“Never before has our future seemed so shrouded in fog and noise,” I’ve written, and discussed its paralytic effects on our decision-making. Comes now academic vindication of just how strong the effect is.
But I’ve also dug up, from the same academic source (the Wharton School), a potential antidote. If we have the courage to embrace it.
The disabling power of having no forward visibility is recapped in “‘Uncertainty Traps:’ Why a Lack of Information Can Paralyze an Economy,” published last month in “Knowledge@Wharton.”
We know that no one is fond of uncertainty, but in relatively mild recessions it takes only a few augurs of good news to begin to revive the economy’s natural “animal spirits.” Deep recessions—that would be this one—create a self-reinforcing information vacuum where no one seems to be generating signals indicating a turnaround in the works. The academics (one each from Wharton, NYU, and UCLA) give their theory the full-dress graduate-level economics mathematical treatment in a paper, explaining for example, that “Standard [Bayesian] updating rules have a straightforward interpretation: the mean of the posterior belief is a precision-weighted average of the past belief û and the new signals Y and X,…”
(Toldja.) We’ll stick with the English language version.
But by way of digression, here we have an example of much of what I fear ails modern economic theory, at least as practiced in graduate programs at leading universities. The French economist Thomas Piketty, now on something of a victory lap up the East Coast in connection with his recently published book Capital in the Twenty-First Century, a formidable, rigorous, 700-page history of wealth, and which improbably just made The New York Times best-seller list, acerbically critiqued his own profession:
“For far too long,” [he wrote,] “economists have sought to define themselves in terms of their supposedly scientific methods. In fact, those methods rely on an immoderate use of mathematical models, which are frequently no more than an excuse for occupying the terrain and masking the vacuity of the content.”
Back to the Uncertainty Trap: The heart of the theory is that at least as important to economic decision-makers in evaluating the state of the markets going forward is not just the goods and services being churned out, but the information that’s generated as a byproduct of economic activity. Not just macroeconomic variables like new claims for unemployment or housing starts, which are doubtless of great moment to the Fed Board of Governors, but less so to the managing partner of an AmLaw 200. The information that’s pertinent includes, “Is your competitor hiring? Opening in new markets? Investing in practice management or technology?”
“The production process itself generates information, and this information, at least some of it, is available to everyone in the economy,” [co-author] Taschereau-Dumouchel says. “When there is a lot of information, it reduces firms’ uncertainty about the economy, which makes more firms invest…. We are basically trapped in that bad state where uncertainty is high and the economy is not producing very much. Everyone is waiting for others to invest, which leads to no one investing.”
Commonsensically, much of the truly useful information flows through social channels, not BLS statistics. While more (positive) information is generally better, it turns out that less information is not worse simply in a linear way, but that below a certain threshold of a minimal amount of information, everything comes to a halt.
Fewer signals lead to greater uncertainty and less investment, and vice versa. But this ebb and flow is not steady. Below a certain threshold, information is so skimpy that investment virtually ceases. That stops the flow of social-learning information, creating a vicious cycle that becomes hard to break.
The authors note that “the long-run response to a temporary negative shock becomes considerably more protracted when the magnitude is above some threshold. The economy quickly recovers after a small temporary shock, but it may permanently shift to a low activity regime after a large shock of the same duration. In turn, a positive temporary shock of sufficient magnitude can put the economy back on track.”
So what, pray tell, is to be done?
According to these authors, not much, at least not single-handedly:
Nor is there much a CEO could do to offset the effects of a deep recession, he adds, other than respect the study’s unhappy conclusion: Barring surprises, deep recessions are likely to be followed by torturously slow recoveries. “If we’ve had a very bad initial shock, [that can lead to] a long recession.”
A counsel of, if not despair, little comfort.
As I’m constitutionally incapable of taking that for a final answer, let me offer another bit of Wharton learning with the somewhat more promising title, “How to Solve the Jobs Dilemma: Attract and Retain More Entrepreneurs.”
Loyal readers will immediately recognize that if I’m proposing that lawyers suddenly embrace their inner entrepreneur, I’ve written with conviction that there is no such thing: “Entrepreneurial?” Really? My point was that individuals working in the safe and sheltered confines of a profitable and successful ongoing business, whose income-not to mention their homes and 401(k)’s-doesn’t turn on the success of the venture they’re proposing, cannot seriously be called “entrepreneurs.”
No, I’m trying to suggest something a bit different.
The Wharton article I cited talks about employees (think: lawyers) within the firm who are thinking about other ways of doing things. People, that is, who have ideas. And if your lawyers constitute an idea-free wasteland, you have other problems.
Studies show that entrepreneurs within companies are significantly more likely to be on the lookout for new growth opportunities than managers, making them more likely to recognize opportunities. If growth and innovation are an important part of your corporate strategy, you want to attract and retain these employees with entrepreneurial mindsets.
If you are to have any hope of encouraging these aspirations and capturing some part of the value within your own firm, the first decision you have to make is not to judge their proposals on the traditional management metrics, which our Wharton friends summarize as whether the skunkworks:
- Makes measurable financial gains
- Makes the company more cost efficient
- Improves the company’s status as an industry leader.
But industry-shaping ideas rarely show signs of being able to meet these measures early on. Innovative plans are usually ripe with option-value. They are moves that “buy” you an option to potentially do something valuable in the future, but whose value cannot be accurately predicted in their early stages.
One trick that successful large-company entrepreneurs use is to focus their business cases on elements of an idea that address immediate threats. [emphasis supplied]
You need to recognize that new ventures always begin in a phase of uncertainty, when the effort put in far exceeds the results coming out. Give it room to breathe: See how it’s doing first on market adoption, only then on revenue, and only finally, after time, on profits.
Ask yourself these things:
- Is the “growth” environment flat? (Check)
- Are we unwilling to commit to conventional growth/investment initiatives so long as nobody else is doing so? (95% odds of “check.”)
- Are we facing threats that didn’t exist before? (If you don’t answer “check” here, you may as well stop reading right now.)
- Is it possible people at the front lines, interacting with clients and markets all day long, might have given some creative thought to these realities? (I certainly hope so, for you and your firm’s sake.)
Then your course is straightforward:
- Support them; let them know their ideas matter to you.
- Give them sufficient freedom to pursue their ideas, even while not abandoning everyday business exigencies.
- Don’t commit infanticide by imposing the wrong (mature-business) metrics.
I told you I can’t take a counsel of paralysis as the end of the story.
Neither, I pray, should you.