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Posts Tagged ‘Harvard

The world is not a zero-sum game, but it matters if you think it is

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tall-poppy

Question: A farmer in your neighbourhood has had an exceptionally productive 2016. He has managed to double wheat output, and his favourite cow – Daisy – was awarded first prize in the national competition. What is the reason for the farmer’s success? Is it: a) He has worked very hard, b) He was lucky, or c) he put a spell on the rest of the farmers in his village?

This is an example of the type of survey questions a team of Harvard economists have been asking to subsistence farmers in the Democratic Republic of the Congo on several visits over the last few years. In contrast to what one might think, the answer to this question is almost always the same: C. Witchcraft and supernatural beliefs are widespread in Africa and throughout the developing world. One aim of the research group is to identify how these cultural traits affect economic decision-making. Clearly, if my answer to this question was that the farmer’s success was due to hard work, I would conclude that the way to excel is to work harder. But if my understanding is that this farmer somehow cheated – that his success was due to a spell he put on the rest of the community, and that his gain was our loss – then my takeaway is that I need to spend more of my surplus not on investing in my farm, but on bribing the local spiritual leader for favours.

The belief that the world is a zero-sum game is widespread. Like these Congolese farmers, many of us believe that the success of one member of our communities must be to the detriment of others. In some cases, this is, of course, true: when one bowler takes 7 wickets in an innings, it leaves only 3 scalps between the remaining bowlers. But, generally, the world is not zero-sum. China’s success is not a consequence of America’s decline, despite what the Trump propaganda machine says. Trade, as economists have known since David Ricardo, can be mutually beneficial, even if it means that the benefits and costs of growth are not shared by everyone equally. My neighbour’s financial success after she designed and marketed a new app is not the result of her ‘stealing’ my success.

But beliefs of a zero-sum world are widespread, and results in what has become known as the Tall Poppy Syndrome. I’ve seen this in action: students that excel sometimes draw the envy of their poorer-performing peers. And it has consequences: the envious ones believe that the good student must have achieved the high marks because of external factors, such as being the teachers’ favourite. They avoid taking responsibility for their own mediocre efforts. The star student, depending on the sanction of the envious ones, also reacts, either by withdrawing from social interaction or, worse, by putting in less effort in the next test to avoid standing out.

The Tall Poppy Syndrome is prevalent in all societies, but its density and effects are likely to vary. If TPS is more concentrated in poorer communities, for example, it will hamper social mobility, reinforcing both the poverty and the cultural beliefs itself. Development economists are therefore hoping to not only identify the causes of these beliefs but also how to change them.

This will not be easy: beliefs are difficult to measure accurately, and their origins may be deep in history. Nathan Nunn and Leonard Wantchekon’s work several years ago showed how the Atlantic slave trade still affects trust in African societies: people that today live in areas where most slaves were captured are more likely to distrust their neighbours and the government. In a new paper, Oded Galor and Ömer Özak show that people’s belief about time preference – whether you have a long-term horizon or not – were affected by what type of crops their ancestors grew. Both trust and time preferences are necessary ingredients for development. As Adam Smith already pointed out in the eighteenth century, trust is necessary for specialisation and exchange. A long-term horizon allows one to forego future income, invest in the present and earn the higher future returns. It affects our propensity to save, to adopt new technologies, and, as Galor and Özak show, even our likelihood to smoke.

If these cultural beliefs are so deeply rooted and have such a pervasive influence over our behaviour, what can be done to change them? This is difficult to answer and requires the interdisciplinary efforts of psychologists, economists, anthropologists and neuroscientists. The answers they provide may not only contribute to sustainable development and social mobility, but may have applications elsewhere. Marketers may have to design products that appeal to those with a zero-sum worldview, or managers may have to lead teams of people where some ascribe to this view. The incentives that motivate people who have Tall Poppy Syndrome, for example, are likely to be different to those who are less envious of their successful colleagues.

Our beliefs about the world shape our economic decision-making. We are only now beginning to understand how it does, and what to do to change it.

*An edited version of this first appeared in Finweek magazine of 1 December.

Written by Johan Fourie

January 16, 2017 at 08:16

Why (African) business schools need more business history

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Early retail and distribution? Parade sales in early twentieth-century Cape Town (Source: Cape Town Archives Repository, Elliot collection, E8308)

Early retail and distribution? Parade sales in early twentieth-century Cape Town (Source: Cape Town Archives Repository, Elliot collection, E8308)

On Monday, when stock markets crashed globally, Larry Summers tweeted: “As in August 1997, 1998, 2007 and 2008 we could be in the early stage of a very serious situation.”

The first thing Summers did was to reference financial history. Implicitly he asked: what can we learn from the past to make sure we adapt, survive and prosper when conditions in the present change? I would think that the same applies to the world of business too: CEOs, directors and managers need to know how to react when change inevitably comes, either externally to the firm – for example, when the economy is heading into a recession (as the South African economy seems to be doing) or when the state decides to intervene – or internally to the firm – for example, when the firm grows beyond what it’s organisational structure can support or when developing a Corporate Social Responsibility strategy. And one source of wisdom to learn from (not the only one, granted, but an underappreciated one) is history.

The need for business history is understood in the world’s top business schools. Harvard Business School, most famously, has a large team of business historians and publishes the Business History Review. The reason a place like Harvard invests in business history is because of intellectual honesty. As Andrew Godley, director of the Centre of Entrepreneurship at the Henley Business School explained to me,

almost all MBA subjects are taught using case studies. Case studies are, by definition, historical. They are justified as devices to aid student learning of a particular theme (e.g. Diversification strategies). But because they are historical by definition, any successful interpretation of the case study (and so any successful learning outcome) depends on the students understand the historical context facing the decision makers in that particular firm. Acknowledging explicitly that context matters and that context changes therefore leads to the further acknowledgement that MBA students need some sort of grounding in business history methods to be able to correctly interpret (and so learn from) case studies.

While business history was born in the early twentieth century, it took off  in the 1960s. Alfred Chandler’s seminal Visible Hand (1977) explained the development of the firm from small-scale (often family-owned) businesses to large corporations and conglomerates. A 2002 paper by Naomi Lamoreaux, Daniel Raff and Peter Temin explain this Chandlerian view most succinctly:

Writing in the mid 1970s, Alfred D. Chandler, Jr., attributed the success of the U.S. economy in the twentieth century to the rise of large, vertically-integrated, managerially directed enterprises in the nation’s most important industries. These enterprises, Chandler argued, were dramatically more efficient than the small, family owned and managed firms that had characterized the economy earlier. Small firms had to depend on the market to coordinate their purchases of raw materials and the sale of their output, but large firms took on these supply and marketing functions themselves, coordinating them internally by means of managerial hierarchies. This visible hand of management, Chandler claimed, was such a vast improvement over the invisible hand of the market that firms that exploited its capabilities were able not only to dominate their own industries but to diversify and attain positions of power in other sectors of the economy as well.

The problem, though, is that this linear trajectory of firm development reversed by the 1980s. Conglomerates dissolved and large corporations began to divest their vertically integrated components. Here’s Lamoreaux et al. again:

Indeed, as the economic environment changed during the 1980s and 1990s, classic Chandlerian firms increasingly found themselves outperformed, even in their home industries, by smaller, more specialized, vertically disintegrated rivals. Many of the enterprises that now rose to the top succeeded by substituting for the visible hand of management alternative means of coordinating vertically and horizontally linked activities—most notably long-term relationships that were intriguingly similar to those that prevailed before the “rise of big business” or even before the so-called “market revolution.” Large Chandlerian firms in turn sought to improve their competitiveness in this new environment by refocusing resources on their “core” businesses, selling off subsidiaries and even entire divisions and, in the process, reducing significantly the range of economic activity subject to managerial coordination.

Lamoreaux et al. then develop a framework to understand why this trend reversed. Although there is much more in the paper, the following paragraph effectively summarize their view:

The perspective of hindsight enables us to see that this puzzling combination of trends can be attributed in part to the effects of communication and transportation costs on the location and organization of economic activity. When these costs are high, economic activity tends to be local and consequently small in scale. At the other extreme, when communication is virtually free, as on the internet, and transportation is very cheap, then economic activity can be located anywhere and even tailored to individual needs. In the middle, however, when communication and transportation costs are neither prohibitive nor trivial, there are advantages to be obtained from concentrating productive activity in specific locations and in large firms.

Thus, a u-shaped curve: when communication and transport costs are high, firms will be small; when they are infinitely small, they will also tend to be small. But when they are somewhere in-between, large firms will be the equilibrium outcomes.

Except: the paper was published just before the tech industry blossomed. (Google was four years old, Facebook was yet to be founded, the iPhone would only be released four years later.) How have their model held up to these developments? Not great. Only last week, Google announced that it will restructure into Alphabet as a conglomerate in industries ranging from ‘search’ (the original Google), to self-driving cars, to health, to finance. Apple, originally in PCs, now has phones, and watches and there is talk of a car too. I’m perhaps oversimplifying their argument, but it is clear that business forms do not only depend on communication and transportation costs.

This is especially true in emerging markets. As Harvard’s Aldo Musacchio suggests, emerging markets have specific ‘institutional voids’ that entrepreneurs must overcome if they are to be successful. This may be anything from capital market failures, a poor education system, or severe labour market regulations. How businesses react to these institutional voids determine the type of firm that will be established. His example: the rise of the Tata Group in India.

Our lack of understanding how these institutional voids gave rise to indigenous businesses is especially acute in Africa. In South Africa, we have two excellent business historians (Anton Ehlers at Stellenbosch and Grietjie Verhoef at UJ), but both are within a decade of retirement. There is much to be done to understand the institutional voids that gave rise to firms like SAB, or Discovery, or Black-Like-Me or the myriad of family businesses and informal businesses that continue to co-exist with larger corporations. We need to understand the rise and decline of state corporations. We need to know why banks collapse. We need to know why not-for-profit corporations exist. What are the role of ethnic minorities? What about black-owned businesses? What role for the apartheid state and sanctions? And what about colonialism and independence and state capitalism and corruption and its interplay with businesses in other African countries?

The rise of African capitalism over the next decades will require a large pool of skilled managers that can both understand the domestic complexities and global supply chains. I hope that these managers, trained in Africa’s leading business schools, will draw from the lessons of our own history and context. This, then, is my challenge to South Africa’s top business schools: Encourage student dissertations on the histories of indigenous businesses, introduce a course in business history (or the History of African Capitalism), appoint a tenure-track professor to research the histories of African businesses, create an archive of business history to protect the documents that future generations will need to understand our current successes and failures..

These challenges are not easy to fulfill in the time and resource constrained business schools of today, where accreditation uber alles. Yet we must try harder. We have a rich continent, with a rich (if largely unwritten) history. This history is messy and it still affects us. Which is why I love this quote by Stephen Mihm of the University of Georgia:

Business history – or the history of capitalism – is not a science. It’s a way of looking at the world that acknowledges the messiness of human economic activity even as it promises to explain both the recurrent patterns of the past and the unique factors that led up to the present. For business school students, history breeds recognition that the present is nothing more than the leading edge of the past.

On the road to riches

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RDP houses

Road to nowhere: RDP houses outside Kokstad, South Africa (Rhodes University)

Escaping poverty is one of the most difficult things to do, especially in a country like South Africa where at least a quarter of the labour force is unemployed. Every year, thousands of young rural men and women move to the urban periphery in search of jobs and a better life for their children. They mostly end up in townships on the fringes of South Africa’s largest cities where the lack of services – housing, water and sanitation, education and health – are unlikely to allow them to escape the poverty they so desperately hope to. Their children, in all likelihood, will remain on the fringes of the formal economy, unable to break free from the poverty trap.

How to solve the immobility of the poor is one of the most vexing questions that captivate economists. What are the policy levers that we can pull to allow a poor household migrating from Qunu to Cape Town to build a better life for their children? One might think of a plethora of policy options: more housing, clinics and sports fields, better sanitation, teachers and public transport, safer streets, classrooms and public parks; in short, all the things we associate with better neighbourhoods. But better neighbourhoods are highly correlated with high incomes, and it is difficult to know which comes first: do rich people create better neighbourhoods, or do better neighbourhoods create rich people?

Two Harvard economists have recently provided the most compelling evidence to date to show that it is neighbourhoods that, in fact, create rich people. They track the participants of a lottery programme in the USA that allowed some families – those that were lucky to win the lottery – to migrate to better neighbourhoods. Because it was a lottery programme, selection is not an issue, meaning they can interpret the difference between those that migrate and those that stay behind as the causal impact of the new neighbourhood. Here they summarize their results:

As an example, consider a set of families who move from Cincinnati to Pittsburgh. Children who grow up in low-income families (at the 25th percentile of the national distribution) in Cincinnati from birth have an income of $23,000 on average at age 26, while those in Pittsburgh have an income of $28,000. Now consider the incomes of children whose families moved from Cincinnati to Pittsburgh at some point in their childhood.

Harvard

 Figure 1 plots the fraction of the difference in income between Pittsburgh and Cincinnati that a child will on average obtain by moving at different ages during childhood. Children who were nine years old at the time of the move (the earliest age we can analyze given available data) capture 50% of this difference, leading to an income of approximately $25,500 as adults. Children who move from Cincinnati to Pittsburgh at later ages have steadily declining incomes, relative to those who moved at younger ages. Those whose families moved after they were 23 experience no gain relative to those who stayed in Cincinnati permanently.

The earlier you  move to a better neighbourhood, the better chance you will have to escape poverty. While this might sound intuitive, this is the first time that economists have credibly established the causal link from residing in a better neighbourhoods to better outcomes later in a child’s life.

But what is it about these better neighbourhoods that really matter? Is it, as Justin Wolfers writes in the New York Times, “their schools, community, neighbors, local amenities, economic opportunities and social norms” that matter the most? The Harvard team has an answer: commuting time. This is how one newspaper reported it:

Commuting time has emerged as the single strongest factor in the odds of escaping poverty. The longer an average commute in a given county, the worse the chances of low-income families there moving up the ladder.

The relationship between transportation and social mobility is stronger than that between mobility and several other factors, like crime, elementary-school test scores or the percentage of two-parent families in a community, said Nathaniel Hendren, a Harvard economist and one of the researchers on the study.

These results should have profound implications for how we think about attempts to alleviate poverty in South Africa. Following the end of apartheid, the government decided to build large, new townships of what became known as RDP-houses in response to the massive housing backlog. These, located on the outskirts of towns and cities, was a legitimate attempt to provide shelter and a basic living standard for South Africans neglected by the previous government. But while they may have improved standards of living immediately, these new neighbourhoods had the crippling effect of locking households into poverty: far from town and city centers with job opportunities, these promises of a new future did little more than to entrench the nefarious spatial policies of apartheid. South Africa today, I venture to say, may be less socially mobile than it was at the dawn of democracy.

What does the South African city of the future look like? More urban sprawl with longer commuting times? Possibly, but then we should accept the fact that it will also be a society with lower levels of social mobility, a society locked into the inequalities of the past. The only way to expunge the past injustices is to bring the poorest closer to the city center. Public transport can help, which it is great to see that Cape Town is now building MyCiti to the poorest neighbourhoods. But it is only a beginning. Why not make Paardeneiland, located close to Cape Town’s city center, a model for new, denser neighbourhoods that cater to low-income households?

If the kid from Qunu will make it in Cape Town, he needs to live in a good neighbourhood with short commuting times for his parents. The walk to economic freedom is still too long.

Written by Johan Fourie

May 20, 2015 at 07:09