Essays on Management: Importance of non-market institutions

Organisations as diverse as government departments, hospitals, universities, public research laboratories and voluntary organisations describe themselves as businesses even while delivering non-market services.  It is a common error to confuse economics with business, and then apply business models and mind-sets to organisations falling outside these models.

Running a business requires the opposite mind-set to running an economy.   Businesses are open systems that grow by drawing resources from other parts of the economy.  When they shrink they shed staff to be employed elsewhere, or be supported through social welfare.  Economies are closed systems – everything has to add up.  In a recession businesses often retrench, cut costs and reduce debt, while economies should expand through debt-funded Keynesian expansion. Applying business language and mind-sets to non-market organisations is damaging at both larger (including economy-wide) scales and at an organisational level.

While a business can measure itself on profit and net tangible assets, non-market institutions need to achieve things that are often difficult to measure.  A business knows it is successful when it can internalise success in its balance sheets, while a school or hospital is successful when people leave them educated or healthy, which can be hard to measure and report on.

While business profit, returns to shareholders and net tangible assets are a core purpose of business, for non-market institutions financial viability is a condition of staying “in business,” not the organisation’s core purpose.  Market mechanisms fail when temporary imbalances are intolerable – such as when the lights go off.  Non-market institutions cannot operate effectively on narrow business principles because they have more complex external interests to address.  They often have to motivate by encouraging intrinsic motivations rather than through money.

A stylised and purist economic model suggests all things have value and can be priced and traded in freely competitive markets.  It implies only market exchanges can lead to efficient resource allocation.  An underlying problem with the market model is its failure to address non-commensurable goods that are valuable but not priced, since pricing implies a willingness to trade.  These are goods which are conflated with self-identity, whether family heirlooms or cultural treasures.  Intergenerational cultural goods go beyond market valuation timeframes.  These goods are not delivered by profit-making firms and require non-market institutions to create and protect them.

People instinctively distrust putting a price on things needed to maintain a society’s values.  They oppose charging for rights enforcement or taking a cost-benefit approach to discovering and convicting a murderer.

Market models also have shortcomings in handling risk and uncertainty.  Risk is part of life and can often be managed by individuals and families.  Markets have evolved many risk-shifting devices, often embodied in contracts.  However, many of life’s big risks such as health, redundancy and marriage breakups are not well managed by markets, Where the transactional costs of addressing risks through markets are excessive, either NGOs or government need to create risk-shifting institutions or devices to manage them.  This might include charities supported voluntarily, or risk management agencies such as ACC.

While the market pricing and trading model still works well in risk mitigation it fails to deal with Knightian uncertainty.  The risk of a particular outcome occurring can be assessed and a probability distribution assigned.  However where the broad form of an outcome is known but not the likelihood of a specific one occurring then uncertainty cuts in, risk management processes fail, and uncertainties have to be managed in non-market ways.

The market model has no mechanism at all to deal with sins of omission, including the failure to recognise the future has more rights than the present.

It is too easy for public officials to generate activities and therefore costs that neither meet Minister’s immediate needs nor long term public interests.  Public sector cost control is therefore a special challenge. In the public sector there is no price mechanism to value output and ensure efficient short-term resource allocation.  In a rapidly-growing, input-oriented public service fostered by “left learning parties” public organisations expand capability without the discipline to focus it and make it productive.  The growth and lack of price discipline means waste occurs, in the form of intellectual laziness and lack of focus, as well as higher salaries, wasteful travel and organisational extravagance.

Without any clear work programmes to focus on, policy entrepreneurs emerge.  Some of their entrepreneurship is well-focused, some misdirected, none is subject to market price “acid tests.”  Policy entrepreneurs drive their own pet projects with little managerial oversight or peer review.  Their concentrated interest means no one has the time or knowledge to challenge them. By the time things turn out badly they have gone on to other projects and can blame failure on poor execution.

A challenge for non-market institutions is creating incentives for and measuring their performance.  All organisations face scarce resources and are subject to economic constraints. All need to be sufficiently “business-like” to manage their assets, know their cost structure and optimise outputs for given inputs.

The market model was applied to the public sector from the mid-1980s because of the inherent difficulty in making public sector organisations perform in the absence of price signals.  Some public sector reforms aimed to replicate business behaviours in public agencies.  This involved adapting to business language and psychology.  It aimed to replicate price signals and customer-business relationships.  One benefit of such reforms was making it more obvious what it cost to deliver services and forcing capital pricing to make better resource allocation possible.

However, in the late 1980s and early 1990s the New Zealand public service assumed neoclassical economics was a universal prescription shaping how non-market as well as market institutions work.  Some of the more egregious proposals market model thinking led to, such as privatising public roads, never saw the light of day.  However, state assets were privatised and the telecommunications sale in particular cost New Zealanders billions of dollars.  Only later did it become clear that sovereign funds, state-owned enterprises and mixed asset ownership models were becoming increasingly important in the world.  Such business models are often quite stable, face market pressure to perform, have demanding owners, and can minimise the waste associated with highly volatile listed market trades and the analysis and reporting overhead associated with them.

The science and tertiary education sectors were “liberalised” and competition encouraged through price-driven drivers and fragmented moves to a perfect competition model. This ignored several considerations.  Too many choices make it difficult to make any choice at all. Reputation requires time to build up, and reputational losses are often irreversible.  There are significant scale and scope economy issues.  Worse of all, treating education as a fish market led to a profit-making focus that maximised enrolments and institutional returns rather than delivering educational achievement to students and supporting the working life contributions they make to society.

People forgot all economic models are wrong (that is they are incomplete), but many are useful thinking aids.  The philosophy was There Was No Alternative (TINO) when homespun common sense tells us there are always alternatives.  Group think ensued and people forgot that market economies depend on underlying regulations and other rules of the game, and non-market institutions exist to do what markets can’t do.

People are citizens of government not customers of government.  The public service is not a business, it is an institution that delivers the intent of the elected administration, moderates its powers, takes a longer view than electoral cycles and transmits through time such principles as Magna Carta property right protections and the law binding the government.

Public service organisations have a paramount obligation to serve the public interest.  Elected politicians must interpret what that interest is unless the public is able to voice its wishes directly.  Public servants have a near constitutional obligation to give advice that transcends short-term and partisan considerations and which address term consequences.  They need analysis going beyond Google searches and social media.

Advice should always aim at a pure ideal of what might be achieved rather than asking what might be acceptable.  If you anticipate what a politician, manager or a board might think and want you to say then you compromise your advice and it becomes worthless.  You effectively sacrifice the truth to make something untruthful acceptable.

Public sector organisations need to deliver today while showing fidelity to enduring underlying principles.  This requires navigational adeptness and ability to change course over shorter distances while maintaining course over the longer route.  It requires courage, including offering unpalatable advice.  It takes courage and vision for public servants to focus on longer term interests when rewards are given for making others look good today.  The ability to manage today with an eye on the long term interests will be the big challenge for the public sector and for non-market institutions facing the future.

Non-market institutions have especially important roles in health and natural hazard mitigation.  People recognise that health has a high level of effort-independent variance.  People feel “there but for the grace of God go I.”   They are Rawlsian in their desire for institutions designed for those who do not know the circumstances they will be born into or the unwilled capricious events they may be subject to, whether cancer or earthquakes.

Businesses must pay tax to fund the non-market infrastructure, education, health services and social risk management devices without which neither business nor society can properly function.

Businesses have an interest in competition policy for economic health, to foster innovation, and sometimes as an opportunity for high-performing businesses.  Courtney Place restaurants are highly competitive, however they cluster together to create gravitational attraction for customers for them all.  More competitive markets allow more consolidation as the better businesses take over the weaker and allow new businesses to emerge.

Profit-making business models depend on non-market systems and institutions to perform, ranging from property rights systems to professional associations.  Property rights depend on a broadly-given consensus on who owns what and who has freedom to operate.  Property rights must be socially mandated. The countries with the strongest property rights have the least sign of property being physically protected – unfenced front yards in the United States versus window grills in Latin America and Russia.

Property rights require a complex and largely invisible records system recording transactions, and the interests, rights and liabilities associated with them.  Even jobs are now property rights which, like Magna Carta rights, can only be taken away with due process.

Leaders and managers in organisations need to focus vertically on their external stakeholder interests (“customers”) and the results they need to deliver to them.  However while an organisation’s professional specialists focus on vertical results for customers they also have horizontal responsibilities to their professional affiliations and to the standards that professional, regulatory and accreditation authorities hold them to.

Professional associations are non-market institutions that help markets to function and also have wider societal benefits.  The horizontal affiliation and recognition of professionals creates the risk that bad behaviour by some can besmirch a whole profession.  We have seen this in recent years for financial advisers, architects and economists.   Professional associations maintain standards that give customers confidence, and overcome information asymmetries that would otherwise occur.  Professional accountability is often determined by peer standards, and this delivers wider and generally positive externalities.

However, professional associations can impede market workings at the expense of consumers and new professional entries.  Much legal and other professional rent-seeking can be a form of redistribution in favour of those who write the regulations.  If professional bodies focus more on the competencies of new entries rather than that of incumbents it suggests rent-seeking.

While rent-seeking can be a risk, there are many reasons why professional identity, affiliations and supporting institutions need to be supported.  Professionals share learning.  They translate higher level leadership and management into action.  They make it impossible for autocracies and dictatorships to survive in the long term because all governments need professionals, professionals think for themselves, and their competency is judged in ways transcending hierarchal interests.  This has profound societal implications.

Peter Drucker argued that the emergence of a managerial and professional class ensured the long run downfall of the communist system in the Soviet Union.  Early in the development of the Soviet regime, Lenin and Stalin idolised Henry Ford and his system of mass production because of its perceived potential to produce wealth and power with a deskilled and subservient working class and without the intervention of a management and professional class they feared.  The mass production system Ford developed implied an ability to industrialise without requiring the creation of a class of people who would think for themselves.  This led to Ford being idealised in the Soviet Union as a near demi-god.  In fact, Ford’s refusal to allow a management and professional layer to develop in his company almost doomed it to bankruptcy because it meant it failed to innovate and it lost competitiveness.

Disasters such as the Pike River tragedy and building failings in the Canterbury earthquakes can occur when managerial pressures (“get the coal out of the ground”) or ideological norms (“markets will sort things out – why regulate”) weaken horizontal professional standards.  Modern information technology will discipline professionals more in future because it will be increasingly possible to use record management systems and cloud computing to trace who did what and when, and to hold people accountable.

Professional associations and networks have benefits for individuals as well as businesses and society.  People are well-advised to maintain their horizontal networks if only to protect their self-respect if things go wrong in a job.  Professional affiliations mean individual competencies are validated objectively, that businesses know the abilities of those employed, and society can be confident in professional service quality.  Networks give professionals horizontal mobility so they are not beholden for life to their employing organisation.  This can mean some organisations may be best to recruit professional services externally rather than retain them internally because professionals cannot be fully controlled internally.

There is a wider civil society benefit in professional networks and interests that traverse narrowly defined organisational, nationalistic, sectarian interests that involve double standards of morality between in and out groups.  During the 1980s and beyond stand-off between New Zealand and the US over nuclear policy, New Zealand and US scientists kept cooperating in Antarctic research.  Soviet and American scientists maintained cooperation throughout the Cold War.  Iranian and American scientists cooperate on climate change research.  Health research advances across nationalistic, ethnic and religious borders.  Information technologists make so much happen through the global networks they create and which the political, ethnic and religious elites struggle to close down.

The greatest fear of autocratic regimes is of highly educated people who have some intellectual autonomy because of their position as managers, professionals, academics, writers and others.  The Nazi genocide of Jewish people attacked Europe’s most highly educated ethnic population.  Stalin executed around 22,000 Polish officers, intellectuals and others at Katyn in 1940 to deprive Poland of its leadership.  Pol Pot targeted “people who wore glasses” and otherwise showed signs of higher education.  The Chinese cultural revolution was an attack on China’s thinkers and independently-minded, educated people.

Free-thinking professionals inside governments and other organisations are therefore a check against narrow thinking, autocracy and abuse of power.  They are complemented by free-thinkers outside these organisations, especially those with ideas and talents that can influence others.  Developing knowledge-intensive manufacturing and services businesses in New Zealand creates wider opportunities for the rich array of our country’s professional talents to be expressed and retained. This makes for healthy polity, discourse, democracy, and the society it gives rise to.

When the surreal regime in North Korea breaks down it will not be because its children are stunted through malnutrition.  It will be partly because the internet and modern ICT makes it impossible for any country to seal itself off from the world’s flood of subversive ideas, philosophies and choices.  And North Korea’s inevitable collapse will also have much to do with the horizontal workings of people whose connections and loyalties are to their professions rather than vertical hierarchies.

Market models have particular limitations in knowledge-oriented fields such as science because the currency traded includes peer recognition (a status positional good) rather than something having an absolute and fungible value.  Public research laboratories and universities are important for pluralism in society because they create new ideas and reduce power concentration in government and business.  They also counter “the pretence of knowledge” since their existence recognises knowledge is diffuse and open rather than centrally controlled and closed.

Organisations can be effective without either a business model mind-set or even a clearly-defined owner.  After all, churches, universities and a host of voluntary and cooperative organisations function well without “owners”.

Different institutions emerge to deal with problems unsolvable by market workings.  Friendly and mutual aid societies emerged to foster cooperation among groups of people and communities with shared interests.  The Danish folk high movement emerged in the nineteenth century to help Denmark survive the socio-economic crisis occurring after cheap New World grain imports collapsed much of its agricultural economy.  A host of nineteenth century movements, and in recent times the kohanga reo movement, iwi organisations and wananga emerged in New Zealand to provide institutions to support Maori interests.

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About Peter Winsley

I’ve worked in policy and economics-related fields in New Zealand for many years. With qualifications and publications in economics, management and literature, I take a multidisciplinary perspective to how people’s lives can be enhanced. I love nature, literature, music, tramping, boating and my family.
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