‘Morality’ isn’t as clear cut as we sometimes assume. Read my report for The Foundation here

As if we weren’t in enough trouble, among the wreckage thrown up by the still-receding economic tide is a crisis of innovation. It may be hard to credit in an era of apparently ubiquitous technology, but the innovation that has powered the rise of the western economies has stalled. Tyler Cowen in his 2011 book called it ‘The Great Stagnation’. ‘The American economy has enjoyed… low-hanging fruit since at least the 17th century, whether it be free land,… immigrant labor, or powerful new technologies’, he notes. ‘Yet during the last 40 years, that low-hanging fruit started disappearing, and we started pretending it was still there. We have failed to recognise that we are at a technological plateau and the trees are more bare than we would like to think’.

Robert Gordon’s provocative paper, ‘Is US Economic Growth Over?’, goes over similar ground. In Gordon’s account, growth and progress have been driven by the pervasive uptake of General Purpose Technologies, or GPTs, that have fuelled three ‘industrial revolutions’ based on respectively steam and the railways, then electricity, the internal combustion engine, chemicals and petroleum, and finally, already 50 years old, communications in the shape of semiconductors, computers and the internet.

But productivity growth in the third wave has been much lower than in the second industrial revolution which reached its apogee in the decades after the Second World War. Both Cowen and Gordon attribute this to the fact that many of the advances in the first two rounds were one-offs, the magnitude of whose effects become progressively harder to reproduce. This may be true. But the incidence of innovation is also falling. Not only is the effort less effective, there is less of it about. Why should this be?

One important clue is in the dates. To anyone approaching the problem from the corporate end, the fact that the innovation began to falter in the late 1970s is a tell-tale sign. To see why, we need to look at the ecology of innovation, which is much more complex than the conventional picture of a couple of nerds tinkering in a garage allows.

Entrepreneurial inventors – Steve Jobs, Jeff Bezos, Sergey Brin and Larry Page – are the photogenic face of innovation. But iPhones, Amazons and Googles don’t spring from nowhere. For innovation to have systematic effect, would-be innovators need two other elements to be in place. With the great corporate labs (AT&T, Xerox) a thing of the past, one is state support for the fundamental blue-skies research that provides the seedcorn for long-term innovation. It is well known that the internet came out of the US Defence Research Projects Agency (DARPA); perhaps less so that Google’s search algorithms, some of Apple’s iPhone technologies and the whole US biotech industry also emerged from publicly funded research. Historically the US administration has been responsible for 60 per cent of the country’s R&D effort, and particularly the fundamental part.

The second element is finance. As Gordon Pearson notes (see his excellent The Road to Cooperation), the modern finance sector and the public limited liability company developed together as a means of managing the risks of bringing innovations to market. Finance supported corporate innovators by raising the capital necessary for the uncertain process of exploiting technological development, benefiting the economy as a whole.

But in a triple whammy, over the last three decades all three of innovation’s components have broken down, and for the same reason – the cult of shareholder primacy. In the corporate sector, innovation is a prominent victim (along with pensions, wages and long-term investment generally) of the ‘downsize and distribute’ policies that have been adopted since the 1980s to maximise short-term gains for stockholders (and thus also CEO bonuses). Companies are more concerned with protecting and extracting rents from existing positions than developing new ones. At the same time, finance has turned from means to end, and a predatory end at that. The roles have been reversed. Instead of supporting industry in the patient work of real-world value creation, finance has dedicated itself to value extraction. Instead of creative destruction, taking economies to a higher plane of efficiency, finance has pursued destructive creation, in Mariana Mazzucato’s phrase. Companies that innovate and invest for the long term are particularly vulnerable to the City and Wall Street raiders. For their part, governments in thrall to the same benighted notions of efficiency as the private sector have cut back on support for long-term research in favour of more applied projects. Austerity has just reinforced this tendency.

The result is a monument to perversity, a market failure of world-endangering proportions. On the one hand sits a financially and environmentally overheating real world in desperate need of a bundle of green GPTs to drive a fourth industrial revolution centred on sustainability. On the other are corporates stuffed with cash that they don’t know what to do with, while capital markets not only do nothing to connect the two but actively siphon off for their own ends the money that governments have printed to kickstart their economies. Thus the phenomenon noted by Mazzucato of ‘poverty (underfunding) in the midst of plenty (tens of trillions of dollars of wealth in search of high returns)’; venture capital retreating progressively from innovative startups; and b-school graduates whose entrepreneurial ambition is limited to founding social-media firms that can be flipped to Google, Facebook or Microsoft without the bother of establishing a business model capable of making money from real customers.

Instead of handing out yet more money to an unreconstructed finance sector, governments should be looking to unblock the arteries of corporate innovation by protecting companies from financial predation, speeding up City reform and setting careful incentives for long-term investment in green technologies – preferably before rather than after the lights go out.

Read my piece for FT Business Education, 15 October 2012, on the promise and perils of ‘big data’, here

Read my piece for The Guardian, Comment is Free, 9 October 2012, here goo.gl/d2z3H

The cult of bigness is so ingrained that we barely think about it. It’s become axiomatic that big is efficient because of the ability to standardise, specialise, and spread the management overhead. It underpins regulation, management thinking and political solution-seeking alike.

The bigger/better conflation contains a grain of truth. In the early 20th century the discovery that things became cheaper to make as quantities increased was ably exploited by Henry Ford and other mass-production pioneers to invent the consumer market and make their fortunes. Scale economies live on in some areas of manufacturing. But except in limited cases, the Fordist idea of scale economies has been superceded by Toyota’s discovery of the superior economies of flow. In services it is an irrelevance. ‘There is no longer any reason to rule out localisation of economic activity on the grounds of scale economies. Scale economy, beyond very small volumes, is a concept that should be discarded’, declares accounting professor Tom Johnson.

Why then is the hold of scale economies so powerful? One reason is that it harks back to a simpler mechanical world where a large problem could be addressed by taking it apart and ‘solving’ the individual parts. So even when the big retailers control the vast bulk of the UK grocery market, have screwed the local supply chain into the ground and reduced the High Street to a dreary sameness whereno one wants to shop, competition authorities repeatedly find in their favour on the narrow economic grounds that competition between them benefits consumers in terms of price. They take no account of the effects on the system as a whole.

We should know better. As the Bank of England’s director for financial stability Andy Haldane has pointed out, a large contributory factor to the financial meltdown in 2007-2008 was the astonishing failure of anyone in the system to think in terms of the resilience of the structure as a whole. The banks were too big, too interconnected and too similar not only for their own good but also for the resilience of the entire financial system – and we are still paying for the consequences today.

As the banks might suggest, and Vanguard’s John Seddon has formally proposed, in services economies of scale are an optical illusion. The reliable rule of thumb is that the bigger the organisation, the worse the customer service. It should be no surprise that while outsourcing, shared services and specialised call centres have achieved the promise of lower unit costs from size and specialisation, the price has been the wrecking of flow, worse service and soaring overall costs. W. Edwards Deming instructed 50 years ago that optimising the parts necessarily underoptimises the whole and vice versa. And so it has proved. Companies, like regulators, have lost sight of the wood for the trees; which is why everything touted as an ‘improvement’ from their point of view is always the reverse from ours.

But at last people are beginning to query the cult of size. John Kay notes that in the case of big projects, returns to scale do not increase but diminish. In 1908 the London Olympics cost £20,000 and in 1948 £750,000. The estimated 2012 total of £11bn is out of all proportion to previous amounts, even with inflation. This seems to be a phenomenon of the last 50 years, and it holds for tube lines, IT projects and military spending, to name but three. ‘Perhaps technological advance has reduced rather than increased productivity, by offering enhancements that do not represent value for money,’ suggests Kay. ‘The result is that major projects cannot be afforded or, if they are afforded, squeeze out smaller advances that would add more to human welfare’. More is less.

In the case of the banks, even the market is having second thoughts. Haldane recently observed that many banks are currently valued at less, sometimes much less, than the sum of their parts. In other words, he writes, ‘there are market-implied diseconomies of scale and scope. The problem for investors appears to be not so much too-big-to-fail as too-complex-to-price’. The banks would be more valuable broken up. Unbundling would not only create financial value. It would also make the system more resilient and simpler to regulate, both of which would reduce risk.

Yet don’t count on this impeccable logic prevailing in the short term. For it runs up against the most potent reason for the persistence of defunct scale ideas, which is self-interest. There is one area where returns to scale are enormous and increasing: power. CEOs now find they get a better return on their time and effort lobbying legislators than working to please customers. This is one reason why acquisitions continue to be such an important part of corporate strategy despite their dodgy record.

Consider the much-discussed merger of European high-tech manufacturers EADS and BAE Systems. EADS makes civil airliners (Airbus) and BAE weapons; no manufacturing economies of scale there, then. As the crash and events since should have made clear, claims for economies of scale in management or HR also need to be taken with a sack of salt. The truth – and the only possible justification for BAE and EADS getting together – is that both companies are hoping that the added clout the combined company can bring to bear in Washington and Brussels will make up for strategic and operational failings in the past. In short, it can make itself too big and politically troublesome to fail. Other merger bonuses (for them, not us) are pricing power (eg Glencore-Xstrata) and, literally, more bunce for top managers (Glencore-Xstrata again).

Adam Smith famously wrote that ‘People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices’. Now they’ve got politicians to do their conspiring for them. ‘Conservatives in both the US and the UK now represent vested over public interest, big business over small, international over national capital. They typify and defend an economic system that serves the minority rather than the majority…. narrowing opportunity, concentrating wealth and protecting monopoly interests’, writes Phillip Blond sorrowfully. As Blond suggests, size isn’t a technocratic issue, it’s political. It’s time to nail down the zombie’s coffin and put a stake through its heart.

How do we get more responsible, ethical business? In order to answer that, we have to ask ourselves why we have so much unethical, or to be more accurate, a-ethical business (as by and large we do), in the first place.

The answer is very simple: that’s the way it has been designed. People seem constantly surprised by the fact that business can and does behave badly, but they shouldn’t be. I’ll spell it out: business is an amoral, ethics-free zone because that’s what it’s been set up to be.

Generations of managers have learned at business school, from consultants, their peers and the business press that:

• Shareholders own companies
• The exclusive job of managers is to to make as much money as possible for shareholders
• The business of business is business; its purpose is to make profits, and provided it does it legally, that’s the only obligation it owes to society
• The way to get managers to do this is to heap them with equity-based incentives, so they act in the interests of shareholders.

Actually, all these propositions are false. Shareholders don’t own companies – they own shares which give them certain rights, a very different thing. In law, diirectors have to have regard for shareholders, as they do for employees and customers, but their direct fiduciary duty is to the company itself, for the benefit of all its members over time. As for purpose, Dave Packard, one of the founders of HP (who must be writhing in his grave at the moment), put it like this: the purpose of management is not profit, it’s profit that makes the proper ends and aims of management possible. And all the evidence is that incentives simply teach people to take their eye off the job and pay attention to incentives: except for the very simplest and most direct tasks (which emphatically does not include running a company) incentives are more likely to do harm than good, by wrecking teamwork and cooperation, for example.

Nonetheless, this is what managers have absorbed with their mother’s milk, and it’s no surprise that many of them behave accordingly.

So in survey after survey, managers say that despite the talk of ethics and corporate social responsibility, they would engage in dodgy practices if it benefited shareholders, because that’s what their pay structures encourage them to do. So even when behaviour isn’t illegal or criminally reckless, as much of the behaviour of the banks clearly was, it’s often irresponsible to the point of endangering sustainability.

To take a small example from retail (for which thanks to that wise observer, John Carlisle): in 1990s the farm gate price of potatoes was 9p a kilo and the retail price 30p; a mark-up of already more than 200 per cent. Ten years later the shop price per kilo had gone up to 47p, which the farm gate price at 9p hadn’t budged. The mark-up was no 425 per cent: not a penny of the extra profit had gone to the farmers. That’s not fair profit: that’s predatory rent-seeking.

Or Apple, a company which gets so much right for customers. How could Apple be caught out imposing indefensible conditions on subcontractors building $600 iPhones on which it makes a 70 per cent marging? Because its managers believe, or at least act on, the myths that I listed a few moments ago, in particular the imperative to maximise returns to shareholders. Prominent among whom, of course are Apple’s own managers. When he became CEO last year, Tim Cook was awarded nearly$400m-worth of stock options to vest over the next 10 years, and last time I looked they were worth more than double that. That’s a pretty strong incentive to go on screwing your suppliers, whatever the ethics might look like.

The Apple example of course illustrates exactly how and why executive pay keeps on going up and up as it does. It’s an integral part of the same nonchalantly ethics-free dynamic, which has a massive weight of vested interest in theory and practice behind it, not least among the top-level managers who stand to gain from it above all.

Given all this, the surprise is not that much business should display so little concern with ethics, but that there is any that is ethical at all. We should be even more grateful for such stand-outs than we are.

So how do we level the playing field?

The first thing is that we need some politicians brave enough not just to talk vaguely about responsible capitalism but to recognise that this is a crisis, more particularly a crisis of what has been the engine of capitalism up to now, the public limited company; and that since the mess we’re in is squarely man made, the result of faulty design, it shouldn’t be beyond the wit of man to put it right by designing a better system.

This isn’t chiefly a matter of regulation or law change: you can’t regulate to make people better. If you could, Sarbanes-Oxley would have prevented the financial crash. Instead, as John Kay says, we need simple structures that foster resilience. It’s not just the banks – in obsession with economic ‘efficiency’ we have allowed far too many companies of all kinds to grow too big – too big to manage, too big to fail and too powerful for the good of the rest of us. So competition policy should be reframed in the light of sustainability concerns, and that probably means breaking up some of the larger concentrations of corporate power, again, not just the banks. Will Hutton’s Ownership Commission has argued that instead of the current overreliance on the public limited company, we should encourage a plethora of other corporate forms – mutuals, cooperatives and social enterprise, for example, and that’s an important part of the equation. We could make a start on diversification, as suggested by Oxford’s professor of global economic governance, Ngaire Woods, by reincorporating the investment banks with unlimited liability – which is not as far-fetched as it sounds, since as partnerships that’s how most of them effectively operating until as late as the 1990s. Seriously, why not?

But the biggest change has to be internal. This goes far beyond the figleaf of corporate social responsibility. Business needs to acknowledge, explicitly and directly, what is abundantly clear to everyone else: that it can only prosper in the long term if it simultaneously pays attention to the interests of customers employees, shareholders and the communities it is embedded in. That needs to be written into the corporate governance codes, which ironically, and with the most earnest of intentions, have congealed into the bastions of the current corporate social irresponsibility.

But I sense the grain of an opportunity here. Interestingly, there is no empirical evidence that current governance ‘best practice’ – independent boards, splitting chairman and chief executive roles, aligning management with shareholder interests – has any beneficial effect on performance. In fact, the whole enterprise of making business morals-free doesn’t even benefit shareholders in whose name the privilege is claimed. Over the last 30 years, companies have done less welly by shareholders than they did in the previous period when shareholders weren’t put first in the same way. Ethics-lite shareholder capitalism fails even in its own terms.

That means that for once we’re in that rare situation where we have nothing to lose and everything to gain by doing the right thing. So who’s up for it?

Read my column in FT Business Education, 16 September 2012, on goats and power here

Read my essay, ‘The only way is ethics?’ in the High Pay Centre’s publication, Better Business: Morals Matter, here

The English Premier League is the highest-profile in the world. It is a magnet for footballers, spectators and advertisers alike. Some of the top clubs are global brands. Yet under the glitter, the competition is a sham. Only four or five clubs can realistically win it, and they are playthings of potentates who compete to buy victory with mountains of cash. Football clubs aren’t ‘clubs’ in any meaningful sense; they are crude businesses living far above their means, kept afloat only through life-saving injections of cash from the sale of TV rights. Even so half of the Football League have been in administration since 1992 and many wobble perennially on the edge. Top footballers are grossly overpaid, the eyewatering wealth of top stars contrasting cruelly with the pitiful salaries of club retainers. Oh yes, and English players and English managers never win anything. The chief beneficiaries of Premier League largesse are foreign players and managers who are consistently more skilful, thoughtful and adaptable than their British rivals. Under the surface, the beautiful game is in a parlous state.

Does this remind you of anything? It should. In their troubling Going South: Why Britain Will Have A Third World Economy by 2014, Larry Elliott and Dan Atkinson suggest that the parallels between the national game and the national economy are close. On display in both are the same unrealistic ambitions and rose-tinted spectacles, the same boom and bust, the same U-turns, the same workforce and management deficiencies thrown into sharp relief by superior imported talent. The surface bling covering bankruptcy beneath is reminiscent of another tawdry show in which the UK believed it led the world, banking. Ominously, note the authors, ‘the Walter Mitty tendency is even more apparent in those charged with running the national economy [than those running football].’

Elliott and Atkinson, economics editors at The Guardian and The Mail on Sunday respectively, have been dismissed in the FT as ‘professional pessimists’. It is true that Going South is not immune to occasional exaggeration for effect. It is also overlong. But their analysis is not easily put out of mind. Their argument is that Britain is not just in the middle of a painful recession from which it will one day recover and resume business as usual. Rather, they see it as the end of a century of relative decline in which it has not just (like many other western economies) de-industrialised, but de-developed. As in the book’s subtitle, Britain is going backwards, a submerging rather than emerging economy. It’s not a recession, but a reckoning.

In a compelling roster of evidence, the duo point out that despite an effective 25 per cent devaluation of sterling Britain continues to run a chronic balance-of-payments deficit on visible goods at a time when exports should be growing strongly. Their conclusion (strongly supported by the findings of researchers Karel Williams et al): critical mass in manufacturing has been definitively lost – meaning that ‘recovery’ (not to mention rebalancing) won’t and can’t happen automatically. Manufacturing capacity, including supply chains and clusters, will have to be recreated from scratch.

Second, educational performance. Despite Tony Blair’s policy priority of ‘education, education, education’, the UK has celebrated the first decade of the new millennium by skidding helter-skepter down the OECD league tables: eighth to 28th in maths, seventh to 25th in literacy and fourth to 16th in science. Sixty per cent of UK workers are classified as low skilled, compared with 20 per cent in Germany and 30 per cent in France. Then consider the state of UK infrastructure, energy in particular. Coal is a legacy industry, oil production has fallen by two-thirds and gas by half. To cope with likely demand and the need to cut greenhouse gases, the country will need ‘a vast expansion of wind and solar, coupled with dozens of nuclear or “clean coal” plants’; the authors give it five years before the lights start to go out.

They give plenty more reasons for gloom. By 2015, median incomes will have been falling for an unprecedented 13 years, the pensions timebomb is ticking, youth unemployment high and rising, the debt mountain growing, the banks frozen and Europe paralysed. Rather than a one-off criminal spree, the riots of August 2011 may in hindsight turn out to be the start of retribution ‘not just for the financial follies of the last 30 years, but for a century of relative economic decline.

The strength of Going South is its historical sweep. In the historical context, much of the UK’s current plight is not due to chance or bad luck, as often presented, but the predictable result of expediency and indecision. Britain’s education was already causing concern in the last years of the 19th century, the loss of world market share in manufactures likewise. The failure to invest in infrastructure (unlike, say, the equally impoverished France) dates back to the war, and the policy flip-flops and U-turns are legion. When the windfall of North Sea oil landed, the UK copied football rather than Norway: instead of investing the proceeds for the future it blew them on maintaining its profligate lifestyle. When the finance sector boomed it did the same, never taking into account that financial might and manufacturing weakness were two sides of the same coin. Is Britain a free-market or a European social-market economy? It has never decided, vacillating painfully between the two and often getting the worst of both.

Now the jig is up, the die is cast, the goose is cooked and the cat is out of the bag, in the immortal words of James Thurber. Hard choices, put off for so long, can no longer be avoided. I share much of the Elliott-Atkinson analysis – indeed it’s only by putting on very short term blinkers that you can avoid it. For far too long we have let ourselves to be persuaded we can get to where we want to be via short cuts: we don’t need to learn languages because everyone speaks English, we can (to borrow Jim Slater’s odious distinction) make money rather than things, and that we can be creative rather than industrious and productive. Hence the emphasis on show, presentation (we do royal weddings rather well), and the ‘creative’ and advisory industries (in telling other people to do as we say, not as we do, we certainly lead the world).

Yet I think the authors might just have missed something. At first sight, the success of the 2012 Olympics might seem the apotheosis of the UK’s bullshit economy – just another show, if a glorious one. But when you look at it more closely, that’s not true. In fact, tthe Olympics were the pay-off for just the sort of difficult, meticulous execution that the British supposedly don’t do. In fact they so don’t do it, as Michael Skapinker recently pointed out in the FT, that several totemic companies – BAe, BT, BP – have over the last decade quietly purged themselves of the ‘British’ in their name to escape the brand-damaging associations. Yes, they cost a lot, but the games came in on time and under budget. Two million tons of concrete were poured without a single casualty; at one stage a truck was arriving at the front gates every sixty seconds. As for the athletes, the most striking thing about the performances was that they were the result not so much of natural talent but of unBritish amounts of hard work and minute attention to detail. They were hard wins, not easy ones. Not to mention the volunteers. And all that accounts for the, surely rightful, sense of national pride the games provoked. ‘The desire of millions to feel decently and proudly British is a story the elites – business, media and political – have been missing for years,’ notes Skapinker (none more grotesquely so than the right-wing Tories now caricaturing the workforce as workshy layabouts). If we’re to defy the weight of the past and start going north again that’s the joyous, challenging spirit we’ll all need to tap into.

Read my Foundation article here