“Economic progress, in capitalist society, means turmoil” wrote Joseph Schumpeter. Society can’t move forward if we don’t make space for new ideas. If we want creation then we must accept the destruction that comes with it. You can’t have capitalism without failure.
In fact, business failure rates are highest in the places where it’s easiest to start a business and raise finance.
Yet we shouldn’t fetishise failure. Paypal founder Peter Thiel was right to say that “Failure is massively overrated”. It’s true that we learn from our mistakes, but often we learn the wrong lessons. Beyond the obvious personal tragedy, it can lead entrepreneurs to scale back their ambitions and others to write them off.
It goes without saying that we shouldn’t try to save every failing business. Protectionism traps labour and capital in unproductive firms, limiting the ability of new entrepreneurs to create wealth and raise living standards.
At the same time, not every business failure is due to a fundamentally unsound business model.
We should distinguish between necessary and unnecessary business failure. Often, passionate business owners have identified a gap in the market but lack the business know-how to capitalise on it. If they were better prepared then they might have stayed afloat and even scaled up.
The key might be management. While economists have typically hypothesised a link between management and productivity there have been few attempts historically to quantify the impact. But that’s changed over the past decade or so.
A novel study found that managerial innovations such as Taylor’s Scientific Management, Motorola’s Six Sigma (popularised by GE’s Jack Welch), and Agile Software Development increased productivity and aggregate output by almost as much as technological innovations.
In another study economists surveyed over 35,000 US manufacturing plants about the management practices they use; the results were impressive. Good managerial practice predicts a firm’s success better than R&D spending, IT spending or how skilled their workforce is. The study revealed that every 10 per cent improvement improvement in management quality was linked to a 14 per cent improvement in labour productivity.
The research also found that well managed firms were more profitable and less likely to go bust.
Put simply, when businesses are well managed they create more jobs, pay higher wages, and sell better (and cheaper) products.
Yet when it comes to management, the UK has fallen behind. A survey of over 11,000 businesses across 34 countries found that British firms are less likely to have adopted productivity-boosting management practices than their American, Japanese or German counterparts. Good news though, we’re marginally better than France. The study found that differences in management account for just under a third of differences in productivity within and between countries.
Management may seem a dry topic politically, but it’s essential to the case for popular capitalism. Competition, business-friendly regulation, and openness to trade all drive improvements and innovation in management.
Take the case for more competition and choice in public services; research from Propper, Bloom and Van Reenen found when patients had more choice within the NHS, hospitals were more likely to adopt best practices in management. This in turn lead to improvements in clinical outcomes. In other words, good management saves lives.
The same is true in education. A study that reviewed management practices in 1,500 schools across eight countries found better management was strongly linked to better student outcomes. Which school were managed best? They found that state schools with greater autonomy – think academies and charter schools – outperformed traditional state schools and private schools.
What can the UK do to catch up with Germany and the US? While the Dysons and JCBs compete internationally, the UK’s smaller firms are less likely to adopt managerial best practices. One issue could be addressing Brits’ relative unwillingness to engage with adult education and training. The UK’s business owners lag behind their counterparts in 17 other OECD nations (including Germany and the US) when it comes to engaging with job-related training.
Tax reform could help. The UK tax code currently offers no relief when workers opt to self-fund training. On this issue we’re an outlier – over two-thirds of OECD countries offer a deduction for self-funded work-related training.
We should also look at reforming the Apprenticeship Levy. Larger firms should get more freedom to use Levy payments to support management capability within their supply chain. Under the status quo, Levy funds can be put towards relatively expensive MBA apprenticeships, they should also be free to go towards shorter and cheaper course too.
But while the government can pull a few levers, the solution to upgrading the UK’s management capability might come from the bottom up. Research from China suggest peer-to-peer advice leads to better uptake of management best practices and makes firms more profitable. We need to allow the environments where fledgling business owners can learn from business veterans to flourish if we’re going to have fewer unnecessary failures and more high-quality entrepreneurship.
This willingness of successful entrepreneurs to meet with and mentor startups is one of the most striking things about Silicon Valley, arguably the centre of modern capitalism. If there is one lesson to learn from them, it’s that management really does matter.
Article originally published by CapX.
