In his speech and conversation with Stuart Crainer, Roger Martin encourages the audience to build an understanding of the economy as a complex adaptive system, and not a machine that we can perfect.
America, and the rest of the world to an extent, have become obsessed with economic efficiency, and that is not producing outcomes that are good for us. Arguably, we got on the path of efficiency inspired by Adam Smith, who encouraged efficiency by way of two means- a division of labour and relatively free and fair markets guided by the invisible hand of market forces. The founding fathers of the US quoted him quite liberally in their works. Later, David Ricardo added to the discourse with the idea that it would be more efficient if countries specialised in what they have a comparative advantage in, and traded with countries that have other comparative advantages. There were other economists down the years as well who talked about ways of increasing efficiency, such as Frederick Winslow Taylor who was the father of scientific management, and W Edward Demmings. We, therefore, had this increasing view of the importance of efficiency to the economy, and arguably it was great for America. America prospered, became a highly efficient and highly productive economy, so it was not a bad thing. But the expectation of what this would produce was rooted in the bell curve or the Gaussian distribution.
The notion was that we would produce with this combination of democracy and capitalism, and capitalism based on efficiency would be the kind of distribution of outcome where there is a very large middle class, some rich people, and some poor people, and the rich would be taxed more heavily so that they could help the lives of the poor people. Most importantly, the assumption was that if we pursued efficiency, we would produce this kind of progress over time, so that the economy would shift that Gaussian distribution ever more to the right. For the first 200 years – from 1776 to 1976 – this was arguably the case for America. It became viewed as part of the importance of any democratic country that there would be a middle class that was large and whose life got better most years on average so that the average family would be moving ahead. This was largely the story of American progress.
Things have changed since then. In 1980, when the American economy grew, the people who benefited the most were the lowest income, and the people who benefited the least were the highest income. By 2014, 34 years later, that had flipped entirely. The payoff structure to the US economy used to be, as recently as 1980, that growth is great for the poor and now economic growth is great for the rich. The problem with this is that up to the bicentenary, the American median family could expect to double their income in a generation or 30 years, whereas now, since 1976, the American median family has the expectation of doubling their income in three generations, that is, 100 years.
In my view, the thing that has changed is the distribution system that we follow. We are not following the distribution of Karl Friedrich Gauss, but that of Vilfredo Pareto. He gave the Pareto curve, which is a very different curve and is challenging to democratic capitalism. This can be seen played out in wages. All American employed people can be separated into four categories- first, Routine-in-local, people who are in routine jobs i.e., a job where they are asked to follow a routine, not asked to make decisions on their own and they are in an industry that is dispersed across the country. These are hairdressers, landscapers, and the like. These are most of the Americans and are part of the lowest income group. Second, routine-in-traded, people who have a routine job like an assembly line worker in an industry that is clustered in a few places. Third, creative-in-local, people who are in a job where they have independent judgement and decision-making, and they are in the local industry. Fourth, creative-in-trade is the best place to be, where people get creative jobs, in an industry that trades outside its area. These jobs are engineers, pharmaceutical scientists, and the like.
The income distribution curve across these four groups is distinctly pareto in shape. The key thing is that the curve is getting ever more Pareto in structure as the data from 2000 and 2012 shows, which means that in 12 years the wages for the first two categories did not grow at all, and the income for the third and fourth category has grown dramatically. So, income distribution is getting more and more Pareto in structure. The tricky thing with Pareto distribution is that we lose that bulge in the middle that we believe democratic capitalism is predicated on. Instead, we have that bulge flattening, and more people are in low income while fewer people are taking the vast majority of the benefits of economic growth. It is now becoming more dramatic and so the median family is feeling a sense of stagnation.
The next question is what causes the Gaussian distribution that we were counting on, to shift to this Pareto distribution. Gaussian distribution of outcomes is very consistent with democracy; in such distribution, capitalism and democracy work well together. In a Pareto distribution, democracy and capitalism are utterly at odds, but when we continue to apply more and more pressure to the Gaussian distribution and decrease the cost of connection among the data points in that system, it converts from Gaussian to Pareto. This is what is happening to the US economy.
Freer trade, deregulations, a belief in the efficiency of capital markets that allowed for a greater amount of trading, and a focus on quarterly income that puts more pressure on executives to perform, cut costs and lay people off is pushing our Gaussian distribution to work towards a Pareto distribution. So, in the last 50 years, we have been excessively focused on increasing the efficiency of the economy by putting more and more pressure on all the entities in the economy. That is producing, which shouldn’t be a surprise- income inequality, and the top 1% getting unbelievably richer. It is a direct result of our obsession with efficiency that has gone beyond the bounds of something that is good for the economy to something that is not so good.
This produces a fragile monoculture. A field of almond trees in California’s Central Valley is an example that can explain this. Due to this pressure of efficiency, we found out that the Central Valley of California is the best place to grow almonds. Almonds used to be grown all over the world but now 80% of the world’s supply of almonds comes from one valley in one state of the US. It’s a monoculture and if there were a blight as there was one in the monoculture of potatoes in Ireland, the entire crop would be lost. It also causes us to ship beehive in from all across America to pollinate almond trees for some amount of time. Some people speculate that the fact that bees are dying off in major amounts is because they are being shifted around to these monocultures to pollinate during a narrow window. Now, the concern of the day is the location of the pharmaceutical production as well, as we are getting these monocultures in the pharmaceutical sector that are not stable and not good for the country.
We need to have the understanding that the economy is not a machine that we can perfect. It’s a complex adaptive system, that when you pull a lever it is not as clear what would happen. In this current scenario, the key thing is to balance efficiency and resilience. We need to have an economy that is not all about efficiency. There are many good things that efficiency has given us but we need to balance it with resilience. It means three things where we need to create more of a balance underneath efficiency and resilience to create an overall balance; one is the balance between pressure, increasingly putting on pressure on the economy, versus friction. We are treating the economy as if any sort of friction is a bad thing, but it is not, so friction in the form of slack is not the enemy to be wiped out. Another form of slack is citizens multihoming; the least friction thing to do is to say “I like Amazon Prime and I buy everything from Amazon Prime, I like Facebook and I can get all my news from Facebook.” Citizens have to recognize that they need to put in some friction in the system that is driving us to monocultures through a decision to fight that with multihoming.
Second, instead of striving for perfection like we are running a perfectible machine, we need to balance that idea with improvement. We are never going to be able to perfect a complex adaptive system, so politicians should not be saying that we will create a perfect bill, a perfect piece of legislation that will fix the dot com crash or fix the global financial crisis. We have to realise that all these are going to be deeply flawed and we should improve these. Seek improvement and not perfection, which means writing revisions in the legislation, reviewing every piece of legislation five years later, and revising it rather than thinking it is perfect.
Third, we need to balance connectedness and separation. We have gone too far in the US in opening the country to trade, which is creating more connectedness than is good for the country. But there are some things that we have to be more connected in, such as executives should stop being so reductionist in thinking only about one thing, one function at a time. Their company is a complex adaptive system in a big complex adaptive system. In education as well, we need to stop teaching reductionism as something laudable when it is something that makes us less capable of dealing with the complex adaptive system in which we live.
We will get more problems for democratic capitalism and more of a challenge of the electorate, saying, “I don’t like this, let’s blow it up.” We have seen examples of that already in the US and the UK. We are going to see more of it unless we take to heart the need to balance efficiency and resilience.
Stuart Crainer in Conversation with Roger Martin
Stuart Crainer: You usually talk about design, strategy, thinking- all organization-related, but this is a much bigger picture.
Roger Martin: It is, and it is funny how it all links together. The older notions of design are linked to the complex adaptive system, integrative thinking, and the notion that we can be reductionist, so it’s interesting how a bunch of what I have worked on before has come together in my head in the application to the greater economy.
Crainer: Does America have a monopoly on this problem?
Martin: It is an issue for other Western countries too but America has gone the farthest down this path. It is more obsessed with efficiency than any other country. Other countries are heading down that path and America is, in some sense, leading them down that path in certain respects.
Crainer: More is a proxy for better has been true for 10,000 years since the dawn of the agriculture revolution. You used Adam Smith as your starting point for it. Do you think that is true?
Martin: I think in many systems, more was better and is better for a long time, so you could go back as far as you want. I was going back to Adam Smith only on speaking to the issue of efficiency. In many respects, the push for efficiency and productivity in many ways started with the inside of the pin factory. This is why it is a delicate thing; this is a complex adaptive system question, this is not linear, that is, more isn’t better by the same amount as you go along. More is better for a while and then it seizes to be better and gets worse. It’s back to the point that economy is not a machine but the greatest problem we have is viewing the economy as a machine. It’s not and that is going to be an even bigger challenge.
Crainer: You talked about Frederick Taylor and scientific management but since then Fordism is how we have understood organizations, and we still understand them in a very linear way.
Martin: Absolutely, and business education has been the leading light in this problematic direction. Business education divides the disciplines into narrow disciplines. Peter Drucker, the greatest management thinker of all time said there are no tax decisions, accounting decisions, or marketing decisions; they are only business decisions, and business schools do precisely the opposite. This is accelerated over the last 50 years. The view of narrow bits of knowledge, and being scientific about things for which you cannot be scientific are all heading us in the direction.
Crainer: Does the holding out with the manufacturing sector have anything to do with these issues you talk about?
Martin: Absolutely. If something is fractionally more efficiently done somewhere else, we do it there rather than here. Now, is some of that a good thing? David Ricardo said so, but when you take it to the utter extreme, you will get utterly extreme outcomes. This is what I’m trying to help people see, that we are taking things to complete extremes and then we are surprised that we are getting extreme outcomes.
Crainer: Is this strive for efficiency behind the problem of getting safety supplies the US needs at the moment?
Martin: Absolutely. What we are seeing now is a reflection of the drive for efficiency. I am sure Governor Cuomo in New York would wish that he had signed that order to buy 16,000 ventilators three years ago, but I don’t think he was in some sense wrong in the current context, because he would have probably gotten eviscerated for that; somebody would have said, “What? 16,000 ventilators just sitting in the warehouse somewhere, in case something happened? You don’t care about the taxpayers.” He would’ve been roundly attacked in this environment of more efficiency is better. It’s the same with a lot of our pharmaceuticals, produced in one country that’s done some sabre-rattling on that front.
Crainer: So, efficiency is effectively working against longer-term planning?
Martin: It’s working not so much against long-term planning as much as just a long-term resilience. We’ve implicitly decided that by having more efficiency today we’re sacrificing less resilience tomorrow. People are doing that as individuals when they don’t buy their local newspapers anymore, they are making a pitch for efficiency.
Crainer: You talked about fragile monocultures potentially vulnerable to catastrophic failure. I presume that what you said about the almond harvest in California is the same as we are experiencing to some extent with the virus?
Martin: Yes. That couldn’t be more right. All the things that we wish we had now are no surprise because everybody involved has been evaluated on the basis of their improvement in efficiency. So, all those pharmaceutical committees that are considered evil are judged by shareholders on a quarterly basis for their growth numbers. They are then pushed to move production to places overseas where the earning per share increases by 2 cents. So, these are not bad people, it’s a complex adaptive system that is adapting to the incentive structures in place, which demand sacrificing resilience for efficiency flat out.
Crainer: If not efficiency, what are the new markers of business success?
Martin: I do think it is having a resilient model. If your business model depends on things happening in society that are not good for society, it is not sustainable in a broad sense. Therefore, we have to start judging business models to a greater extent based on whether they are sustainable from a societal basis. So, if a company that is selling half of its output to Americans and is not producing using Americans, you could ask the question, “Is that long-term sustainable for the economy, the people, the workers, the communities or not?”
This concept of sustainability that we should be measuring companies on is much broader than environmental sustainability. For example, the hedge fund business overall is an unsustainable business that requires screwing other parts of the social system in order to make a buck. Those are the industries that we should look at and ask the question about who is funding them. The top 20 pension funds are publicly mandated pension funds. These public funds tasked with making sure the return for pensioners 40 years from now are high enough as they promised, are giving money to activist hedge funds to screw up the companies that we need to perform well over the long term. We have to have a harsher eye for completely non-sustainable anti-social business enterprises, and activist hedge funds are exactly that.
Crainer: When you go to a company, what are the warning signs that show it is obsessed with efficiency?
Martin: When they have a goal, which is to be more efficient, it is reflected in their statements like, “We must cut labour cost, we must cut our employee base”. For example, in Costco, the minimum wage is irrelevant as everyone is earning well above that. Instead of trying to be more efficient, they recognize the need of having extremely well-compensated people on the store floors who have more training and are trained to do multiple jobs, so that the customers get a great experience, which eventually increases revenue. High is therefore not bad but a necessary part of a system that is designed to make the jobs of the people in the store awesome, so that they can also have an awesome life, they can contribute to their community and raise their family and children well and the customers are happier.
If I were an investor, I’d invest in Costco rather than a business where the workers are shuffling around demoralised as they cannot afford healthcare and have to rely on food stamps to get their food for the sake of efficiency. No matter how much they get their labour costs down, the experience of employees and consequently of the customer shows that they are in a desultory place where you cannot find anything because no one has got the time in the store to help you. It is observing things like these that you should do if you want to be supporting a future that is worth having.
Crainer: Are you optimistic that the people, the organizations, and the politicians have an appetite for change along the lines you have discussed?
Martin: I am cautiously optimistic because it won’t take gigantic things but it will take a lot of people doing a lot of small things to turn around the situation that we are currently in.