How to fix democratic capitalism: A Review of Martin's "When More Is Not Better"

When More Is Not Better: Overcoming America’s Obsession with Economic Efficiency

The following is a thought piece based on Roger Martin’s newest book “When More Is Not Better: Overcoming America’s Obsession with Economic Efficiency.” I blend his ideas with my own, but give him all the credit for what’s below.?

Introduction

What comes first, the government or the economy? While the economy grows food, creates jobs, and provides incomes; the government makes and enforces laws, prints money, and guides society. If our government came tumbling down, how long would the economy last? Will food still flow to your grocer? Would you feel safe inside your home? Can you trust your money to your banker? ?Underlying Roger Martin's new book is the recognition that the relationship between governments and the economy is critical to our prosperity. If we think markets can solve all our problems, we are sadly mistaken. In fact, the rise of neoliberalism over the past 40 years has seen bigger problems, at greater scales, than we've ever seen before. We as citizens need to demand more from our governments not less if we hope to tackle income inequality, climate change, or systemic discrimination.

A) The Problem

“All models are wrong”: They’re abstractions of truth

Martin argues that the world is a complex and adaptive system which, for the past four decades, has been treated too much like a predictable and perfectible model. Contrary to the view of many economists and politicians, the economy is not a machine—it can’t be easily understood. To believe that the US economy can be managed by simply changing the interest rate or cutting a tax rate is na?ve. It is a story we tell ourselves to make easier sense of the world. This view, however, has been adopted by business leaders, politicians, and educators, who preach efficiency of the system above all else. This obsession with efficiency has come at the cost of resiliency: leaving our system vulnerable to shocks. We must strive for a better balance between efficiency and resilience.

Democratic Capitalism: We voted for this

The West largely operates as “democratic capitalist” societies. As Martin defines: We are democratic because “a majority of voting citizens determine who populates the government, which sets the rules for the functioning of the country and its economy.“ And we are capitalist because we have decided that the “means of production are largely in private hands and the markets allocate resources based substantially on supply and demand.”[1] The advantage to democratic capitalism is that people can vote on how their economies are run. It inherently plays to the median voter, ensuring that at least 51% of citizens ought to be happy with the direction of society. At least that is how it’s supposed to work.

Martin and I don’t believe that our current economic system is serving the 51%, and especially not the median voter. The gains and profits of our system are going to a small minority of the population, while prices continue to rise. For the century prior to 1980, productivity and wages grew in parallel: people made more money as the economic pie grew. In 1980, there was a divergence: deregulation, tax cuts, and privatization unhinged the wealthy from the rest. While economic productivity has grown 84% since 1972, wages have only grown 13% (or 0.25% per year—far below inflation). The pie has grown, but the slices being handed out are growing thinner.[2] The gains of productivity have not gone to workers, they’ve gone to shareholders. Trickle-down economics was a lie.

Income Inequality: From Normal Distribution to Right Tailed

Martin believes our society has moved from a normal distribution to a Pareto one. Which, in English, means that for the century leading up to 1980, income distribution looked like a bell-shaped curve, with a strong middle class (blue line); but the past few decades have turned our society into a long right-tail (red line). The rich are getting richer, while a growing number of non-rich are stagnating. This is eroding the middle class, destroying the idea of the median or moderate voter, and driving up income inequality. Wealth creates more wealth, and fewer people have it. This growing number of non-rich cut across all socio-demographic groups: urban/rural, ethnic background, red/blue, even left/right. They are being realigned politically through populist-identity rhetoric rather than economic arguments. How did we lose our way?

Proxies: The war for more efficiency

Our society has become obsessed with using proxies as a way to measure success. How do you measure the success of a country? Just look at its GDP. How do you measure the success of a company? Just look at its stock price. How do you increase profitability? Cut costs. The problem with proxies is that they assume that the world works in a simple, defined way that can be adequately measured with a number or two. But all models are wrong; we sometimes forget that they are abstractions of reality, substitutions for truth. Lowering interest rates does not always lead to more productivity. Lowering employee wages does not always lead to greater profitability. However, many of the leaders (and their consultants/advisers) who make these decisions have become overconfident in the models they use to understand their worlds.

Proxies for efficiency can create sub-optimal outcomes

Some inefficient outcomes from the obsession with proxies include a breakdown in Antitrust enforcement, lower average wages, and the primacy of capital markets:

·?????Corporate Consolidation: The top 100 firms in the US made 48% of all profit in 1978, they now earn 84%. The 1980s saw an erosion of anti-trust regulations in favour of the “efficiency defence”: M&A are allowed to happen if the new corporation is more efficient. Additionally, a "consumer harm test" is used, but the proxy here is often pricing (e.g. Amazon, Facebook). The problem here is that cost efficiencies are easy to measure, but poor societal outcomes are not. A bigger company may involve fewer people at head office, but they also have less incentive to innovate or compete--take a look at your phone bill or bank fees if you disagree. Amazon and Facebook might be cheap to use, but they destroy millions of small businesses and undervalue our personal data, respectively.

·?????Shareholders over Workers: CEOs are mostly paid in stock-based compensation, which is contingent on the stock price going up. As a result 91% of S&P profits over the past decade have been handed out to shareholders (buybacks & dividends), while worker wages and R&D investment remain stagnant. In fact, labour costs are seen as an obstacle to profit: to be minimized at all effort. Lower wages, fewer workers, and fewer hours came as a result—as well as the death of client experience. This helps explain the first graph above, as well as the mass labour shortages in low-wage work today.

·?????Efficient Markets Hype: Finance 101 teaches students that the market are perfectly efficient and prices are correct. Capital markets, using the bid-ask spread as a proxy for market efficiency, fell under the spell of derivatives and their capacity to more accurately price financial assets. Until of course, the financial system collapsed in 2008. Not only are markets never perfectly efficient, they're often gamed.

Each of these examples demonstrate that choosing the wrong KPIs can lead to disastrous outcomes…yet the leaders of our governments and biggest corporations do it all the time. If you keep trying to perfect the machine, you’re going to break it.

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B) The Solution

Martin approaches the second half of the book with a list of solutions to the problem of over-efficiency that various stakeholders should consider. He believes that an obsession with efficiency leads to Pareto (sub-optimal) outcomes and suggests that we design our society to be more resilient:

·?????Design for complexity: Balance pressure with friction to limit damaging extremes. This could mean raising interest rates above 0% to cool ballooning housing markets or adding a small (Tobin) tax to stock trades to price-out high frequency traders (70% of all volume on NYSE).

·?????Design for adaptability: Design for perfection with the drive for improvement. Pursuit of perfection is delusional and dangerous. Tweaking on a continuous and incremental basis is the way to make meaningful, long-lasting change in adaptive systems. Wholesale change is much less likely to stick.

·?????Design for systemic structure: Balance connectedness with separation. We live in a highly interconnected world. But interdependence amplifies the gravity effect of efficiency. Ensuring that there are “firebreaks” or “circuit breakers” in the system can protect against the reductionist’s trap of “not recognizing when dysfunction in one part of the system may spread to another part.” There are no side effects, only effects.

Some specific pieces of advice for various stakeholders:

1) Business Leaders

9/10 CEOs have a business or engineering undergraduate degree. They’re taught to think in models, numbers, and constituent parts. This helps explain how capitalism lost its way. A company is not the sum of its parts, it’s a system.

·?????Slack is not the enemy: the optimal level of slack isn’t zero. Top retailers know that higher pay, more training, and greater slack produce the best results. Machine operators know to perform preventative maintenance to minimize breakdowns. Eliminating slack means no umbrella on a rainy day.

·?????Having multiple, contradictory proxies can prevent a drift to over-efficiency. Contradictory proxies prevent extreme outcomes. Southwest succeeded at becoming both the lowest cost and highest customer satisfaction airline; had they focused on either, they like would have likely got neither.

2) Political Leaders

Fix the system step-by-step. Beware of snake oil salesmen.

·?????Legislation should include regular reviews: it’s never perfect. The Canadian Bank Act of 1871 contains the provision that it should be reviewed every decade. As a result, the Canadian banking regulatory system is centralized, organized, and keeps with the times--unlike the US. Stop thinking legislation is perfect and walking away.

·?????Fight the giants: the power of monopolists is the problem, not their profit. Monopolies beget monocultures that become vulnerable to shocks and have a tendency to abuse clients with their power. The EU has had the courage to fine Google ($10B), but do North American leaders? Should Facebook continue to operate as it is?

·?????Extend time horizons: capital markets feed short-termism. The majority of US CEOs admitted that they defer and cancel attractive projects because it hurts short-term profits. They are afraid of activist (i.e. hedge fund) investors pushing them out of their positions. As a shareholder, what if instead of one-share, one-vote, you were alloted a vote for each day that you held a share? Long-term shareholders want what’s best for the company, there just aren’t many. Reward them with greater voting power.

·?????More Progressive Tax Rate: wealth creates wealth, but the train has left the station. Tax rates on the richest Americans went from 70% in 1980 to ~28% today. The effect was a gutting of social services such as income supports for disabled, abused, and discriminated groups. Progressive taxes moderate inequality and empower governments to provide better social services. Wealth creates wealth, and right now, it’s not being shared.

3) Educators

The most important job for educators is to help students become capable of thinking in a complex and uncertain world.

·?????Recognize & teach the Ladder of inference. We tend to select which data to take into account and then make increasingly specific inferences about the selected data. This leads us to jump to conclusions. We need to teach students that they don’t always have all the data to see the big picture or to solve the problem at hand. To be okay with uncertainty. SATs, GREs, GMATs, LSATs preach the opposite of this.

·?????Stop teaching reductionism as if it’s a good thing: no more ceteris paribus. The education system is broken. Economists teach economics. Mathematicians teach math. Philosophers teach philosophy. Education is so specialized that it has become a series of closed loops. Graduates are not equipped to operate in a complex system. 60% of Canadian STEM graduates can’t find work related to their field of study.

·?????Elevate the appreciation of qualities: read a book or something. An obsession with quantitative data can send students on a wild goose chase towards efficiency. However, “many very important things in life cannot be quantified—the strength of one’s love, happiness, the beauty of an object, the quality of one’s life.”

4) Citizens

We’ve been conditioned to believe that once we vote, there’s nothing else we can do. That’s a lie, and millennials are believing it.

·?????Buycotts: utilize your purchasing power. Visit Buycott.com, scan the barcode of the products you buy. Get to know where your purchases come from and how they are made. Spread your purchasing across multiple platforms (Uber/Lyft/Taxi). Don’t feed the monopolies.

·?????Leverage collection action: create political frictions. Collective actions can be made more powerful when they combine numbers, commitment, unity, and worthiness. Few have succeeded like Mothers Against Drunk Driving (MADD). Collective action can change government policy quickly: i.e. welcoming refugees into Canada (Vietnamese in 1979, Syrians in 2015).

·?????Insist on reciprocal political relationships. If you believe the relationship between you and your elective officials ought to be one-sided and passive, then that’s on you. There has been a rise in “participatory budgeting” in over 3000 global cities, which sees governments set aside funding for citizen proposals and voting. Imagine $1B of the budget was left for us to decide and vote on?

Conclusion

Democratic Capitalism is a choice. How it operates is also a choice. Each day, the ways we behave, from the news we read, to the food we eat, to the clothes we buy, creates winners and losers in the system. For over four decades, the balance of power has shifted from the middle class towards the rich. From workers to shareholders. The straw is destined to break the camel’s back of this system. But it is not too late to turn these outcomes around.

[1] Democracies and capitalist systems take many forms. Some democracies are two-party (USA) and others are multi-party (Canada); some have Presidents (Brazil), while others have Prime Ministers (UK) or both (France). Capitalism can also take many forms, including oligarchic (Russia), state-guided (China), and big-firm (Korea).

[2] We have enough money on this planet to give everyone $56,000 a year, enough food to feed twice our population, and yet, 40% of Americans don't have $400 in the bank.

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As a millennial civil servant, I'm on a mission to re-imagine a society that considers all stakeholders and aims to tackle big problems collectively. I'll continue to share thoughts and summaries as I learn. Please feel free to share your thoughts, words, and feedback with me along the way.

Darcy Drury is a Senior Policy Advisor + Senior Consultant with the Ontario Government. He has previously worked in financial services, the foreign service, entrepreneurship, education, and a smorgasbord of odd jobs in between. He is an avid writer, reader, and songwriter; perpetually seeking to make the world a better place. Reach out to connect!