THE THREE EFFICIENCIES
Efficiency isn’t always what we think it is. In a perceptive analysis, Everything for Sale: the Virtues and Limits of Markets, the economics writer Robert Kuttner points out that there are three very different types of efficiency. He calls them Smithian, Keynesian and Schumpeterian, after those three very different but influential economists. For the most part, when we talk about efficiency we are discussing the use of price to ensure that the right things are made in the right place at the right cost. This is the efficiency of Adam Smith. It is the one we are all familiar with.
But there is also Keynesian efficiency, which addresses the potential output that is lost when the economy is performing well below its full employment potential. More Adam Smith efficiency in that case does not help. It may even hurt, by driving more people out of work in order to increase local efficiencies. World War Two, in America, violated most of the precepts of Adam Smith’s efficiency, and allowed firms to make some indecent profits, but it pushed up GDP by 50% in four years and force-fed the two decades of growth that followed. Economists want to set these two types of efficiency up against each other as rival theories, when what is really lacking is a conceptual framework that allows them to co-exist.
Add in Schumpeterian efficiency and it gets even more complicated. Joseph Schumpeter preached technology as the engine of growth, but he also pointed out that to invest in technology there had to be spare resources and long time horizons. Too much Adam Smith efficiency narrows those margins, and shareholders tend to want their money sooner rather than later, leaving too little money available in the business for technological advance. Perfect competition can be mutually ruinous as everyone bids each other down in an attempt to be more cost efficient and cheaper. You need deep pockets to keep ahead of the field.
We can all recognize Schumpeterian efficiency at work if we consider creativity. Creativity needs a bit of untidiness. Make everything too neat and tidy and there is no room for experiment. Keep a tight rein on costs and there is no cash available to try new things or new ways. Cram your days too full and it’s hard to find time to think. We all need a bit of slack to give us the space to experiment. Schumpeter would have understood the consultancy manager’s complaint that her people had no time for thinking.
The German Mittelstandler, or small family businesses, are well known for resisting price competition, preferring to keep prices high and use their margins to invest in technological leadership. Japan practises price competition, in the export field, but also non-price competition in her domestic market, and managed, until recently, to grow four times as fast as America. It is a mistake, therefore, to assume that a competitive price is the only determinant of market success. It can be one way, instead, of pricing oneself too low and out of contention in the future. Douglass North, the first historian to win a Nobel prize in economics, observed, in his acceptance lecture, that it was what he called adaptive rather than allocative efficiency that was the key to long-term growth. Adaptive efficiency is Schumpeter’s efficiency. Schumpeter beats Smith in the long run. Quality can matter more than price, but quality costs money to start with.
Finding the judicious balance between the three types of efficiency is a key task not only for managers but also for government, who can switch that balance by tax and monopoly legislation, and by regulation. If we stick to allocative efficiency alone, Adam Smith’s variety, we are favoured with low prices but are also likely to be stuck with low growth, high unemployment and, in the end, higher prices when we have to buy in what we failed to create. Markets need countervailing mechanisms if the costs of that sort of efficiency are not going to outweigh the benefits.
Take, for instance, the labour market. Left to itself, Adam Smith’s type of efficiency drives down wages and payroll numbers but increases inequality. Worse, this competition for efficiency leaves no spare resources for the investment needed to redeem the situation by training and re-education. The incompetent are left to get more incompetent. Some form of buffer, be it a minimum wage, a learning bank, stronger unions or legally required expenditure on training, is needed if the bottom group is not to be lost for ever. It is the old analogy, that brakes allow the car to go faster.
It is not that one type of efficiency is better than the others, but that all three are relevant. If we want to boost demand we may need first to stimulate it by putting more people to work, even if that violates the Adam Smith type of efficiency. To get away with the increased costs that result, you either have to put barriers around the industries involved so that they are protected from foreign competitors, or do it only in the non-competitive parts of the economy such as the public sector. To stimulate investment in new technology we may need to discriminate against large dividends by taxing them or prohibiting them. Kuttner’s analysis reminds us that it is not always heresy to suggest such things.
DUMPING THE DIRT
When Japanese manufacturers developed their just-in-time procedures they were delighted by the reduced costs of warehousing, because stocks were now, in practice, warehoused in the delivery vehicles carrying them to their factories. But those lorries soon jammed the highways around the cities, impoverishing life for ordinary citizens and requiring more and better roads, paid for by the general public. The manufacturers had dumped the costs of their improvements on to the general public.
Hospitals can improve their efficiency by discharging patients earlier, but someone still has to care for them at home. Businesses can, and do, work their staff longer and harder, with consequent gains in efficiency within the firm, but with uncounted problems of stress and damaged relationships outside. Schools can improve their results by selecting only bright youngsters as their students, but someone else has to educate the others, or deal with the consequences of an underclass of the uneducated. Anyone can boost the short-term profits of a business by cutting out all varieties of development expenditure and slashing the staff numbers, but no one counts the human costs to those affected.
In theory, all the on-costs can be charged back to the originator. Pollution could be put on the company bill, as could human stress, or unemployment. The hospital could be asked to pay for the care in the community or at home, and the school to make a contribution to the education of the children it does not take. In practice, of course, this does not happen. Efficiency calculations are ring-fenced, confined to the economics of the particular unit; they are local and partial, which leaves society in general to pay for the unintended outcomes.
This is the necessary price, some would say, for the benefits of economic growth. There is, however, no one place where the overall costs of increased efficiency are measured against its benefits. Until the costs really hurt, efficiency is allowed its head within each unit of society, irrespective of its effects on others. The hope is that individual self-interest will ultimately result in a collective benefit, but it makes for a bumpy ride. As Adam Smith pointed out long ago, self-interest has to be balanced by what he called ‘sympathy’, if it is to be tolerable to the rest of us. But there is, unfortunately, no way of putting sympathy into the efficiency numbers.
THE TILTING SOCIETY
John Kennedy’s assumption, that a rising tide raised all boats, has turned out to be false. Even if all the boats shift a little, some rise dramatically higher than others. The pursuit of efficiency tilts society towards the few and away from the many. In an information age one can grow richer without growing much bigger, meaning that more wealth in the country no longer automatically creates more jobs. In fact, to grow at an average of, say, 3% per annum, a society has to improve its efficiency at, maybe, 5% overall in order to remain competitive with the global competition.
The difference between those two numbers is disappearing jobs. In effect, to grow richer a country has, actually, to watch its corporations grow smaller. Downsizing is not a one-off phenomenon. But this drive for efficiency may erode the very civilization it is designed to promote, because its benefits do not fall equally, nor do
its costs. The 20/80 formula is a familiar one in business, meaning that 20% of your products, more often than not, generate 80% of your profits. It is a formula that seems to be becoming applicable to the market society: 20% of the people seem to be generating, and getting, 80% of the extra wealth.
A competitive business soon discards the 80% of less profitable products, or clients, to concentrate on the better 20%. Much as some people might like to, society cannot jettison its less productive people in the same way, but it does not quite know what to do with them, except to keep them in limbo, offer them some rather short educational ladders, and hope that they will start to climb up them.
Forget the 20/80 society, it could be worse. The following numbers were compiled by David Korten for his book When Corporations Rule the World:
In 1989 the top 1% of Americans earned an average of $559,795 each, receiving, as a group, more than all the bottom 40%.
In 1992 the top 1000 CEOs in America received, on average, 157 times as much salary as the average worker.
Forbes top 400 richest people had a net worth, in 1993, of $328 billion, equal to the combined GNP of India, Bangladesh, Nepal and Sri Lanka.
70% of world trade is managed by 500 corporations.
A society in which the top 1% earn more, collectively, than the bottom 40% will not long be tolerated in a democratic state. The 40% will, eventually, revolt, and dictatorship, one hopes, is not an option in our societies – yet.
Britain is little different. In November 1996 a Sunday newspaper produced a chart comparing the gross weekly earnings of selected occupations and key individuals. A footnote said ‘the scale has been compressed at the top end to accommodate the highest earners; otherwise we would have needed 1,400 pages.’
In 1996, Britain was boasting of being the fastest growing major economy in the European Union but that year it was revealed that, in 1993, 17.2% of British families were living below the poverty line, defined as being half of the average income for the country as a whole. This figure was up from 14.3% ten years before. The 17.2% figure compared with 5% in the Benelux countries, and was higher than every other country except the four most deprived states in Europe: Spain, Portugal, Greece and Ireland. If the price of national efficiency is relative poverty for more, the more may not want it.
Francis Fukuyama, the author of The End of History, argued that the combination of liberal democracy and the free market was an unbeatable combination. In that sense it was the end of the historical search for perfection. It seems, however, that democracy and markets are not natural bedfellows after all. We shall either have to restrain the free market or limit democracy, unless we change our value system. Estonia, a country that is reinventing itself after forty-five years under Soviet rule and Soviet economics, is an interesting test case.
The Estonian Case
Estonia is not a name that will ring bells with everyone, but exciting things are happening there. A small country on the edge of Russia, up on the Baltic coast, it has a population of only one and a half million and is smaller than New York State. It also has a capital city, Tallinn, that is, if anything, more beautiful than Prague. But the real reason to go there, as I did recently, is to see what they are doing with their newly-discovered capitalism.
The place is buzzing. They told me that there were more Mercedes cars per head than in neighbouring Finland, and more mobile phones. I could well believe it, watching the Estonian yuppies doing business in the traffic jams. Everyone we met was young, and running something – either a part of the government or one of the countless new service or information businesses that have sprung up in the five years since they broke free from the Soviet Union. And it was all remarkably efficient. If you want to see how capitalism and the free market can release adrenaline, go to Tallinn.
It must be great fun to build a country from almost nothing, particularly when it’s so small that most of the people running things went to the same school. But outside Tallinn, and that cosy group of insiders, things aren’t quite so rosy. Inflation is still hovering around 25% per annum, which is not good news for the pensioners, the small farmers and the many people, like teachers, still on the government payroll. The small towns are still desolate places, unlit, unloved and, I suspect, unheated.
Estonia has a wonderful chance to prove that their new-found capitalism and efficiency could be to the benefit of all, not just for the educated and entrepreneurial few. Estonia could even show the rest of us how to do it, but there were all the signs that it was going to end up as yet another 20/80 society, leaving the 80% wondering what economic growth meant. The 20% were also discovering that efficiency in practice meant long hours. They were exciting hours, it was true, but they were not hours spent with the family, any more than they are in other countries. Most of the people we met were divorced.
If this exciting experiment in capitalism is to succeed, those Mercedes owners must not hug all their new wealth to themselves. They must have that ‘sympathy’ for their fellow citizens, which Adam Smith, their new hero, insisted on, and they must be happy to invest in the future of other peoples’ children as well as their own. If not, their new democracy might not long tolerate their new capitalism. Since that visit the Prime Minister has resigned, accused, although he denies it, of enriching himself at the public expense.
THE D.I.Y. ECONOMY
There is also, however, a positive side to the improved efficiency of an economy, even if it is tilted. A 3% annual growth rate does mean that there is 3% more money to spend. There may be fewer corporate jobs, but there are more potential clients and customers. There is no limit, in theory, to the numbers of services and products that could be sold to them, although it will tend to be individuals and tiny firms, rather than the new lean corporations, that do the selling. New jobs come from new businesses, which often start as one person operations. If we think ‘customers’ not ‘jobs’, and nudge ourselves towards a self-employment society, there would be potential work for everyone. People with money but no time are ready meat for those with time but no money, as long as they have something useful to offer, whether it be financial advice or walking the dog.
The ‘something useful’ can be more exotic or quixotic. Two examples:
I met a nurse from Cambridge, Massachusetts. ‘What sort of nursing do you do?’ I asked her.
She beamed. ‘I specialize in twins,’ she said, ‘training their parents in the ways to look after them in the first months after birth. I don’t do triplets,’ she emphasized, ‘only twins.’
‘That must be a rather small niche market,’ I suggested.
‘Oh no. You see, Cambridge, Mass. has a large number of dual career professional couples. They tend to postpone having children until they are both in their late thirties or early forties. They need fertility drugs to help, so they often end up with multiple births. Then they need help, but they’ve got money and are prepared to pay well for the sort of service I provide. There’s so much demand that I only do twins.’
The son of a friend is 28 and living in London. A couple of years ago he met up with some young people from Australia and New Zealand. Young people from these countries commonly come to Europe for six months or so at the end of their education before going back home and settling down. They get jobs in London and tax is quite properly deducted from their pay. When they return to their home countries, however, they are entitled to most of that tax back, because their income in the year as a whole seldom goes over the tax threshold. It’s too complicated to reclaim it so they go home and forget about it. My son’s friend offered to reclaim the tax for them, provided he could keep 30% of whatever he got back from the Revenue. He now has a thriving little service business, run from his bedroom, collecting overpaid tax for occasional workers, with the full help and cooperation of the Revenue.
All you need is an eye for a customer, the market, and a useful skill, be it nursing, computing or just a willingness to help. In the service sector, you don’t need much money up front. My daughter
ran her first business from her pager, without an office at all.
The trouble is that those who will have to be the new self-employed and the new business starters are those who are, on the whole, the least well-equipped for it. They are the ones who have just been dismissed from their jobs, if they ever had them. They are the discards of the efficient society. It will require a major change of mind-set, and a huge investment in education and reskilling, to create the sort of self-employment economy which, alone, might turn efficiency to universal advantage.
It is, therefore, worrying that only 6% of Americans are, officially, self-employed, half the percentage of Britons, for instance, or of Japanese. Most Americans have yet to be weaned away from the organization society, with its promise of health care insurance and pension plans, however illusory these promises may turn out to be in the end. Sympathy would have to extend to paying extra taxes to make the weaning happen. In Britain, the Prince’s Youth Business Trust acts as a venture capital resource for young people, providing these youngsters with start-up money and mentors from the business community to help them set up their own new businesses. More organizations like the Trust are needed if we are to change the culture, so that more people think ‘customers’ instead of ‘jobs’.
A CHINDOGU WORLD
Efficiency generates growth, even if that growth does not get spread around as evenly as one would like. We must, however, wonder what all that extra money will be spent on. A 3% growth rate continued for 100 years would mean that we would be consuming 16 times as much stuff as we do today. If the population remains stable, or falls, as seems most likely, the results are mind-boggling. We cannot – can we? – buy 16 times as many cars or television sets, travel, all of us, 16 times as far or as often, eat 16 times as much food or consume that amount of extra oil and gas. There will, undoubtedly, be all sorts of new goods and services but they will, increasingly, tend to be ‘chindogu’.
The Hungry Spirit: New Thinking for a New World Page 4
