Submitted by Erico Tavares of Sinclair & Co. [10]
Presented here is a simple framework that can help us analyze the impact of certain policies in our companies and economies. This is Part 1, in the forthcoming Part 2, perhaps the most interesting one, this framework will be used to show why the Keynesian approach will deliver very little results in western economies
Optimizing Economic Performance – Part 1
- Squeezing the Lemon
We began our professional career at General Electric when it was still under the leadership of the legendary Jack Welch. At that point he was ramping up the implementation of Six Sigma, a systematic approach to improve and manage key company processes in order to reduce errors and inefficiencies, across the entire organization.
This was a bold move given the size of the company, but Welch astutely realized that this approach could deliver radical benefits to an organization that had been in operation for over a century. There was always more juice that could be squeezed out of that lemon. And that’s exactly what happened across many of the company’s businesses and divisions (we did our bit and even earned a green belt in the process).
What really impressed us at such an early stage of our “real work experience” is that a business is all about processes (when we moved to investment banking later on, it all became about faxes at midnight!). It's an obvious statement really, but it’s only when you are fully enmeshed in fixing communication breakdowns, file corruptions, server and IT failures, document losses and customer complaints that you can really appreciate it.
Improvements typically don’t work in a linear fashion, but more like shown in the following graph:
What is being described here is how much effort we need to exert in order to achieve a certain level of improvement (time in this context is an unnecessary complication, so we assume everything happens instantaneously), and this largely depends on where we are in that curve:
- At the outset, a large number of opportunities for improvement can be achieved with relatively little effort. This is called the “low hanging fruit” and it’s a good analogy. You can easily pick up those fruits without having to use a ladder, which requires much more effort for the same result;
- After that you can reach an acceleration stage, as you become more knowledgeable of the process, can execute it faster and even improve it further;
- Of course trees don’t grow to the sky. At some point to sustain additional improvements more and more effort is required. Think of this as squeezing harder to get those last drops of a lemon – just like Welch (although he also found many new lemons). As a result the curve starts to flatten, and it can even turn down beyond a certain point (like you pushed the engine too hard and now it’s broken).
what is interesting is that this graph can be applied not only to a company but to the entire economy – which is nothing more than an agglomeration of all the processes undertaken by economic agents. It provides a simple yet very intuitive and powerful framework that we can use to conceptualize a number of economic policies and events.
In fact, the more we think about it, the less the classical division between microeconomics (which studies the behavior of individuals and production entities) and macroeconomics (which deals with the performance of the economy as a whole and not its individual markets and components) makes any sense - certainly not in the 21st century.
And in our view it is this disconnect between the two that is at the heart of the failure of Keynesian economics – which at best is incomplete and at worst is all just baloney. You might disagree given the pedestal on which John Maynard Keynes was placed by academia and government, but please bear with us throughout these series. It never hurts to get a different perspective (although the truth might…).
OK, so what happens when a company or an economy can’t squeeze any more juice out of the lemon? Is it doom and gloom?
Not necessarily! They can still function with much less growth, as long as the cash inflows can sustain the outflows. But there is a pathway towards continued improvement and hopefully new growth… through INNOVATION! This is what has sustained Mankind’s relentless march towards seven billion people on this planet today. Eat your heart out Malthus!
When innovation is mentioned images of robots and computers immediately spring to mind. These can certainly be a part of it, but there is a multitude of other interrelated areas to consider. Many companies in the 1980s found little to no improvement after introducing robots in their production lines. Why? Because they were still repeating the same mistakes, only now the machines were repeating them faster.
So what other things can also be regarded as innovation? Plenty – as far as the human imagination can reach in fact. Here are just a few (more mundane) examples:
- Better management practices. At GE many improvements were made just by managers encouraging people to think about their own business processes, even without getting into all the sophistication of Six Sigma. That's the power of a spotlight. And the whole initiative was further cemented by tying it to executive compensation. Good management can make a real difference.
- Better educating and training. The more skills you bring to your job, the more effective you can be (provided they are relevant of course). For instance, learning how to really take advantage of Microsoft Office can help you automate a number of menial tasks and give you more time to do better things (we are certainly not advertising Microsoft here, but we speak from experience after almost going insane on a project if it weren’t for Excel macros).
- Better logistics. Amazon is testing the use of drones [11], which could significantly reduce total logistical costs per mile. And you can also reduce the number of miles by relocating production and distribution centers, which Amazon already did. In some countries (like Brazil) there is still a lot of juice left in that lemon, and country and financial risks aside these tend to make the most profitable infrastructure projects.
- Better process reengineering. Henry Ford did not add robots to the assembly line (OK, they did not exist back then). But he radically transformed how automobiles were manufactured. Rather than having each worker focus on a certain part of the car, he made them specialize on very narrow assembly tasks along a production line streaming around the shop floor. And the increase in both productivity and the bottom line was massive – so much that he could afford to pay his employees much more to compensate them for all the mind numbing repetition.
You have probably heard the story about NASA spending millions to invent a pen that would write in Space, whereas the Soviets merely used a pencil. This is just a myth [12], but it illustrates the point that you don’t need to be super fancy to innovate; often the simple solutions work best.
Let’s go back to our graph and see what happens once innovation gets in the picture:
Finding new and better ways of doing things shifts the curve upwards, so that we can achieve more with the same or even less effort. Again, this is applicable not only to our companies but also to our economy as a whole (and even to our own individual skills and competences, but that’s getting a bit deep…).
These improvements can significantly add to our wealth and well-being. A worker in an advanced economy can produce an abundance of cars leveraging all the technology and infrastructure at her disposal. With that extra time she can go to a movie, dinner with friends, bicycle ride and so forth – all of which contribute to more economic activity elsewhere. She can also learn new skills that will make her even more productive at work and therefore more valuable. It’s all part of that acceleration in the curve.
In contrast, the reality of millions of people in developing countries can unfortunately be very different. Many spend a considerable amount of time just to pick up water. Imagine if you had to spend more than four hours a day just to pick a bottle of (dirty) water; what would that do to your productivity? Much more time is also robbed by lying in bed fighting diseases, many of them preventable using modern medicine. This leaves precious little time and opportunity for work or study – basically to break away from that vicious cycle of poverty and economic underachievement.
On the flipside, there is an abundance of low hanging fruit opportunities in these developing nations, where even the most modest of improvements (like buying a bicycle) can generate a huge return. No wonder their growth prospects remain so compelling. The outlook for developed nations in this regard is much less rosy, which is a big part of the reason why our governments and central banks have become even more interventionist in the economy.
In Part 2 we will look at this important economic reality in more detail and use our framework to assess if more government intervention can boost our fortunes in a durable manner.
