Management as a productive resource

I’ve been browsing through Edith Penrose’s Theory of the Growth of the Firm, having read the biography by Angela Penrose, No Ordinary Woman. Published in 1959, it is an interesting narrative approach to the dynamics of individual firms, with plentiful examples from case studies. One can see that it was heading in a very different direction methodologically from mainstream economics, and hence why Penrose was taken up by business schools instead.

Yet mainstream economics is arguably rediscovering her core reasoning:
“The emphasis is on the internal resources of the firm – on the productive services available to a firm from management within the firm. … the experience of management will affect the productive services that all its other resources are capable of rendering.” The manager’s mind interprets the environment in which the firm is operating, the expectations of future demand and the directions in which to expand, she continues. It is not only the objective resources available, but how the management of the firm can use them, and how they understand the competitive environment in which they are operating. All of this reminded me very much of the recent World Management Survey work by Nick Bloom, John Van Reenen and colleagues looking at the importance of management quality for firm productivity. They write: “Economists have long puzzled over the astounding differences in productivity between firms and countries. In this paper, we present evidence on a possible explanation for persistent differences in productivity at the firm and the national level — namely, that such differences largely reflect variations in management practices.” Maybe Penrose was less puzzled than many.

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Low investment – another moan

A quick update on my previous post bemoaning low investment in the UK economy. Stian Westlake of NESTA asked a good question: one of the books I cited, Keith Smith’s , was published in 1984. Was this not just ahead of a long upturn in UK productivity growth, one of the stronger productivity performers in the OECD until the 2000s?

He answered his own question with a link to a NIESR growth accounting paper (pdf) concluding that both capital deepening and skills (human capital) deepening made small contributions to the improved productivity performance from the mid-1980s to 2009. The paper concludes: “The majority of the improvement comes from factors affecting the level of technology and the efficiency of factor use.” This in turn was driven by FDI and openness to trade. The impact of FDI on management skills has been confirmed subsequently by John Van Reenen and others.

Stephen King of HSBC, author of ,  pointed me to the chart below indicating the same thing.

Contributions to annual growth

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The tough life of the corner office

 by Ray Fisman and Tim Sullivan has a subtitle that many people might consider to be a contradiction in terms: The Underlying Logic of The Office. A majority of us work in offices, and we know it isn’t logic so much as emotion or perhaps just habit that drives things. Often, indeed, the emotions of the kindergarten playground.

Nevertheless, Fisman and Sullivan have achieved that rare feat of writing a book about management and organisation that offers genuine new insights, and is a good read as well. I thoroughly enjoyed it.

The key moment of illumination comes early in the book when they write: “Jobs that stay inside the org are the hard ones: hard to measure, hard to define and hard to do. If they were easy, we’d hire contractors to do them for us, and the market, with prices working their magic, would work just fine at getting the job done.” The way to understand orgs – and why so many are so badly run – is that the work people do in them is characterised by information asymmetries and transactions costs.

The book applies the principles of information economics to many examples of organisations ranging from the US Army and the Baltimore Police Department to Apple and Citigroup. It also covers issues such as organisational culture, rocketing executive pay, merger mania, innovation (they recommend the ‘skunkworks’ approach) and the like, bringing in other areas of economics as needed – game theory, economics of ‘superstars’, behavioural psychology.

For example, take the pay spiral. The chapter begins by recounting John Thain’s extravagance – $1,400 for a waste paper basket in an office remodelling that cost $1.2 million. It moves onto Henry Mintzberg and others documenting that what CEO’s do is get interrupted by people who want to talk to them, in between all the meetings. They have little time alone and certainly don’t spend time poring over data and documents to make a rational calculation about the best thing for the business to do. Decisions are based on the CEO’s judgements about information conveyed verbally by a selection of other people. The skill of the CEO is gathering and weighing soft information.

Relatively few do this well. After all, running an org is really difficult, as already described. So slightly greater skill in doing so is amplified into significantly greater pay: a good CEO decision will be really valuable financially to a big company. Just like Hollywood stars, a slight edge makes an individual executive a hot property in the CEO jobs market. The market rewards them correspondingly. Remuneration committees embed this upward spiral because they have interlocking memberships – not necessarily the same individuals, but connected in a social network. Besides, the Remcos believe that their guy is better than average – the Lake Woebegone effect – so deserves better than average CEO pay. And the spiral continues.  So this chapter uses various parts of the economics toolkit to explain the excessive pay phenomenon. CEOs are doing difficult work, are valuable to their orgs – and they’re still overpaid.

For, contrary to popular belief, management is in general a good thing. The authors cite evidence that better managers deliver better outcomes in the public sector, where administrators and managers tend to be reviled  – in terms of exam results in schools or survival rates in hospitals. One of the most striking bits of evidence is the massive increase in productivity in an Indian textiles firm given $250,000 of free consultancy advice by Accenture (49 firms turned down the offer, showing what they thought of management consultants). The key to the improvement was installing systems for tracking inventory and monitoring performance – reducing, in other words, the information asymmetries that had held back the business.

The book is packed with great examples. Fisman is Professor of Social Enterprise at Columbia Business School, and was the co-author of another terrific book,  (with Ted Miguel). Sullivan is editorial director of Harvard Business School Press.

Their bottom line is that managing an organisation is intrinsically difficult. “If there’s one message to take away from this book, it’s that a glass half full may be the best you can hope for.” That is so much more plausible a conclusion than conventional management books that advocate one gimmick or another.

Even with this note of realism, though, the principles and examples set out in The Org will help anybody who manages anything think through the specifics of their own organisation, and maybe improve its management a little. And even small improvements are well worth having.

[amazon_image id=”0446571598″ link=”true” target=”_blank” size=”medium” ]The Org: The Underlying Logic of the Office[/amazon_image]

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Business monoculture

My post yesterday on the lack of interest in Lincoln Electric’s combination of profit with an employment guarantee has prompted some debate. The story is told by Frank Koller in his book .

[amazon_image id=”1610390539″ link=”true” target=”_blank” size=”medium” ]Spark[/amazon_image]

Henry Stewart (@happyhenry) of Happy Computers pointed to more evidence on the commercial benefits of good employment practice (in his comment). On Twitter, Stephen King of HSBC (@KingEconomist) said Lincoln’s practice sounded like the Japanese system of a lifetime employment guarantee, which was now discredited. I think it’s actually a bit different: a promise by specific firms not to lay workers off rather than an expectation that many or most people in society will stay in one firm for their whole career. After all, Lincoln operates in the context of the fluid US labour market.

However, Stephen and I agreed that there is every reason to prefer a plurality of corporate models, and what a shame it is that there are not more alternatives to the conventional joint stock model. Monocultures are rarely healthy.

The model chosen by a specific business should depend on the transactions costs and information asymmetries that we know are important in determining the shape of any business. A commitment by employers to keep workers in a job as long as they want will make a lot of sense in an industry where craft skill and tacit knowledge is vital, for the reasons explained by the signalling literature; less so where the tasks involved in the job are easily codified.

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Reality versus belief about corporate success

Frank Koller, the author of , emailed me this week in response to reading (on VoxEU) about the book I edited on the teaching of economics, .

Frank’s book is about businesses with no-layoff employment policies, and particularly about a company called Lincoln Electric – I’d never heard of it but it’s the global number one in arc welding. Lincoln has a formal guaranteed employment programme as well as rewarding employees with bonuses and incentives. The company history sets out its longstanding (since 1895) commitment to employees and customers as well as shareholders. According to its latest results, published last week, employees got an average bonus of $33,915, the 79th annual bonus in a row, a bonus pool of $99.3m (the pool normally represents 32% of pre-tax profits).

[amazon_image id=”1610390539″ link=”true” target=”_blank” size=”medium” ]Spark[/amazon_image]

Spark has sold very well but the depressing news is that Lincoln’s CEO John Stropki told Frank that not a single other senior US executive has asked him the secret of the firm’s combination of phenomenal financial success with employment practices so good they sound like something out of a fairy tale. Why the lack of interest? Maybe – and this is where economics comes in – it’s because the reality demonstrated by Lincoln and the handful of other companies with such a strong commitment to what by now seem to be extraordinarily good employment practices is inconsistent with the belief system so many people hold about the way business works and the imperative of free markets. If so, the charge sheet against the narrow version of economics grows even longer.

[amazon_image id=”1907994041″ link=”true” target=”_blank” size=”medium” ]What’s the Use of Economics?: Teaching the Dismal Science After the Crisis[/amazon_image]

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