Leadership, the economic critique

01/11/2012 Comments Off on Leadership, the economic critique

One of the keys to economic thinking is models. We are always simplifying the world into models of cause, effect, and interaction. Economists try to do this explicitly, to write down the inputs (causes), outputs (effects), and equations (interactions) in a way that clearly explains our mental models. Then, they ex-sist in a way that allows us to play with them openly and consistently.

When we are analysing a particular phenomenon, the choice of model is very important. In this, the third of four reviews of The Leadership Challenge, by James Kouzes and Barry Posner, I’m suggesting a few different economic models and trying to figure out what they mean for leadership.

One model is the $20 bill on the footpath. It’s an old economics joke. An economics professor and a graduate student are walking down the street. The graduate student says, ‘Hey, there’s a $20 bill on the footpath.’ The professor replies, ‘No, there’s not. If there were, someone would already have picked it up!’

Another model is a standard production model, in which factors of production are combined to produce outputs. In addition to land, labour, and capital, we can add other factors like entrepreneurship, managerial capability, and leadership. We can imagine two scenarios: both have the same physical inputs, but one has high leadership and the other low leadership.

The second model suggests that, yes, we can produce more. We can be more productive and more efficient. This is essentially what The Leadership Challenge is offering. With low leadership, employees are not engaged and are not contributing to the full extent that they could. With high leadership, they can be encouraged to work harder and smarter, to present new and better ideas, to do more.

This is where the first model comes in: if there are these $20 bills lying around that can be ‘found’ by reading this book, we would expect that they would have already been found.

The likely explanation is that leadership is hard. Learning about and practising good leadership takes time and effort. Adding more leadership to your production function isn’t costless and its success is uncertain. If a business wants to produce more, it may be better off adding more machines or workers, rather than worrying about the uncertain pay-off from leadership training. It is safer to depend on mediocre leadership.

There is an interesting wrinkle, though. From the firm’s perspective, it may be safer to assume mediocre leadership. However, the individual’s perspective is different. An individual can become richer by increasing human capital, in this case, leadership abilities. Furthermore, self-help books are efficient from the firm’s perspective. The firm doesn’t have to select people, spend resources training them, and then discover that it has only a 20% success rate (or whatever). Instead, individuals self-select as those who are willing to spend time improving their leadership, bear the costs, bear the uncertainty of success, and then potentially reap the benefits of improving their own human capital. The firm provides the environment in which individuals could improve their fitness by improving their leadership, but allows variation and selection to do the work of identifying those superior organisms.

You will have noticed that I have slipped into a third model, that of evolution.

A further observation: the low price and wide distribution of pop-management books is further evidence of the difficulties with leadership. Here, I take up a fourth model: expected value. Let us assume that the gains to good leadership are as great as suggested. That is the potential payoff. Expected value is the potential payoff multiplied by the probability that it will happen:

EV = probability * payoff.

If I as an individual invest in buying and reading a book, I am investing according to the EV of the self-improvement project. A $40 to $50 book and a few hours of my time reading is a relatively low investment. If the payoff is huge — tens of thousands of dollars to me, personally, and thousands or potentially millions to the firm — the the probability of success must be quite small. Just to throw in some numbers:

$500 per year = probability * $10,000 per year

probability = 5%.

There you have it, four economic models for thinking about leadership: $20 bills, production function, evolution, and expected value. They all suggest that leadership is hard and uncertain. I don’t think Kouzes and Posner would disagree. The difference is that their book cheers, ‘You can do it!’ My models mumble, ‘Well, no, you probably can’t.’


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