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Grey suits as soooo 20th century fashion

March 28, 2009


Yesterday, I made one of my frequent trips to London. As I was sipping my morning coffee at Starbucks, looking out of the window, I was wondering how grey this city is. I am not talking about the whether now, as any good Englishman might presume; I am talking about the fashion. Almost every gentlemen seems to be wearing a grey suit, and quite a few ladies seem to adapt to the male style as well. Have they not realized that the fashions have changed? The finance boom is over, and grey pinstripes  should be 'out' as well. Other places where I hang out - like Bath, Copenhagen, or Munich - are so much more colourful than London when it comes to fashion.


Let's look at this from an economics perspective. Consider, we could convince every banker, every government official, and everyone else wearing grey that grey is the colour of the financial crash of 2008. You really don't want to be associated with the colour of that time, do you? So, every banker, governmental official and other grey-suit-wearer should be heading to his local tailor, or department store, and buy some more fashionably coloured suit. The demand thus created would stimulate demand and pull around at least one sector of the economy. Equally important, London would become so much more cheerful and colourful, and who could be a pessimistic about the economy if everyone is cheerful? So, let's campaign for fresh colours on London pavements - and don't you dare showing up in a grey suit!



Green Energy, an industry for the next upswing?!

March 27, 2009


As we are experiencing what most likely is a 'structural break' in the economy, it is crucial to identify industries with the potential for carrying the next upswing. One industry that keeps popping up in conversations is 'green energy', a broad amalgam of manufacturing and service industries that generating alternative forms of energy, or to help reducing the consumption of energy. The Guardian published a special supplement on Green energy last Wednesday, reporting new initiatives by businesses generating energy from wind, water and solar power as well as by biogas from organic refuse - and there is a steady flow of articles on that topic on their website. Closely related businesses help to save energy in the home, such as improved insulation and more efficient boilers etc, and the recycling industry which reuse both household and industry garbage.


In some countries, these industries have become one of the focal areas for economic stimulus programs, for example the US Congress allocated 65.7 billion US$ to research into energy related R&D. Equally important are the regulatory conditions under which small providers of alternative energy can sell their surplus energy into the national grid - innovative schemes along these lines played a pivotal role in creating Denmark's early lead in the windmill industry. More generally, those who develop new technologies first - possibly encouraged by forward looking policy frameworks - many generate technologies and market positions that generate long term competitive advantages. In this sense, a stimulus program to overcome the recession could build the basis for a long term upswing.


There is fiscal policy, and fiscal policy...

March 26, 2009


Governments seem to have entered a funny kind of 'mine is the biggest' bragging when it comes to fiscal stimulus programs. Fiscal stimulus programmes are about governments spending more money, and given the interconnections between economies, everyone benefits from their neighbours spending a bit more - thus the arguments about governments pushing each other to spend more.


Yet, let's get a few facts straight - everyone seems to be using different numbers in this debate. Firstly, there are automatic stabilizers, and there are discretionary spending increases. Automatic stabilizers are increases in government spending  (such as social security spending) and decreases in government revenues (such as tax revenues) that fluctuate with the business cycle. These contribute to how much a government contributes to 'stimulating' an economy. The automatic stabilizers tend to be bigger in countries with extensive social welfare systems and highly progressive tax rates - such as Northern European countries - and much smaller in countries where the state has less of a re-distributive role - such as the USA, where state are by law required to balance their budgets and thus had to drastically cut expenses when tax revenues fell.


Secondly, we ought to distinguish between government spending - be it extra payments or tax reductions - and government investment, such as building or improving infrastructure. Tax relief, such as the VAT rebate in the U.K., goes directly into citizens wallets. From there, a high share goes to savings accounts, while the remainder is spend, often on imported goods. Thus the impact on the economy is fairly weak, apart from money given to those who struggle to make ends meet, and thus need every penny. On the other hand, if additional spending goes into building infrastructure, from railways to broadband, or into education, then this provides a long term basis for economic growth, and - crucially - for higher tax revenue with which government borrowing may eventually be paid back. Thus stimulus policy should focus on investing in the future! (To make this happen before the recession is over, this may require pragmatism in planning processes, which have the tendency to hold investments up in many countries with extensive local consultation procedures.)



Extreme Environmental Change and Evolution

March 23, 2009


The other day, I was looking over my bookshelf when my eyes caught a book called 'Extreme Environmental Change and Evolution'. As I was thinking about the global crisis and its consequences, the title triggered associations that the authors had presumably not intended - this is a biology book, and it deals with the evolution of species of plants and animals. The authors are probably blissfully unaware that the word 'environment' is used by business scholars to refer to everything outside the firm, rather than the natural environment as is the normal use of the term among biologists and the general public. This notwithstanding, this study provides some thought stimulating insights:


"Extreme conditions cause periods of intense selection. They may enhance fitness differences among genotypes ... As a consequence, rapid evolution is possible when conditions are extreme. The fossil record indicates periods of rapid evolution and diversification associated with drastic environmental changes, especially where productivity is high. Uncommon conditions that are stressful can have a major impact on the evolution of life history traits and lead to tradeoffs between environments."


Ideas from evolutionary biology have stimulated evolutionary theorizing on social phenomena, though such a transfer needs to be cautious (for instance, there is no distinction of genotypes and phenotypes when it comes to firms). Yet extreme environmental change could be hypothesized to accelerate the evolution of firms and business models by both tougher selection and greater generation of new varieties. Hence, we should expect to see a lot of change in the ways business operate in the near future!

  • Hoffmann, A.A. and Parsons, P.A. 1997. Extreme environmental change and evolution, Cambridge University Press.


Redesigning Financial Sector Regulation

March 22, 2009


Last Wednesday, Lord Turner published a report on regulation of the U.K. financial sector that features prominently in the Financial Times, yet received little attention in the wider public. Yet, the reforms that Lord Turner is to initiate for the Financial Services Authorities (FSA) are probably more important to overcoming the recession that the billions of pounds spend by Gordon Brown's government. After all, this is not a conventional recession - at its core is the disintermediation of the financial sector. In other words, banks are far less willing to lend to each other, and to businesses in the real economy. Overcoming this credit crunch is most essential to turn the economy onto a positive growth path again.


At the core of financial sector regulation is - or should be - that maker decision makers carry the risk that they assume. In other words, if a loan collapses because the client was not credit worthy, then the loss should be carried by the individual and the institution that have approved the loan in the first place. It should not be possible for executive to earn huge bonuses when risky investments are undertaken, but walk away when the losses come in. Neither should the taxpayer be left to pick up the bill when large banks fail. These principles sound easy, but their implementation is rather complex, as it requires very detailed monitoring and risk assessment, and losses may often be only incurred years after the initial loan decisions.


Lord Turner's report is naturally complex, yet encouragingly Martin Wolf, and influential commentator of the F.T., takes an optimistic view. All I can do is to wish Lord Turner good luck in his endeavors.


Stock markets up 10%!

March 21, 2009


You don't believe me? We have become so much accustomed to hearing bad news that we can hardly believe good news we hear. And, unsurprisingly, I found the good news buried in the small print. I have the habit of, occasionally, reading The Economist back-to-front. And there on the last page it says this week, in a big Table of small print, that the stock markets are up by over 10% week-on-week in the U.S. (S&P 500), India, Mexico and Pakistan - and they are down in only a handful of countries, and only by small margins (Poland, Netherlands, Norway, Malaysia).


Did we already reach the end of the tunnel? Well, even an optimist like myself would not believe that - but may be there is a light at the end of the tunnel?



Survival Strategies for the Budget Segment

March 19, 2009


Not every business suffers during the recession, some are doing rather well. This includes in particular many who serve basic needs - including food, clothing and household goods - in the value for money segment. Peter Scott, business historian at the University of Reading, recently told me the story of Marks and Spencer whose turnover rose from £1.3 million in 1927 to £6.9 million in 1932, while pre-tax profits rose from £75,000 to £670,000 over the same period. Their recipe for success was to apply rigorously the latest ideas of cost focus and supply chain management: They set a 5 shilling ceiling, and aimed to provide good value for money within this ceiling. This was - at the time - an innovative approach to deliver value-for-money to cash-strapped consumers.


In recent months, in the U.K., retail chains like the Germans Aldi and Lidl for food and Primark for clothing have been reporting growing their sales and market shares, while in the U.S. so-called 'dollar stores' have been spreading. Similar opportunities exist for those manufacturing goods for these segments. What these recession-survival-strategies have in common is that they innovate business models to lower costs.


The challenge for many businesses is, however, whether push into the budget segment to benefit from the recession, or to keep their brand up-market to prosper in the next up-swing. Marks and Spencers' is positioned quite differently in 2009 than in 1929; they like many others face the challenging trade-off between short-term revenues and long-term positioning.



It's a great time to be a strategist!

March 18, 2009


Many business leaders appear to believe that we are experiencing a structural break, that is a point in economic history where old models of business are replaced by new ones. A crisis is often a symptom that the established business models have reached the end of their lifecycle. Corporate crises induce companies to rethink the ways they do their business; the current worldwide crisis should similarly induce businesses worldwide to rethink their business models. The fundamental shifts in some key economic variables suggests that the next economic boom is likely to be driven business models and industries than the last ones.


In the short term, businesses may struggle to define their survival strategies, adjusting to lower demand and less available credit. Yet, at the same time businesses have to position themselves for the next upswing. Richard Rumelt, a leading strategy professor, recent argued along similar lines in the McKinsey Quarterly: "When the business model of part or all of the economy shifts..., we speak of a structural break. Such a break often means hard times. Adjustment is neither easy nor quick. ... The first order of the day is to survive any downturns in the real economy, but the second is to benefit from these new patterns. A structural break is the very best time to be a strategist...! The the real question thus is 'what are the business models driving the next upswing?'. Rumelt suggests redesigning corporate incentive schemes and reducing complexity of organizational processes are key elements of future business models. I shall be thinking and blogging on this question in the next weeks.

  • Rumelt, R. (2009): Strategy in a 'structural break', McKinsey Quarterly 1/2009, p. 35-42.


Why did Banks get their risk management so wrong?

March 15, 2009


I have just read a conference speech given by a Bank of England Executive Director, Andrew Haldane, last months. It aims to explain a lot how the banks - and their regulators - missed the risk that they were exposed to. It reminded me a lot of what Galbraith has been writing the 'The Great Crash'. The essence of the argument goes as follows:


After the last, moderate, financial crisis of 1996, financial institutions and their regulators have been developing new techniques to assess risk, in particular 'VaR' (which is supposed to capture the worst possible loss a firm might incur in a day) and the practice of stress testing, i.e. assessing risk by running the bank's financial data through complex financial simulations. This originated in the banking sector, but it has also been incorporated in financial sector regulation, including "Basel II". The practice however has three problems. 


Firstly, the use these models fostered disaster myopia as rare events were not captured appropriately, and the 'Golden Decade' 1996 to 2007 had unusually low dispersion of key economic variables. Secondly, these models could not capture appropriately the interdependencies within the financial sector, the so-called contagion effects. Thirdly, incentive systems prevented information on risks to be communicated effectively from risk takers to risk managers, and from banks to regulators. Haldane explains these problems vividly: "According to one of those present [at a high level meeting of bankers], there was absolutely no incentive for individuals or teams to run severe stress tests and show these to management.… All the other assembled bankers began subject their shoes to intense scrutiny.” [p.12]

  • Haldane, A.G. (2009): Why Banks failed the stress Test, Mimeo, Bank of England, dated 13.2.2009.


Did we fail to teach economic history?

March 13, 2009


The teaching of economics has for decades focused on economic models, both in macro- and micro-economics. These types of models can be quite powerful analytical tools - as long as the analysis is concerned with small changes in relatively stable systems. Alas, the real world is at times not very stable. Several decades ago, an 'Economist' was someone who had a good understanding of how the economy works. Nowadays, many academic economists define their profession as those knowledgeable in the world of theoretical models, and the rigorous reasoning within the assumptions of such models.


There has been a grumbling on the fringes for some time that graduates of 'Economics' really ought to understand not only formal models, but be knowledgeable of the economy in a broader sense. Thus, Economics degrees really ought to include a range of courses such as public policy, social studies and history, to train students as rounded individuals rather than as ivory tower analysts. Yet, those calling the shots in many of the top economics departments are neither interested nor qualified to provide such broader training.


In the 1975 introduction to the third edition of his 1955 study 'The Great Crash' [see below], J.K. Galbraith wrote "As a protection against insanity, memory is far better than law. When the memory of the 1929 disaster failed, law and regulation no longer sufficed. For protecting people from cupidity of others and their own, history is highly utilitarian. It sustains memory and memory serves the same purpose as the S.E.C. [securities exchange commission] and, on the record, is far more effective". Galbraith's study outlines the grave mistakes made by millions by individuals on the New York Stock exchange, which ex post seem like madness but seemed individually rational at the time. It would be hard to believe such madness to repeat itself... until be learn about the practices that had evolved in the financial sector by 2008.


In this spirit, I would like to call on universities worldwide to make 'Economic History' a mandatory module in the Economics degree programs - with Galbraith's study as mandatory reading!



Will this Recession be as bad as that of 1929?

March 12, 2009


No! The scaremongers among the media are drawn to making this comparison, and many data suggest that indeed we are currently experiencing the worst recession since the 1930s. Yet, as things stand at the moment, there is little reason to suggest that it will get as prolonged as it was eighty years ago. The main reason is that the initial reaction of policy makers has been almost diametrically opposite: In 1929, they have been cutting expenses and tightening monetary policy, whereas  2008 they have been increasing government spending and loosening monetary policy. There are risks, and they are considerable, but the years following 1929 does not provide a good basis for predicting what will happen after 2008.


To further investigate this question, I recommend reading three documents. John Kenneth Galbraith's classic study published in 1955 provides a very readable account of the events that led up to the crash of 1929. Paul Krugman discusses the contemporary crises - both the Asian crisis of 1997 and the global one unfolding in 2008 - in a comparative perspective with the events of the 1930. Allen von Mehren provides a very systematic comparison enriched with plenty of relevant graphs of statistical data. Here is my - very simplified - synopsis of von Mehren's arguments:


Why did it get so bad?
Are we seeing the same trends?
1. Strong credit expansion ahead of crisis
2. Breakdown of financial intermediation
3. Tight monetary policy, maintaining gold standard
Loose monetary policy, flexible exchange rates
4. Tight fiscal policy
Massive expansionary fiscal policy
5. Deflationary spiral
So far, no indication (apart from falling energy prices)
6. Protectionism
So far, little indication


  • Galbraith, J. K. (1955): The Great Crash 1929, reprinted by Penguin Books 1992.

  • Krugman, P. (2008): The Return of Depression Economics and the Crisis of 2008, Penguin Books.

  • von Mehren, A. (2009): Lessons from the Great Depression, research memo, Danske Bank. web-document, February 23.


Should we blame our finance colleagues for the crash?

March 4, 2009


Recently, an esteemed scholar of economics gave me a ride in his car, and, as you would expect, the conversation turned to the banking crash and the global recession. My companion opined that, really, the blame should go to the finance scholars and their teaching of financial models. Was this just the usual jealousy between economics and finance scholars, the latter usually earning substantially better salaries for the far more narrow work?  Probably there is more to it.


University graduates are normally finance - and banking - primarily as the application of economic theories and financial modeling. They may thus indeed lack a broader understanding of how financial markets work. A recent HBR article by Rene Stulz points in a similar direction, identifying six reasons why financial risk analysis went wrong. Most important, in my view, is that using forecasting techniques that reply on historical data do not capture events that occur only once in a lifetime. Risk models capture only events that are known and can be assigned a likelihood, uncertain events such as a tsunami, a SARS crisis or a banking meltdown escape such models, leaving decision makers unprepared.


Stulz concludes his sobering review of risk management technique with a call to be prepared rather than crunching numbers:  "If you live in Florida or Louisiana, you shouldn’t spend a lot of time thinking about how likely it is that you’ll be hit by a hurricane. Rather, you should think about what would happen to your organization if it was hit by one, and how you would deal with the situation. Instead of focusing on the fact that the probabilities of catastrophic risks are extremely small, risk managers should build scenarios for such risks, and the organization should design strategies for surviving them. One might call this ‘sustainable risk management." Amen.

  • Stulz, R.M. (2009): Six Ways Companies Mismanage Risk, Harvard Business Review, March, p. 86-94.


Stop the collective fatalism, it's dangerous for our health!

March 1, 2009


It seems that many enjoy themselves in generating and publishing ever worse predictions, either because they enjoy the 'I told you so feeling', or because they have a professional interest in being pessimistic - notably tabloid journalists and opposition politicians.  Two years ago, institutions publishing their forecasting scenarios would expect their highest scenario on the housing prices to make the headlines; now they can be certain that the press will report mainly their worst case scenario, and the worse the worse-case scenario the more likely it makes the front page. Of course, it is usually mentioned in the small print that this is a worse-case scenarios, but the other scenarios are hardly mentioned. (and how many readers understand scenario planning, and thus the purpose of an worst-case scenarios?)


The problem with this competition for publishing worst case scenarios is that it has a real effect on the economy. The importance of expectations for economic decisions is well established, especially by research on inflation. Thus, central bankers are always cautious in what they say as it may form price and wage setting decisions, as well as investments. The housing price bubble that we saw until about two years ago was certainly fueled by consistent expectations in the press that prices would go up, notwithstanding that experts may offer more reasoned reflections in the business pages. Bankers seems to be blamed for giving mortgage loans to those whose budget plan dependent on rising house prices (especially 100% mortgages for buy to let properties). But private investors actually asked for such mortgages: How did they develop the expectation of continuously rising house prices - not from the professional economists!


Now we see the opposite tendency. If there is good news - like Standard Chartered Bank reporting 19% rise in profits for 2008 - it is buried in the small columns. The headlines are gives to the bad news - because that gets attention. The problem is that this practice affects the public perception of where the economy is heading - and thus millions of small purchasing decisions. The worse the headlines, the more reluctant become consumers, and the worse the economy will turn - a self-fulfilling prophecy. Journalist like to portrait themselves as independent observers. They are not! They are an endogenous part of the social dynamics of the economy. At the current stage of the recession, in my view, a collective fatalism has evolved, that has become a major obstacle to turning the economy around.



John Dunning's Legacy

February 18, 2009


Last week, we celebrated the life and remembrance of John Dunning, a scholar whom I have much appreciated both as a scholar and as a human being. John knew that his days on this earth were coming to an end, and in mid January he circulated an e-mail that called on his fellow scholars to engage with the current economic crisis. John has always been at the interface of scholarship and policy advise, being recognized not only by scholars in the field of International Business, but by policy advisors for instance in UNCTAD. He now urged his colleagues not only to conduct research on the recession - which would normally take years to get published - but to contribute to ongoing policy debate.


Between the lines - John being a gentlemen would be to polite to say it directly - I read a frustration that the public debate is too often left to journalists many of whom have a very limited understanding of, for example, what a multinational enterprise is, and how it interacts with home and host economies. On the other hand, how much do we as scholars really have to say on how to handle the current crisis for the perspective of either a corporate boardroom, or a government policy maker? Probably, many of us scholars would have some well reasoned things to say, but we wouldn't be able to do it with the kind of analytical rigour that we are trained to apply to our own work, and we are not exactly encouraged by our performance criteria (RAE and all that) to engage in public debates. John appeared rather unhappy about this limited role scholars in (British) society; in his legacy we ought to work on improving our engagement.


Note: C-numbers relate to chapters in: M.W. Peng & K.E. Meyer, 2011 International Business, London: Cengage.




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