#171 The House That Jack Built And Other Stories
Welch's legacy. Missing meta-institutions in India. The benefits of paradiplomacy.
Global Policy Watch #1: The Man Who Broke Capitalism?
Global policy issues relevant for India
Over the last couple of years, I have run through a list of books in what I call the ‘crisis in liberalism’ genre. There is a template that most of these books follow – begin with the fall of Berlin wall, remind readers about Fukuyama’s ‘The End of History’ paper, run through the mistakes that a triumphal liberal order made through the next two decades, talk about capitalism running amok leading to the global financial crisis and then build a grand theory for the populist backlash we saw in the last few years.
I wrote about these books on these pages. The list is long – The Globalisation Paradox, Radical Uncertainty, Radical Markets, The Light That Failed, The Code of Capital and maybe you could add the various Piketty books in here too. There’s a cottage industry that’s built up here and you can say I’m a huge patron of their artisanal products. Well, the good news is there’s a new addition to this genre this week. “The Man Who Broke Capitalism: How Jack Welch Gutted the Heartland and Crushed the Soul of Corporate America--And How to Undo His Legacy” by David Gelles. The title is a mouthful, but it is also convenient. It says everything it has to say in its unwieldy length. There’s not a lot more in the book except trying to retrofit all kinds of ills of capitalism seen today by the author back to Jack Welch. Gelles is all over the media this week (here, here) talking up the book and making the same points over and over again. And it got me thinking on two counts. One, why business management research and literature is almost always garbage? And two, why do we get public policy on managing business and capital wrong so often?
On the book itself, I will try and summarise (in deliberate broad strokes) the three key arguments Gelles makes:
There was some kind of a ‘golden age of capitalism’ in the thirty years after WW2. Companies took care of their people, distributed wealth equally, happily paid the taxes and employed people for life. Businesses saw themselves as more than profit maximising engines. There was a feeling of loyalty to the country, a fraternal sense of belonging to a community and a wider obligation to the supporting the government. All quite nice.
Then in the early 70s, Friedman wrote that shareholder value maximisation paper (“The Social Responsibility Of Business Is to Increase Its Profits”) and the world was never the same again. Businesses focused more on their profits and soon lobbied for lower taxes and greater freedom in conducting their affairs. Reagan and the conservative revolution of small government followed. Into this mix came in Jack Welch as the CEO of GE, the iconic American institution. Welch singlehandedly destroyed capitalism as we knew it. He laid off people, shut factories, offshored jobs, built a shadow bank called GE Capital that reaped the benefits of financialisation, obsessed over meeting quarterly EPS numbers, stack ranked the employees in a bell curve, created the cult of CEO worship and initiated everything that you find wrong today in business. Quite an extraordinary feat in doing bad things at work. In Gelles’ words: “He's on the Mount Rushmore of men who screwed up this country.” The book then goes onto show how Welch’s long shadow still haunts corporate America despite obvious evidence that he got it all wrong. GE is among the worst performing stock in the last two decades. It announced last year it plans to split itself into three different businesses to unlock shareholder value. GE Capital, the engine that Welch built, is defunct. Yet, business leaders worship at the altar of quarterly earnings, force ranking employees, financial engineering, building personal brands and negotiating ever increase compensation packages for themselves.
So, what’s the solution? I’m not sure if I understood it from the book. Gelles isn’t advocating for socialism surely. But he does throw around words like stakeholder capitalism and praises the current CEO of Unilever and the founder of WEF that holds an annual event at Davos for their efforts to build compassionate capitalism. Some kind of a future where we don’t measure companies on shareholder value but another set of metrics involving all stakeholders that rein in the single-minded pursuit of profits is his solution. All quite fuzzy because he seems to run out of steam by the end of the book. All that Welch bashing is tiring.
Let me digress a bit here.
When I started my career, the ‘GE way’ was a rage in corporate India. I remember picking up a pirated version of Welch’s autobiography from a streetside vendor at Kala Ghoda. Everyone I knew was reading it. Except for the parts about his growing up that were written with some honesty, the book was terrible. All the stories followed the same pattern. Welch gets a call and goes down to a factory floor or to a customer site. There he hears or notices something small that gets him thinking. Then he finds someone young who reminds him of his younger self – direct, analytical and abrasive. Welch decides either on shutting down or buying a new business based on his gut. He gives this young man (almost always a man) the mandate to do it. Young man does the magic and Welch basks in his foresightedness.
Interspersed between these familiar stories, I got Welch’s views on lifelong employability (not employment), how to be tough but fair, his views on future of business and, of course, six sigma.
Ah, Six Sigma.
You couldn’t ignore Six Sigma in India during those days. Welch had elevated it into some kind of a religion at GE. Everyone had to follow it. There were weekly Yellow belt and Green belt training programmes in every company where employees would be taught some basic statistics, and something called the DMAIC model. If you did well, you would then go on to a rigorous Black belt certification programme. The ultimate big daddy of them all was the Master Black belt - a Shaolin master with scores of Black belts in his stable who could be unleashed on any problem. All Master Black Belts came from GE and for them the answer to every single problem was a Six Sigma project. Complaints about canteen food in office? Run a Six Sigma project. Spending too much on office stationery? Why, Six Sigma can help. People quitting because the work is drudgery? No problem, Six Sigma will solve it. I even remember a training programme where a Six Sigma expert told us he could solve the Israel-Palestine problem using Six Sigma if only they invited him. To me the whole thing, as it was run in India, was a charade. There was no new idea or insight that came out following it. It was just bureaucracy with some babus lording over us because they were certified in this nonsense. Japan was always shown as a shining example of the success of such techniques. I guess no one had heard about Japan’s lost decade.
Anyway, reading the book and seeing the success GE had then under Welch, I was convinced of two things. One, he foresaw the two trends of globalisation and financialisation way earlier than others. He figured both the threats and opportunities they presented and moulded GE take advantage of them. He did this better than anyone else who was running a large business then. Two, he realised that running a diversified, globally distributed enterprise requires a certain ‘way’. So, he codified it - bell curve for ranking employees, global training centres for creating a kind of manager, Six Sigma as the common language to solve for everyday problems and a common scorecard to rate business performance. In his scheme of things, process and order were more important than individual enterprise and innovation. GE probably didn’t produce a single world-beating product during his time but they did make truckloads of money for shareholders by being more efficient and faster to market than their competitors. And that didn’t happen by just mindless shutting down of plants or fudging the books as Gelles seems to allege.
Coming back to the book, I have three problems with it.
First, there’s no pause to consider the counterfactual turn of events. Had Welch not done what he did at GE, what would have been the alternative history? It was clear by early 80s that cheaper, and often better, consumer durables and industrial products were coming into America from Japan and the Tiger economies of far east. American labour was getting more expensive especially the retirement funds of workers that was run often on a defined benefit programme. Remember the great American motor companies had to be bailed out after the GFC in 2009 because they couldn’t fund the pension benefits of their ex-employees anymore. Welch was realistic enough to understand there wasn’t going to be any breakthrough technology that could change the businesses that were cash cows of GE. A refrigerator is a refrigerator. They had become commodities. Welch took a hard look at it and asked why couldn’t GE take the battle to the challengers? Why couldn’t GE outdo them in being more more efficient, use the same sources of labour as them and get into newer businesses? The breakup of USSR and the opening up of economies around the world helped him to go overseas. So did the steep fall in telecom rates that powered the BPO revolution. He also figured he could use the large cash flows his core businesses generate to build a financial institution. And he created a behemoth in GE Capital.
These two decisions extended the lifespan of GE and, perhaps, saved a lot of jobs. GE might be thinking of splitting itself into three today but these are still reasonably profitable businesses employing thousands of workers. The graveyard of corporate America is packed with companies who once competed with GE in sectors as varied as electricals (Westinghouse, Whirlpool), packaging and plastics (Tyco), household goods (Xerox, Kodak)…the list is long. They died because they didn’t do what GE did then. You can accuse Welch of being just a manager who got a couple of trends right and rode them but who didn’t innovate and build genre-defining products. That’s fine. Not being a gifted innovator isn’t really a moral failure. But Welch ran a management template that worked for its time. A lot that was good in that has helped other enterprises manage scale and complexity. He overdid things for sure and that toxic legacy of being obsessed over quarterly EPS targets, financial re-engineering to meet them and treating people as expenses is uniquely his too. But, on balance, he was responding to the incentives that he and GE had during that time.
The problem with a lot of business management books is that they use the hindsight of success or failure to go back and find reasons for it. This is a useful exercise in history. And it should be only read as history. As one version or interpretation of events. The trouble is many of these books start peddling these as some kind of deeply researched scientific material. It is not science because every single one of them will fail the falsification principle of Popper to demarcate science from non-science. Pick any book that teaches the Toyota way or the Netflix method of managing people and apply them in another context. The success rate of any such application, however generously you may use the term, is still quite low. In fact, the moment I see a book written on the unique way a company does something, I realise the company has jumped the shark. Gelles’ argument about Welch being the one man responsible for breaking capitalism is as flawed as the many books urging companies to follow the GE way a couple of decades back. There’s no science or verifiable truth here.
Second, the book has an America centric view of how Welch made things worse. Sure, Welch shut down plants and shipped jobs offshore. And you could argue that made lives of American workers worse. But that trend was already inevitable. I don’t know about you but I don’t think the pre-Welch era, say of the 70s, was some kind of golden age for capitalism. People were still protesting against inequality, wars and seeking global brotherhood. Inflation was high. Diversity in corporates was low. Politicians were being voted out of power because of how they fared on economy. Doesn’t sound like a golden age to me.
Gelles blames Welch for hollowing out the industrial belt and increasing inequality in the American society. Maybe it is true. But what about the countries where Welch set up new shops? Without Welch there wouldn’t have been millions of jobs created in places like India, China, Philippines and Eastern Europe. In the mid-90s, GE was the biggest customer of the then fledgling Indian IT companies. The likes of TCS, Wipro and Infosys scaled on back of GE business that at various times accounted for about a third of their revenues. By late 90s, GE began the BPO boom in India and other companies followed. Almost every company would visit the GECIS centre in Gurgaon to see what’s possible to outsource in India. You could claim with some confidence that he created the most jobs in the history of independent India. I witnessed this first hand. An entire generation made a good living and gained global experience because of the platform GE created in India. There is a good argument then that he might have actually reduced global inequality because of his actions. GE was a global enterprise. Why should only American workers and equality in American society matter in judging his legacy?
Lastly, it is easy to diss Friedman and his famous paper on maximising shareholder value without understanding him fully. Friedman didn’t advocate some kind of cut-throat capitalism where nothing else except profits mattered. He was a better thinker than that. I wrote about this a couple of years ago on the 50th anniversary of that Friedman paper and Raghuram Rajan’s assessment of it:
Over the years it has been attacked and its central message discredited in the light of the global financial crisis. Even businesses are reluctant these days to invoke shareholder value maximisation as their goal. There have been calls for societal value maximisation, stakeholder wealth creation and conscious capitalism to replace the Friedman doctrine. All good intentions aside, nothing has truly replaced it in how businesses operate. What explains its enduring appeal? Three reasons:
A simple and measurable metric: The shareholder value maximisation goal is easy to set and monitor. It helps that there is a common understanding of the metric. The alternatives are amorphous. It is difficult to understand what does maximising societal value entail, for instance. Who will define what society wants? Are societal objectives of India and the US similar?
Rewarding the risk takers: The shareholders invest risk capital in an enterprise. This willingness to take risk is what leads entrepreneurs to build new products, satisfy the consumers and create new jobs. The shareholders deserve the pursuit of maximum return by the firms for this risk they undertake. It is up to them what they do with these returns. They can invest it in newer enterprises or use it to improve the society as they deem fit. The management or anyone else should have no claim on how to invest the returns that belong to the shareholders.
Shareholders are the residual claimants: Everyone who contributes to the value creation of an enterprise – the employees, the management and the customers – get their fixed claim on the value through compensation for their efforts, stock options and the value derived from the products or services offered by the enterprise. Only when these fixed claimants are served well, the value for the residual claimant (the shareholder) is maximised. So, the pursuit of shareholder value will by itself serve the other stakeholders well.
Any kind of over-indexing on input metrics (like environment or society) instead of residual metric like shareholder value runs the risk of the measure becoming a target and ceasing to be a good measure (Goodhart’s Law). The recent events around ESG investing and greenwashing are examples of this. See the Deutsche Bank story on this. More will follow.
And to quote Friedman from his original article:
“But the doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book “Capitalism and Freedom,” I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud.”
There is always a desire to ‘manage’ the economic system in a way that it allocates resources and rewards most efficiently. As we have seen over a few centuries now, this is a noble but flawed pursuit. It generates worse outcomes than a system that builds itself on fundamentals of human enterprise, behaviour and its response to incentives. There are many economic concepts that sound evil or counter-intuitive: efficient market mechanism, free trade, comparative advantage or Ricardian equivalence. But they work. There are reasons for market failures and there are extended periods of time when these failures are allowed to persist. But the beauty of spontaneous order is that the correction to its excesses is also built in. The correction is the time to learn from past mistakes and improve it. Not to call for discarding the system itself in favour of some kind of ‘planned design’. Welch was a remarkable manager – both a product of his times and someone who shaped his time. He pushed the boundaries in ways good and bad. That which was bad is already interred with his bones. The good must survive.
India Policy Watch: Missing Pieces in the Jigsaw Puzzle
Insights on burning policy issues in India
— Pranay Kotasthane
A popular way to think about strengthening the Indian Republic is to ponder on improving its institutions. However, this route often ends up in mere despondence over our many underperforming institutions. While confronting these demons is an absolute necessity, here’s another way to think about this issue: what are the meta-institutions that the Indian Republic is missing altogether?
We aren’t talking here about institutions that don’t work, but institutions that don’t exist at all. And I’m not talking about the likes of a new sectoral regulator for cryptocurrencies, but about more important institutions, ones that could improve decision-making in governments across spheres.
I don’t have a comprehensive list yet. However, there are at least three that I’ve heard many experts talk about.
1. Parliament’s own think tank
Of all the roles parliamentarians end up donning, our current structure equips them the least for the very function they exist: making well-designed laws in their constituents' interests. India’s MPs are not assigned any research budget or research personnel. Combine this congenital defect with the curse of the anti-defection law, and you get a structure that’s subservient to political party interests. Of course, some MPs do stand out despite these constraints, but it does appear that the odds are heavily stacked against them.
Thankfully, a solution has emerged from civil society to fill this gaping hole: PRS Legislative Research — a 17-year old non-profit organisation that aims to provide independent and non-partisan research to the parliamentarians.
However, just one such institution is not sufficient for an India-scale entity. What we need, in addition, is another much bigger research think tank of the Parliament, that’s paid from the Consolidated Fund of India and has researchers who develop deep expertise in specific areas over the years. Consider, for instance, the Congressional Research Service in the US. This federally-funded agency has over 600 employees who are specialists in a variety of policy domains.
As the size of the Parliament increases after delimitation, and as policy issues keep getting more specialised, it’s imperative for India to invest in this missing institution.
2. An independent fiscal council
This institutional gap has been highlighted by the Thirteenth, Fourteenth, and Fifteenth Finance Commissions. While India has an institution (the Comptroller and Accountant General) to audit policies that are already in action, there is no institution that makes an independent financial evaluation of government policies before they receive the final approval.
The result is that tall promises of handouts in electoral manifestos of parties often become government policies swiftly, without any regard to the fiscal sustainability or opportunity cost assessments. A recent example is the One Rank One Pension (OROP) scheme which was implemented in 2015 after appearing in the 2014 election manifestos of both the major national parties.
An independent fiscal council then is an institution that is supposed to do three things. One, evaluate the quality of budget forecasts given how there is a wide gap between budgeted estimates and actual expenditures. Two, develop cost estimates of budgetary proposals ex-ante. Ang three, monitor if fiscal rules are being adhered to.
Dr Govinda Rao writes in The Hindu that the global experience with such institutions has been largely positive:
A study by the IMF (“The Functions and Impact of Fiscal Councils”, July 2013), documents that the existence of IFIs is associated with stronger primary balances; countries with IFIs tend to have more accurate macroeconomic and budgetary forecasts; IFIs are likely to raise public awareness and raise the level of public debate on fiscal policy. Case studies in Belgium, Chile and the United Kingdom show that IFIs have significantly contributed to improved fiscal performances.
In Belgium, the government is legally required to adopt the macroeconomic forecasts of the Federal Planning Bureau and this has significantly helped to reduce bias in these estimates. In Chile, the existence of two independent bodies on Trend GDP and Reference Copper Price has greatly helped to improve Budget forecasts. In the U.K., the Office for Budget Responsibility has been important in restoring fiscal sustainability. Cross-country evidence shows that fiscal councils exert a strong influence on fiscal performances, particularly when they have formal guarantees of independence.
Clearly a meta-institution we are missing.
3. An institution for vertical and horizontal bargaining
This idea again comes from Dr Govinda Rao. He writes in his recent book Studies of Indian Public Finance that India lacks an institution that can act as a credible umpire between various states, and between the states as a whole on one side and the union government on the other. The National Development Council created for this purpose is defunct, the Inter-State Council is a part of the union government, the Rajya Sabha is no longer the council of states in reality, and finance commissions are dissolved after making their recommendations. The result is that there is no institution that can truly champion cooperative federalism. The GST Council perhaps performs acts as a bargaining and negotiation platform in the limited area of indirect taxation. To manage India’s heterogeneity, a meta-institution that is dedicated to horizontal and vertical balance is imperative.
Another big lesson here is that the view that India’s government is oversized is inaccurate. The Indian State is quite anaemic when it comes to staffing for its core functions. We need more institutions, not less.
What are some more missing meta-institutions in the Indian Republic? Leave a comment.
India Policy Watch: The Paradiplomacy Opportunity
Insights on burning policy issues in India
— Pranay Kotasthane
Note these two developments over the last few weeks: Tamil Nadu was first off the blocks to send a relief consignment to the crisis-stricken Sri Lanka. And as many as three Chief Ministers—besides the sons of two other CMs—made their presence felt at the World Economic Forum in Davos.
Moreover, chief ministerial visits to business capitals of the world are now commonplace. Virtually every Indian state now has its own global investor summit. And yes, two states (Punjab and Kerala) already have departments for non-resident Indians.
Put all these developments together and it becomes clear that Indian states are also geopolitical and geoeconomic entities. In the past, I’ve written how Australia gets around its low diplomatic corps strength by allowing its states to have their own trade and investment offices in other countries. India too should take this path, and encourage state governments to have permanent trade and investment desks in important business centres of the world.
This view is not a popular one. The policy orthodoxy believes that since foreign affairs is under the Union List of the Seventh Schedule in the constitution, states have no role to play. Besides, state governments having their own foreign policy is at odds with the popular “one nation, one X” idea.
But in my view, economic diplomacy by Indian states can be beneficial to all relevant stakeholders. It is in the states’ interest because they understand their comparative advantages, needs and challenges far better than the union government. Thus, they can choose to invest in external economic relations that are suited to their conditions.
Economic paradiplomacy can also benefit the investors as they get to directly engage with the entity that controls crucial variables for running businesses, such as land, labour, electricity, and law and order.
And finally, this strategy can benefit the union government as well. It frees up the already strained capacity of the external affairs and commerce ministries for broader issues. The role of states in the India-Israel relationship demonstrates that there is also a political utility:
“Full diplomatic ties were established between India and Israel in 1992. Even after this move, collaboration with Israel was seen as a hot potato issue in India. The domestic implications of taking sides in what was essentially a religious conflict was a significant impediment to the ties taking off. A few Members of Parliament criticised this step on humanitarian grounds, arguing that New Delhi should have waited until an independent Palestinian state came into being. Some members of the ruling Indian National Congress feared that this step would be detrimental to their electoral appeal to the Indian Muslim community. The Babri Masjid riots further thickened the plot and the Indian government slowed down the pace of the partnership.
It was under these circumstances that the Indian states were allowed to expand Indian collaboration with Israel. Traditionally, Indian states were kept out of India’s foreign policy debates. Even the Constitution assigned all matters of legislation related to foreign policy exclusively to the Union government. Consequently, the proliferation of collaboration between Indian states with Israel was a bold and unique experiment by the PV Narasimha Rao government. While this allowed relations to prosper, it also avoided the politico-religious undertones that would have been hard to suppress had this engagement been anchored by the Union government alone.”
And so, economic diplomacy by the states is a win-win-win. For an India with global interests, its states have to come to the party. Should they be invited?
Reading and listening recommendations on public policy matters
[Book] Dr Govinda Rao’s Studies in Indian Public Finance is a must-read for policy enthusiasts. I really hope OUP prices it such that the common Public can Finance the book purchase. Nevertheless, the book links to some classics in public finance. Here’s the compilation: Public Principles of Public Debt by James Buchanan, Public Finance and Public Choice: Two Contrasting Visions of the State by James Buchanan and Richard Musgrave, The Logic of Collective Action: Public Goods and the Theory of Groups by Mancur Olson, Public Finance in Theory and Practice by Richard and Peggy Musgrave, The Power to Tax: Analytic Foundations of a Fiscal Constitution by Brennan and Buchanan, The Calculus of Consent by James Buchanan, The Road to Serfdom by Hayek, and Democracy, Dictatorship, and Development by Mancur Olson.
[Prediction Market] We’ve written previously about the utility of prediction markets in foreign policy. Check out this US-government project that is explicitly meant to ‘build a collective foresight capability that can provide U.S. Government policymakers with an accurate and nuanced rendering of the future’.