A Framework for Management Research

Republished from Department of Veterans Affairs Website

The past 20 years have seen intensive development of new models for organization and management in industry and health care. Many observers believe, however, that popular trends and fads have guided this development more than research on organizations and management practices. Often managers rely on consultants for assistance in making and implementing important strategic decisions, but they do not rigorously challenge the information upon which such recommendations are based.

At the same time, however, there has been a significant shift in the way that health care professionals use evidence from scientific research in clinical practice, and the concept of evidenced-based health care has become part of the language of clinicians, managers, policymakers and researchers. But the leaders and managers of health care organizations, while often strongly encouraging clinicians to adopt evidenced-based practices, have been slow to apply the ideas to their own management.

The Nature of Managerial Decision Making

Managers make fewer but larger decisions than clinicians—and the timeframe for those decisions is usually longer. Major managerial decisions may take weeks, months or even years to be made and implemented, and it can be difficult to discern or describe the decision-making process or to pin down when a decision is actually made. Managerial decisions are also more heterogeneous than clinical decisions, in the sense that they do not usually involve the application of the same body of knowledge to a series of similar but different circumstances, so guidelines of decision support aids are seldom used in managerial decision making. Therefore intuition often plays a part in decisions that would defy any rule-based, procedural analysis.

In addition, decision-making for managers, even within a hierarchical structure and chain of command, is often a team or group activity, whether formal committees or informal groups. Securing the support of others is often a key part of the process. Managerial decisions are also often significantly constrained by organizational or wider system requirements, such as resource availability, pressure in the marketplace, policies and procedures and stakeholders' views and interests.

These factors may act as limitations or may even directly conflict with research findings. Because of the constrained, contested and political nature of many managerial decisions, it may be difficult for managers to apply research evidence even when it is available.

Managerial Culture

There are a number of significant reasons that managers may not consider research when making policy decisions. In the past, nonprofit organizations have lacked accountability for the costs of growing or discontinuing lines of service, and therefore have had little incentive to investigate best practices. Rather, health systems have focused on operating margins and past budgets. Research is often viewed as producing little or no return on investment. More money tends to be spent on consultants’ strategic recommendations, which may not be backed up by research.

In reality, most healthcare organizations are not large enough to carry out management research. But, in larger systems, management has not used the advantage of system size to gather evidence on best practices. The evidence that does exist is often not shared even within the same system. Again, in fairness to managers, it must be noted that there is little evidence available related to best management practices.

There are some practical problems that suggest that conditions typical of health care organizations may be counterproductive to fostering support for management research. These factors include working conditions that involve a heavy workload and tight deadlines. Without a system in place to cope with heavy workloads, the pressure to meet deadlines restricts the time managers have to consider their decision-making process or to examine research. Attitudes that focus on making speedy decisions can interfere with managers’ acceptance of research. In addition, a belief system reinforced by years of experience that management is an intuitive process will restrict support for management research.

Research evidence is more likely to be used in organizations that have a culture that values and encourages innovation, experimentation, data collection and analysis and the development of critical appraisal skills among managers. Organizations must cultivate what has been called a culture of learning through research.

Source: A Framework for Management Research, Department of Veterans Affairs.

Risk Management in Demand

As the global financial disaster continues unabated, research is beginning to percolate findings about some of the causes of the storm, as well as the precautionary measures that might avert future crises of this nature. In a recent survey of over 500 key financial executives conducted by MPI Europe (April 2009), several important views prevailed. One of the survey's strongest findings was the perceived need to develop a “risk management culture” in today’s financial institutions, including bolstering the relative power of risk management functions vis-à-vis its trading counterparts. Now, as good as that sounds, I am skeptical as to whether our financial services industry has it within itself to embed a new risk-aware culture without demonstrable intermediate measures to lead the way (after all, our world is inspired by capitalism). The good news is that several other findings were more specific and actionable. Over 75 percent of the respondents saw a shortage of sufficiently and appropriately trained personnel as having a “high impact” on creating the crisis. Additionally, a significant majority of respondents wanted to see an improvement in their “risk management applications,” to include a shift from predominantly quantitative measures toward qualitative methodologies (e.g., internal controls). Both of these latter measures are fully actionable through increased investment in risk management technologies and training. Moreover, implementing stronger spreadsheet control regimes, coupled with stricter guidelines for spreadsheet checking and auditing, are another immediate requirement. Finally, I would argue that by funding and initiating improved risk management technologies and training, executives will be taking the first vital steps toward creating the risk management culture that they seek. The recognized need for effective risk management is gaining traction in today’s financial services industry. The real question remains whether the industry’s leaders will have the courage to recognize the deficiencies of their existing risk management structures, and respond by investing in the technologies and training that can address these shortcomings.

Enterprise Risk Management is a Farce

In the wake of the still expanding ecological crisis in the Gulf of Mexico, management experts are beginning to ask critical questions about the nature and effectiveness of enterprise risk management. Sam Friedman of National Underwriter Property and Casualty reaches this conclusion:

The BP oil spill disaster exposed serious shortcomings in both technology and regulation, but the biggest culprit is a catastrophic failure of enterprise risk management.

Most Americans presume that a multi-billion dollar energy firm of BP’s stature has the resources, technology, and skills to recover oil in a manner that is both profitable and safe for society. However, the extent of the ongoing catastrophe defies this presumption. According to Friedman:

It's hard to imagine a scenario any worse than this. An offshore oil rig explodes, killing 11 workers. The rig collapses. Oil keeps gushing from a deep-sea well, threatening the Gulf Coast, Florida Keys and perhaps even the Eastern Seaboard.

Of course, even multi-billion dollar global corporations can make mistakes, and so society takes great comfort in knowing that the Federal government is diligently regulating and inspecting high-risk industries in order to protect its citizens from the deleterious effects of ecological devastation. Once again, the public apparently presumes too much.

The BP oil spill is not only a stain upon enterprise risk management as an occupation, but upon the entire US regulatory establishment as well. Let’s face it, enterprise risk management in America is a farce.

Source: Friedman, S (2010, May 31), BP Oil Spill a Stain on Risk Management, National Underwriter Property & Casualty.

The Purpose of Risk Management

Here is a useful quote from Prof Emanuel Derman about the nature and purpose of risk management:

When I worked in firmwide risk I didn't clearly understand what our job was -- control risk, measure risk, whatever? Recently I heard a very good logical and philosophical talk by Steve Allen of NYU on the whole business. He's the author of Financial Risk Management: A Practitioner's Guide to Managing Market and Credit Risk. One of the things he said is that the purpose of risk management is neither to control nor measure risk, but rather to make risk transparent. It's such a clear and sensible idea. And, he said, and I think I'm quoting him correctly, that a risk manager shouldn't get fired if a firm loses a lot of money. They ought to get fired if a loss occurs owing to some risk that he didn't bring to the firm's attention.

Source: Derman, E (2007, March 13), The Purpose of Risk Management, Emanuel Derman’s Blog on Wilmott.

Practical Steps for Corporate Risk Management

The Economic Intelligence Unit (2009, "Managing Risk in Perilous Times: Practical Steps to Accelerate Recovery," London) recently published a white paper admonishing corporations regarding the practical steps necessary to accelerate recovery during these perilous times. The lessons and steps outlined in the report are instructive for corporations of all industries:

1. Risk management must be given greater authority.

2. Senior executives must lead risk management from the top.

3. Institutions need to review the level of risk expertise in their organization, particularly at the highest levels.

4. Institutions should pay more attention to the data that populates risk models, and must combine this output with human judgment.

5. Stress testing and scenario planning can arm executives with an appropriate response to events.

6. Incentive systems must be constructed so that they reward long-term stability, not short-term profit.

7. Risk factors should be consolidated across all the institution’s operations.

8. Institutions should ensure that they do not rely too heavily on data from external providers.

9. A careful balance must be struck between the centralization and decentralization of risk.

10. Risk management systems should be adaptive rather than static.

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The Risk Paradox

Risk management is too often perceived to be a perfunctory activity assigned to the lower echelons of the firm. As described by Douglas W Hubbard (2009, p. 174):

The paradox of risk management... is that the most sophisticated risk analysis methods used in an organization are often applied to low-level operational risks, whereas the biggest risks use softer methods or none at all.

How do we elevate the stature of risk management (and analysis in general) in the executive suite?

Reference: Hubbard, D W (2009), The Failure of Risk Management: Why It's Broken and How to Fix It, Hoboken, NJ: John Wiley.

The Minds Behind the Meltdown

In an effort to assign responsibility for the Wall Street financial meltdown that began in 2007, Scott Peterson (2010) makes the case that "quants" were the demons that somehow misled investment managers and the public:

On Wall Street, they were all known as "quants," traders and financial engineers who used brain-twisting math and superpowered computers to pluck billions in fleeting dollars out of the market. Instead of looking at individual companies and their performance, management and competitors, they use math formulas to make bets on which stocks were going up or down. By the early 2000s, such tech-savvy investors had come to dominate Wall Street, helped by theoretical breakthroughs in the application of mathematics to financial markets, advances that had earned their discoverers several shelves of Nobel Prizes.

Regarding the management teams that supervised these "quants," Peterson is mute. I tend to take the alternative view that management is responsbile for everything that happens or fails to happen within their domains. My question for the investment managers and policy makers is simply, "How could you be so dumb as to let your trading staffs run over you?" I tend to point the finger directly at the investment policies and greed of the investment managers and other senior executives rather than the traders. After all, the public can hardly hold staff traders responsibile for the devastating loses that ensued. The executive management teams of these investment institutions have a lot to answer for from my perspective. The minds behind the meltdown sit amongst the policy makers - not the traders.

Reference: Peterson, S (2010, January 23), The Minds Behind the Meltdown, Wall Street Journal Online.

Evidence-Based Management Imperatives

Evidence-based management (EBM) is the conscientious, explicit, and judicious use of current best evidence in making management decisions (Pfeffer & Sutton, 2006). EBM creates two imperatives for managers:

1. Demand Evidence. Whenever someone makes a seemingly compelling claim, ask for supporting data and check the data for currency and accuracy.
2. Examine Logic. Parse the logic behind evidence presented to you pragmatically for currency, as well as faulty cause-and-effect reasoning.

Source: Pfeffer, J & Sutton, R I (2006, January), Evidence-Based Management, Harvard Business Review.

The Future of Risk Management and Financial Ratings

I recently came across a thought-provoking table purporting to compare the present and future of risk management and financial ratings (2009, Ontonix). Most of the predictions are illuminating. However, I doubt that financial risk analysts will migrate away from statistics and Monte Carlo simulation (MCS) models toward "model-free" methodologies (whatever that means). In fact, I predict that the use of statistics and MCS methods in financial risk analysis will expand in the coming years. Nevertheless, I find the juxtapostion of the conventional and future to be parallactically interesting and intriguing.

Reference: "The Present and Future of Risk Management and Rating," (2009), Ontonix Complexity Management.

Elevating the Roles of Risk Analysts and Managers

The ongoing economic crisis has brought with it a heightened interest in risk analysis and management. Yet, something seems awry at the risk management desks of our nation’s largest banks and financial institutions. Goldman Sachs CEO, Lloyd C Blankfein was recently quoted as saying, “too many financial institutions and investors simply outsourced their risk management -- rather than undertake their own analysis, they relied on the rating agencies to do the essential work of risk analysis for them.” Mr Blankfein contended that banks and financial institutions must elevate the status of risk analysis in order to alleviate the “systemic lack of skepticism” that he alleged was precursor to the ongoing economic crisis. Mr Blankfein suggested that banks and financial institutions redefine the roles of risk managers, including giving them equal stature “with their counterparts in revenue producing divisions.” This redefinition of roles includes delegating greater responsibilities and authority onto risk managers, whereby “if there is a question about a mark or a disagreement about a risk limit, the risk manager's view should prevail” (WSJ, April 7, 2009). My personal interpretation of Mr Blankfein’s statements is that those trained and charged with risk analysis and management were apparently left standing outside the boardroom as our nation’s banking and financial “executives” undertook investment policy-making in isolation. Let us hope that the regulatory changes to come might at least mandate that risk managers and analysts get a seat at the table.

On Management "Style"

The matter of "baby-boomers" remaining in control of their destiny has significant implications for management, particularly since society has yet to send the "Bob Hope" generation packing. For example, the US Congress is still dominated by members born prior to World War II. For this reason, there may actually be a generation "skipping" tendency in favor of younger leaders from diverse backgrounds -- witness Barack Obama's rise to power. My sensing is that there is a large segment of our society that views "change" as the replacement of anyone born prior to 1955 with much younger leaders. The impact of these views on management selection could be significant in the coming years. The second issue confronting management is the continuing demise of elitism, the entrenchment of populism, and the rise of pluralism. The net result could be a generation of leaders who insist on securing more than a simple majority in support of their decisions, but rather require a plurality of support closer to two-thirds majority. Imagine if the US President vetoed legislation because it did not come with two-thirds support of Congress. If the same approach took hold in corporations, it would require boards to listen carefully to all of their stakeholders in depth. In summary, I believe that generational issues coupled with society's move toward pluralist thinking will require mangement to change its "style" of decision-making in the coming years -- probably for the best.

The Future of Work is Serious Play

Writes Prof Jason Scott Earl in The Beginner (2012, Aug 30):

The great divide between the gaming community and management educators is quickly coming to a close. The past relationship between gamers and business management educators, whereby one dismissed the others based on what has now increasingly proven to be unsupported information, is changing. As research points out, there is a significant opportunity in adopting an engaging business simulation strategy and its potential impact on the world of management education. The truly disruptive innovation nature of online business simulations has the potential to dramatically impact emerging markets – such as online education – with new and more powerful ways of teaching and learning.

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Prof Jason Scott Earl

Virtual learning environments are the future of learning. Firms such as Rosetta Stone are already pioneering new methods for distributing knowledge via simulation technology. Everything we know about education will change as virtual learning systems eventually supplant the classroom approach to instruction. Those changes will affect not only "bricks and mortar" classrooms, but the current notion of online course room structures as well. Computer learning systems are set to revolutionize education as we know it.

Source: Earl, J S (2012, Aug 30), The Future of Work is Serious Play, The Beginner.

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Risk Management in Review

I recently responded to a question in a public forum regarding the limitations of risk management. The specific question posed was, “What limits our ability to effectively manage risk?” This is an interesting question given the financial crisis still underway. My response follows:

Risk management continues to be a misunderstood discipline. The truth is we do have the analytics to understand and manage most kinds of risk (at least to some extent). The more serious problem confronting our society is our apparent inability to apply that knowledge. I'm reminded of the story of a civil war soldier who was listening to one of his officers read from a newspaper. The story goes that the officer quoted from a story by commenting, "...it says here there were fifty percent casualties at the battle of..." The soldier who was listening to the officer's comment responded by asking, "...wow, is that a lot?"

The point is that having the analytics to describe risk, and having the knowledge and training to understand the analytics are two different things. My impression is that many (if not most) business leaders are poorly trained at understanding risk analytics beyond what might be described as layman's terms. What is most needed today is for our business leaders to become more knowledgeable of how to understand and use risk analytics in an effective and meaningful manner. The days of making guesses based on institutions are long gone, especially when those decisions can result in losses of billions of dollars, as well as suffering amongst the ranks of employees and other stakeholders who are ultimately victimized by those decisions.

My advice to business leaders at all levels is to make risk analysis a centerpiece of their training in graduate school. If you puzzle over terms such as variance, standard deviation, stochastic, optimization, and so forth, then it may be time to schedule some training in these skills as part of your lifetime learning plan.

General Electric: Specialists Replace Generalists

According to Kate Linebaugh of the Wall Street Journal:

General Electric (GE) is opening a new chapter in management philosophy. The conglomerate that once groomed jack-of-all-trades generalists is now betting on deep industry experts instead.... The shift is a change in philosophy at a corporation that for decades had made a rigorously applied but generic management tool kit central to its identity. Like all companies, GE wants some of both traits in its leaders, but the balance has tipped toward expertise.

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The shift from management generalists toward industry specialists is long-overdue in enterprise, at least in my opinion. Replacing MBA generalists with MS specialists would be a positive first step. For that matter, the education industry would benefit from replacing MEd generalists with MA and MS specialists as well. The movement toward specialists in all forms of enterprise is picking up steam!

Source: Linebaugh, K (2012, March 7), The New GE Way: Go Deep, Not Wide, Wall Street Journal.

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Excel + ModelRisk: Practical Spreadsheet Risk Modeling for Management

Risk professionals seeking practical methods for modeling risk using spreadsheets will be interested in the new textbook, Practical Spreadsheet Risk Modeling for Management (Lehman, Groenendaal & Nolder, 2011). Click the image below to preview the contents.

[click image to preview]

I have adopted Practical Spreadsheet Risk Modeling for Management as the standard textbook for my online training courses linked below.

Risk Modeling & Decision Analysis via Excel + ModelRisk

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A Regulatory Architecture for Cross-Border Banking Groups

by Stefano Micossi © VoxEU.org

Policymakers and commentators have suggested that large banks should be broken up. This column argues that such an idea risks the very existence of a global financial system. It outlines an alternative framework in which deposit insurance should be covered by banks not taxpayers, banks should not be guaranteed a bailout, and regulators should be mandated to step in when the warning signs begin.

Following the demise of Lehman Brothers, the debate on regulatory reform has led to the conclusion that large banking institutions must be broken up and their risk-taking activities limited by law along the lines of the ‘Volcker rule’ (Gros 2010). Not only are such actions unnecessary, they may be hard to implement and could reduce the availability of credit to the economy (if for example they reduce the ability of banks to hedge their credit positions). The main consequence of such a plan would be the disintegration of global financial markets as they break down into segregated national markets.

In recent research, my colleagues and I set out an alternative solution that can achieve a more stable and resilient financial system without renouncing the benefits of global and multi-purpose financial institutions and innovative finance (Carmassi et al 2010). These are predicated on effectively curtailing moral hazard and strengthening market discipline on banks’ shareholders and managers by raising the cost of the banking charter to fully reflect its benefits for the banks, and restoring the possibility that all – or at least most – large banks can fail without unmanageable systemic repercussions.

Back to basics

The crisis was generated by cross-border banks levering their deposit base and acting, through the wholesale interbank market, as the residual suppliers of liquidity for all the other players in financial markets. This multiplied funds for speculation and helped to sustain a gigantic inverted pyramid of securities made up of other securities and yet again other securities. Without the money-multiplying capacity of the banks, the asset price bubble and the explosion of financial intermediation and aggregate leverage would not have been possible. Extreme investment strategies by bankers obviously reflect moral hazard created by the expectation that governments would step in to bail them out in case of large losses.

The first thing that needs to be done in order to restore corrective incentives for bank managers and shareholders is to eliminate the most obvious pitfall in banking regulation, that is, reliance on capital requirements based on risk-weighted assets. This approach is flawed since asset risk cannot be assessed and measured independently of market conditions and market sentiment. As a result, the need for capital will always be underestimated under favourable market conditions, leading to balance-sheet fragility and precipitous asset sales when market sentiment turns sour. Banks need a capital buffer to overcome the massive asymmetries of information between bank managers on one side, and investors and regulators on the other. This asymmetry currently makes it easy for bankers to accumulate excessive risks in the quest for higher returns, before markets become aware. The way to do this is to set capital requirements in straight proportion to total assets or liabilities of banking groups.

Fixing flaws in prudential capital rules does not remove moral hazard from the banking system, whose specific sources must be tackled separately. These are:

• the deposit-institution franchise,
• the implicit or explicit promise of bailout in case of threatened failure, and
• regulatory forbearance.

The problem associated with the deposit franchise is well known. If depositors have doubts on the bank’s solvency, they will run for the exit, forcing rapid liquidation of banks’ assets, possibly with large losses and contagion spreading instability to other banking institutions.

First pillar for tackling moral hazard

Deposit insurance can reassure depositors, and thus is the first pillar for tackling moral hazard, but it also mutes their incentive to monitor the management of their bank, since they no longer risk losing their money.

More importantly, deposit insurance has evolved in most countries into a system effectively protecting the bank, or the entire banking group, rather than depositors. When a bank risks becoming insolvent, supervisors step in to cover its losses and replenish its capital so as to avoid any adverse repercussions on market confidence. Moreover, most deposit insurance systems are inadequately funded by insured institutions, entailing an implicit promise that taxpayers’ money will make up the difference in case of failure of large banks.

Thus, in order to re-establish a proper price for the banking charter, banks should carry, ex ante, the full cost of deposit protection, making sure that in most circumstances the guarantee fund would be adequate to reimburse depositors when individual banks fail. Of course, no fund could ever be sufficient to meet a general banking crisis, but a fund of an appropriate size would offer adequate protection in normal circumstances, with only a predictable share of banks going bankrupt.

Deposit insurance fees are the right instrument to make banks pay for risk generated by banks. They should be determined on the basis of a careful probabilistic assessment of the likelihood of failure within the overall pool of deposits and risks of the banking system (within appropriately defined market jurisdictions). This is where the risk profile of banks’ asset and loan portfolios can be taken fully into consideration, together with, more broadly, the quality of bank management and risk control, thus creating effective penalties for riskier behaviour. Size itself could be appropriately penalised by higher fees that would incorporate a probabilistic price for the potential threat for systemic stability.

Second pillar: Not “too big to fail”

The second pillar required in order to greatly limit moral hazard in the financial system is credibly removing the promise that large banks cannot fail. To this end, all main jurisdictions should establish special resolution procedures – as already exist in the US and the UK – managed by an administrative authority, with powers to require early recapitalisation, manage required reorganisations and, once all this has failed, liquidating the bank with only limited systemic repercussions. Crisis prevention, reorganisation and liquidation would all be part of a unified consolidated resolution procedure managed for each bank, by one administrative authority.

In order to make resolution feasible, all banks and banking groups would be required to prepare and provide to their supervisors a document detailing the full consolidated structure of legal entities that depend on the parent company for their survival, the claims on the bank and their order of priority, and a clear description of operational – as distinct from legal – responsibilities and decision-making, notably regarding functions centralised with the parent company. This "living wills" document may also comprise "segregation" arrangements to preserve certain functions of systemic relevance even during resolution: for clearing and settlement of certain transactions, netting out of certain counterparties, suspension of covenants on certain operations.

Third pillar: No regulatory forbearance

Finally, the third pillar of an effectively reformed financial system is a set of procedural arrangements that will prevent supervisory forbearance. Supervisory discretion to postpone corrective action would be strictly constrained, so that bankers, stakeholders and the public would know that mistakes would always meet early retribution. To this end it is necessary to establish a system of early mandated action by bank supervisors ensuring that, as capital falls below certain thresholds, the bank or banking group will be promptly and adequately recapitalised. Should capital continue to fall, then supervisors should be required to step in and impose all necessary reorganisation, including disposing of assets, selling or closing lines of business, changing management, ceding the entire bank to a stronger entity.

Should this not work, then liquidation would commence. A bridge bank would take over deposits and other “sound” banking activities, thus ensuring their continuity. All other assets and liabilities, together with the price received for the transfer of assets to the bridge bank, would remain in the “residual” bank, which would be stripped of its banking licence. An administrator for the liquidation of the residual bank would be appointed to determine its value and satisfy creditors according to the legal order of priorities (based on the law of the parent company and other jurisdictions involved).

The attractive feature of mandated corrective action is that asset disposals and change of management will normally take place well before capital falls to zero, so that losses for the insurance fund and ultimately taxpayers are more likely to be much smaller.

References

Carmassi, E L, and Stefano M (2010), "Overcoming too big to fail - A Regulatory Framework to Limit Moral Hazard and Free Riding in the Financial Sector," CEPS-Assonime Report.

Gros, D (2010), "Too interconnected to fail = too big to fail: What is in a leverage ratio?", VoxEU.org, 26 January.

Republished with permission of VoxEU.org

The Nordics in the Global Crisis

by Thorvaldur Gylfason, Bengt Holmstrom, Sixten Korkman, Hans Tson Söderström, and Vesa Vihriälä © VoxEU.org

Is the Nordic model an asset or a liability? The global crisis has seen GDP in the region decline by between 4.5% and 7%. This column argues that the Nordic model, with its welfare state and high rate of investment in human capital, can, properly implemented, be part of the solution.

The Nordic countries – Denmark, Finland, Iceland, Norway and Sweden – are champions of free trade and open markets. And for a good reason; they see international specialisation within a global framework as a means of raising productivity and income. Much of the Nordic socio-economic model can be interpreted as aiming at collective risk sharing with a view to fostering acceptance of open markets, new technologies and the need for change.

In a broad sense the model includes a set of labour market organisations, with an important role for negotiations, a comprehensive safety net and a high rate of publicly supported investment in human capital. Embracing globalisation and sharing risk are mutually reinforcing planks of the Nordic Model, as discussed in Andersen et al. (2007).

Is the Nordic model an asset or a liability?

The current crisis is not only a financial and economic crisis but also a crisis of the much heralded globalisation process itself. It therefore raises many key questions for small open economies, not least the Nordics. What are the lessons of the crisis for economic policies? Is the future of the global economy more unstable than the past, and does that perspective call for a fundamental review of the economic policy strategy? Is the Nordic model an asset or a liability in the light of the crisis?

As we discuss in our new report (Gylfason et al. 2010), the crisis is best seen as the outcome of a lopsided globalisation process that overwhelmed the global financial system. The global savings glut was largely absorbed by the US shadow banking system, because of its capacity to create innovative products. It seemed to offer safe investment outlets at attractive rates of return, while at the same time encouraging excessive leverage. Once the bubble burst and the world economy went down, the Nordics, with their high dependence on exports of investment goods and consumer durables, were particularly hard hit (with the exception of oil-rich Norway). Their GDP in 2009 declined at rates between 4.5% and 7%.

While the sharpness of the global downturn was a surprise, so was the early stabilisation, which started around the middle of 2009. At this point the recession has been declared over in many countries and a recovery – though weak and hesitant – seems to be underway. There is little doubt of the explanation; policies matter. Authorities have demonstrated an unprecedented activism in monetary and fiscal policy as well as inventiveness in financial crisis management. While the world escaped a repetition of the Great Depression, the crisis has nevertheless left a legacy of difficult issues and challenges.

The Nordics are vulnerable but also resilient. While Iceland is a case of its own, we believe that the Nordics have the capacity to recover and to continue combining economic efficiency with high social ambitions. Sweden and Finland experienced a severe banking crisis in the early 1990s, thereby learning a lot about the need for better financial regulation and supervision.

Lessons were learnt about the need for a solid crisis management framework, the pros and cons of a blanket government guarantee for financial institutions, the need for precautionary and other capital injections, the problems of transferring assets into “bad banks”, and the case for not shying away from the government taking over institutions in certain circumstances. Many of these lessons were useful in avoiding mistakes in this crisis and they have attracted interest in other countries. This is also why companies and banks in the region have had balance sheets strong enough to weather the crisis pretty well (we obviously leave out Iceland again).

The effect of the euro

The Nordics have all had different monetary regimes since the euro. Given their similarity in other respects, a comparison of Finland and Sweden is especially interesting. It is almost a laboratory experiment. Sweden has a floating exchange rate and an independent central bank geared to price stability, while Finland is part of the Eurozone. Who has made the better choice?

The krona was mostly stable and developments in Finland and Sweden were strikingly similar during the first decade of the euro. Once the crisis erupted, however, the krona fell significantly relative to the euro, thereby strengthening the price competitiveness of Sweden relative to Finland and the euro area. One might expect this to help Sweden come through the crisis at less cost than Finland, arguably benefitting at the expense of its neighbour by capturing market shares.

The decline in exports and output in 2009 was indeed smaller in Sweden than in Finland, and GDP growth is forecast to be somewhat faster. However, the differences do not seem large. Also, manufacturing output shows little response to the change in competitiveness, and unemployment is rising in parallel with developments in Finland.

Either the effects of the improved competitiveness are relatively modest or the lags are long, or a depreciation of a floating currency has less effect on export and output volumes than a devaluation of a pegged currency used to have. What is clear is that the floating exchange rate does not insulate an economy from external shocks, and the economic differences between the two exchange rate regimes seem smaller than often claimed in the heated debate about the Eurozone.

An effective fiscal stimulus?

For small and open economies, in particular, one may question the power of fiscal expansion as an instrument of demand management. Nevertheless, we still find that an expansionary fiscal policy is helpful in a crisis. It is a useful complement to monetary policy when the interest rate hits its lower bound or when the credit system becomes dysfunctional. Also, fiscal action may alleviate particular problems such as long-term or youth unemployment. Furthermore, automatic fiscal stabilisers allow the government to avoid hasty and unduly harmful measures. The social contract is very valuable in a crisis as it tempers the panic and gives the government more time to plan and undertake measures to reignite growth in an orderly manner.

Of course, sustainable public finances need to be restored, and it is useful to consider the merits of alternative means of fiscal consolidation. Public expenditure may be cut or its composition twisted in a growth-friendly direction, and efficiency in the provision of public services improved. The tax base may be broadened by measures to raise the employment rate, particularly by prolonging the length of working careers. There is some scope for changing the structure of taxation with a view to encouraging economic growth, notably by reducing the share of taxes that fall directly on corporate profits and wage income.

The Nordics were in a position to pursue fiscal expansion in the crisis because these countries were – in contrast to the US and almost all other EU countries –running sizeable budget surpluses in the preceding decade. The government debt level of the Nordics is only half of what it is in the OECD on average and they continue to borrow at very favourable terms. Given their track record, there is reason to believe that the Nordics will continue to be countries with relatively sound public finances, retaining the scope for fiscal policy to be used when needed.

Safety in numbers

Most importantly, the Nordic model itself contributes to resilience. The comprehensive safety net, one of the attributes of the Nordic model, has proved to be robust also in times of crisis. The entitlements are not tied to the fate of individual companies or particular markets, and risks are widely shared in the society. While forest plants are shutting down in Finland and car manufacturing is sharply contracting in Sweden, the governments are firmly rejecting requests for support of ailing industries. Still, there are no crowds protesting in the streets, largely because flexible work arrangements, based both on general and company-specific agreements between businesses and labour, alleviate a rise in unemployment. Structural change is enhanced by the employment protection legislation, which is more liberal than in most other EU countries. A well-educated labour force, another of the attributes of the Nordic model, facilitates adjustment by making it easier to upgrade skills through additional training.

Provided that governments continue to be able to take the decisions needed to safeguard competitiveness and the sustainability of public finances, the Nordic model can be both robust and resilient. The Nordic model with its welfare state, labour market institutions and high rate of investment in human capital, is not the source of the current problems. On the contrary, the Nordic model, properly implemented, can be part of the solution.

References

Andersen, T, Holmström, B, Honkapohja, S, Korkman, S, Söderström, H T, and Vartiainen, J (2007), ”The Nordic Model – Embracing Globalisation and Sharing Risks,” The Economic Research Institute of the Finnish Economy, Helsinki: ETLA.

Gylfason, T, Holmström, B, Korkman, S, Söderström, H T, and Vihriälä, V (2010), "Nordics in Global Crisis – Vulnerability and Resilience,” Helsinki: ETLA.

Republished with permission of VoxEU.org

The Language of Business Intelligence

Vernon Prior has released a new edition of his glossary of terms used in competitive intelligence and knowledge management. Follow the link below to download a copy:

Source: Prior, V (2010), Glossary of Terms used in Competitive Intelligence and Knowledge Management, Institute for Competitive Intelligence.

Business Intelligence (BI) versus Data Science (DS)

Steve Miller of Information Management offers this summary of the key distinctions between business intellience (BI) and data science (DS):

Below is a summarization of what I currently see as some of the differences between DS and BI. I consider the observations preliminary, more gray than black and white. My hope is that in time the “best practices” of BI will weigh positively on DS – and vice-verse. Just as I think BI will benefit from a deeper focus on approximate answers and ubiquitous machine learning, data science should appreciate what's been learned over the years in BI on methodology and governance.

Business Intelligence (BI) versus Data Science (DS)

Source: Miller, S (2011, May 3), Data Science, Part II, Information Management.

Related Posts

Polyvalence Defies Commoditization

One of the tacit objectives of commoditization is to disembed knowledge from humans in order to reembody that knowledge into technology (Giddens, 1990). The impact of commoditization on knowledge workers is a well-understood facet of post-modernization and the new economy.

The success of the commoditization movement has been particularly discouraging for professional services as the public sector is increasingly unwilling to pay premium fees for services, and the private sector is too distrustful of professionals to engage them even when doing so is arguably prudent. Joan Capelin's (2005) expressed sentiments are commonplace:

It is cold comfort to realize that all the professions are experiencing this race to the bottom. We tend not to see the effects of commoditization — nor even feel sympathetic — when lawyers, accountants, and management consultants find they are being squeezed for lower fees by their marketplace. They are far more rewarded for their time, to begin with. But I can tell you that there is much handwringing going on across all the business-based professions.

Nevertheless, as the forces of commoditization continue their forays into the realm of human knowledge in search of latent technologies, critical issues are emerging about how and if certain human specific functions can feasibly be transferred into machines. In particular, the expert handling of polyvalent information and data seems to defy commoditization.

Polyvalence denotes something that has multiple values, meanings, or appeals. Polyvalence (which is a synonym for multivalence) is a state or the way something is with respect to its main attributes, as in “the current state of knowledge,” “the state of one’s health,” and “the state of the economy.” Polyvalent symbols and metaphors carry multiple (often esoteric) meanings and can fulfill expressive, transactional, and interactional functions concurrently.

Prof Daniel Bell (2003) first used the term polyvalent to describe human activities that are difficult or impossible to delegate, let alone commoditize. Examples of polyvalent human functions include surgery, piloting an aircraft, coaching a professional sports team, and representing a client in court. Thus, the professions are often associated with polyvalence.

If technology can displace a particular human activity, then the displaced activity is no longer truly polyvalent.

More to follow about polyvalence in future posts.

Sources:

Capelin, J (2005, September 8), Confronting Commoditization, DesignIntelligence.

Cohen, D (2003), Our Modern Times: The New Nature of Companies in the Information Age (S Clay and D Cohen, Trans), Cambridge, MA: MIT Press.

Giddens, A (1990), The Consequences of Modernity, Stanford, CA: Stanford University Press.

Related Posts:

Financial Management Requires Polyvalence

The Topological Landscape between Automation and Expertise