Read my article on zombie management in the Daily Mail, 17 January 2011

It’s hard to know which is more unappealing: ministers ineffectually begging bankers to show ‘sensitivity’ in this year’s bonus round, or the bankers themselves, who like the aristocrats of the Ancien Régime show absolutely no sign of altering their behaviour one jot until they are forced to do so.

Now, I have no problem with workers being handsomely rewarded for corporate success. The conventional view that financial capital is the scarcest and most important corporate resource, and that financial investors are the only stakeholders that matter, is ideologically-inspired nonsense. It’s human capital and the accumulated know-how embodied in products and processes that are today’s source of competitive advantage, not raw financial clout. In this perspective, Nicholas Sarkozy’s rule of thumb that in a solidly profitable company, returns should go equally to employees, shareholders and future investment (due taxes having been paid, of course) sounds about right.

So what’s the issue with bankers? Actually there are two. The first, much neglected, is internal fairness, which appears to be much better correlated with firm performance than individual rewards. Income inequality within firms, just as in society as a whole, undermines solidarity and engagement; any effect of increased competition is nullified by decreased cooperation. As the past 30 years conclusively prove, trickle-down economics is a myth.

On the other hand, bonus systems such as John Lewis’s, that reward everyone after the event and equally (in proportion), have the opposite effect. By recognising the reality that corporate success (or failure) is a collective effort, not the work of one or two stars, they foster commitment and cooperation. Individual bonuses, especially large ones, have the perverse effect of making people think about the money, not the job. The best reward system, by contrast, is fair and generous enough that no one has to think about it at all, freeing people to concentrate on the object of the exercise, ie doing a good job.

The second issue is even more basic. Lesson 1 in Economics 101 is that in a competitive economy very high profits can’t exist for long, because they will attract new entrants to the industry who will compete the excess profits away. As the sainted Adam Smith put it: ‘On the contrary, it [the rate of profit] is naturally low in rich and high in poor countries; and it is always highest in the countries which are going fastest to ruin.’

The obvious inference is the right one. Banking is not efficient, in economic terms. In fact it is profoundly inefficient. To put it more colourfully, as Tony Hilton did in the Evening Standard, the City of London and Wall Street are the biggest market failures of all time. There is no incentive to keep costs down (Merrill Lynch’s John Thain reportedly spent $1.2 million on office decorations and paid his driver $230,000 a year) – and perversely, more onerous regulation just protects the current oligopoly (and its profits) by making it harder for upstarts to break in and shake things up. Meanwhile, the size of the rewards on offer for just one large deal means that individuals are no longer subject to the reputational discipline of the past. When deal participants need never work again, the old City boast that ‘my word is my bond’ becomes irrelevant.

The situation is made still worse by the ‘too big to fail’ syndrome. As Justin Fox pointed out in a perceptive HBR blog recently, the increasing returns to work in finance were for a long time justified as rewards for creating alpha. In light of the global financial crisis, that claim provokes hollow laughter. Instead, writes Fox, ‘it seems more likely that the combination of massive risk-taking in the financial sector and government backstops and bailouts when those bets go bad has created a situation where financial sector pay is kept artificially high’.

How high? About 40 per cent, according to academic work quoted by Fox that compares financial-sector pay packets with those of other professions where people had similar skills. Note that that’s for the financial sector as a whole; in the more rarefied reaches of Wall Street and the City those percentages would be astronomically higher. Hardly surprising, then, if you can hear ‘a giant sucking sound’ (Fox’s term) as these purlieus ‘hoover up the smart and self-interested’ – among whom figure plenty of out-of-office politicians, whose presence among the snouts in the trough perhaps helps explain the strange reluctance to enact reforms that would reduce finance’s unhealthy dominance, cut bonuses down to size and respond to voters’ concern all at the same time.

In one sense, the bankers’ heel-digging is logical. In their eyes they really are Masters of the Universe, so why wouldn’t they expect to be paid as such? To the rest of us, they look more like the callow Sorcerer’s Apprentice, whose pretensions to power far outstripped his ability to use it, resulting eventually in a bail-out by his master. To prevent the servant getting ideas above his station again, the banks have to be broken up, with no connections allowed between narrow utility banks, protected and guaranteed, and their casino offspring. The investment banks, too, as a useful article (you may need a subscription) by Seth Mallaby in the Financial Times points out, are riven with conflict and should ideally also be split up.

Crucially, making them small enough to fail would remove the implicit incentive for overexuberant risk-taking. Together with a Tobin tax on transactions and a requirement to subject financial innovations to pharma-style safety testing, these measures would drastically reduce the subsidised profitability of the financial sector and slash the size of the bonus pot available. Yes, short-term tax receipts would suffer; but that loss would be vastly outweighed by the benefits of a better-balanced economy, greatly reduced systemic risk and an end to that horrible sucking sound.

Although it’s not man-made, unlike the financial hurricane that ripped through the world two years ago, the extreme weather conditions of the last six weeks, and the subsequent orgy of blame and recrimination, provide some timely management food for thought for both individuals and institutions.

Thus, terrorists and plotters everywhere, eat your heart out. It doesn’t take bombs or sophisticated conspiracy to unhinge our our ultra-managed, protected, securitised, organised and information-swamped environment and throw it into panic. It takes rain and snow. Our antediluvian grandparents would have been astonished. They were profoundly undismayed by the idea that each year they might suffer temporary inconvenience from cold, wind, and precipitation. They got in extra provisions, stocked candles, and wore warm clothes. They even had a name for it: winter. They would have understood the sentiment, if not the language, of the twitterer who wrote at the height of the crisis: ‘Caught short by the snow? Confined to barracks? Buy a f****** shovel.’

As ever, the reaction for such natural ‘disasters’ is to look for culprits and resolve that it will never happen again. Why weren’t we told? Whose fault is it? Who’s going to pay/resign/say sorry? Hence the tidal wave of retrospective regulation slamming the door after the horse has bolted. Not only that: by reinforcing the belief that natural causes can be managed away it perversely and tragically undermines the individual resilience that our grandparents knew to be the only sensible and proportionate response.

At institutional level too the weather raises some important questions about long-term issues of economic management – issues that have been long brushed under the carpet of conventional wisdom. Could it be that the winter of 2010-2011 will come to mark the full stop at the end of the era of privatisation?

In his excellent Zombie Economics: How Dead Ideas Still Walk Among Us (of which more on another occasion), John Quiggin nails privatisation as of one of the undead: an idea whose substance has been sucked away by the global financial crash but whose empty husk lingers spectrally on.

Who’d have thought even a few years ago that such capitalist icons as Bank of America, General Motors, Royal Bank of Scotland and Citigroup would find now themselves in public ownership? Of course, these will almost certainly be temporary public enterprises. But in truth privatisation has been in retreat for years. It’s not just that that there has been a steady stream of individual renationalisations: Railtrack and London Underground in the UK, rail and the national airline in New Zealand, broadband in Australia, health (controversially) in the US, not counting the crash casualties for which the public sector has turned out to be a literal lifeline. It’s that its underlying pretensions to efficiency and public benefit are increasingly revealed as threadbare.

Quiggin, an economist, notes that despite the strident free-market rhetoric, empirical evidence on the effects of privatisation is both rare and ‘decidedly mixed’. Some privatisations, as in Russia, were organised banditry. When Quiggin looked at selloffs in Australia, he concluded that the only ones yielding the government a net fiscal gain were those that took place in a bubble, with the result that they were later resold at a loss. In most cases, he says, ‘there was a net fiscal loss from privatisation’, with no offsetting benefits to workers or consumers, implying that there was also a net social loss.

You don’t have to be a revolutionary to note that what the theory suggests, this winter’s snow and ice made bleeding obvious. As FT columnist and deputy editor Philip Stephens wrote recently, the shambolic events at Heathrow before Christmas exposed, not for the first time, an increasingly evident truth – ‘a culture of private ownership, financial engineering and short-term financial reporting that militates against long-term investment in major infrastructure’. In the same newspaper, John Kay, another economist, agreed: ‘Highly geared businesses are not suited to the long horizons needed for airport planning’ – or indeed other infrastructure projects, which is why the UK’s railway system too is such a mess.

Stephens called for Heathrow to be nationalised, or at least turned over to London mayor Boris Johnson. Meanwhile, writing in Libération, an observer of similar events in Paris noted that his abiding memory of the episode was of EDF (Electricité de France) engineers behaving like real public servants: working all night without a break in freezing rain to get the lines back up again.

The lessons of the coldest winter and the iciest financial climate for the best part of 100 years thus converge at the same perhaps unexpected point. The unmanaged market is a recipe for disaster. What is needed is a system that is actively mediated by the government, in which individuals, private companies and the state all have a complementary part to play. The boundaries between them are permeable and shift over time, but none can thrive exclusively of the others. As Quiggin notes, this is not a compromise between free markets and socialism: unlike the vapid offerings of Tony Blair and Bill Clinton in the 1990s or David Cameron, it is a real Third Way that free-market ideologies made it previously impossible to envision.

Happy New Year. And let’s hope the weather improves.

This article was published on Systems Thinking Review on 21 December 2010. To read it, click through here

This article appeared in FT Business Education magazine, 6 December 2010. To read it, click here

Of course there’s such thing as an ethical business. There are plenty of organisations that have at their heart the idea that business is not just a vehicle for making profits but a force for the broader good: John Lewis and the coops, social enterprises, Fairtrade firms; even in the US there are companies like Whole Foods Markets, 7th Generation and others that as well as believing wholeheartedly in capitalism believe in doing the right thing too.

Lots of these companies are extremely successful too (although that’s not and shouldn’t be the rationale for being ethical. Remember the saying of Archbishop Whateley: ‘Honesty is the best policy. But he who says so is not an honest man’). And why shouldn’t they be successful? The truth, I’ve come to believe, is that it’s not what you know (or think you know) about business that’s crucial to business success: it’s knowing what you believe in and what you want to do strongly enough to make your own rules – and that includes being ethical or indeed being non-ethical.

So how come the myth has grown up that business can’t be ethical? Put crudely, in the 1970s-1980s there was an ideological hijack of the business orthodoxy by an unlikely and opportunistic alliance of corporate raiders and business schools. Each had their own reasons for formulating a kind of free-market fundamentalism to which the returns have steadily declined and now turned negative, as witness the series of scandals that culminated in 2008 in the banking crisis – which, let me remind you, was the result not of impersonal economic forces but mistaken, venal, greed-motivated decisions by human beings, managers, at the top of large financial firms.

Of course, there has always been a tension between what you might call a light side and a dark side of business: Quakers on one hand, robber barons on the other. But it is only in the last 30 years that a single dogmatic orthodoxy has hogged all the speaking roles, drowned out the counter-examples that I’ve mentioned above and turned business officially and explicity into a morals-free zone. That orthodoxy is the doctrine that the purpose of business is maximising returns to shareholders. After some initial resistance, the original gang of two promoters was quickly joined by top managers who instantly saw that far from being a threat managing for shareholder value could be very much in their interests too. Articulated by three powerful interest groups, the mantra ‘no ethics please, we’re businessmen’ was locked in place by corporate governance codes for which by the way there is no empirical evidence that I know of that they make business more successful and some that they make it worse.

As we have experienced, morals-free business is a disaster – but it’s also based on an egregious legal fallacy. It turns out – I’m quoting here – ‘[after a systematic analysis of a century’s worth of legal theory and precedent] that the law [is] surprisingly clear […]. Shareholders do not own the corporation, which is an autonomous legal person. What’s more, even when directors go against shareholder wishes […] courts side with directors the vast majority of the time…

‘And yet, in a 2007 article in the Journal of Business Ethics, 31/34 directors surveyed… said they’d cut down a mature forest or release a dangerous, unregulated toxin into the environment in order to increase profits. Whatever they could legally do to maximise shareholder wealth, they believed it was their duty to do so.’

This, says the article I’m quoting from, is plain wrong. Directors are being taught the wrong things, with the result that they simply don’t know what their legal duties are. Hence the tragic irony of innovative, proudly ethical Quaker companies like Cadbury, which campaigned against slavery and alcoholism and food adulteration, and Friends’ Provident and Barclays – did you know Barclays was orginally Quaker? – setting aside their ethical principles in the mistaken belief that they have to privilege stockholders above all the rest, and suffering the terrible consequences that we’ve seen.

Now a test: where do you think the text that I quoted comes from? No, not Marxism Today or New Left Review, or even the Observer. It appeared in that revolutionary organ Harvard Business Review – and while that sinks in, consider something else that I read in HBR a couple of months later: shareholders have not done better under shareholder capitalism, in fact they have done worse, than they did in the previous three decades from the end of the war to the late 1970s when managers and directors commonly believed they owed something to employees and society as a whole, not just the stockholders.

There are plenty of reasons for that, and I won’t elaborate on them here. But the point is that there’s no argument even in shareholder capitalism’s own terms for not behaving ethically; and very many arguments for, the biggest one being that if capitalism isn’t underpinned by an internal commitment to bettering society rather than just oneself then no amount of external regulation will prevent more and worse crashes in the future, and this one’s quite bad enough, thank you. Let me end with a quote from Peter Drucker, as relevant now as when he wrote it in 1954: ‘Free enterprise cannot be justified as being good for business. It can be justified only as being good for society’.

Text of a talk given at The Foundation on 29 November 2010

Oh, how I wanted to hate this book.* That grating note of injured victimhood: the very title sets your teeth on edge. Yet another attack on the baby boomers. As if it was their fault they were born in the explosion of fertility that followed the most horrific war in history – in which many of them lost family and almost everyone someone or something precious. As for the optimistic aspirations of the 1960s – at least they had some. And guilt at having (eventually) bought houses and signed up (the lucky ones) for pensions? Grow up, get a life, get a job!

By the time I finished Ed Howker and Shiv Malik’s book, I was still boiling – but not at them. I still think the baby boomer angle is sensationalist and unhelpful: generations are too slippery to be useful units of analysis, let alone blame (as one cross friend said to me on his 46th birthday: ‘What about us? Our parents are going to live to 100, and our kids are still at home because they can’t get jobs or houses!’).

Above all aiming at their grandparents deflects attention from the real culprit – which the thrust of their case makes abundantly clear. What they eloquently trace is the consequences of a breathtakingly foolhardy 30-year (not 60-year) experiment in dismantling the state and individualising responsibility that has led straight to the debt crisis we face today.

As the authors note, this was a deliberate political project. Dazzled by the hard-edged arguments of Chicago monetarists, Margaret Thatcher (who hated the baby boomers) and co-ideologues in subsequent governments acted out the belief that the state wasn’t just inefficient: it was hostile to the individual. In this view, public service was an oxymoron, public employees of all kinds pursuing their own interests at the expense of those of citizens (think Yes, Minister). Since the latter could be relied on to know what they wanted, the argument ran, let’s get rid of the former and allow the marketplace – an instant information processor, in contrast to the hopelessly clumsy proceses of democracy – to coordinate needs and provision without bureaucratic interference. Even better: since markets are efficient and tastes constant, there was little need to plan for the future at all!

In a wealth of charts and tables, Howker and Malik lay out the price of this institutionalised short-termism for three things that matter most to young adults: jobs, housing and inheritance. These chapters are urgent, surprising and enraging. They show how at every turn human beings pirouette around rigid economic theory as effortlessly as foreign footballers past dim English defenders. In housing, they demonstrate how the great council-house sell-off and deregulation have bequeathed us a housing stock and tenancy regime (respectively poky, expensive and insecure) that meet the needs of buy-to-let investors but not those of young adults wanting a home. In jobs, the dropping of full employment as a political goal has been just as counterproductive. Far from being a consequence of Labour welfarism, the ‘benefits explosion’ that George Osborne is now trying to rein in is the direct result of Thatcherite deregulation – the counterpart to rising unemployment and, even more striking, a race to the bottom in employment in which more and jobs, particularly for young people, are so badly paid that they have to be supplemented by handouts from the state. Subsidising skinflint employers now accounts for a large part of the £90bn benefits budget.

As the book shows, abandoning collective responsibility for the future had other dire consequences, notably the crumbling of the apprenticeship system and the casual shrugging off, still proceeding, of pension obligations (let alone career). Free university education went the same way. Paradoxically, Conservative and New Labour governments that lectured the 1960s generation so sternly about living within today’s means were being as profligate with tomorrow’s as a flash City trader on his third bottle of Bolly. Unlike Norway, which quaintly funnelled North Sea oil revenue into a sovereign wealth fund for collective benefit, we blew it. Likewise the £60 bn proceeds of privatisation. And no, as our authors point out, the unleashed private sector proved no better at investment than the public, chief executives quickly twigging that the simplest way to win City kudos (and lavish bonuses) was to slash investment, research and jobs. Meanwhile, like a desperate gambler, governments have thrown around off-balance-sheet IOUs like confetti. Through the PFI, capital projects worth £56bn will end up costing £267bn.

Labour Treasury chief secretary Liam Byrne’s cheeky note to his coalition successor that the cupboard was bare was no joke. There’s nothing left to sell or pawn. Howker and Malik are right to dig through that flippancy to expose how successive governments have bet (and lost) the farm on a barren economic formula. This month’s savage cuts are payback not just for bankers, but for three decades of voodoo economics. We should applaud their forensic skill in exposing the rarely discussed assumptions than have led us where we are, and in setting out the consequences in concrete terms. Perhaps not surprisingly, they are less convincing in putting forward remedies, however. It will certainly take more than the mild doses of social enterprise and employee ownership that the authors suggest.

Yet it defies belief that that a nation with Britain’s resources should be going backwards in terms of simple basics that matter most to most people. To change that, it’s not the fringe manifestations of capitalism that have to shift, but the brutal and unrealistic economic credo at its heart. Putting forward a political programme that does that is the real challenge for the jilted generation – and one that the baby boomers, forgiving the brickbats, will support all the way.

* Jilted Generation: How Britain has Bankrupted its Youth, Ed Howker and Shiv Mali, Icon Books: London 2010

This article was published in Financial Times Business Education magazine, 25 October 2010. To read the article on ft.com, click here

This article was published in Financial Times Business Education, 20 September 2010. To access the article on ft.com, click here

THOSE OF a timorous disposition may want to avoid Enron: The Smartest Guys in the Room. Most Hollywood horror is ultimately comforting, since you can tell yourself it never happened. Not so the events recounted in this blood-curdling, neatly constructed documentary on the rise and fall of the notorious Houston energy giant, culminating in the world’s biggest bankruptcy.

As the film progressively reveals, principally through the mouths of the protagonists, they really were as bad as they seemed. We see the hubris (one of the shell companies set up to shelter the firm’s mounting losses was called M. Yass – OK, move the full stop to the right), the self-serving and the rampaging greed. In retrospect, though, what should send shivers up every spine is that if Enron and Arthur Andersen were business’s Twin Towers (40,000 jobs and $100bn of capital were lost between them), the fundamentalism that brought them crashing down was not some external malevolence: the enemy was, and is, within.

At one level, Enron was a microcosm of the dotcom extravaganza, a one-company bubble of its own. All the ingredients were present: within the firm, leaders who believed they could outsmart anyone or anything, and products that became increasingly disembodied from reality (from energy to futures and markets: at one stage it planned to sell weather) outside the firm, political support and willing believers – ‘useful idiots’ in both academic and financial worlds who took at face value everything the firm told them and eagerly talked it up.

Once the bandwagon started to roll, Enron became a model of self-sustaining momentum. Everyone was dazzled by the honeypot. Investors scrambled over each other to pile in. The top US investment banks, Wall Street’s creme de la creme, enthusiastically subscribed to the loss-hiding schemes, no questions asked. Laxer accounting rules? Regulators, perhaps mindful of chairman ‘Kenny Boy’ Lay’s political connections, were happy to oblige. Lawyers and auditors – the latter well enough aware of what was happening to shred the offending documents in panic when the balloon burst – were far too dependent on the gravy train to even attempt to apply the brakes.

Enron was a bubble in another sense. Disconnected from reality by both its conviction of invincibility and its fantasy accounting, and unchecked by guidance from the top, Enron employees behaved as if they were in a world of their own. Just how perverse this world had become is shown in one of the film’s most disquieting sequences where Enron traders are overheard laughing and boasting about their efforts to disrupt California’s energy supplies in 2000. The famous blackouts that year were not caused by shortage of capacity or poor regulation – they were caused by Enron, which drove prices (and profits) up by as much as nine times by shutting down power stations and creating artificial shortages. Caught on tape, one trader exults at the forest fires sweeping over the state, crowing ‘Burn, baby, burn!’

It may be significant that it took two women to make the first small punctures in this testosterone-inflated balloon – Fortune reporter Bethany McLean (one up for journalism here), who mildly asked if the company’s stock was overpriced, and Sherron Watkins, the Enron employee who undertook the dangerous job of informing the company emperors that they weren’t wearing any clothes.

Although Enron bosses used considerable ingenuity in their attempts to disguise the true state of the figures, in retrospect the most striking thing about their drive to auto-destruction is its utter pumped-up, fanatical single-mindedness: business as extreme sport.

Enron was the most extreme corporate monument to shareholder value ever erected. The entire system was geared to keeping the share price up. On the carrot side, the incentives for doing so were vast: even in the last months executives were collecting bonuses of tens of millions and cashing options for hundreds, even as they exhorted lowlier employees to invest their retirement savings in company stock (which was later pillaged in a desperate attempt to buy time). On the stick side, the system was ‘rank and yank’: every year all employees were graded one to five, and all the fives were fired. Fifteen per cent had to be fives.

In a culture formed by the sack on one side and a pot of gold on the other, it’s scarcely surprising that employees stopped at nothing, including shutting down California (which is now suing for $6bn compensation), to keep the quarterly numbers moving up. After all, their own greed could be, and was, justified because it was all for the shareholders.

But we should know that. In systems where incentives are sharp enough and the moral compass deliberately disabled – what’s good for shareholders is good for the company is good for me – that’s what happens. In that sense, to get where Enron ended up didn’t require management to be deliberately evil; it just required it to take what most MBAs learn at business school and pursue it to its logical conclusion.

The Observer, 7 Ma7 2006