How do we apply Deming’s profound knowledge vis a vis our Congress?

6 08 2011

Extreme Politics with Communication, Collaboration and Commerce at the Speed of Light

A reader of my blog writes:

“Since the elected officials do not share the same goals or theories of knowledge they do not act like cooperating players in a system with a common vision or goal. Instead they behave as adversarial players trying to get the best deal for themselves and their patrons (or sponsors who lobby for their causes) at the expense of others. Current shared goal among all the players seems to be convincing the voters that their side is right, so that they can impose their views on all voters.  How do we apply Deming’s profound knowledge vis-a-vis our Congress?”

A good question.

Deming’s approach is based on developing a consensus based on facts supported by measurements.  The first step in a collective consensus building approach is to show respect to each other.  Do not blame people.  Blame the process.  This is a learned skill.  This has to be accepted and observed and when people violate this rule, they should be called out and reminded to observe respect toward each other.  Without this acceptance, there will be no meaningful dialogue except noise.  If a Vice President of the country calls (or condones when others do it in his presence!) other members of congress terrorists, he is not showing respect.  If a member of congress questions the patriotism of the President, it is not showing respect.  Showing respect and cultivating the ability to argue one’s point of view to convince the other is a learned skill.  Old tricks of political demogaugory no longer work in the age of communication at the speed of light.  Politicians will be immediately exposed in 24X7 multi-media in living color.  Our corporate leaders went through the same transformation from being disrespectful noisy authoritative self-centered managers to becoming consensus building visionaries developing common goals and mission with Deming’s approach.
When Deming arrived at Ford, the management at Ford resembled today’s U S Congress and the Executive Branch – highly polarized, bickering, undermining each other’s efforts and totally ignoring what their customers were saying [1]. To Ford management’s surprise, Deming did not focus on quality but scolded the management for being mainly responsible for 85% of the problems in developing better cars. Before Deming, Ford management paid only a lip service to quality [1]. The incentives and appraisal systems, which were intended to motivate people to do a good job, were cost-oriented, not quality oriented. As a consequence, people who wanted to be successful had no reason to collaborate across divisions and focus on end-to-end process and product quality. At the top levels, the bickering, back-biting and self-promotion were so prevalent that they had to bring in a facilitator to mediate at management meetings and to bring focus back to issues on hand. Deming’s success at Ford is well documented [2, 3] in the literature and “the system of profound knowledge” describing the fourteen key principles for management and the “Seven Deadly Diseases” which must be addressed by the management are well articulated in Deming’s book [4]. There is no shortcut to developing leadership skills.  Education, training and experience are essential to polish our leaders.  Perhaps every elected official should undergo a three-month education on Deming’s profound knowledge before they take the oath to serve the people who have trusted them to do the right thing.

It is important to remember that when the resources are abundant, some waste in the system is tolerated but in a competitive world where communication, collaboration and commerce are conducted at the speed of light, resources become scarce, and waste is not tolerated by the system.  It behooves the leaders of this great nation to focus on competing with the rest of the world instead of fighting with each other on their ideologies that are only marginally different.  A majority of citizens probably favor fiscal conservatism and social liberalism.  If one cancels the noise from the left and the right, the majority agrees that we should first cut waste, live within our means, then reform the tax system to make it fair, and provide a social net.  If leaders do not listen to their customers (in this case the citizens), they will vote them out.  A leader’s reponsibility is to develop consensus with a vision for the future.  It is not to expoit fear to cause a riot to promote their views!

One easy way to fix the current stalemate of extreme liberalism and extreme conservatism is to elect republicans who will promise to reform tax code to be fair and elect democrats who want to cut spending.

Democracy  (Aristotle classifies democracy as a deviant constitution (albeit the best of a bad lot),) works well when everyone pitches-in toward a common purpose and the leadership role is to define and develop a common purpose based on consensus and will of the people.

References:

[1] Deming, Systems Thinking, Organizational DNA and Putting America First – Part I

[2] Mary Walton, and W. Edwards Deming, “The Deming Management Method”, The Berkeley Publishing Group, New York, NY

[3] Womack, James P., Jones Daniel T, and Roos Daniel, “The Machine That Changed The World”, Free Press, 1990

[4] Deming, W. Edwards, “Out of the Crisis”. MIT Press, 1986.





Organizational DNA, Disruptive Innovation, Economics at the Speed of Light and the Impact on Investment in Future

4 12 2010

Marye Anne Fox, National Medal of Science Winner (2010) and Walter Kohn, Nobel Prize in Chemistry Winner (1998) at a recent UCSD 50th Anniversary Celebration

Abstract:

The economics of communication, collaboration and commerce at the speed of light is changing the global competitive landscape by leveling the playing field in product leadership, operational excellence and customer intimacy through commoditization of technologies. The only choice open for nations to be number one is to bring disruptive innovation to differentiate.  Time and again, evolution has proven that architectural simplification through disruptive innovation brings orders of magnitude productivity. Life forms survive and thrive by changing their DNA and adapting to external changes.  Will the differentiation in the future for an organization come from investing in disruptive innovation? 

Introduction:

A nation’s vibrancy is often, visible in the halls of its learning institutions.  It was most visible recently at the 50th anniversary of University of California, San Diego whose chancellor, Marye Anne Fox, was awarded the national medal of science by President Obama just a day before.  Many of the old alumni and faculty were invited to celebrate the 50th anniversary.  Walter Kohn, a card-carrying physicist who won a Nobel Prize in Chemistry in 1998 was there.  There were talks about the origins of the university and now legendary Roger Revelle [1] “whose dream it was to establish a great institution of learning and recruit world-class scientists to come and join its faculty — for their names lured other outstanding people to come. And their prestige attracted money for research grants and superior students to enroll.  At one time UCSD’s faculty had eight Nobel laureates and 50 members of the National Academy of Sciences.  Revelle hoped to desegregate the sciences and the humanities and social sciences, because of the profound effect of technology and scientific discovery upon all aspects of modern society.”  Starting from its humble beginnings as UC La Jolla, UCSD today has grown to encompass six undergraduate colleges, five academic divisions and five graduate and professional schools. 

Equally visible were the protests from the students on recent 8-percent student-fee increase from $10,302 to $11,124 for the 2011-12 academic year, which comes a year after a 32-percent increase passed last November.  The increase is proposed because of the decline of California state budget allocated for supporting education.  “What does it say about any state that focuses more on prison uniforms than on caps and gowns?” Schwarzenegger [2], the governor of the state of California said recently, adding that “30 years ago, 10 percent of the general fund went to higher education and 3 percent went to prisons. Today, almost 11 percent goes to prisons and only 7.5 percent goes to higher education. Spending 45 percent more on prisons than universities is no way to proceed into the future.” The state’s priorities, he added, “have become out of whack.”

State and national priorities on where they invest become a critical issue in a globally competitive market place where nations fiercely compete for their market share.  In an Internet connected global economy where communication, collaboration and commerce are conducted at the speed of light, the national boundaries have blurred with respect to competition in the market place.  Technology innovations propagate rapidly and products and services get commoditized globally seeking cheap resources and customer demand.  Global corporations in their quest for profits, in a competitive environment with profit margins under constant pressure, are no longer sensitive to a nation’s local economics.  The invisible hand of economics that establishes equilibrium in a free competitive market place cannot cope with rapid fluctuations introduced by the communication, collaboration and commerce conducted at the speed of light [3].  For example, cheap labor in a particular sector of economy may transfer jobs very rapidly from one nation to another but the laid off workers cannot move with the same speed from one sector to another or one nation to another.  The time scale disparities of economic cause and response have diverged so much, with the advances in technology,  that the non-equilibrium economics becomes the norm and all the economic theories that address equilibrium and small deviations from equilibrium become the exception.  How can nations cope with this side effect of technology advances that also have improved productivity and quality of life for everyone?

The answer may lie in understanding the organizational DNA that assists in developing patterns of evolutionary advantage and competitive differentiation.

Organizational DNA, Disruptive Innovation and the Culture of Game Changers

According to a new management theory [4, 5, 6, and 7] organizations evolve developing their own DNA which contributes to their business success.  Four following base elements constitute the organizational DNA:

  1. Leadership
  2. Strategy
  3. Culture and
  4. Organizational structure

Very similar to the DNA of biological systems, the organizational DNA consists of different patterns combining the base elements and some patterns have evolutionary advantage over others that promote competitive differentiation and survival.  These successful patterns define how leadership implements  the four strategies exploiting the cultural diversity and different management structures.  The four strategies identified as primary drivers for success are:

  1. Customer intimacy,
  2. Operational Excellence,
  3. Product Leadership and
  4. Disruptive innovation.

Each strategy, the theory claims, has evolved different combinations of cultural traits and organizational style for its successful implementation.  One combination that works well for implementing one strategy may be not optimal if not fatal for implementing another strategy.  By successfully exploiting the right combinations of strategy, culture and structure, leadership manages to develop competitive differentiation in the open competitive market place to assure long-term survival and sustenance. 

In particular, the disruptive innovation as a strategy to provide competitive differentiation requires a culture of cultivation and an organizational structure that promotes collaboration between technical functional organizations that bring technical competence in multiple disciplines and business and marketing organizations that have a pulse of the market drivers.

If the theory has any validity, it has profound implications on how we approach innovation and exploit our halls of learning to be number one as a nation. 

Disruptive innovators or game changers are different breed of people who cause technological change —distinct from simple increased inputs of land, labor, and capital— which contributes to great leaps in economic growth.  As another Nobel Prize winner Solow pointed out, about four-fifths of the growth in US output per worker was attributable to technical progress [8].  On the other hand “a generation of scholars had arduously and systematically documented empirical evidence that supported the conclusion of Joseph a Schumpeter’s [9] “What we have got to accept is that the large-scale establishment or unit of control has come to be the most powerful engine of progress and in particular long-run expansion of the output.”  John Kenneth Galbraith [10] provided a postwar interpretation:  ‘There is no more pleasant fiction than that technological change is the product of matchless ingenuity of the small man forced by competition to employ his wits to better his neighbor.’”

The organizational DNA theory reconciles the observations of Solow, Schumpeter and Galbraith by pointing out that all four strategies with associated patterns are equally important for evolutionary success.  The disruptive innovation cultivated by individuals needs both technical competence and market savvy to translate into product leadership which then has to scale to sustain through operational excellence and customer intimacy.  This means that the entrepreneur and unit production cost reduction through large-scale are both essential for evolutionary success.

The cycle of product and technology maturity is described by the S-curve shown in figure 1 which describes the three phases of evolution and associated return on investment.

S-Curve depicts the evolution of technology/process innovation and associated productivity enhancements

Three important points need emphasis:

  1. Technology or process innovation that improves productivity evolves through three distinct phases (incubating, emerging and mature) which have different returns on investment.  Disruptive technologies that raise the productivity from one level to a next higher level occur through evolutionary need for competitiveness. Traditionally, as technologies start to mature, governments and corporations have devoted a part of their revenues (taxes or profits) in incubating technologies as an investment to their future competitiveness and survival.  History has shown that this investment is about 3 to 6 percent of their revenue.  History also has shown that such investment attracts the creative scientists and engineers to nurture the culture of cultivation and structures that collaborate (without the near-term profit oriented cut-throat competition) and go on to achieve Nobel  prizes  and National Science Awards.  DARPA and NSF funded projects, UCSD and AT&T Bell Labs are just a few examples.  Incubating technologies require expertise in multiple disciplines and collaboration which Roger Revelle emphasized when he was advocating the need for a university.  His main concern was that for Scripps Oceanography Institute to be successful, it needed multi-disciplinary expertise of highest quality available nearby.
  2. When the incubating technologies start to show promise as emerging technologies, the Animal Spirits and Venture Capitalists start smelling high profits and exploit entrepreneur’s product development expertise and establish product leadership.  The culture and structure required for this phase according to the organizational DNA theory is different from the culture of Nobel Laureates and structure of collaboration required from many disciplines.  
  3. As the products, processes, services  and technologies prove themselves in customer environments, conventional capitalism kicks in and large corporations exploit scale through establishing operational excellence and customer intimacy.  Again the organizational DNA theory emphasizes that the culture and structure that is exploited by conventional capitalism are different from the cultures that support disruptive innovation and establishing product leadership.  The culture of control that helps in establishing operational excellence fails miserably in creating disruptive innovation.

The long and short of the theory is that the patterns of evolutionary advantage are different in supporting different phases of implementing productivity improvements and establishing competitive differentiation.

Organizational DNA and Impact on Investment in Future of a Nation

Communication, collaboration and commerce at the speed of light have changed the global market place and both corporations and nations are struggling to establish a new economic equilibrium where they need to respond to establish competitive differentiation in a level playing field.  Global connectivity and instant information access has allowed strong coupling between minor changes in global supply and demand to cause large fluctuations in price of goods and services.  Instance arbitrage and risk management at the speed of light have introduced large fluctuations in the economic equilibrium that classical economics of the invisible hand does not address.  In addition, as the technologies get commoditized also at the speed of light crossing corporate and national boundaries, operational excellence and customer intimacy that are the hall marks of conventional capitalism [11]  can no longer provide competitive differentiation due to global competition and strain on profit margins.  This leaves disruptive innovation and product leadership in bringing new innovations speedily to market as the only options for corporations and nations to differentiate themselves.  Corporations and nations that successfully exploit these strategies with right combination of strategy, culture and structure will have an evolutionary advantage over their competitors.

During the past three decades, as conventional capitalism has thrived based on past investments in R&D, more universities, and corporate R&D efforts have been hijacked by the short-term profit motives at the expense of long-term investment that can yield disruptive innovation.  Professors have become entrepreneurs and VCs have moved to conventional capitalism by investing in coffee shops and toll roads in India [12].  This has resulted in dismantling national assets such as Bell Laboratories and engineering professors in universities focusing on their own side businesses than educating, collaborating and conducting research.  This is further exacerbated by the state and national governments diverting funds from education to prisons and pension plans for government employees.  As the recent scandals of for-profit universities demonstrate, educators are also getting drunk with short-term profit motives causing a national hangover for the tax payers [3].

If the organizational DNA theory has any merit, as a nation, it behooves us to revisit our halls of learning and reexamine our investment priorities to reestablish right strategies that are aligned with successful evolutionary patterns.  It is important to emphasize that the four strategies mentioned require different patterns of culture and structure and wrong combination may lead to a dead-end in the struggle for survival in a competitive market place controlled by the new economics of the invisible hand at the speed of light.  If there is a lesson from the organizational DNA theory for the VCs, business leaders and our legislators who are the high priests that control our investments and our future with their decisions, it is to learn that the Research and Development investments which influence conventional capitalism serve a different purpose from the investments which influence the entrepreneurs and the disruptive innovators.  They have a social responsibility to use right incentives to balance the short-term profit motives and the long-term investments towards a better future for the system as whole.  Assembling teams with right culture and structure to execute the right strategy is key to successful evolution of the system as a whole as Roger Revelle strived to do.   As we have seen recently, a few high priests can get drunk in the Wall Street [3] and cause a collective national hangover for the tax payers in a connected world at the speed of light.

After all, as Deming said “What we need to do is learn to work in the system, by which I mean that everybody, every team, every platform, every division, every component is there not for individual competitive profit or recognition, but for contribution to the system as a whole on a win-win basis.” [13].  The evolution of DNA in biology attests to this dictum. Survival depends on system thinking.  The selfish gene over time has learnt to collaborate for its survival [14].  The organizational DNA theory suggests that there is a time and place for collaboration and a time and place for cut-throat competition.  Successful DNA exploits both to its advantage.  Perhaps the organizational DNA theory is worth paying attention to.

References:

  1. http://www.sandiegohistory.org/bio/revelle/revelle.htm
  2. http://www.newsweek.com/2010/06/28/classrooms-or-prison-cells.html#
  3. An Inquiry into the Nature and Causes of the Collective Hangover of Tax Payers, When Wall Street Gets Drunk
  4. http://www.dnaglobalnetwork.com/
  5. Deming, Systems Thinking, Organizational DNA and Putting America First – Part II
  6. Deming, Systems Thinking, Organizational DNA and Putting America First – Part I
  7. Kabuki Theater, National GDP, Disruptive Innovation and Japanese Business Conundrum
  8. David B. Audretsch, Max C. Keilbach, Erik Lehmann, “Entrepreneurship and economic growth”, Oxford University Press, 2006
  9. Schumpeter J, “Capitalism, Socialism and Democracy”, Harper and Brithers, New York, 1942
  10. Galbraith, J. “Economic Development in Perspective”, Harvard University Press, 1962
  11. Can Cisco Sustain Competitive Differentiation on Operational Excellence Alone?
  12. Are the Short-Term Profit Motives and Wall Street-like Investing under the Influence, Trumping Long Term Innovation in the Silicon Valley?
  13. http://thinkexist.com/quotes/w._edwards_deming/2.html
  14. Dawkins, R. (1989). The Selfish Gene. In R. Dawkins, The Selfish Gene (p. 23). New York: Oxford University Press.




Can Cisco Sustain Competitive Differentiation on Operational Excellence Alone?

24 11 2010

Cisco, a quintessential Silicon Valley innovator which had its beginnings in 1984 with its internetworking multi-protocol routers, has become a global leader with its dominance in global networking products.  Since 1995, when John Chambers took the helm as the CEO, Cisco has taken the acquisition route to bring innovation and expansion with an operational excellence that is second to none [1]. However, more recently, Cisco has found itself becoming more as a commodity product company with a competitive squeeze on its margins and missing on two disruptive innovations that are changing the network services landscape namely mobile computing and cloud computing.   In order to catch up, it has tried to partner with VMWare, a pioneer in virtualization technology that is driving the cloud computing revolution.  With its operational excellence, Cisco has been able to integrate its networking products with Virtualization to get an entry into enterprise cloud market.  However, Cisco is facing competition from three fronts:

  1. Virtualization has altered the networking product landscape by moving networking hardware services into software as Vyatta is doing by offering software based virtual routers [2].  As data centers are upgraded to take advantage of new generation of multicore processors with 10X performance improvement, hardware assisted virtualization, space, power and management savings, Cisco’s current product strategies will be challenged by competing disruptive innovation in the private, public and hybrid cloud markets [3].  As data centers start deploying servers with large number of multicore processors, networking technology migrates to inside the server connecting virtual computers forcing a new product strategy for internewtworking.
  2. Chinese companies such as Huawei are bringing competition in traditional Cisco telecommunications service provider market on a large scale by acquiring American Technology by hiring many laid off Silicon Valley experts from companies such as SUN and using cheaper engineers and lower production costs in China
  3. As Cisco moves more toward consumer and small and medium business market with products such as video conferencing and commodity networking products, it faces competition from many other vendors reducing its profit margins.

Can Cisco continue its double digit growth that has been its strength depending on operational excellence alone?

The answer may lie in examining how companies sustain long term competitive differentiation.  A new theory on organizational success claims that certain combinations of leadership, strategy, culture, and organizational structure have an evolutionary advantage over others [4].  While organizations that do not develop the right organizational DNA may have short term success, they cannot sustain competitive differentiation in the long run in an open globally connected environment where communication, collaboration and commerce occur at the speed of light [5, and 6]. 

Figure 1 shows the business stakeholders and various strategies that have proven to be successful.

Organizational DNA and Strategies with evolutionary advantage

The leadership has to manage the organizational structure and develop a culture among various groups that suit the strategies as shown here; For example, in order to succeed in developing disruptive innovation, leadership must foster a culture of cultivation that is nurturing and an organizational structure that brings both business and technical organizations to work together as a matrix to exploit customer intimacy and technical leadership.  The same organization, in order to foster operational excellence must assemble a team with a culture of control with a strict hierarchical organizational structure.  The consequences of this theory to various companies and even to nations are discussed in my blogs [5 and 6].  An organization may choose to become a leader in both disruptive innovation and operational excellence by assembling different teams in its organization or focus on one strategy.  In the past, AT&T succeeded in developing both using Bell Labs and its Operating Telephone Companies.  IBM did it with its Research Labs and its services offerings.  Today, Intel and Apple seem to have mastered all four strategies successfully.

In the past Cisco has successfully depended on acquisitions to complement their lack of great R&D in-house.  Only time will tell if this strategy will prove to bring same success in the future?  Obviously, same acquisition options are available to its competitors as well, and companies such as Huawei seem to be successfully exploiting them with their big purses. 

The economics of communication, collaboration and commerce at the speed of light levels the playing field in product leadership, operational excellence and customer intimacy, and Chinese and Indian companies with their cheaper human resources and lower production costs can successfully compete with companies such as Cisco by hiring the right expertise.  They will be more Cisco’s competitors to become number One; After all, there is room at the top for only one number One.  As everyone starts to battle in establishing product leadership, operational excellence and customer intimacy using same technologies that get commoditized, only choice open for companies to be number one is to bring disruptive innovation to differentiate.  Time and again, evolution has proven that architectural simplification through disruptive innovation brings orders of magnitude productivity. Life forms survive and thrive by changing their DNA and adapting to external changes.  Will the differentiation in the future come from organizing to excel in disruptive innovation?  What will Cisco do?

References:

[1]   http://www.fundinguniverse.com/company-histories/Cisco-Systems-Inc-Company-History.html

[2]   Does the New “Virtual Network” Spell Sunset to the Heterogeneous Physical Network Infrastructure as We Know in Today’s Data Centers?

[3]   Is the Network-centric Computing Paradigm for Muti-core, the Next Big Thing?

[4]  http://www.dnaglobalnetwork.com/

[5]  Deming, Systems Thinking, Organizational DNA and Putting America First – Part II

[6]  Deming, Systems Thinking, Organizational DNA and Putting America First – Part I





Deming, Systems Thinking, Organizational DNA and Putting America First – Part II

12 11 2010

Abstract:

A new theory on organizational success claims that certain combinations of leadership, strategy, culture, and organizational structure have an evolutionary advantage over others.  While organizations that do not develop the right organizational DNA may have short-term success, they cannot sustain competitive differentiation in the long run in an open globally connected environment where communication, collaboration and commerce occur at the speed of light. 

 In part I of this blog [1], we examined how Deming’s systems thinking [2 and 3] and the new organizational DNA theory [4 and 5] offer some insights into developing sustainable competitive differentiation in business.  In part II, we examine how these theories apply to our nation and in particular the implications for the congress, the executive branch and the citizens to become an integral part of the system by putting “America First”.  The main lesson from this analysis is that the leadership of a nation needs to leverage different individual characteristics that are part of different cultural behaviors and support different organizational structures to execute different strategies to gain evolutionary advantage and competitive differentiation.  Leadership, strategy, culture, and organizational structure form the four base elements of a nation’s DNA.

This theory, if it is valid, puts the burden of success on the leadership and the citizens of our nation to apply Deming’s system thinking to collectively develop and execute successful strategies by cultivating and leveraging the necessary cultural and organizational diversity of the nation.

Individualism, Collectivism, organizational DNA, and Patterns of Evolutionary Advantage:

Theories abound that analyze individualism and collectivism and their role in organizational behavior and success.  “Although societies differ along many cultural dimensions, a key distinguishing characteristic of work behavior in societies is the way in which members relate to one another as a group. The pattern of responses with which individuals relate to their groups reflects their degree of individualism or collectivism. From an evolutionary perspective, a collective orientation has permitted humans the capacity to aggregate knowledge, develop a shared history, and protect evolutionary adaptations. Sociologists and anthropologists argue that people do not exist except within a social context.”   With these words, Earley and Gibson [6] take stock of a hundred years of progress in our understanding of individualism and collectivism. 

They make an observation that while individualists operate according to a self-interest, and collectivists operate according to a group interest, it does not, however, simply imply that collectivists behave selflessly nor do individualists behave selfishly.  “For instance, collectivists pursue self-interests as well as group interests as long as priority is given to the group, and they often set aside their personal goals out of a sense of obligation and normative control. The self-interests may coincide with group interests or be instrumental in attaining them.  Rather than viewing self and group interests as opposing motives, we can view them as separately linked to knowledge structures that are evoked in a culturally prescribed fashion.”  This observation makes it very important for the leaders of the group, when they define what Deming calls the aim of the system, to consider the self-interest as well as group interest and mobilize the collective strength to accomplish the aim.

The new organizational DNA theory claims that the leadership, strategy, culture and organizational structure are the four base elements and certain combination patterns of these elements have evolutionary advantage over others.  It goes further and states that different strategies require different combinations of culture and organizational structure to have an evolutionary advantage.  What works well for one strategy may not help to execute another. 

In part I of this blog, we examined how the organizational DNA applies to business and the strategies that provide competitive evolutionary advantage.  The aim of the business is to bring satisfaction to its stakeholders and different stakeholders are satisfied in different ways.  The investors and shareholders are satisfied with profits and customers are satisfied with good products and services that meet their cost and quality constraints.  Figure 1 shows the business stakeholders and various strategies that have proven to be successful.

Business Stakeholders and Organizational DNA

The leadership has to organize the organizational structure and develop a culture that suits the strategy as shown here,  For example, in order to  succeed in disruptive innovation, leadership must support a culture of cultivation and an organizational structure that brings both business and technical organizations to work together as a matrix to exploit customer intimacy and technical leadership. 

National DNA, Full Employment, Life, Liberty and Pursuit of Happiness:

How does the organizational DNA theory apply to our nation?  As a nation, we have the aim set by our constitution.  The leadership (the executive, legislative and the judicial branches) role is to develop the right strategies and execute them by leveraging the culture and organizational structure.  Figure 2 shows a potential stake holder model.

A Nation's Stakeholders

From Deming’s system view, different stakeholders have different interests.  For example, global private enterprises have no national loyalty because they are purely driven by their own profit motives and survival.  They will go wherever the resources are cheaper and wherever consumers are willing to pay for their products and services.  Non-Partner nations have no incentive to collaborate and will compete in any manner that is available to pursue their self-interest.  Without an overall level playing mechanism that lets free markets allocate resources optimally to benefit all parts of the system, the invisible hand of the free market economics which works well in an open environment to create a natural economic equilibrium falls short in a closed and artificially constrained environment created by overt and covert competition.  The” aim” of the nation which should benefit its citizens has to take into account the inherent conflicts and use right incentives to develop right strategies and create the right DNA for the nation.

If a nation’s aim is to protect and foster the “unalienable rights of its citizens, that among these are Life, Liberty and pursuit of Happiness of its citizens,” a national DNA that promotes equal opportunity for its own citizens to engage in gainful employment and contribute productively will have an evolutionary advantage.  A DNA which subsidizes a particular group’s interest over another will in the long run introduce friction in the system and cannot sustain competitive differentiation to compete with other nations. 

Invisible Hand of Economics, Communication, Collaboration and Commerce at the Speed of Light:

In addition, as long as nations operate as loosely coupled collaborating systems putting their own self-interest first, with rigid boundaries, each nation’s DNA tends to optimize its own survival probability at the expense of the other in the short run.  Global corporations will work within these constraints with their own self-interest.  For example, while cheap labor may attract global companies to move to other nations, it leaves the citizens behind with unemployment and diminished quality of life unless they can freely migrate or find other ways to compete.  The invisible hand of economics in the long run will establish an equilibrium by fostering the evolution of a nation’s DNA that optimizes the interests of the group of nations as a whole.  But in the short run, as communication, collaboration and commerce are conducted at the speed of light, each nation is on its own to fend its self-interest without causing short-term disruption.  New economic theories have to accommodate the impact of high latency that existed in the days of Adam Smith and John Maynard Keynes in conducting a business transaction compared with today’s speed of light transcending national boundaries.  The role of government in leveling the playing field with appropriate regulation also at the speed of light becomes important to guard against “hit and run” global operators and non-partner nations who want to exploit a free market access to further their self-interest at the expense of others.

Conclusion:

Deming’s system thinking and the new organizational DNA model provide an explanation of why some organizations sustain competitive differentiation in the long run.  Businesses leaders who leverage cultural diversity and different organizational structures to execute the four strategies (customer intimacy, operational excellence, product leadership and disruptive innovation) develop an organizational DNA that provides evolutionary advantage and sustainable competitive differentiation.  The aim of the business is to be profitable while satisfying all its stakeholders interests.

A nation on the other hand has to address a different set of issues in order to ensure its aim that benefits all of its citizens.  The major concern for the leaders of a nation is to provide a level playing field for its citizens, domestic businesses and global corporations while addressing the needs of its stake holders.  In an environment where communication, collaboration and commerce are conducted at the speed of light, a nation must provide a level playing field to its citizens and businesses that operate in its boundaries and guard against “hit and run” operators who try to exploit a free market access.  This puts a burden on the ideologues from the extreme right and the extreme left to reexamine their theories in view of the new reality of real-time commerce at the speed of light that transcends national boundaries.  Without a global regulatory mechanism that levels the playing field with authority, for all participants, each nation has to fend for itself.  A nation has to deal with both partner nations who collaborate and non-partner nations who do not cooperate to address issues through negotiation.  The resulting non-equilibrium economics cannot reach equilibrium through the influence of the conventional invisible hand economics.  A national DNA must adopt to cope with this non-equilibrium by developing appropriate strategies and execute them by organizing the culture and structure of its government to gain evolutionary advantage and competitive differentiation.   The new non-equilibrium economics puts a major responsibility in the hands of our nation’s leaders to develop right strategies and execute them with right combinations of culture and organizational structure.   Unless the leadership puts America first and thinks strategically to act in the interest of everyone and changes the national DNA to adopt to the new economic reality, we may revisit the fate of Ford, before Deming admonished the Ford management, on a national scale and our nation will loose our competitive differentiation we enjoy today.

As Professor Ballon [7], pointed out in my class on current issues in Japanese management twenty years ago, waste, duplication and occasional mismanagement are of no visible consequence in a culture that promotes individualism when the resources are abundant.  When the resources start becoming less and less abundant, the group as a whole cannot afford increased entropy that waste brings.  Similarly, in a collective culture, as resources start becoming more and more abundant, the group can afford a little waste, redundancy and individualism to foster innovation.  Groups usually decide where they stand in this spectrum of possibilities from completely unbridled individualism to totally stifling collectivism and adjust to optimize their chances of success both as an individual and as a group.  Success seems to lie in the middle.   The aim for our nation is clear.  It is to provide a level playing field by putting America first so that all citizens can enjoy life, liberty and pursuit of happiness to the fullest extent.  It is up to the leadership to develop the right strategies and execute them with right combinations of culture and structure to achieve the aim of the system by “making life better for everyone”.  It is up to the citizens to put the right leadership in place by voicing their approval or disapproval at the ballot.  Thanks to the wisdom of our founders, our democracy allows a self-correction process to adjust our national DNA.  Are we wise enough to choose the right leaders who will put America first?  Recent elections seem to show that most of the citizens are fair minded and want to choose the middle path.  Now it is up to our leaders to show that they can lead by putting America first.

References:

[1]   Deming, Systems Thinking, Organizational DNA and Putting America First – Part I

[2]  W. Edwards Deming, “The New Economics for Industry, Government, Education (Paperback), First MIT Press Edition, 2000.  (Also reproduced at http://deming.org/index.cfm?content=66 )

[3]   Mary Walton, and W. Edwards Deming, “The Deming Management Method”, The Berkeley Publishing Group, New York, NY

[4]  http://www.dnaglobalnetwork.com/

[5]  Kabuki Theater, National GDP, Disruptive Innovation and Japanese Business Conundrum

[6]  Earley, P. C., and Gibson C. B., “Taking stock in our progress on individualism-collectivism: 100 years of Solidarity and Community, Journal of Management, 1998, Vol. 24, No. 3, 265-304

[7]  Robert J. Ballon, “Human Resource Management in Japan”, Issue 23 (Vol. 12, No. 1), June 2002, pp. 5-20.  Robert Ballon is a professor Emeritus in Sophia University, Tokyo.  He has written many articles and books on Japanese management, role of individualism and collectivism in business management.  His lectures inspired me to write my thesis under his guidance in 1990 titled “Current Issues in Japanese Management – “Is Japanese Software Thrust As Powerful As Their Hardware Thrust?”

[8] Chao C. Chen, Xiao-Ping Chen and James R. Meindl , “How Can Cooperation Be Fostered? The Cultural Effects of Individualism-Collectivism, The Academy of Management Review
Vol. 23, No. 2 (Apr., 1998), pp. 285-304 





Are the Short-Term Profit Motives and Wall Street-like Investing under the Influence, Trumping Long Term Innovation in the Silicon Valley?

6 06 2010

 

When the Wall Street gets drunk, the tax payers get a collective hangover [1].  When Silicon Valley Venture Capitalists start investing in coffee shops in India [2], will the entrepreneurs, who are this country’s best hope in creating jobs, get a severe migraine?

According to Joseph Schumpeter, the patron saint of innovation, entrepreneurs are the agents of innovation and creative destruction.  With their creative and restless quest for new approaches, they displace old products and processes with better ones often causing massive disruption to the equilibrium of economic tranquility.  The Silicon Valley Venture Capitalists institutionalized the process of creative destruction by developing the financial backbone and the economies of scale to overcome the associated risk.

According to Wikipedia “A core skill within VC is the ability to identify novel technologies that have the potential to generate high commercial returns at an early stage. By definition, VCs also take a role in managing entrepreneurial companies at an early stage, thus adding skills as well as capital (thereby differentiating VC from buy out private equity firms which typically invest in companies with proven revenue), and thereby potentially realizing much higher rates of returns. Inherent in realizing abnormally high rates of returns is the risk of losing all of one’s investment in a given startup company. As a consequence, most venture capital investments are done in a pool format where several investors combine their investments into one large fund that invests in many different startup companies. By investing in the pool format the investors are spreading out their risk to many different investments versus taking the chance of putting all of their money in one start-up firm.”

However, it seems that all is not well in the Silicon Valley.

“What’s intriguing is how that strategy has evolved, and where U.S. Venture capitalists are finding the big wins.  Forget the next iPod, or Facebook.  The firms succeeding in India are doing so with some very un-Silicon Valley-like investments.  Think toll roads.  Think coffee shops.  Think insurance companies.” 

These remarks from Chris O’brien [2] sound very alarming given the raison d’être for  venture capital firms is to invest in long-term high-risk high-gain strategies and not conventional short-term profit-making ventures.  According to Answers.com, the venture capital is money made available for investment in innovative enterprises or research, especially in high technology, in which both the risk of loss and the potential for profit may be considerable. 

Unfortunately, it seems that the current day VCs, while considering themselves as the high-priests of innovation, are not only not able to identify “novel technologies that have potential to generate high commercial returns”, but also they are plundering valuable investment capital available to them with substantial tax advantages compared to other investment firms, by looking at coffee shops and toll-roads in India for profits.

“Many VCs say their specialized financial industry merits special treatment in the private equity field because it makes long-term, high-risk investment vital to job creation.”  With this observation, Scott Duke Harris discusses current efforts by the venture capital firms to fight current government efforts to change the way the “carried interest” fee is taxed [3].

It is a good time to examine the relevance of the VC firms and their compensation in the times of large unemployment, dwindling resources and severe pay cuts elsewhere.  Where is the capital best utilized? Is it in creating innovation and paradigm shifts in the US or in coffee shops in India even with high profits?  How is a VC different from other investment firms looking for high return?

Why Does Innovation Matter?

The following extract from David A. Hounshell [4] clearly explains not only why innovation matters but also differentiates the impact of creative destruction from the conventional competitive capitalism.

“So why is innovation important? One way to answer this question is to go back to a classic paper published in 1957 by Robert Solow, an economist at MIT, entitled “Technical Change and the Aggregate Production Function” (Review of Economics and Statistics ). Solow was one of the first major economists of the postwar period to examine technological change seriously. In this paper, he studied the sources of productivity growth, looking over U.S. history, and concluded that when he accounted for all the increases in land, labor, and capital inputs and overall productivity growth, only about 40 percent of this growth could be explained with conventional economic input factors. Less than half of the productivity growth in American history could be accounted for through normal means—i.e., the means employed under competitive capitalism in Schumpeterian terms. The other 50-60 percent of productivity growth has come to be known as the “Solow residual.” Solow argued that technological change essentially constituted this residual. Technological change—distinct from simple increased inputs of land, labor, and capital—thus was a principal source of economic growth. This phenomenon in economic growth had not been formally recognized by any economist to date, although had Schumpeter been living in 1957, he surely would not have found Solow’s conclusions surprising.  Schumpeter would have said, “yes, this residual is a measure of the product of the perennial gale of creative destruction, which stems fundamentally from innovation.” Solow won the first Nobel Memorial Prize in Economics for his work, which has become a basic building block of economists’ work in economic growth theory ever since.”

The technology of creative destruction requires an entrepreneur with vision, tolerance for high risk and a thick-skin to keep persisting against all odds in an environment of competitive capitalism that attempts to suppress drastic changes to the status-quo.  The S-curve shown in figure 1 describes the three phases of innovation characterized by the return on investment.

The incubating phase where the return on investment is almost zero can only flourish with investments that have a high risk-tolerance.  Traditionally, Government institutions, universities and some large companies with vision and long-term focus have participated in developing and incubating ideas that are considered as a long-shot.  Occasionally, rich patrons who have made their money in traditional ways have indulged in incubating technologies.   On the other hand the VC’s are interested in the emerging technologies because the technologies show promise of creative destruction and associated big profits that could result from changing the game.  In order to compete with the status-quo that will attempt to stifle emerging technologies that threaten their profits, and to create the eco-systems that are required to scale and demonstrate the value of the new paradigm, the entrepreneur needs  investment, expertise and the global access that organized investment by the VC community brings.  In the past, the Silicon Valley VCs played that role very successfully with the right bets on disruptive technologies.  However, as the rising tide of their success floated all boats and created a new generation of VCs, the tide seem to have changed from emphasis on vision, disruption, and 10X improvements in productivity to incremental gains, less risk, and dubious business models such as the one that gives free software supported by labor and knowledge intensive human services that have proven not to scale time and again. 

The return on investment to improve mature technologies is poor.  Process improvements bring mostly incremental improvements in deploying mature technologies.  Investment in coffee shops brings returns not through investment in disruptive new technologies, but through process improvement to squeeze the profits or through clever marketing. Investment in coffee shops belongs in conventional competitive capitalism.  In a society struggling for resources, one precious VC dollar spent on coffee shop in India is ten dollars not realized in creating new jobs in US.  Would it not be better if investment in coffee shops is best left to Starbucks and McDonald?

Communication, collaboration and commerce at the speed of light, today, enabled by the very same technology innovation has created a new order in investment community.  Short term profit incentives, appetite for instant gratification fostered by a casino-like real-time investment in Wall Street, a twitter influenced culture of management with superficial knowledge, short-attention span of VC community and profit-at-any-cost investment culture are all contributing to the diminishing of long-term focus, innovation and civic responsibility. 

Investing in coffee-shops and toll roads in India is the last desperate leap from creative disruption to conventional capitalism in search of quick-profit.  Is this what the investors in VC firms are looking for and are the compensation and tax incentives congruent with the VC mission?  Are the same factors that created Enron, sub-prime mortgages and innovation in financial instruments now influencing the Silicon Valley VCs?

Food for thought!

References

[1] Metooeconomist, “An Inquiry into the Nature and Causes of the Collective Hangover of Tax Payers, When Wall Street Gets Drunk” (https://metooeconomist.wordpress.com )

[2] Chris O’brien , “Changing focus in India:  Deals downshift from tech to ordinary living”, San Jose Mercury News, Sunday May 23, 2010

[3]  Scott Duke Harris, “Uncle Sam eyes bigger slice of VC”, San Jose Mercury News, Friday, June 4, 2010

[4]  David A. Hounshell, “Innovation and the Growth of the American Economy”, The Newsletter of FPRI’s Wachman Center, Vol. 14, No. 3, February 2009 (http://www.fpri.org/footnotes/1403.200902.hounshell.innovationamericaneconomy.html )





An Inquiry into the Nature and Causes of the Collective Hangover of Tax Payers, When Wall Street Gets Drunk

14 11 2009

Abstract

The perennial debate about unbridled free markets with or without safety nets, stifling socialism with its inefficient central planning and control, individualism, collectivism, life, liberty and pursuit of happiness is rekindled with the recent near-catastrophic economic downturn caused by the Wall Street innovators, the high priests of global commerce, who broker the trade of global goods and services.  While the classical theories of economics have served us well during the industrial and post-industrial periods, the advent of information technology has introduced a new wrinkle into the economic equation, namely the real-time nature of global communication, commerce and collaboration at the speed of light transcending space-time boundaries.  For example, recently, if you were an investor, you would have noticed the impact of a falling value of the US dollar, in the immediate rise of stock prices (within milliseconds) even when half of the world was still sleeping.  The stock prices of billion dollar companies that have been very successful in business for decades wildly fluctuate hour to hour based on some pronouncements of few self-appointed pundits and analysts on daily business networks.  These pundits attribute instantaneous cause and effect between an innocuous comment by the president or a surprise international event and gold price or oil futures. 

In this paper we study the impact of global communication, collaboration and commerce at the speed of light on the global economy and explain the reason why when Wall Street gets drunk, the Tax Payers get a collective hangover.  

Using the Gaussian superposition principle, Shannon-Nyquist information theory and an inquiry into the impact of ‘global communication, collaboration and commerce at the speed of light’, we demonstrate that the invisible hand that shapes the ebb and flow of commerce in a free market can be manipulated by a few and cause economic instabilities.  A balance between individualism and collectivism through a well-governed society is required to avoid harm to a larger population who depend on the economy for their livelihood and retirement without a safety net, and are unwittingly affected by the follies of a privileged few. 

Introduction

“Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society which we actually live, with the result that its teaching is misleading and disastrous if we try to apply it to the facts of experience.”                                                                  John Maynard Keynes 

“The facts of experience” are quite different today, much more so than in the days of Keynes, when he proposed the general theory of employment, interest and money [1] while pointing out how different the characteristics were during his day compared to the assumptions made by the classical economists such as Adam Smith.  

Recently, Senator Jay Rockefeller started his senate hearing on “distracted driving”, with a statement that at any moment, eleven percent of the population in the United States is holding an electronic device and is distracted from the task at hand, such as driving while communicating at the speed of light, using voice, text or video.  

Then there is the embarrassing moment, where President George Bush found himself caught on a video [2] speaking about how big business had failed in managing the sub-prime mortgage crisis and caused a systemic danger to the economy, which resulted in a major recession: “There’s no question about it. Wall Street got drunk –that is one of the reasons I asked you to turn off the TV cameras — it got drunk and now it’s got a hangover. The question is how long will it (take to) sober up and not try to do all these fancy financial instruments.” 

More recently, the social networking websites played a major role during the Iranian election and the resulting aftermath [3].  “Twitter is, far and away, the best social media tool for second-by-second information on what’s happening in Iran. People on the ground and across the globe are chatting about every breaking update, every news item, and every story they find….   Everybody’s favorite social video site YouTube has been a central distribution medium for the Iran riots. Iranians have been posting videos nonstop of what’s happening on the ground. This really is the best way to see what’s happening without any filters…… One blog stands out for its Iran coverage: Revolutionary Road has been bringing constant updates on the Iran Riots from the front lines. We rely on citizens like these to get us news from the ground.…… The social media photo site Flickr is brimming with some eye-popping and gut-wrenching imagery from the ground. Beatings, protests, military photos from the election…it’s all there, in full color.” 

All the three examples highlight the transformation that has been occurring over the last decade in how we have come to depend on global communications, collaboration, and commerce at the speed of light transcending both space and time boundaries.  While some claim that this has opened new opportunities for individuals to indulge in life, liberty and the pursuit of happiness, others argue that the opportunities are limited to only the top one percent of the population and others are left behind struggling to make ends meet.  

The perennial debate about unbridled free-market forces on the one extreme and the stifling collectivism with planned economies on the other extreme is raging again with pundits positing the virtues and the vices of both approaches, the chatter now being escalated in its volume and intensity through 24×7, real-time communication over voice, data video channels at the speed of light.  In this paper, we reexamine the concepts of individualism, collectivism, animal spirits and group harmony to understand the economic realities when individuals and groups engage together as a network of connected individuals, in improving life, liberty and pursuit of happiness.  The “network effect” has a profound influence on the outcome of the group transcending beyond the intent of each individual and creating the effect of the “invisible hand” described by Adam Smith in his classic work [4].  The result becomes even more dramatic when the network facilitates communication, collaboration and commerce at the speed of light. 

In this paper, we examine the impact of this real or perceived information leverage on the affairs of men and women and show why when one part of the economy gets drunk, it results in a collective global hangover.  In today’s economy where the access and use of knowledge provides a huge advantage (or disadvantage), individuals and groups can become unwitting victims, and pay for other’s follies if they do not actively measure, manage and optimize their own affairs leveraging communications, collaboration and commerce at the speed of light.  Information access at the speed of light has transformed the Wall Street to become real-time gambling casino where people trade the future of companies and commodities based on instantaneous knowledge.  Gambling like drinking can become a vice in short order if attention is not paid to its impact on others.  Social drinking is pleasurable and an occasional red wine may be good for the matters of heart, but excessive alcoholism becomes a social evil when it impairs judgment and causes harm to others.  

Even Adam Smith recognized the need for a well-governed society that guards itself against excesses. 

“The great multiplication of the productions of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people. Every workman has a great quantity of his own work to dispose of beyond what he himself has occasion for; and every other workman being exactly in the same situation, he is enabled to exchange a great quantity of his own goods for a great quantity, or, what comes to the same thing, for the price of a great quantity of theirs. He supplies them abundantly with what they have occasion for, and they accommodate him as amply with what he has occasion for, and a general plenty diffuses itself through all the different ranks of the society.” 

Of the division of labour, Individualism, and Collectivism

“Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog. Nobody ever saw one animal by its gestures and natural cries signify to another, this is mine, that yours; I am willing to give this for that. When an animal wants to obtain something either of a man or of another animal, it has no other means of persuasion but to gain the favour of those whose service it requires. A puppy fawns upon its dam, and a spaniel endeavours by a thousand attractions to engage the attention of its master who is at dinner, when it wants to be fed by him.                                                                              Adam Smith 

sociobiology not withstanding, with his almost poetic descriptions, the master [4] explained how an individual pursues economic self-interests intending only his/her own gain and as an unintended consequence, he/she behaves as if led by an invisible hand to promote an end which was no part of his/her intention.  Smith clearly articulates the role of specialization, separation of concerns through division of labor, the role of contractual obligation, the role of productivity and the influence of the free market’s invisible hand shaping the ebb and flow of commerce. 

The opening web page of the Adam Smith Institute [5] succinctly summarizes the importance of the work and makes it all available on-line. 

“This remarkable book was published in 1776, at a time when the power of free trade and competition as stimulants to innovation and progress was scarcely understood. Governments granted monopolies and gave subsidies to protect their own merchants, farmers and manufacturers against ‘unfair’ competition. The guilds operated stern local cartels: artisans of one town were prevented from travelling to another to find work. Local and national laws forbade the use of new, labour-saving machinery.  

 And, not surprisingly to us today, poverty was accepted as the common, natural, and inevitable lot of most people.  

 Adam Smith railed against this restrictive, regulated, ‘mercantilist’ system, and showed convincingly how the principles of free trade, competition, and choice would spur economic development, reduce poverty, and precipitate the social and moral improvement of humankind. To illustrate his concepts, he scoured the world for examples that remain just as vivid today: from the diamond mines of Golconda to the price of Chinese silver in Peru; from the fisheries of Holland to the plight of Irish prostitutes in London. And so persuasive were his arguments that they not only provided the world with a new understanding of the wealth-creating process; they laid the intellectual foundation for the great era of free trade and economic expansion that dominated the Nineteenth Century.  

 The Wealth of Nations changed our understanding of the economic world just as Newton’s Principia changed our understanding of the physical world and Darwin’s Origin of Species.” 

Time changes everything and new theories challenge or augment even the best of them.  Just as Einstein’s theory superseded Newtonian mechanics, with the observation that the speed of light is a constant, John Maynard Keynes added the concept of animal spirits that transcend the rational behavior of individuals and harness the uncertainty or ambiguity through creative speculation [1].  

While Adam Smith explained, why people employ each other when they pursue commerce, albeit with pure self-interest, Keynes explained why, in a closed system, there is always some amount of unemployment during a period of economic equilibrium.  He introduced the concepts of aggregate output and the demand driven economic equilibrium where unemployment is possible and departures from equilibrium caused by various factors including speculation based on “animal spirits” [1]. 

“It is safe to say that enterprise which depends on hopes stretching into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death.” 

The master goes on and makes the following observations that are so appropriate in the context of today’s collective hangover and rising unemployment. 

“There are, moreover, certain important factors which somewhat mitigate in practice the effects of our ignorance of the future. Owing to the operation of compound interest combined with the likelihood of obsolescence with the passage of time, there are many individual investments of which the prospective yield is legitimately dominated by the returns of the comparatively near future. In the case of the most important class of very long-term investments, namely buildings, the risk can be frequently transferred from the investor to the occupier, or at least shared between them, by means of long-term contracts, the risk being outweighed in the mind of the occupier by the advantages of continuity and security of tenure. In the case of another important class of long-term investments, namely public utilities, a substantial proportion of the prospective yield is practically guaranteed by monopoly privileges coupled with the right to charge such rates as will provide a certain stipulated margin. Finally there is a growing class of investments entered upon by, or at the risk of, public authorities, which are frankly influenced in making the investment by a general presumption of there being prospective social advantages from the investment, whatever its commercial yield may prove to be within a wide range, and without seeking to be satisfied that the mathematical expectation of the yield is at least equal to the current rate of interest, — though the rate which the public authority has to pay may still play a decisive part in determining the scale of investment operations which it can afford. 

Thus after giving full weight to the importance of the influence of short-period changes in the state of long-term expectation as distinct from changes in the rate of interest, we are still entitled to return to the latter as exercising, at any rate, in normal circumstances, a great, though not a decisive, influence on the rate of investment. Only experience, however, can show how far management of the rate of interest is capable of continuously stimulating the appropriate volume of investment. 

For my own part, I am now somewhat skeptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organizing investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest.” 

More recently, the book “Animal Spirits” [6] by the Nobel Laureate George Akerlof and Robert Schiller takes the discussion to the next level.   They discuss the impact of human factors such as confidence, fairness, corruption & antisocial behavior, money illusion (caused by fear of inflation or deflation) and the human need for a sense of reality through creating narratives or stories, on the deviations from equilibrium and shape the destinies of groups. 

The long and short of the economic story is that: 

  1. When individuals act with self-interest in a group, it creates an economic equilibrium where the individual behavior is guided by an “invisible hand” of market forces shaping the ebb and flow of commerce resulting in specialization, separation of concerns, scalable network of management structures etc.
  2. One type of deviation from equilibrium occurs when external conditions change demand, technological changes cause productivity improvements or affect supply chain of resources.  Classical theory of economics explains and estimates these deviations.
  3. Another type of deviation from equilibrium occurs when animal spirits prevail and take risk to harness the ignorance and uncertainty of the future.  This often can change the equilibrium state in a profound manner.

Human factors such as confidence, fairness, corruption etc., impact the equilibrium.  While they may be tolerable in small doses, the multiplier effect depending on the size and scope can cause instabilities. 

entropy

Figure 1: Entropy minima and economic equilibria

Figure 1 shows the different levels of equilibrium and corresponding levels of unemployment and how the levels of equilibrium are attained by the impact of animal spirits or instabilities caused by human factors.  It is important to note that the productivity improvements in an equilibrium state are obtained through Kaizen or continuous incremental improvements and paradigm shifts and orders of magnitude impact are often obtained through animal spirits taking risk to cause the chaos required to cross the entropy barrier to next lower minimum.  The instabilities caused by human factors often lead to higher level of equilibrium (hopefully last only for a short period before being rescued by animal spirits). 

In the next section, we discuss a major disruption that has changed the way affairs of men and women are conducted and its impact on the economic equilibrium. 

of the Communication, Collaboration, and Commerce at the Speed of Light

In 1965, Intel co-founder, Gordon Moore published an article in Electronics magazine that was the source for what became known as Moore’s Law, which says that computers double in capabilities every 18 months.  During the four decades following the statement, we have seen a radical transformation in the way people are connected with each other and communicate.  This was made possible by the evolution of telecommunications infrastructure and the voice network services management platforms that allowed dynamic and real time allocation of resources to optimize voice connection and messaging infrastructure. 

Thirteen years later, in 1998, Nielsen observed that the Internet bandwidth is growing at 50% annual growth rate.  A decade later, we are seeing a radical transformation in the way computers communicate with each other.      The resulting Internet data connection and data services management platforms have facilitated a new level of human interaction through information sharing. 

The result of bandwidth inversion (the network bandwidth is large enough that the information access is limited by only the speed of light) is an information infrastructure that connects global human networks and facilitates real-time communication, collaboration and commerce.  Since the beginning of time, bandwidth had a major influence in how humans organized themselves in groups (or human networks) to evolve and adopt ways to respond to changes in their environment.   According to Vancho Cirovski, [6], the effectiveness of the human network depends on the connections, communication and mastery (or specialization) of the individual human agent.  Better the quality of mastery of the individual (forming the node in a human network), the quality of connection and communication, the higher the effectiveness.  Humans have created organizational frameworks through evolution.  According to Malone [7], organization consists of connected “agents” accomplishing results that are better than if they were not connected.  An organization establishes goals, segments the goals into separate activities to be performed by different agents, and connects different agents and activities to accomplish the overall goals.  Scalability is accomplished through hierarchical segmentation of activities and specialization.  

There is always a balance between the cost of coordination of the agents and economies of scale obtained from increasing the network size, which defines the nature of the connected network.  Efficiency of the organization is achieved through specialization and segmentation.  On the other hand, agility of an organization depends on how fast the organization can respond to changes required to accomplish the goals by reconfiguring the network.  Dynamic reconfiguration is accomplished using signaling abstractions such as addressing, alerting, supervision and mediation.  

Connection management is achieved through effective communications framework.  Over time, human networks have evolved various communications schemes and signaling provides the fundamental framework to configure and reconfigure networks to provide the agility.  The bandwidth of communication determines the organizational structures.  Groups or subgroups requiring a high degree of communication, band together and optimize the bandwidth available.  If the bandwidth of communication is large enough, the groups tend to get distributed to optimize the resources available.  

Of the General theory of Economics, The Gaussian Superposition and Information Content

When individuals form into groups, inevitably the statistics, probabilities and the laws of large numbers come to play whether we like it or not.  In probability theory, the Gaussian (also called Normal) distribution plays a central role by representing a stable or equilibrium distribution toward which all other distributions gravitate under a wide variety of conditions such as large numbers, convolutions and stochastic processes.  Figure 2 shows [8], the Gaussian distribution. 

gauss

Figure 2: Gaussian Distribution

The figure shows two distributions using the formula 

 equation 

where µ is called the mean and σ is called the standard deviation.  

The uniqueness of the Gaussian (also called normal) distribution, ubiquity of its use and its elegance in which just two parameters provide the information content of a series of observation with the principle of maximizing entropy and the history of its discovery and evolution are well documented and provide a fascinating journey into the annals of mathematics [8]. 

Consequently, if you have a collection of individuals engaged in an activity together, particular skill level or knowledge of the individuals will be spread around a value given by the mean, and the standard deviation gives a measure of how far the skill varies from the mean.  About 68.3% of the people fall within 1 standard deviation and 95.4% fall within 2 standard deviations and 99.7% fall within 3 standard deviations.  The mean and standard deviation characterize a particular group. 

In a society that values individualism culture, both the latency of information access and the latency tolerance of customers receiving the goods and services were limited by physical proximity and transportation network speeds.  In a world that is globally connected at the speed of light, the divergence of the latency between information access and the latency of fulfillment of contractual obligations introduces a new element and those leveraging the information can manipulate the invisible hand to disadvantage others who do not have access to the same information.  The impact becomes more dramatic when information is influencing investment decisions at the velocity of light.  

We represent this for a homogeneous group (who can be parameterized by a single mean and a single standard deviation) in figure 3. 

homogeneous

Figure 3: Homogeneous distribution of skills and knowledge leverage distribution

In figure 3, individual skill is represented by a gaussian distribution.  The knowledge leverage is represented by a another Gaussian distribution with the same mean and standard deviation representing the impact of access to knowledge in a global commerce at speed of light.  Slight variations in knowledge leverage and distribution of skill lead to great variation in the ratio of losers to winners.  Figure 4 shows these variations. 

reduction

Figure 4: Impact of Variation of mean on winners & losers

The complexity becomes even greater if you consider superposition of different groups with different means and standard deviations in a global network where only a few people are impacting the lives of many through real-time information management. 

heterogeneous

Figure 5: Impact of Heterogeneous groups on winners & losers

The information theory of Shannon postulates that the noise in a series of observations increases when the sampling frequency becomes higher than the frequencies present in the signal.  Obviously, if commerce transactions in real world are conducted at frequencies lower than the sampling frequency at which investors make decisions and change them, then small variations caused by daily events are exaggerated and can cause instabilities by increasing the entropy.  The impact of knowledge mastery and access to information depends on the mean and width of the distribution function and as this function becomes narrower making the system depend only on a relative few, the probability of causing instability becomes larger. 

Of the Real-Time Universe, Noise, Entropy, Life, liberty and persuit of happiness

If the purpose of life is to pursue happiness in an environment that supports individual freedom and choice, then individuals have to develop the skills to monitor, manage and optimize the resources that are available to them to pursue their goals.  The availability of resources depends on external circumstances some of which are under their control and some that are not, such as the acts of nature.  It also depends on the availability and the abundance of resources and the competition from others also pursuing their own happiness.  The economic system of Adam Smith as we have seen creates an equilibrium where individuals form into groups with similar goals and collectively pursue happiness together to optimize the resources available to the group. 

Humans have developed a network model of distributed computing where individuals specialize in developing skills to collect information, analyze and control the environment to accomplish the goals of the group.  The law of large numbers postulates that in any group, there is a normal distribution of skills and the groups distinguish each other by the spread and mean of these distributions.  

In an environment where the information access is slower than the need with which one has to interact with the environment of necessity, risk management is implemented to cover the ignorance or higher entropy involved.  In the case where information access is faster than the time scales in which the external environment responds, it can lead to a situation in which lot of noise can be created in manipulating the system without waiting to see the effect.  Current technological advances have created a situation where information access and control of economic systems are limited only by the speed of light.  That has created two important effects: 

  1. High level of noise in the economic system that masks real signals that are relevant to advancing the cause of the whole group and
  2. Instabilities that can occur with feedback that can cause global headaches when individuals make manipulative moves and the invisible hand does not have the time to respond before the instability causes the damage

In addition, the skill level required to process the information and act intelligently is limited to a few, and the system becomes vulnerable to the individual frailness.   

Unless, systemic process checks and balances are introduced to dampen the fluctuations caused by the privileged few, many will be affected unwittingly with no fault of their own. 

Adam Smith’s “well-governed society” becomes a true requirement for individuals to enjoy life, liberty and pursuit of happiness in a society where communications, collaboration and commerce are always at the speed of light. 

Conclusion

In this paper, we reviewed theories of how individuals form into groups driven by self-interest to better their own lot and in the process give rise to an invisible hand that shapes the group behavior, which in turn benefits everyone in ways not intended by the individuals.  The group behavior led by the invisible hand leads to an economic equilibrium with stable employment levels.  The deviations from equilibrium can occur when external changes cause perturbations to supply and demand or technological changes cause improvements to productivity.  Classical economic theory explains the cause and effect of small deviations from equilibrium.  

However, external forces causing large deviations from equilibrium that in turn can lead to instabilities, could manipulate the invisible hand.  Two kinds of instabilities are discussed.  Keynes discusses the positive kind, where Animal Spirits (that transcend the rational behavior of individuals and harness the uncertainty or ambiguity through creative speculation) can create such instabilities, which can eventually lead to new equilibrium points with different levels of unemployment.  

Human factors such as confidence (or lack thereof), fairness or unfairness, corruption etc., also impact the economic equilibrium.  While they may be tolerable in small doses, the multiplier effect depending on their size and extent can cause instabilities.  These instabilities cause disruption and usually end up in higher level of unemployment and economic down turn.  The invisible hand may attempt in the long run to correct the situation but in the short run, there is a possibility for irreversible transitions. Even Adam Smith has acknowledged the need for a well-governed society to create the right conditions for maintaining equilibrium economics. 

More recently, the technological advances that have made it possible for groups to engage globally in communication, collaboration and commerce at the speed of light, have introduced a new element that influences the economic equilibrium profoundly.  They change the odds of individual success, which becomes very much dependent on access to knowledge and the skill to act on it at the speed of light.  This has concentrated the power to influence the free market in the hands of a few who can manipulate the invisible hand, resulting in the benefit of a few at the expense of many.  The recent hangover that is felt by the tax payers world-wide when a few Wall Street bankers got drunk with their clever schemes is a clear example of the inequities that can cause economic instabilities. Narrower the population that leverages knowledge at the speed of light, greater is the risk of causing irreversible instabilities.   

We have demonstrated using Gaussian superposition of skill level of individual groups, how a few with access to information can win in the economic game at the expense of many who lose.  In addition, the Shannon Nyquist theorem shows that the real-time analysis of various economic entities that change much slower in time causes lot of noise and does not add to the stability of the economic equilibrium.  The stock prices of enterprises are burdened with a short term noise fluctuations that are independent of the actual long term performance and are solely created by the speculation.  In a well-governed society, groups will impose self-will to provide incentives to reduce the noise and restore equilibrium.  A well-governed society also will decide whether the Wall Street is a gambling casino and is treated as such with appropriate regulation that befits a casino or a long term investment vehicle that creates economic equilibrium and facilitates long term growth with appropriate risk/reward incentives.  A well-governed society also allows animal spirits to develop innovative paths to new states of lower entropy and the society at large is protected from human frail qualities such as excessive corruption, unfairness etc. 

[1] Keynes, John Maynard , “The General Theory of Employment, Interest and Money”, Atlantic Publishers and Distributors, New Delhi, India 2006 (First published in 1936) 

[2] Read more at: http://www.huffingtonpost.com/greg-mitchell/banned-bush-video-surface_b_114363.html, and see the video at http://www.disclose.tv/action/viewvideo/6169/Bush_in_leaked_video__Wall_Street_got_drunk_/ 

 [3]  http://mashable.com/2009/06/14/new-media-iran/ 

 [4]  Smith, Adam, An Inquiry into the Nature and Causes of the Wealth of Nations. Edwin Cannan, ed. 1904. Library of Economics and Liberty. 2 November 2009. . 

 [5]  http://www.adamsmith.org/smith/won-intro.htm, Preface By Dr. Eammon Butler, DIirector Of The Adam Smith Institute, London, 2001 

 [6]  http://www.orgnet.com/MCO.html “Managing the Connected Organization” by Valdis E. Krebs 

 [7]  Thomas W. Malone, “Organizing information systems: Parallels between human organizations and computer systems”, Cognition, Computing and Cooperation, edited by Scott P. Robertson, Wayne Zachary, John B Black, Greenwood Publishing Group, January, 1990 

 [8] http://en.wikipedia.org/wiki/Normal_distribution