Seminar recap, session 5, 11/30
why do institutions fail?
I posed the question of whether institutions fail for external reasons (changes in the environment) or internal reasons (natural decay of some sort).
I received a preview copy of a book by Jonathan Heskel and Stian Westlake with the vague title of Restarting the Future, which gives an example of an external factor. They argue that an important change in the environment is an increase in the importance of intangible assets. This puts pressure on a number of institutions. For example, patents take on more significance, so that mistakes in the design or execution of patent law are more serious. Debt finance works tolerably well when there are tangible assets as collateral, but not so well for intangible assets.
An example of an internal dynamic is the drive for expansion and power. An organization creates a department to solve a problem, and the leader of that department wants to increase its size and scope. You end up with an unwieldy bureaucracy.
Sometimes, institutions react to threats in ways that make things worse. For example, Ross Douthat sees the Catholic Church in the wake of the sexual revolution having a hard time recruiting priests, which made the Church reluctant to aggressively police the behavior of those priests that it had.
Another example is the Savings and Loan industry. In the 1960s, they funded long-term fixed-rate mortgages with short-term deposits. In the 1970s, this made them unprofitable. They responded by getting into riskier loans and ended up losing more money.
Also, when an institution faces a troubled future, the executives have an incentive to loot the remaining assets by awarding themselves high salaries and bonuses. This happened when the Berlin Wall fell and Eastern European companies were privatized.
In general, businesses are forced to adapt to external threats or else they disappear. Government institutions are less adaptive.
Consider schools during the pandemic. Private schools were more likely to find a way to accommodate parents, both the parents who wanted in-person schools and those who did not. But public schools gave in to the minority of parents who did not want in-person schools as well as to the constituents in the teachers’ unions who wanted schools closed. They shut down schools even though it cost them a tremendous amount of good will with parents.
How do institutions get taken over by intransigent minorities? Everyone else is looking for consensus, so if one group is intransigent the only way to have consensus is to go along with them.
Some common external factors: new technology, war, population movements, cultural changes. One example is the sorting of our work force into college-educated and non-college educated, along with assortive mating.
Internal factors include careerism, gamable education credentials, elevating DEI over merit.
The transition from a founder may put the company in hands of a political power-grabber rather than a creative, forward-looking leader. For example, a social media founder might have an ideal of free speech, but the successor may be more interested in appeasing those who want to censor.
One simple narrative for the U.S. in recent decades is that during the Vietnam War and its aftermath, radicals became professors and gradually took over universities, which in turn radicalized students who then moved in journalism and corporations. But is this a reliable story? Are college students so susceptible to radical teaching?
What to do about lack of integrity, e.g. Enron? The Board fails in that case, so you get Sarbanes-Oxley. Does that legislation solve the problem? Can you legislate morality in that way? Activision shows that ESG investing does not necessarily ensure that companies follow the ethical standards. Bebchuk’s research says that managers are incented to focus on profits regardless. For other goals, they can make symbolic gestures.
What about counter-examples of institutional improvement? Articles of Confederation replaced by Constitution; China under Deng; Jimmy Carter appointing Alfred Kahn and Paul Volcker.
How might journalism rebound? A more distributed model, with truth-seeking journalists outside of the legacy media getting more attention
How about religion? Perhaps religious Catholics will rely less on the structure of the church. Similarly with other religions.
Perhaps the Internet is creating uneven distributions of many cultural traits. Perhaps there will be various religious cults, a cult of extreme truth-seekers, or what have you.