Is the economy in a recovery? The question today is almost meaningless. That’s because “the economy” is an aggregate of three very different economies, each going at its own speed, each with its own dynamic and each with its own very different trajectory. Each of the three economies faces a different set of leadership challenges. The Traditional Economy—still the largest—is in steep and fundamental decline: it needs more honesty, vision and courage from its leaders. The seemingly prosperous economy of Financial Capitalism continues to run on bubbles and needs to be reconnected to the real economy. Meanwhile, the Creative Economy is the genuinely flourishing economy of the future: its leadership needs to institutionalize gains already made.
Three economies operating at different speeds
The Traditional Economy is the economy that we inherited from the 20th Century. It’s a real economy producing goods and services. Many of the firms in it are strong and powerful and still have plentiful resources, both tangible and intangible. They include big lumbering giants, like GE [GE] and Walmart [WMT], which mainly practice the hierarchical bureaucracy of traditional management. This way of running organizations was a good fit with the mid-20th Century when sellers were in charge of marketplace. Now these firms have difficulty delivering what today’s more demanding, interconnected customers desire. Responding to a marketplace in which customers require “quicker, faster, cheaper and more convenient” lies outside the performance capabilities of firms run with the traditional management and leadership practices, attitudes and values. For the moment, the Traditional Economy is getting by on cheap government money while waiting for an improvement in the business cycle. But its problems are not cyclical. It is an economy in steep decline with a grim future.
The second economy is the economy of Financial Capitalism. It is epitomized by the big banks which are enjoying record profits, although their fundamentals remain shaky. It is a world of financial instruments that is increasingly focused on making money out of money, often disconnected from the real economy. A significant proportion of the profits is based on gambling in the vast derivatives market (with notional value greater than ten times the size of the world economy). In this economy, generating productive wealth by financing the real economy has become a subject of secondary concern. Though Financial Capitalism is apparently flourishing today, in its current incarnation, it is vulnerable to successive crashes, such as the Long-Term Capital Management crash of 1998, the Dot-Com Crash of 2000 and the Housing meltdown of 2008. Since government bailouts protected the big banks and its executives from any harsh consequences from these disasters, its modus operandi has continued with little change, as regulatory efforts, such as regulations being written under the Dodd-Frank law, to make the system safer seem likely to have only a modest effect. It remains to be seen whether the big banks can shift their energies to reconnecting the financial sector to the real economy and assisting in the transition to the Creative Economy, or whether an even worse financial crash will be necessary to achieve the necessary transition.
The third economy is the Creative Economy. This is a real economy that generates products and services for real customers. It is booming despite the Great Stagnation since 2008. It exploits an inter-connected constellation of technological innovations and brings to the marketplace dramatic reductions in cost, size, time and convenience, new systems of infrastructure, new ways of socializing, new meaning as to how time is spent, and new ways of living these possibilities. The Creative Economy has many firms now showing the way, including prominent firms like Apple [AAPL], Amazon [AMZN], Salesforce [CRM], Whole Foods [WFM] and Costco [COST], along with thousands of lesser-known firms.
It is not an American invention. An early exemplar was Toyota [TOM] in the 1960s and 1970s with its lean production and networks of suppliers. Other firms on the international scene include the Haier Group, Li & Fung, Samsung and Zara [BMAD:ITX]. Even earlier roots can be found in the humanist management movement with Mary Parker Follett back in the 1920s.
Successful firms in the Creative Economy are tightly focused on delighting customers by mobilizing whole ecosystems that deliver continuous innovation and mass customization. In this economy, hierarchical bureaucracy doesn’t cut it. The Creative Economy requires a different, more agile, and more demanding kind of leadership and management. Because the Creative Economy is in sync with today’s marketplace, it is hugely profitable: great fortunes are created in extraordinarily short periods of time, e.g. Facebook [FB]. The productivity gains of the Creative Economy are genuine: innovations in the Creative Economy have shifted the production frontier of what is possible. The Creative Economy represents the future.
These three economies co-exist not only in the same national economy but even in the same organization. For example, GE is a firm that is still largely in the Traditional Economy, although parts of it, such as GE HealthCare, have begun to operate in the Creative Economy, while GE Finance operates as part of Financial Capitalism.
Given the stark differences in performance of the three economies, aggregate national economic statistics tend to conceal what is really going on. In both Europe and US, the Traditional Economy is still dominant: As a result, the US economy appears to be growing anemically (the Great Stagnation) while most of Europe is in recession. The Traditional Economy represents a drag on widespread prosperity. Meanwhile Financial Capitalism represents the continuing threat of another massive financial crash and a lost opportunity to help accelerate the necessary shift to the Creative Economy.
The trajectory of the three economies
The trajectories of the three economies are very different.
A. The Traditional Economy that is dying
The Traditional Economy is still the largest of the three economies. It is the economy in which most of the working population is still embedded. It is governed by the practices of traditional management—a goal of making money for the company (aka maximizing shareholder value), managers acting as controllers of individuals, coordinating work through the rules, plans and reports of bureaucracy, a preoccupation with efficiency and cutting costs, and predominantly top-down communications.
As a result of its 20th Century management practices and the associated habits, attitudes, values, and control-based ideology, in which leaders and managers decide and workers execute, the Traditional Economy lacks the capability to cope with the dynamic of today’s rapidly shifting and more demanding marketplace.
In the Traditional Economy, returns are generally meager, once accounting tricks have been set aside. The rates of return on assets and on invested capital are only a quarter of what they were in 1965, even though management leaders and business schools are still largely in denial that there is a problem or that they are responsible.
Some firms, such as Microsoft [MSFT], have found a temporarily profitable niche based on an installed infrastructure, an established brand and market inertia. Others have succeeded by propping up short-term earnings with practices that jeopardize long-term capacity to compete, e.g. large-scale offshoring of manufacturing, excessive executive compensation and questionable financial practices, such as ripping off pension funds or stuffing them with unsuitable assets like scotch whiskey, cheese or golf courses.
Firms in the Traditional Economy generally are a long way from the current frontier of what is possible in terms of speed, size, cost and reliability of communications and transactions. These firms are undergoing significant disruption from firms in the Creative Economy.
As Allen Murray writes in the Wall Street Journal, organizations in this traditional economy “have missed game-changing transformations in industry after industry—computers (mainframes to PCs), telephony (landline to mobile), photography (film to digital), stock markets (floor to online)—not because of ‘bad’ management, but because they followed the dictates of ‘good’ [traditional] management.” As a result, the life expectancy of firms in the Fortune 500 is declining from over half a century fifty years ago to less than fifteen years today.
Workers in the Traditional Economy tend to be dispirited: only one in five workers is fully engaged in his or her work. Given ubiquitous communications, they can see the extravagant financial gains in the other two economies. Given meager alternative employment prospects, workers have few hopes that things will get better. They tend to view the future with despair.
The Traditional Economy has its origins in the private sector, but the practices of hierarchical bureaucracy have spread disastrously into government, non-profits, education and health. The focus is on growth, efficiency and outputs rather than human outcomes. In these fields, “reforms” often involve intensified implementation of hierarchical bureaucracy rather than a shift towards the more productive practices, attitudes and values of the Creative Economy. Such “reforms” push these fields even further from the frontier of what is possible speed, cost, size and reliability of communications and transactions. The ‘reforms” end up constituting a further drag on widespread prosperity. Since the public is coming to expect from these sectors responsiveness similar to what the Creative Economy has accomplished, public satisfaction with government, education and health is low.
B. The economy of Financial Capitalism
Outwardly successful, with record profits, the financial sector is on a tear, but its prosperity is built on reckless risk-taking that results in repeated crashes and crisis. In the absence of meaningful sanctions for earlier crashes like in 1998, in 2000 or in 2008, Financial Capitalism continues to think that it can live and thrive without having to rely on the “boring” returns of traditional banking business. Gains made in the massive but hidden gambling casino in derivatives (now in notional terms more than ten times the size of the world economy) lead to the belief that Financial Capitalism is capable of generating wealth by its own actions, almost like having invented magic rules for a new sort of economy. The production of goods and services becomes simply another object of manipulation and speculation, with an almost complete uncoupling from the production economy that produces goods and services.
As the managing director of the International Monetary Fund, Ms Lagarde, told an audience in New York last month in the delicate euphemisms of international diplomacy. “In far too many countries, improvements in financial markets have not translated into improvements in the real economy.”
In this world of cheap government money and amazing financial gains, prices tend to become disconnected from real value. Asset inflation sets in. Debt mounts at a reckless rhythm. As some bubbles burst—LTCM, dot-com, housing—other bubbles appear, such as the Fed’s quantitative easing bubble, the derivatives bubble, the student loan bubble and the C-suite incentives bubble. Nevertheless ever-growing wealth, untethered to the value of any real products or services for real customers, can’t stay afloat forever. The only question is whether the landing will be soft, hard or disastrous.
In this world, reputation, which used to constitute a constraint on egregious behavior, has evaporated. The big financial firms like Goldman Sachs, UBS, Citibank, Bank of America, and JPMorgan Chase, have settled cases involving not just shady practices like price gouging, gaming the system, toll collecting, zero-sum trading and excessive compensation but also illegal practices such price fixing of LIBOR, abuses in foreclosure, money laundering of drug dealers and terrorists, assisting tax evasion and misleading clients with worthless securities. The cases were settled for what is chump change to the banks, without admitting or denying wrongdoing.
The management dynamic of Financial Capitalism is to win at all costs. It is maximizing shareholder value on steroids, with barely even a pretence of serving shareholders. The goal is pure and simple: making money by whatever means are available. Self-interest reigns supreme. As George Stalk, Jr. and Rob Lachenauer of the Boston Consulting Group explain in their perversely enlightening book, Hardball, these firms are “willing to hurt their rivals”. They are “ruthless”. They are “mean”. They “enjoy watching their competitors squirm”. In an effort to win, they go up to the very edge of illegality or if they go over the line, get off with civil penalties that appear large in absolute terms but meager in relation to the illicit gains that were made.
In this world, leaders tend to despise “squishy” issues like customer care, employee empowerment, boosting morale, servant leadership or social benefit. Financial Capitalism is a “dog eat dog” world. Those who don’t like or who can’t take it are whiners.
Although the champions of Financial Capitalism see it as a unique development of the last couple of decades, in reality the excesses of Financial Capitalism have appeared many times throughout history, including the Tulip bubble (The Netherlands—1636), the South Seas Bubble (England: 1711—1720), the Canal Mania (England—1790s), the Rail Mania (England—1840s), the Gilded Age (US: 1880s—early 1900s) the Roaring Twenties (US—1920s) and the Big Banks of today.
Down through the centuries, the proponents of Financial Capitalism have in each case claimed to have discovered a new kind of economy, to which economic fundamentals of production of goods and services for real customers didn’t apply. But sadly, these bursts of “creativity” always proved to be unsustainable. The day of reckoning eventually came. Sooner or later, the bubbles burst and the party was over.
In each of the previous appearances of Financial Capitalism—the euphoria has come to an end in a series of partial crises, or in one huge crash, or in some combination of the two. In the better outcomes, new forms of regulation were devised to help ease the transition back to the productive economy.
Today the talent needed to run the gambling casino of Financial Capitalism is already seeing the writing on the wall. The Wall Street Journal reports that “While Ivy League universities continue to churn out a steady stream of finance professionals, Wall Street is no longer the beacon of high pay and innovation it once was, thanks in part to a raft of new regulations, including those that curb compensation. Over the past five years, New York City employment in securities and banking fell 10 percent to 163,600 jobs, compared with a 10 percent rise in high-tech employment.”
C. The flourishing Creative Economy
Meanwhile the Creative Economy is increasingly the beacon for top talent. It has achieved extraordinary improvements in products and services, in terms of cost, size, time and convenience. It is generating new systems of infrastructure, new ways of socializing, new meaning as to how time is spent, and new ways of living these possibilities.
While companies in the Traditional Economy have been laying off staff in a slow economy, firms in the Creative Economy have been creating huge new markets and vast ecosystems of creative people. The fact that these ecosystems don’t show up in employment statistics doesn’t make them any less real.
Unlike the Traditional Economy which sees a rapidly shifting, interconnected marketplace as a problem, the Creative Economy sees the interconnected marketplace as an opportunity. It is flourishing precisely because it is built on innovation as its driving force and uses open platforms to draw on the power of many. Thus Apple has between 100,000 and 300,000 developers working on its behalf— at their own risk in direct contact with Apple’s customers: as a result, the iPhone and the iPad are able to achieve mass personalization. Each iPhone and iPad is adapted to the individual customer’s needs, preferences and passing whims—a feat inconceivable in the inwardly-focused control-minded Traditional Economy. .
The Creative Economy represents a new generation of competitive strategy and a more dynamic, and more inclusive approach to wealth creation. “Traditional scale economics were built by growing a company’s internal resources, through capital investment and hiring,” write Nicholas Vitalari and Haydn Shaughnessy in The Elastic Economy. “Today scale takes place through ecosystems of freely collaborating third parties.”
A new paradigm for leadership and management
Realizing these gains has been accomplished not just from technology but from the fundamental changes in the way these organizations are led and managed. This is not just a tweak to hierarchical bureaucracy or a new management gadget. It’s a paradigm shift in the strict sense as laid down by Thomas Kuhn: a different mental model of the world—a different way of thinking, speaking and acting in the world.
The paradigm shift in leadership and management has close analogies to paradigm shifts in science. Just as science experiences long periods of “normal science” with conceptual continuity and accretion and puzzle-solving within the existing mental framework, punctuated by rare instances of “revolutionary science” with abrupt discontinuities in the mental model of how science should be conducted, so leadership and management have proceeded for almost a century with a standard view of what is “normal” or “common sense” management: hierarchical bureaucracy.
During this period, continuing efforts have been made to stretch and bend the normal framework of hierarchical bureaucracy so as to incorporate “fixes”, such as teams, marketing, innovation, knowledge management, innovation initiatives, agile processes and the like. Because the fixes were at odds with the fundamental assumptions of hierarchical bureaucracy, the fixes didn’t stick and the gains proved to be temporary.
Eventually the internal contradictions became so great, and the growing gap between what the marketplace needs and what the framework can deliver became so large, that the normal mental model of leadership and management “broke” and a new mental model of the world emerged with a better explanation of how the world works: a paradigm shift occurred.
The Creative Economy involves not just a new process or a new system or a technique. It involves a fundamental shift in how leaders think, speak and act in the workplace. Whereas the Traditional Economy flourished an ethos of efficiency and control, the Creative Economy thrives on the ethos of imagination, exploration, experiment, discovery and collaboration. It means:
- a shift from a goal of making money to the goal of delighting customers profitably. Innovation is not an option: it’s an imperative. The only question is how.
- a shift from controlling individuals to inspiring collaboration among self-organizing teams, networks and ecosystems.;
- a shift from coordinating work by hierarchical bureaucracy to dynamic linking, with iterative approaches to development with direct customer feedback and interaction with teams and networks.
- a shift from a preoccupation with economic value to an embrace of values that will grow the firm and the accompanying ecosystems, particularly radical transparency, continuous improvement and sustainability.
- a shift from top-down communications to horizontal conversations. Instead of telling people what to do, leaders inspire people across organizational boundaries to work together on common goals.
As the paradigm shift takes hold, old self-evident truths are being cast aside. Maximizing shareholder value is declared to be “the dumbest idea in the world”. The illusive search for sustainable competitive advantage is abandoned. The supposed short-term gains of large-scale off-shoring of manufacturing are recognized to have caused massive loss of competitive capacity.
In management as in science, some thought-leaders remain intransigent and continue to noisily defend the old paradigm. But the changes of the new paradigm are now inevitable and increasingly obvious to those with eyes to see. Sacred myths are being reexamined. New questions are being asked of old data. In due course, the textbooks are rewritten and university courses are revised.
The various strands of the new leadership paradigm have a long history, going back many decades. Early exponents of the ideas were few and far between. Initially, the exemplars were seen as unique one-off experiments that could not replicated. The reaction was, “That’s just Toyota,” or “That’s just Steve Jobs.” It is only in the last two decades that we have started to see whole groups of firms implementing the ideas as a coherent and internally consistent constellation of practices, attitudes and values.
It is only in the last few years that thought leaders began to join the dots and show what was involved as representing as a single, unified and coherent approach to leading and managing any organization: in effect, the “new normal” way to run a company.