The wheat from the chaff
Weak investment prevents new technologies from scaling, and in my view explains most of the ‘so much innovation, so little productivity’ paradox. If US tax reform boosts investment — there is a heated debate on this — it will help productivity .
But investment is not enough — the toughest challenge for a company is to reorganize its operations and strategy to leverage the full power of the new technologies.
A recent paper by Luigi Zingales (Chicago) and Bruno Pellegrino (UCLA) confirms that the quality of corporate management is crucial to turning disruptive innovation into higher productivity. Their test case is Italy, which has seen zero productivity growth over the last twenty years (a good place to look if you want to identify factors that hold productivity back):
- Italy’s productivity underperformance became dramatic starting around the mid-1990s — exactly when the Information and Communication Technology revolution began to gain traction, boosting productivity growth elsewhere. Between 1996 and 2005, US productivity growth averaged 3% per year; Italy’s a mere 0.6%.
- Meritocratic management is crucial to adopt disruptive innovations. Among other studies, Bloom, Sadun and Van Reenen (2012) find that management practices caused Europe’s productivity growth to lag the US’s during the ICT revolution.
- Italy stands out among advanced economies for the large share of its corporate sector characterized by a loyalty-based management system rather than a meritocratic one.
Management style does not evolve in a vacuum. It responds to the environment. Zingales and Pellegrino note that “loyalty-based management can function better in environments where legal enforcement is either inefficient or unavailable.” In a country with weaker institutions, a loyalty-based management can more effectively surmount bureaucratic, administrative and funding obstacles. When technology stands still, this works: Italy’s productivity growth kept up with its peers in the decade prior to 1995.
When innovation kicks in, non-meritocratic management backfires: In one of the paper’s most interesting results, Zingales and Pellegrino find that after 1995: (1) high-ICT sectors in high-meritocracy countries experienced the fastest productivity growth; (2) high-ICT sectors in low-meritocracy countries had the slowest; (3) In low-meritocracy countries, productivity growth was over twice as fast in low-ICT sectors than in high-ICT sectors.
When disruptive innovation kicks in, poor management practices will not only hold productivity back, but also push a country to specialize more in low-tech sectors, compounding the long-term productivity problem.
As digital-industrial innovation gains momentum, we are approaching a crucial inflection point for both companies and countries.
The past decade of slow productivity and economic growth has fostered complacency. In a slow-moving environment, if you don’t promote the best people, if you are not fast and nimble in re-allocating your human talent and financial resources, you pay a smaller price. If you don’t improve your business environment and your rule of law, you might still be ok. You look around at your peers and feel that efficiency-raising structural reforms and better management are just not worth it.
When innovation does get traction, though, you will be left in the dust as better managed companies and countries zoom ahead.
The productivity gap between ‘the best’ companies and ‘the rest’ has already widened — as evidenced by an excellent 2016 OECD study.
Digital-industrial innovation now raises the stakes. It has already demonstrated tremendous disruptive and productivity-raising power at the micro level. Once it scales, it will drive a wider wedge between strong and weak performers than ever before. Innovation will soon separate the management wheat from the chaff.
