while keeping the pay of everyone else down, irrespective of the effects on the rest of the economy. This is why Smithers said that dismantling the bonus culture that governs managers’ investment decisions is the single most important task facing economic and social policymakers in the world today.

I think he’s right, and that’s why we’re here today. Empirically and intellectually unjustifiable pay is the superstructure and it’s based on shareholder value which in turn rests on the deeply buried foundation of shareholder ownership. We’ve spent four decades vainly trying to make ownership work. It’s time to recognise that it doesn’t, and the alternative moreover is staring us in the face.

The beauty of the corporation is precisely that it isn’t owned, and it’s that which allows it to make the long-term commitments to all its stakeholders that Colin Mayer talks about in his book. Shareholder ownership, the concept launched on the world by Friedman in 1970, is where the demolition work on executive bonuses and shareholder value has to start if serious change is to take place.

In a celebrated passage on the power of ideas, Keynes wrote:

‘The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back… Soon or late, it is ideas, not vested interests, which are dangerous for good or evil.’

I suspect that he’d have written ‘ideas and vested interests’ if he were writing today. He added:

‘The real difficulty in changing any enterprise lies not in developing new ideas, but in escaping from the old ones.’