JOHN LOCKE defined a madman as someone ‘reasoning correctly from erroneous premises’. For Einstein, madness was repeatedly doing the same thing and hoping for a different result. The worst of modern management – and alas, that often seems most of it – manages to combine the two so well that it doesn’t just exclude incremental learning: it takes knowledge backward.

Consider the operational efficiency programme accompanying the budget last week. It identified a further pounds 15bn of public-sector savings on top of pounds 26.5bn already claimed, pounds 7bn to be made through obliging public-sector bodies to share back-office services such as finance and HR and buying better IT.

It’s not that there aren’t savings to be made – of course there are. Done properly, they would boost public-sector capacity beyond the wildest imaginings of the five expert advisers to the Treasury who wrote the report. The insanity is that savings can’t be got at by the cost-cutting methods they put forward, which on the contrary are guaranteed to drive overall costs higher. Not only that: by specifying the methods to be used, the government locks in far greater sys temic inefficiencies at the same time as it places the assumptions behind them off-limits to examination.

Part of the self-referencing madness is seeking assurance from experts who are so attached to current assumptions that they can’t see beyond them. As with recruiting Lord Laming, whose recommendations shaped the dysfunctional childcare system, to report on Baby P, getting the former chief executive of an IT services firm to advise on office efficiency is like asking McDonald’s to devise an obesity policy. Guess what, the answer is fast food! More standardised procedures, more streamlining of back offices, more shared services… in sum, more work for IT services companies.

The paradox of efficiency is that it can’t be addressed head on. It is a by-product that can only be defined in terms of its purpose. Without purpose, efficiency is meaningless. Cutting costs (the government’s purpose) only raises them for the citizen – but because the assumptions are out of bounds, the government can’t see it.

Look at the ‘cost savings’ made at the Department for Work and Pensions and HM Revenue & Customs. Both these flagships of public-sector reform have been subject to top-down makeovers along approved factory lines. Dumbed-down ‘front offices’ sort and feed incoming cases to specialised processing sections in the ‘back office’ in the belief that these mass-production techniques will cut the unit cost of transactions and harvest economies of scale.

Even in manufacturing, economies of scale lost their grail-like allure when the Japanese discovered how to make small quantities of different, high-quality goods cheaply. In services the case is at best unproven (banks, anyone?), and so far the successes in shared services are few and far between. But even if they do make transactions cheaper, that’s irrelevant if from the citizen’s point of view the service is worse, requiring more transactions to put right. And it takes no account of the disbenefits of the efficiency measures elsewhere in the system.

Thus the HMRC and DWP cost savings recorded in official figures reappear, with interest, in the workloads of harassed local councils, housing associations, police, courts and advice agencies. They have to pick up the pieces left by the failure of HMRC and DWP’s demoralised staff and fragmented processes to provide an acceptable (rather than cheap) tax and benefit service.

Much of the work of the UK’s voluntary advice organisations now consists of dealing with mistakes affecting the most vulnerable in society perpetrated by New Labour’s efficiency flagships. There is an opportunity here. By identifying problem areas and working with tax and benefit offices to remove them, these unsung pillars of civic society could be a powerful agent for improving service and reducing costs.

Except that the government has stamped on any such possibility. First, it has disallowed anything except immediately ‘cashable’ benefits to count as efficiency gains – so investment now to prevent costs in the future doesn’t qualify. And second, diabolically combining type 1 and type 2 madness in the same move, it is subjecting the voluntary sector to the same misguided ‘reforms’ as the service providers – putting large advice ‘contracts’ out to tender, forcing agencies to combine or wither, and paying them per transaction, thus removing any incentive to improve the system as a whole.

’In times of transformation, not only do new problems arise, old ways of looking at things become problems themselves.’ That’s the infinite regression the cost-saving programme being rammed through Whitehall locks us into. It is, perhaps, a third form of madness.

AS THE DUST clears after the collapse of the old financial order, mixed with fear and loathing is a palpable sense of release. Of course there will continue to be discomfort, sometimes extreme, as whole industries are sucked into the maelstrom of the imploding debt bubble. Yet now that market ‘solutions’ are no longer self-justifying, new options for the shape of companies and economies come into view. If society comes before markets, as Philip Blond recently suggested in the FT , a different management vista begins to open up.

The nightmare that is finally ending is the 30-year neoliberal project to make humanity safe for markets. On this economic Island of Dr Moreau, individuals and institutions have been bent to fit an abstract framework of theory and ideology rather than the other way around. Pragmatism and a sense of the importance of social relations have been sacrificed to notions of efficiency that now turn out to be wholly misguided.

As George Packer noted in a recent New Yorker , modern conservatism (whether practised by Republicans or Democrats, New Labour or Thatcherite Tories) has turned its back on its origins of respect for tradition and the need for checks and balances and become its rabid opposite – ‘abstract, hard-edged and indifferent to experience and existing conditions’.

Ever in thrall to economics, today’s management has faithfully reflected this deluded rationality. Managers have grown – and been taught – to eschew messy reality in favour of managing by computer model and target.

Indeed, increasingly they don’t know how to manage forward from reality rather than backward from the numbers. Thus the besetting sin of mistaking the map for the territory, the scorecard for the game, the representation for reality; in any collision between humans and the numbers, it is humans who are the casualty of first resort.

Another consequence of this fundamentalist faith has been the growth of colossal concentrations of market power: not just banks, but also oil companies and even supermarkets have become too big to fail. ‘Efficient’ in a very limited sense, and that only at the cost of squelching the life out of our high streets, they offer a deformed, depersonalised style of competition designed to please regulators rather than customers – witness record low levels of trust in big business that are now prevalent in the US and UK.

Indeed, a regulatory regime operating entirely on abstract criteria favouring economies of scale and high-level targets is essential to these oligarchies, spreading the same dehumanised principles from the private to every corner of the public sector. And the accompanying cynicism, its goals being so remote from the concerns of individuals that there is no sense of wellbeing even when targets are met, remains the same.

The twin monuments to this pitiless, mechanical version of modernity are the banks that grew too big to die and the NHS computer system that grew too big to complete. Both institutionalise the impersonal and abstract and fetishise size, speed and scale.

The paradox, of course, is that ‘efficiency’ of this kind turns out to be catastrophically inefficient even in its own terms, let alone social and environmental ones. In retrospect, the vaunted decade of growth was just another management abstraction, a loan from the future that has been called in with interest.

Establishing a new equilibrium between individuals and broad economic forces so that markets can be made to serve social ends must be the first priority. The City no longer having a de facto veto, the stakeholding ideas, so abjectly abandoned by New Labour in the face of its disapproval, can be resurrected. That would be a huge step, breaking the stranglehold of shareholder value, reopening today’s pernicious governance model and helping to put finance back where it belongs – on tap, not on top.

There is little evidence that economies of scale are useful in banking (or any other services), and plenty that anything too big to fail is too dangerous to live. So banks should be broken up and bankers encouraged to get a life inventing goods and services for customers rather than concentrating on making their bonuses. If that makes banking less creative, good: nothing life-critical, preferably nothing at all, should be run by anyone subject to incentives that make them focus on the money rather than the job.

Economic life, as Nassim Nicholas Taleb puts it, should be ‘definancialised’. It should be re-tethered to real things – customers, products and services. The aim is to bring it ‘closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks, and companies are born and die every day without making the news.’ This week’s budget would be a good place to start.

THE CREDIT crunch confronts the corporate social responsibility (CSR) movement with its biggest crisis. Over two decades, the idea that companies should voluntarily ‘put something back’ has acquired impressive support from the great and the good.

No less than 85% of the FTSE 100 refer to CSR in their annual reports, according to one study. ‘It’s never been more important,’ runs a headline prominent on the Business in the Community website over a section on ‘Corporate Responsibility in recession’, with links to how-to articles and an awards scheme. The government also approves, appointing the world’s first minister for CSR in 2000 and asserting in a recent report that by behaving responsibly ‘businesses can make a significant contribution to boosting wealth creation and employment, fostering social justice and protecting the environment’.

Yet the financial meltdown brings a two-pronged challenge to responsibility champions. The first is simply whether sustainability and wider CSR issues will remain on the boardroom agenda. Non-government organisations and a number of other CSR observers see signs of com panies reverting to the default position that, in today’s conditions, anything other than business as business is a luxury that they can’t afford.

In truth, the ‘market for virtue’, as David Vogel put it a couple of years back in a book of that name, is in any case small and weak, particularly in capital markets, which give no sign of rewarding companies that do good with higher share prices or punishing those that behave badly with lower ones. Accordingly, while for a few companies CSR makes business sense as part of their brand and customer strategy, and others use it defensively for risk management purposes, most do it only in so far as it suits them and they can afford it. When it doesn’t suit them there’s nothing to prevent them dropping it, or perhaps cherry-picking the areas to apply it.

It may be no accident that most CSR centres on environmental issues. Doing more with less – ie, resource efficiency – and eliminating pollution before it occurs often directly benefit the bottom line (which means it isn’t really CSR, it’s just sound business). Meanwhile, green credentials may deflect attention from less visible or savoury practices. For example a number of large retailers – Debenhams, B&Q, Boots Alliance and Selfridges among others – have over the past year reportedly extended their payment period to suppliers, sometimes up to 96 days, while the Federation of Small Businesses says that 14 companies, mostly retailers, have taken to charging a 2.5% ‘settlement fee’ when they pay their bills.

While such a power play, like MPs’ lodging arrangements, may not offend literal definitions, it breaches the spirit, potentially putting many credit-starved small suppliers in danger of collapse. It also lays companies open to the charge that CSR is attractive to them because they can gloss what they do in the most favourable light, while not having to do anything they don’t want to.

But more glaring are the contradictions in the financial sector. Much like Enron, financial services have combined being a pillar of CSR with corporate irresponsibility on a grand scale. The immediate cause of today’s crisis was cynical mis-selling of sub-prime mortgages to self-certifying customers whose hope of maintaining payments in a serious downturn was minimal. Scarcely believably, the process was then repeated higher up the food chain, investment bankers re-mis-selling poisonous packages of debt to investors and other bankers, egged on by massive one-way bonus incentives.

Yet, as Ian Christie, an independent environmental consultant, notes, the CSR industry has had nothing to say about the pay and incentives issue, a crucial part of any post-crunch reform, at least in public, and if it has been conducting advocacy on it in private, it was to singularly little effect. A similar outbreak of mutism has greeted the failure of financial self-regulation – indeed, arguing against regulation is a key point on the City agenda. Christie asks: ‘Has any member of any CSR club been ejected or suspended for breach of the spirit of CSR or for flagrant irresponsibility? I think the answer is no.’

How little influence CSR is able to wield within companies was charted in a recent article in Ethical Corporation noting the imperviousness of sales teams to ethical concerns. Sometimes scornfully labelled the ‘sales prevention team’, CSR professionals were ‘completely excluded’ from debates about how to treat customers. Given the ritual obeisance to customers and the central role played by their abuse in the current crisis, this is an extraordinary revelation, kicking away any pretension CSR might have to pose as a saviour in today’s troubles. Rather the reverse: the reputational issues faced by the banks are only matched by those facing CSR itself.

READING THE opinion and letters pages of the Financial Times these days gives a curious sensation of seeing cogs and gears that have not moved for 30 years creaking into motion. The past couple of weeks have seen an article putting forward happiness as a better goal for economic activity than growth a proposal from the Aylesbury Socialist Party to contain banking exuberance by socialist planning and, scarcely less heretical, a declaration by Jack Welch, formerly head of GE and the foremost management icon of the age, that shareholder value is ‘the dumbest idea in the world… a result, not a strategy… Your main constituencies are your employees, customers and products.’

Welch’s comments mark a psychological turning point. While he didn’t invent shareholder primacy, which emerged from seminal US academic work in the 1970s, GE under Welch became a past master at managing it, making a fetish of delivering quarterly earnings and dividend rises – using judicious disposals as necessary to make the numbers. With the crunch, that possibility is no more, along with GE’s treasured ‘AAA’ credit rating. Hence, perhaps, the recantation.

However, while saluting Welch’s conversion, a subsequent FT editorial on ‘Shareholder value re-evaluated’ shows how little the wheels have actually turned. Surviving the ‘re-evaluation’ are all the structures of existing governance: companies as entities run for the benefit of shareholder-owners (even if, as Welch implies, the means are indirect, rather than direct, managing of the share price) alignment of directors and shareholders pay to reflect performance. In short, once the crisis is over, with a tweak or two here and there, it’s safely back to business as before.

This expectation is shared in the City. Entrusting a review of the Combined Code on corporate governance to the Financial Reporting Council – just like the preposterous appointment of Lord Laming to report on the working of his own reforms in child protection – simply guarantees a ‘steady as she goes’ response. How could it be otherwise?

But don’t these people realise the platform is blazing beneath them? This column has long maintained that, regardless of theory, a system that encourages the same organisation to pay one person 470 times what another gets will eventually blow up. This it has now done – in America, of all places, where the freewheeling social contract has broken down under pressure of the crisis. Confidence in business has hit rock bottom. In a recent poll, just 17% of US respondents said they would trust what a CEO told them a ratio of 3:1 wanted tougher regulation.

Does anyone seriously think that assurances about ‘better bonuses’ (as misguided as ‘better targets’, of which they are a close relative) will stem this tide of outrage? It isn’t a question of refining the incentives, chaps – it’s a question of reversing them. As Welch rightly notes, share prices are supported by the value created in product markets by the interrelationship of employees, customers and suppliers. So why should alignment run upwards from directors to shareholders?

’My guess,’ writes Gary Hamel in The Future of Management ‘is that… shareholders would have been better served if their chairman could have bragged about being aligned with employees and customers. It seems to me that a CEO’s first accountability should be to those who have the greatest power to create or destroy shareholder value.’

In any case, the entire notion of the shareholder has to be rethought. In an age when a listed company’s share register suffers 90% churn each year, the very concept of ‘the shareholder’ dissolves, corporate governance expert Professor Bob Garratt told a recent meeting of the Human Capital Forum. Calling for a ‘cultural and behavioural transformation’, Garratt declared that the first duty of directors was not to shareholders, but to the company itself. Organisations have to move from agency theory to stewardship theory, he believes – restoring the original concept of the board’s role from the 17th century.

Ironically, from that perspective it is today’s ‘business as usual’ that is the aberration. In a forthcoming book, The Rise and Fall of Management, Gordon Pearson shows how corporate law, including the 2006 Companies Act, takes a much more enlightened approach to governance than current practitioners want to admit. Contrary to common assumptions, shareholders do not own companies (how could they and benefit from limited liability at the same time?), and directors owing their duty to the company can’t be ‘agents’ of shareholders – indeed, they are charged with acting fairly as between all company members. It’s a measure of how much present governance has lost its way that resurrecting such ideas should now seem so radical – and so urgently necessary.

The Observer, 29 Mar 2009

MRSA, Baby P, now Stafford hospital. The Health Commission’s finding last week that pursuing targets to the detriment of patient care may have caused the deaths of 400 people at Stafford between 2005 and 2008 simply confirms what we already know. Put abstractly, targets distort judgment, disenfranchise professionals and wreck morale. Put concretely, in services where lives are at stake – as in the NHS or child protection – targets kill.

There is no need for an inquiry into the conduct of managers of Mid Staffordshire NHS Foundation Trust, as promised by Alan Johnson, the health secretary, because contrary to official pronouncements, it is exceptional only in the degree and gravity of its consequences. How much more evidence do we need?

Stafford may be an extreme case but even where targets don’t kill, they have similarly destructive effects right across the public sector. Targets make organisations stupid. Because they are a simplistic response to a complex issue, they have unintended and unwelcome consequences – often, as with MRSA or Stafford, that something essential but unspecified doesn’t get done. So every target generates others to counter the perverse results of the first one. But then the system becomes unmanageable. The day the Stafford story broke last week, the Daily Telegraph ran the headline: ‘Whitehall targets damaged us, says Met chief’, under which Sir Paul Stephenson complained that the targets regime produced a police culture in which everything was a priority.

Target-driven organisations are institutionally witless because they face the wrong way: towards ministers and target-setters, not customers or citizens. Accusing them of neglecting customers to focus on targets, as a report on Network Rail did just two weeks ago, is like berating cats for eating small birds. That’s what they do. Just as inevitable is the spawning of ballooning bureaucracies to track performance and report it to inspectorates that administer what feels to teachers, doctors and social workers increasingly like a reign of fear.

If people experience services run on these lines as fragmented, bureaucratic and impersonal, that’s not surprising, since that’s what they are set up to be. Paul Hodgkin, the Sheffield GP who created NHS feedback website Patient Opinion (www.patientopinion.org.uk) notes that the health service has been engineered to deliver abstract meta-goals such as four-hour waiting times in A&E and halving MRSA – which it does, sort of – but not individual care, which is what people actually experience. Consequently, even when targets are met, citizens detect no improvement. Hence the desperate and depressing ministerial calls for, in effect, new targets to make NHS staff show compassion and teachers teach interesting lessons.

Hodgkin is right: the system is back to front. Instead of force-fitting services to arbitrary targets (how comforting is hitting the MRSA target to the 50% who will still get it?), the place to start is determining what people want and then redesigning the work to meet it.

Local councils, police units and housing associations that have had the courage to ignore official guidance and adopt such a course routinely produce results that make a mockery of official targets – benefits calculated and paid in a week rather than two months, planning decisions delivered in 28 days, all housing repairs done when people want them. Counterintuitively, improving services in this way makes them cheaper, since it removes many centrally imposed activities that people don’t want. Sadly, however, the potential benefits are rarely reaped in full because of the continuing need to tick bureaucratic boxes and in the current climate of fear, chief executives are loath to boast of success built on a philosophy running directly counter to Whitehall orthodoxy.

The current target-, computer- and inspection-dominated regime for public services is inflexible, wasteful and harmful. But don’t take my word for it: in the current issue of Academy of Management Perspectives , a heavyweight US journal, four professors charge that the benefits of goal-setting (ie targets) are greatly oversold and the side-effects equally underestimated. Goal-setting gone wild, say the professors, contributed both to Enron and the present sub-prime disasters. Instead of being dispensed over the counter, targets should be treated ‘as a prescription-strength medication that requires careful dosing, consideration of harmful side effects, and close supervision’.

They even propose a health warning: ‘Goals may cause systematic problems in organisations due to narrowed focus, increased risk-taking, unethical behaviour, inhibited learning, decreased co-operation, and decreased intrinsic motivation.’ As a glance at Stafford hospital would tell them, that’s not the half of it.

The Observer, 22 March 2009

HOW FAR have we got in rethinking the management of banking and financial services? Almost nowhere, was the verdict emerging from a recent workshop by the Centre for Research on Socio-Cultural Change (Cresc) in London. The session gathered a rich cross-section of politicians, bankers, academics and commentators who sharply challenged the official analysis of the crisis.

It may be, as The Guardian‘s Larry Elliott suggested, that we are still in the fourth, ‘panic’ stage of the crunch – following the bubble phase (’it’s different this time’), denial (’don’t worry, the fundamentals are sound’) and acceptance (’more serious than we thought, but well placed to recover’) yet underneath all the frenetic activity, the remarkable thing is not how much underlying assumptions have changed, but how little.

For make no mistake: the tectonic plates are shifting. On the one hand, as Professor Mick Moran of Manchester University made clear, the crisis has fatally holed the grand project of the past three decades to shrink democratic control of the economy and deposit it in the hands of the technocracy. The edifice built on an independent central bank, independent regulatory agencies and a business-friendly regime for the markets is tottering. With the technocrats in retreat, economic problems are pushing back into the political and democratic domain: ‘politics is flooding back’.

Yet it is unreflected in either institutional or technical reactions to the crisis. Institutions charged with managing the response, such as government investment managers UK Financial Investments and the Shareholder Executive, remain independent agencies run by the usual Treasury/City suspects. The banks may be effectively nationalised, but governance is still at arm’s length and has no other aim but orderly exit. Shareholder value is still the discourse.

In other words, business as usual. But as other presentations demonstrated, it was business as usual that got us into this mess in the first place. An investment banker acknowledged that three of the miscalculations that caused the meltdown – neglect of liquidity, staggering concentration of risk, and failure to allow for the business cycle – were management errors of the most glaring kind that he was at a loss to account for.

For a second academic speaker, Ismail Erturk, however, the explanation was plain: ‘The problem is shareholder value.’ He argued that this concept, much favoured by the business-friendly financial regulators of the grand project, had driven an ‘unsavoury revolution’ in the banks that damaged the interests of borrowers and depositors and showed itself to be ultimately incompatible with banking’s basic utility function.

In retail, the banks turned themselves into mass marketers selling fee-earning financial products that could promptly be removed from the books by securitisation, while the investment banks switched their focus from corporate services to proprietary trading on their own account. Both sidestepped none-too-onerous regulation to build up formidable levels of leverage. Each of these models has now unravelled.

Erturk’s conclusion is stark and far-reaching. As long as shareholder value prevails, some kind of defensive separation of trading from basic banking functions is essential. More positively, the Cresc researchers propose a remutualisation of retail banking: a gradual euthanasia of shareholders, and a substitution of bonds for equities, giving investors ‘predictability and security of returns on a class of paper whose quality could be second only to government bonds’.

Other workshop participants were quick to extend the diagnosis from the banks to publicly quoted companies in general. If – as it is now becoming permissible to suggest – shareholder value is indeed the problem, then, as Einstein said, ‘the significant problems that we face cannot be solved at the level of thinking we were at when we created them’. A wholesale recasting of today’s unfit-for-purpose corporate governance becomes another urgently necessary response. In short, we are a very long way from business as usual.

Of course some people argue that the situation is now so bad that preventing a future crisis takes a distant, second place to getting things moving again. One inhabitant of the real economy feared that the squeeze would suck so much life out of companies like his that we wouldn’t even care about the possibility of another bubble.

Assuming it doesn’t go that far, the dilemma is poignant. The softer the landing, the more the government will be tempted to shore up the crumbling orthodoxy, making another crisis certain. The worse the depression, the better the chances that Whitehall can be pressurised into a fundamental rethink. Neither prospect is a cheerful one. But as the Obama team keeps repeating: ‘Never waste a good crisis.’

The Observer, 15 Mar 2009

HAPPINESS HARDLY seems at the top of the management agenda when the financial world is falling apart. But, as participants at a seminar on ‘Recession: health and happiness’, organised by the Economic and Social Research Council, heard last week, it probably should be.

Hard times put a premium on real priorities. One of the founding assumptions (and justifications) of conventional economics is that money CAN buy me love, or at least wellbeing: and if wellbeing increases with wealth, GDP growth is obviously of cardinal importance. But in many countries over the past half century, soaring levels of crime, deprivation, depression and addiction to alcohol and drugs seem to have consumed much of the increases in happiness that ought to have accrued from steadily rising living standards.

The Easterlin paradox, as this is called – after American economist Richard Easterlin – has prompted economists such as Richard (Lord) Layard of the LSE and Warwick University’s Professor Andrew Oswald, both speakers at the event, to argue that the aim of public policy should switch from GDP growth to measures that more directly relate to human happiness. As BBC presenter Evan Davies, who chaired the session, pointed out, this is the first recession since the dismal science began taking happiness seriously: an appropriate time to consider the lessons and act on them.

Fear of recession makes everyone less happy. But one finding from the study of the economics of happiness stands out: the devastating effect of unemployment. Ironically, as panellist Melanie Bartlett, professor of Public Management at UCL, pointed out, unemployment was considered so uninteresting in the 1990s that people stopped studying it. Now it is back with a vengeance.

Indeed, so harmful are the consequences – up there with divorce and separation, with the added complication that they get worse the longer it continues – that Layard believes government must guarantee jobs for those still out of work after a year, with further state support conditional on acceptance. Wefare-to-work is justified, he argues, by ‘the huge jump in happiness that occurs when people go back to work’. Training takes a clear second place to getting people back into work. Young people will be particularly vulnerable as recession deepens, making guaranteed apprenticeships ‘one of the top five tasks for government’.

If the public sector is obliged to pick up the pieces, the private sector needs to stop creating the debris in the first place. In particular, the kneejerk reaction to get rid of what until yesterday were ‘our greatest assets’ makes no sense either economically or socially. Recall that up until the 1970s, most companies tacitly accepted that they had an obligation to employees for whom finding a new job was harder and more traumatic than for investors to buy and sell their shares. Sacking people was therefore the measure of last resort.

Over the past 30 years of shareholder dominance, however, redundancies have become the measure of first resort rather than last. However, while shareholders may be temporarily mollified, sackings frequently cast a pall over the survivors, with dire effects on engagement. Lower costs but higher disengagement is not likely to be a winning trade-off in an environment where attracting customers may be key to survival.

The alternative, employee-centric approach is still used by many Japanese countries, many of which go to extraordinary lengths to avoid lay-offs of permanent staff. Toyota has not laid off full-time workers since 1950 as late as last December, like camera and printer manufacturer Canon, it was committing itself to maintaining lifetime employment, although many agency workers have gone. In the UK, it is discussing with the union alternative approaches to facing the crisis, including work-sharing, shorter hours and pay cuts, as well as voluntary redundancy. Japanese companies often cut dividends first, followed by management bonuses (if any), then pay and working hours, and only then jobs.

There is of course more to this than fairness. Although no one is likely to be made happy in the short term by shorter working hours and lower pay, keeping the maximum number of people on is an obvious expression of confidence in the future. Research by the Engage group suggests that employees take the behaviour of companies under crisis as highly revealing of their real nature: the spirit of the decisions made under pressure will be remembered far into the future.

Paradoxically, the age of economic self-interest has turned out to be as destructive of human happiness as it has of the economy. Conversely, a more inclusive, egalitarian, humanitarian era may benefit not only happiness, but the economy too.

The Observer, 8 March 2009

IT’S A LAW of management that more is less – and if it’s complicated it’s wrong. On both these scores, nothing embodies management’s current ruinous disarray better than the knots companies are getting themselves into over pay. In a classic case of vanishing returns, in attempting to construct ‘better incentives’ and ‘closer links between pay and performance’, they are expending more and more effort on trying to get right something that cannot, and should not, be done in the first place.

Endless exhortations to ‘do it better’ are, to put it politely, whistling in the wind. Companies get it wrong because it’s impossible to get right. In Jeffrey Pfeffer and Robert Sutton’s forceful plea for evidence-based management, Hard Facts, Dangerous Half Truths and Total Nonsense , the myths and fallacies surrounding incentives and performance pay are a prime exhibit. As they point out, it’s a hard fact that incentives do change people’s behaviour – but unfortunately that’s the problem. If you pay bankers to dream up fancy new financial products to sell to greater fools, that’s what they’ll do. But it’s total nonsense to expect them to blow the whistle to prevent the products from capsizing the company down the line – that’s not what I’m being paid for, guv.

The Catch-22 – the fatal flaw with all numerical targets and quotas – is that to be understood and acted on, incentives must be simple. But if they are that simple, in any organisation with objectives more multidimensional than a whelk stall, they are simplistic: inadequate to carry the information necessary for the accomplishment of other goals. It’s impossible to specify a simple target for a complex organisation. Hence (thanks for this to a thoughtful reader) the lament of Andy Grove, formerly CEO of Intel, that for every incentive the company devised it had to implement at least one more to mitigate the harmful effects of the first.

Simple incentives make clever companies stupid, like the banks, zapping even the instinct for self-preservation. But complex ones turn them into hotbeds of confusion, envy, fear and loathing, which is no better. Why should some people get bonuses and others not? Why is yours bigger than mine? In any organisation made up of multiple teams and interdependencies, calculating reliable attributions of responsibility for gain or loss is like counting angels on a pinhead. And trying to do it years later, with possible clawbacks depending on it, is a mathematical and legal nightmare.

It’s not even as if money actually satisfies people. As another reader notes, one of the most influential management stud ies ever – with findings replicated many times over – was carried out by psychologist Frederick Herzberg. Investigating motivation at work, he concluded that although pay and conditions could cause dis satisfaction, the reverse was not true: they didn’t generate satisfaction, which came from factors intrinsic to the job itself (challenging work, recognition, responsibility).

People consistently overestimate the importance of money for others but for themselves, money is more likely to be a dissatisfier than a satisfier. Herzberg’s famous dictum rings as true now as it did 50 years ago: if you want people to do a good job, give them a good job to do.

The best thing to do with pay is therefore to stop forcing it do things it is incapable of and instead put it back behind the horse, where it belongs. People can then forget about it and get on with the job. That sounds flip, but in fact is serious, because it reverses the usual twisted logic. A bonus, like profits in general, is a consequence, not a precondition, of doing a good job. In a systems view, a guaranteed bonus is a contradiction in terms, as is the idea of paying any bonuses at all if the organisation is loss-making. Performance can only be optimised at the organisation level, so if the latter has done badly as a whole there is nothing to reward.

Incentive systems quickly become institutionalised: that’s part of the problem. It’s what people learn to expect. As Soviet premier Nikita Krushchev once said: ‘Call it what you will, incentives are what get people to work harder’. But even if that is true, it doesn’t necessarily get you where you want. Financial incentives lead to inequality in rewards – duh, that’s what they’re supposed to do.

For jockeys, loggers and orange pickers (to modify my categorical statement of a couple of weeks ago), that seems to result in higher performance. But it’s death to the co-operation and teamwork on which overall organisational performance depends. From sports teams and university departments to publicly quoted companies, the greater the pay inequalities the worse the results, whether in terms of collaboration, productivity, financial performance or product quality.

The moral of the story is that companies should be very careful what they choose to pay for – because that’s what they’ll get, and nothing else.

The Observer, 22 February 2009

THE MOST REMARKABLE thing on show at last week’s banking hearings was the capitalists’ naivety about capitalism – a gullibility that has endangered both of the economy’s major institutions, markets and companies.

Their credulity about markets has been total. In a forthcoming paper, Professor Brendan McSweeney of the Royal Holloway School of Management argues that ‘market-failure denial’ may have actually helped to provoke the economic holocaust. He notes that, by discounting the evident pitfalls of unrestrained purpose and capital-market-driven myopia, assumptions of market infallibility cleared the way for free markets not to self-correct, as believers predicted they would, but to self-destruct.

Likewise self-interest, another article of capitalist faith, was no more effective as a curb on bankers’ capacity to self-harm than on sharks in a feeding frenzy. In the financial Gotterdammerung, hedge funds that had successfully taken down everything else that moved did the same to the banks, only to discover they were destroying the source of the funds they needed to gamble with.

As for companies, the capitalist orthodoxy got it wrong from A to Z. Managers miscalculated risk, misallocated resources and created incentives of such outstanding perversity that they brought the entire global financial system crashing down around them.

How could this happen? One answer is that, in their Tarzan-like celebrations following the Cold War triumph over central planning, the high priests of capitalism neglected to notice the sting that the moribund system had left behind. With exquisite irony, while central planning had been largely discredited at macroeconomic level, at microeconomic level it remained alive and kicking – in their own organisations. Veteran systems thinker Russ Ackoff is not alone in noting that while at the macro level the west is vehemently committed to a market economy, at the micro level almost everyone works in ‘non-market, centrally planned, hierarchically managed’ ones.

The truth is that much conventional management is central planning in western disguise. This is why most companies are zombie-like in their structural and strategic similarity. This is why, too, they are unable to learn. With their faces toward the CEO and their arses towards the customer – in the immortal words of GE’s former CEO, Jack Welch – what would they learn from? No wonder warnings of disaster were suppressed or auto-censored at the banks, or that the only messages heard were those that fitted with the earnings targets that managers managed by. In turn, the learning failure explains why so many companies adhere to the Zimbabwe school of change management – altering course only after ruin, by coup d’etat.

Central planning imposes a huge co-ordination burden – which is why there’s just so much management. If work is fragmented so that people have no direct line of sight to the customer, people have to be driven by signals from above rather than below. So each company has its own little State Planning Committee, a management factory remote from the people doing the real work, where managers devise top-down production schedules, targets, procedures and carrot-and-stick performance management and pay schemes, with complex systems to keep track of it all.

The cost of maintaining the management factory is immense. Consider that the world’s most efficient large conventionally managed corporation, GE, spends 40% – that is, $60bn – of its revenues on administration and overheads. For every direct worker there’s an indirect one to check or ‘manage’ the work. If anything, overhead costs are increasing as work breeds more work. In less effective organisations, of course, hidden indirect costs are much higher.

None of this adds value for the customer. But although management clearly isn’t costless, we weren’t expecting the balance sheet to be negative. Yet while capitalists chortle over the absurdities of Soviet-style central planning – not to mention over-management in our own public sector – nothing in the pantheon of Soviet nonsenses (plants making a single giant steel bar or only left-foot shoes) compares, for destructive firepower, with the complex instruments rolling off the production lines of Wall Street and the City of London. Warren Buffett’s description of derivatives as weapons of mass destruction was exactly right.

As it turns out, the managers of large western corporations have much more in common with the apparatchiks of the command economies than is recognised. The aim may be different, but they share the same conception of management – faith in targets and incentives, separation of ‘management’ and ‘work’ – and, ultimately, the same neglect of customers and product markets. If capitalism is to be saved, don’t expect salvation to come from the capitalists.

The Observer, 15 February 2009

SOMETHING approaching panic is stirring the rarefied atmosphere of Planet CEO. Last week, President Obama did the unthinkable, in effect imposing a maximum wage ($500,000) on top executives of firms that receive ‘extraordinary help’ from the US government.

The Senate is athrob with other proposals. One senator has proposed an Income Equity Act under which pay that is more than 25 times that of the firm’s lowest-paid worker would cease to be tax-deductible. As part of the bail-out, another wants a five-year, 10% surtax on earners over $500,000.

The pay cap is a blunt instrument, and it won’t affect many of those who deserve it most they have already departed with so much swag that they will never have to work again (one of the many things wrong with present arrangements). It’s a historic moment nonetheless – the moment when the land of the free and the home of the free market decided that enough was enough, and that shelling out $18bn in Wall Street bonuses – that is, payments for performance over and above normal pay – in a year of record losses was way beyond it.

As part of the bail-out, there is repor tedly to be a conference to discuss an overhaul of executive compensation. This is a big opportunity, provided it resists predictable calls to ‘leave adjustments to the market’. It was the market that created the problem: top pay has been one of the most egregious market failures of the last 20 years. But what Nassim Nicholas Taleb, author of The Black Swan, calls ‘asymmetric compensation’ (heads I win, tails I don’t lose) is not just a symptom of distortion: by absolving individuals from responsibility for the consequences of their actions, it is also a substantial cause of the meltdown. Unregulated top pay is simply unsustainable.

To root out the perverse incentives with which chief executives’ pay is riddled, Obama’s conference needs to go far beyond the size of the bonus. At the heart of the pay spiral is governance, in the shape of the disastrous ‘agency’ doctrine that demands the ‘alignment’ of managers with shareholder interests through monetary incentives. Agency theory is management’s very own Ponzi scheme. It is a self-reinforcing enrichment device for top managers and privileged shareholders who, in unholy alliance, have combined to loot the company at the expense of employees, customers and, as we now know, society as a whole. Breaking out of the corrupt and self-serving agency model is an essential first step to lasting pay reform.

When managers are paid for service to the company rather than service to shareholders, other things fall into place. There are three interrelated considerations to be taken into account in setting pay: internal fairness, external fairness and what the company can afford. The agency model has caused most companies to ignore the first and even the third, concentrating exclusively on external benchmarks. The result is that ratios of CEO pay to average pay are beyond grotesque. Ratios of 300-plus, as in the US, wreck internal cohesion, which in the long term is organisationally unaffordable. As the bankrupt Wall Street firms amply demonstrate, they are unaffordable financially, too. A better balance between the three is the second essential of pay reform.

The third essential is to diminish – preferably abolish – the role of bonuses in pay setting (there’s nothing wrong with shared retrospective payments, as at John Lewis). The bonus culture is so ingrained it comes as a shock to find – it’s worth spelling it out – that evidence to show monetary incentives improve performance is simply non-existent. On the other hand, studies demonstrating that it is counterproductive are plentiful.

Actually, that may not be so hard to understand. The proposition behind all incentives – ‘do this and you’ll get that’ – is a crude behaviouristic device to secure compliance. It’s how you train a dog. But in a human context it damages intrinsic motivation – the desire to do a good job – and fatally displaces the focus of effort. In the words of Alfie Kohn, whose book Punished by Rewards remains the definitive statement on such matters: ‘’Do this and you’ll get that’ makes people focus on the ‘that’, not the ‘this’. Do rewards motivate people? Absolutely. They motivate people to get rewards.’ Money doesn’t attract the best it attracts the greediest. Worse, by insisting that bonuses form the largest part of overall pay, current governance guarantees that the tail wags the dog – in the case of the banks, to bits.

If incentives don’t work, what does? Simple. Pay people well and fairly, Kohn and others recommend – and then get them to think about the job in hand. You’d rather like doctors and nurses to be thinking about your particular condition rather than the bonuses they could notch up by taking your blood pressure or giving you a flu jab. The same goes for executives, too.

The Observer, 8 February 2009