Good Managers, Not Machines, Drive Productivity Growth
(Bloomberg View) -- When people discuss what drives long-run productivity, they usually focus on technical change. But productivity is about more than robots, new drugs and self-driving vehicles. First, if you break down the sources of productivity across nations and firms there is a large residual left over (rather inelegantly named “Total Factor Productivity” or TFP for short). And observable measures of technology can only account for a small fraction of this dark matter.
On top of this, a huge number of statistical analyses and case studies of the impact of new technologies on firm performance have shown that there is a massive variation in its impact. What’s much more important than the amount spent on fancy tech is the way managerial practices are used in the firms that implement the changes.
Although there is a tradition in economics starting with the 19th-century American economist Francis Walker on the importance of management for productivity, it has been largely subterranean. Management is very hard to measure in a robust way, so economists have been happy to delegate this task to others in the case study literature in business schools.
Managers are more frequently the butt of jokes from TV shows like “The Office” to “Horrible Bosses,” than seen as drivers of growth. But maybe things are now changing.
A new generation of empirical work has grown in the last decade that has been able to quantify some key components of basic management practices. Stuff like whether firms rigorously keep track of what goes on internally, how they communicate this to employees and how this tracking is translated (or not) into sensible and stretching targets that can be used for continuous improvement. An important part of this is what human resources professionals focus on: Are these measures of performance linked to incentives over rewards and promotion? We have now run surveys in over 20,000 organizations in 34 countries and with strikingly uniform results: Namely, firms with high management scores perform better.
The graph below shows that these scores are strongly correlated with firm performance. And these correlations also persist when looking in hospitals, schools and many other places. It is even possible to run “clinical trials” injecting these management practices into firms and comparing with placebos who get only a minor dose. The impact effects in these randomized control trials are of similarly impressive magnitudes.
Now look at the management scores across countries. They are highly correlated with GDP per capita. In fact, almost a third of the cross-country gaps in productivity are explained by management practices.
So what’s holding firms back from adopting these better practices? And is there anything that can be done? Well, yes quite a lot actually.
Firms themselves can change. Multinationals are able to import better practices even in very difficult environments compared to similar, domestically owned firms. They don’t just bring more capital they also show that there is a different way to doing things. For example, auto makers could make lots of excuses for why Detroit was different from Tokyo – culture, religion, work ethic, etc. But when Toyota started producing vehicles in the U.S. using American workers but with Japanese management that was hugely more productive than the U.S. auto-makers, the excuses wore thin.
This is fundamentally an optimistic message – it shows that the economic environment is not destiny. Organizations can heal themselves. Firms need to be honest with themselves – many simply do not realize that there is much room for improvement. They need to benchmark themselves rigorously and seek out ways to change, even if this involves external advice.
Policy-makers have an important role. Especially for smaller firms they can help with better information and advice to help spread best practice. But a lot of what government needs to do is to make structural changes to the environment firms are in.
First, competition is a major factor. This both weeds out the badly managed firms and gives strong incentives for firms up their game. Strong anti-trust enforcement and openness to trade are major ways to stimulate competition, so it is unfortunate that populist parties all over the world are moving in the opposite direction, threatening tariff increases and trying to roll back globalization.
Second, skills matter a lot. Business education and training can work, but we have found that the talent of the CEO matters less than the human capital of the rest of the employees. Having a culture of continuous improvement needs engaged and able workers – low levels of vocational and basic skills are a major drag on managerial improvements. And change has to begin early, in improving standards in public schools, especially for disadvantaged kids who get a particularly raw deal.
Third, governments love giving firms policy goodies, especially family firms who enjoy tax breaks in many countries. But after firms get beyond a certain size they need the kind of professional management that family firms (especially if run by the eldest son of the founder) find very hard to provide.
Managerial capacity could be the secret sauce, the key ingredient not only for company success, but also for macro-economic development.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
John Van Reenen is a professor at the Massachusetts Institute of Technology's Department of Economics and Sloan Management School. He has received an Order of the British Empire and the Yrjö Jahnsson Award.
To contact the author of this story: John Van Reenen at firstname.lastname@example.org.
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