THE BUSINESS OF BUSINESS SCHOOLS

Pankaj Ghemawat is the Anselmo Rubiralta Professor of Global Strategy at IESE Business School in Barcelona, and posts (6 November) on the Harvard Business Review blog HERE 

“This small-numbers problem invalidates Adam Smith’s “invisible hand” mechanism in which good performance is supposed to be ensured by large numbers of competitors, none controlling more than a sliver of the market and none, therefore, with the power to jack up prices."

"What Economists Know That Managers Don’t (and Vice Versa)

Why did Jean Tirole win the Nobel Prize in Economics? Not for the highly-regarded work on

competition between small numbers of firms with which his career began more than thirty 

years ago but for more recent work on how carefully structured regulation can improve

performance relative to unbridled market forces. This is a reminder that serious students of 

market performance take market failures seriously.

But what many economists generally gloss over is a notion that I will argue is highly complementary to market failures: management failures. For policy-making purposes economists assume that all businesses act rationally in the pursuit of profits. The possibility that that might not be the case is generally ignored, or even when mentioned, quickly finessed."

Comment

Pankaj Ghemawat writes an interesting piece, in which he is interesting in some of his statements (not quoted above) about a new slant on what he distinguishes between ‘market failures’ and ‘management failures’ in modern economics. 

Neoclassical economists - those that came after classical economics - who down-played the human role in economics and imagined universal rules of perfectly ‘rational behaviour’, ‘profit maximisation’ and ‘socially optimal performance’.  The clue to the muddle of much of modern economics is in forgetting that “maximization is [only] a basic mathematical tool” and not a description of actual human behaviour in the real world, leading to exercises like “even if a firm doesn’t maximize profits, it can be treated, for the purposes of many of its interactions with the outside world, as if it does.”

Paul Samuelson got into similar muddle by enunciating almost as a quip of a general rule in the form of Adam Smith’s supposed use of the “invisible hand” metaphor in 1948 (“Economics: an analytical introduction”, McGraw-Hill), supposedly leading to a socially maximum output. He then spent over 50 years, across 19 editions of his best selling textbook, re-casting what the metaphor supposedly implied (see Kennedy, G. ‘Paul Samuelson and the Invention of the Modern Economics of the Invisible hand’, Journal of the History of Economic Ideas, no 3,  2010). This had disastrous results in the the teaching and practice of economics across the world. 

Perfect competition does not and never has existed and was unknown to Smith. Humans behave variously in all manifestations of human behaviour in all situations in which they act purposely.  Adam Smith did not say that humans behaved identically and with mathematical precision and by that behaviour, “good performance” in an economy was assured. The laws of gravity operate with mathematical precision, making gravitational precision predictable years, centuries even, ahead. How much a company will sell of its products this month is and remains unpredictable.

Whether such unpredictability is a ‘market’ or ‘management’ failure seems to me an uninteresting conclusion. More important, whether the ESE Business School in Barcelona can devise a programme that high paying managers will attend is a just and typical incident in the upper-echelons of the management team that runs the ESE Business School. I know the response well; I spent 20 years in the senior management team of Edinburgh Business School (Heriot-Watt University) and was a frequent guest lecturer at a dozen-plus others, here and abroad. 

The so-called debate between ideologues of both Left and Right is a phoney war.  One side calling for more markets and less government versus the other side which calls for fewer markets and more government.  Adam Smith was a pragmatist, not an ideologue. He never used the words ‘laissez-faire’, nor ‘capitalism’. His support for ‘Natural Liberty’ was for everybody. His approach is best summarised as ‘markets where possible; the state where necessary’.