Theory To Practice

Beyond Markets

A clearer view of economics means looking beyond the invisible hand.

Fall 2009 by Michael E. Raynor

The word business is used today within a fairly narrow range of meanings, and for the most part, while not necessarily negative, the connotations are far from unambiguously complimentary. To be “businesslike,” to “get down to business,” or to “take care of business” is to get things done—typically necessary things, rather than noble or enjoyable things—and to do so in a manner that dispenses with pleasantries, ceremony, embellishments of all kinds, even emotion. In the general parlance, business is about the rational, left-brain, mercenary angels of our nature, our desires for material wealth and the soulless accomplishment of requisite but uninspiring objectives.

The business community tends to perpetuate this characterization, perhaps unwittingly, when its members insist that improvements could be found if this or that organization or endeavor were managed more “like a business.” This typically means that what’s required is a more dispassionate examination of costs and benefits, a more ruthless attention to greater efficiencies, the elimination of waste, and above all, a greater reliance on “market mechanisms” to allocate resources and reward good performance.

This last requirement—the hegemony of the market and the primacy of price as a way to measure the worth of many things—is perhaps the signal characteristic of “businesslike” behavior. Deciding what to do based on subjective assessments of value rather than the objective judgment of the market is to substitute politics for economics and power for worth. If late-twentieth-century business has anything to teach the rest of society, surely it is the superiority of the marketplace as a mechanism for deciding who gets what. When people are forced to bid for what they want, those who can create the most value from a given resource are able to pay the most for it. Those who can’t scare up the cash must find other alternatives. It’s not pretty, and it can have some rough edges even when it’s working well, but as Winston Churchill said of democracy, it’s the worst solution save for all the others that have been tried.

There is a great deal of merit in much of this. Markets motivate through reward, not punishment, and create powerful incentives for innovation and efficiency. But there is increasing disenchantment with markets and, by implication, with business generally. The global financial crisis—or, as BusinessWeek has taken to calling it, the Great Recession—has provided only too visible an example of business’s downside: Excess and collapse have always been part of the deal.

The limitations of market forces go beyond cyclical fluctuations, however severe. In some instances, especially in the case of critical resource stocks, it’s unclear whether the seemingly inevitable overshoot and correction characteristic of markets can be tolerated. For example, Canada had to shut down its East Coast cod fishery in 1992—and has yet to reopen it, as fish stocks show little sign of recovering. But the closure was not foreshadowed by rising prices for cod: According to price signals, there was just as much cod as always, right up until they disappeared. This is, in part, because as prices rose in response to scarcity, the fishing industry found ways to be more efficient in extracting resources, largely because the cod fishery was competing with substitute fish stocks, which weren’t under similar pressure. More than fifteen years later, there’s still no sign of recovery. Consequently, markets seem not to let us know we’re running out of something until it’s essentially all gone. If the same dynamic plays out with respect to oil, water, timber, or any number of other critical resources, we could find ourselves struggling with enormously dislocating and abrupt transitions to alternative resources based on ill-developed technologies—if we’re lucky.

Now, if we exhaust the world’s usable iridium or, for that matter, oil, due to market failure, but develop viable alternatives, there seems little cause for concern, even if the road is a little bumpy: All else equal, the iridium wasn’t doing anyone any good just sitting in an ore deposit. But the significant depletion and potential effective disappearance of other resources—especially renewable resources—might not have nearly so neutral an effect if exhausted. As overfishing threatens the long-term viability of the ocean as a food source, as deforestation threatens not only biodiversity but even climate patterns and hence food production, and as carbon-based pollution threatens just about everything, it seems increasingly the case that it is possible to rely too much on markets as a mechanism for allocating resources. In these sorts of cases, we simply cannot afford to overshoot in the pursuit of an optimal long-run solution.

Considerable effort is going into “internalizing” these externalities. For example, the notion of “cap and trade” is designed to impose upper limits that are lower than what markets might lead us to conclude are acceptable. In principle, no matter what a would-be emitter wants to pay for an extra ton, it’s simply not to be had at any price. Proponents of such schemes typically argue that there is only so much carbon the planet can cope with, and since a habitable planet is priceless—literally—we shouldn’t put a price on carbon beyond that limit. Precisely where that cap should be is, of course, subject to debate and the complex interplay of science and politics. But it is not, nor should it be, subject exclusively to market forces.

And it is when grappling with how to transcend market forces that, perhaps ironically, business again has much to teach society at large, for companies are not merely “applied economics.” They are the intersection of sociology and economics, the interaction of groups within markets. We know that organizations that are successful over the long term are often driven by a concern for the larger good in a way that makes it possible for people to balance their checkbooks with their philanthropic books.

As an example, as I write this in the Rendez-Vous Lounge and Bar of the Imperial Hotel in Tokyo, I’m at the annual world meeting of the member firms of Deloitte Touche Tohmatsu (DTT). (I work for the U.S. member firm, Deloitte LLP.) DTT is a Swiss Verein, which is an affiliation of independent member firms from countries from all around the world. The degree of inter-firm collaboration belies the lack of strong formal financial incentives to work together. A plethora of client initiatives, research efforts, or practice-development projects are routinely launched and thrive based almost entirely on factors such as trust, reciprocity, and the “abundance mentality” that suffuses the DTT member firms. Eventually such efforts must pass a market test, but for the member firms, it is the unavoidably nebulous concept of culture that is the overarching framework within which market mechanisms function—not the other way around. And so the market is one among many measures of success, a hurdle to clear, not a master or sole arbiter of value.

What is true of the DTT member firms is, I think, most likely true of most organizations: The market matters, but only within the context of an overriding culture that defines the terms of exchange. Society can learn from business in this regard, for I take the view that companies—the durable, successful ones, at any rate—have done a better job at containing market excesses and failings than the broader body politic. Markets can help us allocate effectively our most precious resources and guide our most irreversible decisions only if they are constrained in ways that are consistent with our deepest values. We cannot avoid the hard work of coming to a consensus—at a social scale that approaches global reach—about what those values are. And in that task, what politicians have to learn from managers is not how best to apply economic tools but how best to pull the more ethereal levers of leadership: vision, aspiration, a sense of shared destiny, and the ability of all to make a difference.

 

MICHAEL E. RAYNOR Michael E. Raynor is with Deloitte Consulting LLP. In addition to applying theory, he occasionally tries to create some; BusinessWeek named his most recent book, The Strategy Paradox, one of the top 10 books of 2007. He can be reached via www.michaelraynor.com.