Wednesday, June 30, 2004

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July's books of the month

If the United States can transfer sovereignty to Iraq a few days ahead of schedule, then I can recommend July's books in June. Both books this month fall under the nebulous category of comparative political economy -- but they were really interesting to me.

The first book is The Power of Productivity: Wealth, Poverty, and the Threat to Global Stability by William W. Lewis. Lewis was the founding director of the McKinsey Global Institute, and the book largely consists of what Lewis learned in analyzing the performance of various sectors in key economies of the world. You can read a brief precis of what he found by clicking here. A few excerpts stand out in particular:

[B]eyond macroeconomic policies, economic analysis usually ends up attributing most of the differences in economic performance to differences in labor and capital markets. This conclusion is incorrect. Differences in competition in product markets are much more important. Policies governing competition in the product markets are as important as macroeconomic policies....

At a conference of global business leaders in Washington in 1992, I presented the results of our service sector case studies. The CEO of Siemens at the time, Karlheinz Kaske, said he was puzzled about the role of service industries in an economy and wondered why we paid so much attention to them. I showed the group some recent results from our analysis of the interconnectedness of the U.S. economy. We had found that for the economic value reflected in the sale price of a consumer good, two-thirds of that value was created by the consumer good manufacturing firm and one-third of the value was generated by the transportation, wholesaling, and retailing functions that got the good from the manufacturer's loading dock to the hands of the consumer.

Moreover, of the total value produced by the manufacturing firm, one-fourth of that value was created by accounting, banking, legal, consulting, janitorial, and other business services. Thus, services accounted for one-half of the value to a consumer from the purchase of a good such as a CD, a can of beans, or a car. On top of this, one-half of all services are delivered directly to consumers and not to firms. From this light, it's easy to see why services make up about 75 percent of the total value created in an economy. Germans were not taking their performance in service industries into account in forming their perception of the performance of their economy....

In every sector in which productivity accelerated in the United States in the second half of the 1990s, competition intensified. Sometimes the increased intensity was triggered by regulatory changes, as in mobile telephone services and the reduction of the price per trade in securities. Other times, it came from business innovation like Wal-Mart's. Information technology was just part of the story. The bigger story was competition causing more productive business enterprises to replace less productive ones. This conclusion is of course reassuring to those worried about the health of the U.S. economy. However, it provides even more reason to worry about all the people living in economies where protection and distortion of competition allow unproductive enterprises to persist and cause these people to fall further behind, but even more importantly, to remain in poverty.

Virginia Postrel is curently reading Power of Productivity and is also a big fan -- which counts as a big endorsement to me.

The Power of Productivity suffers from some of the same flaws endemic to management consultants (Kenichi Ohmae, Daniel Yergin, etc.) when they write big books. A lot of points are repeated and repeated and repeated yet again. And what's the deal with management consultants and their abhorrence of footnotes? Lewis also fails to appreciate the lagged effect of technological innovations, so I strongly suspect he's underestimating the long-term effect of the information revolution.

This is small beer, however. Lewis gets the big picture of what causes economic prosperity by painting a pointillist picture of why different sectors in different economies have such variable levels of productivity, and how policy decisions can affect these levels. After reading this book, I have a much greater appreciation for the importance of the retail sector as a driver of affluence. To get a sense of the impact that improved productivity in the retail sector has on the aggregate economy, click here for the McKinsey Global Institute paper that forms the basis of Lewis' conclusions. His key point is worth repeating:

The purpose of economics is consumption. We realize the benefits of an economy when we use goods and receive services. We want to use goods o do things we could not do without them. We want services to have other people do things for us that we cannot or would rather not do. We can choose to consume everything right now or save to consume later. Of course, production and work are necessary for consumption. We cannot consume what we have not produced. Thus, production and wok are a means to consumption. They are not a final objective themselves.

Many societies get this wrong. They see production as the creation of value. However, they fail to make the link between production and consumption. The goods produced have value only because consumers want them. (emphases in original)

The general interest book looks more closely at the one significant economy that Lewis did not analyze -- China. Elizabeth Economy's The River Runs Black: The Environmental Challenge to China's Future examines the environmental externalities of China's current economic growth. She cites one figure estimating that the environmental side effects of China's factories exact a toll equal to 8-12% of China's GDP. Just as interesting is Economy' portrayal of the political lay of the land in China. First, China's central government has much less control over provincial and local leaders than is commonly believed. Second, because of its weakness, the Chinese government is counting on Chinese civil society to assist in the ratcheting up of environmental protection. This sounds very odd, as Economy correctly observes that the environmental movement was a harbinger of democratization in other post-Communist societies. The Really Big Question over the next two decades is whether China's leaders can effectively control the behavior of Chinese environmental NGOs -- or vice versa.

Go check both of them out.

[Er, doesn't the second book suggest that the first book's emphasis on how to make countries rich overlook environmental costs?--ed. Au contraire, my good editor. Lewis is concerned with increasing productivity, which comes from increasing outputs relative to inputs. Furthermore, most of the improvements in productivity can be garnered in services, which generate much less pollution than manufacturing.]

posted by Dan on 06.30.04 at 01:53 AM


Good shout-out on the China book.

This is an enormous issue. Vast portions of that country are rapidly become desert. I think there was a good Times article a while ago about how they were trying vainly to plant enormous numbers of fast-growing poplars to stem the tide.

posted by: praktike on 06.30.04 at 01:53 AM [permalink]

Frankly, I'm amazed Dan didn't also link to this post from Virginia Postrel.

posted by: Bort on 06.30.04 at 01:53 AM [permalink]

Perhaps I have just been unlucky, but every project I have seen where McKinsey was involved ended up causing major damage to the organization that followed McKinsey’s advice.

And usually the damage was in two rounds: the initial wound, and then a second wound as everyone who tried to flag/contain/fix the damage was labeled a “change resister” and fired. Only after the damaage from losing so many good people became apparent would someone step in and get rid of McKinsey, but in several cases I saw the wounds were already terminal.

Why those guys get away with charging $300/hour is beyond me. If you take anything they write in books seriously, well, good luck...


posted by: Cranky Observer on 06.30.04 at 01:53 AM [permalink]

Isn't that a little misleading Dan? No major modern economy has ever transitioned to a service oriented or information oriented consumer economy without first becoming industrialized that I know of. Anyone know of any such examples where large scale economic growth was created by skipping the industrialization phase?

posted by: oldman on 06.30.04 at 01:53 AM [permalink]

Great post on Crooked Timber on this, related especially to Walmart. I've also had very little luck with "McKinsey" type consultants. Consultants seem to come in two flavors - one, the technically savvy wizards that have come in and fixed huge holes in businesses I've been at. The other are the "management" type consultants, MBA sorts, that spout, to put it mildly, B.S. Salesmen in seersucker suits.

One interesting point is the Crooked Timber article.

"It is an interesting fact that the majority of the “productivity gap” between Europe and the USA can be accounted for by two industries - retailing and financial services - and that these happen to be the two industries in which there are the most serious difficulties in measuring productivity."

and the third point is what I harp on this site, when I see these posts - where unfortunately, Dan always seems to think that the human cost is necessary, rather than a choice -

"When one adopts “flexibility” in labour practices, and gains an improvement in output/input ratios as a result, then it can be made to look as if a massive productivity improvement has been made for free. This is not always the case. A large part of this apparent improvement in the company’s ability to generate outputs from inputs has come about simply as a result of taking the cost of mismatches between inputs and demand, and shifting it away from the company onto the shoulders of some other bugger - either the worker or the taxpayer through the benefits system."

posted by: JC on 06.30.04 at 01:53 AM [permalink]

There are other issues with Walmart as well - from commentator Praktike: "Far more pernicious are its business practices; the company takes advantages of gullible municipal officials, corrupt and incompetent planning commissions, externalizes many of the traffic, environmental, fiscal, and health costs of its superstores on a gullible public."

posted by: JC on 06.30.04 at 01:53 AM [permalink]

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