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USA vs China continued… The Influence of Networks (and the Olympics!)

The last three Olympics have seen a titanic battle between the US and China to head the medals table. If you combine the total of the last three Games, China stands just ahead, with 121 golds to the United States’s 116. But, the US topped the table in both 2004 and 2012, while China edges ahead because of its massive haul in Beijing.

Is this a portent of the wider struggle for global hegemony in the twenty-first century? Just 20 years ago in Barcelona, the US was well ahead – with 37 golds to China’s 16. The Chinese have caught up. Or so it seems.

Building a team for success is a major challenge, and I have massive respect for those behind the triumph of Team GB. But, from an organisational perspective, it is simple. The aim is unequivocal – to win. The methods are well known – just look at Mo Farah’s brutal training regime. To succeed in distance running, an absolutely punishing routine is needed.

The same can be said for the transition China is making from a peasant to an industrialised economy. The goal is clear. The way of achieving it is well understood, as many countries have already gone through the same process. But how do you move beyond this to create a successful post-industrial economy?

We have been here before. The old Soviet Union used terror, iron discipline and massive inequality to build an industrial economy. It succeeded. But it had no idea of how to move beyond this, to the complexities and subtleties of an information-age economy.

It is easy to make a case for US weakness. Its twin deficits, in balance of payments and its government accounts, stand alongside an increasingly divided and embittered policy discourse.

But in terms of its ability to innovate in a complex globalised society, you only need to witness the spectacular success stories of the past 30 years. Microsoft, Google and Facebook are all American.

The networks which make up American society are fluid and dynamic. They have the sorts of structure that both encourage innovation in the first place, and stimulate its widespread adoption.

The network of government, the network of companies, the network of universities, all of these are strongly coupled to one another. The US has learned how to make public-private partnerships work, not by reams of turgid legal contracts, but by honing the structure of connections between these three crucial sectors of the economy.

In contrast, the networks of Chinese society are much more rigid and hierarchical. The Communist Party is the prime example. But Chinese culture in general is far more inclined to defer to authority, and to the established wisdom.

The twenty-first century will belong to those who are best at technological innovation. The open, fluid and dynamic structure of the networks of American society put the US still in prime position.

A version of this article was printed in City AM on 15th August 2012

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Corporate structure, Darwinism and Random Selection

The corporate world exhibits a wide variety of structures. Co-operatives and partnerships have been around for a long time and have some well known examples. The Co-op, for example, was founded in Rochdale as long ago as 1844 and now is represented worldwide. Goldman Sachs was a partnership for most of its existence. There are more exotic forms of the corporate beast, such as companies limited by guarantee, industrial and provident societies, friendly societies and, recently made possible by legislation in the UK, community interest companies.

But by far the dominant form of corporate organisation is that of the joint stock company with limited liability. In other words, companies ultimately controlled by shareholders. These can range from one person bands to the world’s largest firms such as Google.

Although the concept had been around for a long time, the shareholder company came into dominance in the corporate world in the late 19th century. It remains by far the single most important form of corporate structure, even if we count the frequencies of the various structures on a simple head count rather than by value or turnover.

Companies run by managers on behalf of shareholders are coming in for increasing criticism. In the financial crisis, the value of the equity of many banks collapsed and shareholders were sometimes left with nothing at all. But in the process, the managers had enriched themselves. The issue of the pay of senior executives in such companies remains a very live and sensitive political issue.

Is it time to call a day on this form of organisation, and if so how is it to be done?

A lot depends on why we think this particular structure came to exercise such dominance in what we might think of as the ecology of corporate organisation. Many different forms of organisation compete to be adopted by entrepreneurs setting up in business. But it is the shareholder company which is by far the most frequent choice.

If we do a simple plot of the relative frequencies with which the different types of structure are observed – even on a simple head count – we observe a highly skewed outcome. Huge numbers of shareholder based companies, a lot of partnerships, but far fewer than the number of the ‘market leader’, some co-ops, then fewer and fewer until we get down to recent innovations such as the community interest company, with very few examples.

Pure Darwinism would lead us to believe that the shareholder company is dominant because it is better suited to the environment, to the ecology of corporate structure. It is somehow fitter than its rivals. Selection by fitness, however, does not by itself account for the relative frequencies with which we observe the different corporate forms.

A quite different theory also comes from biology, to account for the frequencies with which different species are observed in any given ecology. Stephen Hubbell, based at the University of California at Los Angeles, came up with the so-called ‘neutral’ theory, which generates results which conform to the outcome which we observe empirically in ecological systems. A few species have lots of members, most species have very few. Exactly what we see with corporate forms.

A plausible hypothesis is that, in any given system, rare species are rare because, for whatever reason, they have not adapted well to their environment. Similarly, abundant species must have particular attributes which enable them to flourish. But the word ‘neutral’ in this context means that no species has any special qualities or characteristics which make it more or less suitable to operate in its given environment. Their relative success or failure is ‘neutral’ to their attributes. In other words, how a species behaves, what it can and cannot do, is irrelevant to whether or not at any point in time its numbers are small or large. The outcomes which we observe are the result of purely random processes.

It is a disturbing theory, which appears to defy common sense. But common sense tells us that it is the Sun which goes round the Earth and not vice versa. We see the Sun move, but we seem to stay still. It has the great strength that it fits the facts. Yes, evolution takes place, but the eventual outcome and the eventual ‘winner’ are determined much more at random than by inherent fitness.

The policy implications of this are important. If we think the neutral theory applies in any serious way to corporate structures, the way to remove the dominance of the shareholder company is to allow more innovation, to allow different forms to come forward, one of which will eventually replace the dominant species.

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Co-operation and Competition

Ed Mayo, ex-head of the New Economics Foundation and now of Co-ops UK, has an interesting blog (here) on the importance of co-operation in our economic system rather than competition. This is a really challenging and difficult topic.

Co-operation is extremely important to the successful functioning of the market-oriented economies of the West. But this is not because of co-operation as an organisational structure. The dominant form of corporate structure for over 100 years has been the shareholder-based joint stock company, and not organisations based on co-operative lines. But nevertheless, co-operation between firms is essential.

The most important reason for this is very simple. Complex economic systems contain many linkages between the different component parts. In an evolutionary context, we can think of a competitive relationship between two firms being expressed by a negative connection between them. If one does well, the other is likely to lose out, and its fitness is reduced. In contrast, a co-operative relationship is positive. If one does well, the fitness of the other is increased, and vice versa.

Economic theory focuses exclusively on the competitive links. But these are dominated by the co-oerative ones. The structure of production is the reason why. Most economic activity does not involve the final consumer, the individual. It is business to business. So if a firm learns to produce something more efficiently, or if it innovates successfully, the companies to which it supplies benefit.

More generally, co-operation is needed to agree institutional structures in which economic activity can take place. And it is the basis of most contractual agreements. It is impossible to specify in complete detail most business-to-business contractual relationships – look at the massive difficulties caused by Brownite thinking on this in terms of the relationships between regulators and the regulated in the relevant sectors of the UK economy. A strong element of trust is required.

But all this co-operation, which pervades successful capitalist economies, has nothing to do with the organisational form of companies. It can, and indeed has, shown itself in a system dominated not by co-operative but by joint stock firms.
I have been interested in this for some time, and here is a very technical paper which examines what happens in an evolutionary system when most of the linkages are competitive and not co-operative.

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