31 August 2008

Management of the market

In today's Observer:
For three decades a single dominant thought has crowded out all others: that managing, whether of economies or organisations, is a matter of switching on the automatic pilot of the market's invisible hand and letting rational selfishly motivated individuals do the rest. .... But the dominant idea is now under attack. One prong of the offensive is the course of events; after all, it wasn't supposed to be like this. Over the past decade, rather than a stimulating pat on the back, the invisible hand has administered a succession of increasingly damaging haymakers: South East Asia, hedge fund LTCM, the dotcoms, Enron and other corporate scandals, now the sub-prime shambles. After several knockdowns, the unfettered market has put the global economy on the canvas for the count. [And] just as the practice of financial capitalism is being questioned, so are its intellectual underpinnings. As it excavates the foundations, the burgeoning school of behavioural economics is shouldering aside the desiccated calculations of economic man to make legitimate space for emotion, altruism and fair play in economic behaviour. Simon Caulkin, 31 August
Mr Caulkin points out that there are many incentive structures that can bring about excellence in the private sector and that:
It has nothing necessarily to do with stock options, private ownership or extravagantly paid senior executives. It does have to do with effective work organisation and systems, which the individual performance management regimes favoured by the private sector are as likely to destroy as to support. It is now apparent that where the private sector does excel is in disguising the full costs of its incentives by externalising their dysfunctional results on to society as a whole. Today's credit crunch is the most stunning example of this perverse behaviour in economic history.

Mr Caulkin ends by saying that 'Management of the market is as important as management by it'. I can't disagree with this, except to point out:

  1. that the public sector also behaves anti-socially (see passim on this blog or the websites at right references to perverse subsidies) and
  2. that the broader incentives do matter when it comes to the private sector externalising its costs (onto the environment as well as 'society as a whole').

There are few incentives not to so externalise. The private sector is always going to 'excel in disguising the full costs' of its negative impacts on the rest of us if it doesn't get punished for doing so, or rewarded for not doing so. It is reacting rationally (and anti-socially) to the incentives on offer. So the question is not so much 'how is the market to be managed?', but rather 'how can we rejig the incentives so that the organizations - whether they be private or public sector - behave themselves?' That's where Social Policy Bonds enter the picture. They can act as a market-based device for correcting market failure. If the product of the mix of private and public sector bad behaviour is a filthy environment or a high rate of crime, then rather than regulate with a (pace Mr Caulkin) not-always-efficient public sector, a bond regime with environmental and social goals that are understood and agreed by ordinary people could be the solution. Social Policy Bonds could be issued that reward people for bringing about a cleaner environment and a lower crime rate, however they do so.

So management of the market could in effect be done by the market. The beauty is that under a bond regime it is that the market would be allowed to do what it is best at doing - allocating scarce resources - but in the service of social and environmental goals, rather than the private accumulation of wealth.

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