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177. Mark McGrath On After-Action Reviews

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The business-as-a-flow orientation embraces continuous adaptive change within the firm. Traditional slow-motion control mechanisms like strategy and planning are no longer appropriate. The new toolkit that entrepreneurs are developing includes the after action review (AAR), a learning tool rather than a misguided attempt at predictive control.  

Key Takeaways And Actionable Insights. 

In a VUCA world, entrepreneurial orientation embraces change and adaptation in order to reach goals. 

Learning fast is critical in times of accelerated change. A business firm must change at least as fast as its market and its external environment if it is to survive and thrive – ideally faster. In earlier podcasts, we’ve made reference to the OODA loop as a non-linear change management framework: Observe changing data, filter those Observations through your firm’s capabilities, culture, heritage, and experience to understand what the new data means to your firm specifically, re-Orient if it’s indicated, make new Decisions and take new Actions, and monitor the feedback loops for updated Observations. Speed of progression through the loop is a competitive advantage – make changes faster than your competitors. 

One of the keys to successfully managing change is a bias for action. 

It’s possible that in some situations some businesses may fear taking action – they lack confidence in their own hypotheses and are concerned that their action might be “wrong”. Austrian entrepreneurship takes a different perspective. Entrepreneurial orientation and intent shape decision-making by giving it a high potential focus and, thereafter, every action is framed an experiment from which to learn. Learning enables a greater capacity for reframing. Curt Carlson, in E4B podcast #175, told us that relentless reframing is key to success in innovation. Learning through action is paramount. 

The tool for learning from action is the AAR – After Action Review. 

The After Action Review is a simple device that asks the questions: what did we intend would happen, what did actually happen, what can we learn from what happened, what will we change next time we take action. 

  • Intent – What are the intended results and metrics? 

It’s important to continually review the shared understanding of intent among those participating in any action or project or initiative. Shared intent is the mechanism that supplies direction and thrust so that everyone is moving in the same direction. It’s sometimes called commander’s intent (in the military) or leader’s intent (in Agile team science). It’s key that every team member subscribes to and can articulate the intent. 

  • Performance – What happened? Is there a performance gap compared to intent? 

“What happened” can be a challenging question because observation is often subjective, and individuals in different vantage point and with different perspectives can provide different reports or estimations of what happened. Cultural factors become important – front line actors and individuals located lower in a hierarchy must be able to speak freely about what they observed without fear of contradiction or condemnation by superior. A performance gap must be viewed as a learning opportunity that is good for the entire team and the firm as a whole.  

  • Learning – What was the cause or source of any performance gap? 

In a high-speed learning culture, teams are eager to identify causes or issues that give rise to performance gaps. In complexity thinking, it is not always possible to identify linear cause-and-effect linkages, but it’s generally possible to identify areas for improvement as a result of experiencing a setback. It may simply be necessary to run more experiments until a better performance can be attained. It may be possible to identify obstacles that can be removed. It may be possible to identify risks that can be mitigated. In any of these cases, learning via experience (i.e., after action) advances knowledge and augments adaptiveness. 

One possible learning is that the intended result is not, in fact, within the capacity of the firm, leading to either a decision to augment capacity or a decision to redirect existing resources into other lines. 

  • Next Time – What should we change? 

Learning leads to new hypotheses which can be implemented through new action. The After Action Review identifies what changes in behavior are appropriate to try in a future action. There’s the opportunity to eliminate waste, or abandon no-longer promising trials, or experiment with improved ideas. In a learning culture, there is eagerness to return to action armed with new knowledge and to explore new potential. 

AAR’s can span all time periods: before action, during action, after action. 

When should a firm conduct AAR’s? All the time. In fact, there’s a role for before action reviews, during action reviews and after action reviews. All have the same structure. 

  • What is / was / is going to be our intent? 
  • What challenges will we expect to face / are we facing / did we face? 
  • What have we learned in the past / what are we learning right now / what caused the latest gap? 
  • What will make us successful this time / what adjustments should we make right now / what will we change next time? 

A learning culture and orientation are critical to the successful application of AAR’s. 

Learning via AAR’s is not mechanical, it’s cultural. The culture of the firm must be that there’s no development, no progress, no improvement without learning. Mark McGrath links the learning culture to the growth mindset. The relevant assessment is not one of strengths versus weaknesses but the mindset of the firm compared to that of its competitors. Seeking growth is a mindset, and so is learning. It’s a humble mindset in which we recognize our bounded understanding and seek eagerly to augment it with new knowledge. 

There are simple shared rules for individual AAR’s and for the learning culture: shared goals and mental models, open to every level of the organization, psychological safety, transparency, shared findings, preparation for next time. Within these rules, every firm can build a capacity for learning that becomes a capacity for growth. 

Additional Resources 

E4B AAR template 

Background reading – nextforge.com 

Orientation: Bridging The Gap In The Austrian Theory Of Entrepreneurship (AERC 2022 Paper) 

Mark McGrath on LinkedIn 

OODA Loop 

176. Peter Lewin and Steven Phelan: How Do Entrepreneurs Calculate Economic Value Added? Subjectively.

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At the core of the entrepreneurial orientation that is the engine of vibrant, growing, value-creating, customer-first businesses, we find the principles of subjectivism and subjective value. Subjective value embraces not only the value the customer seeks, but also the value that entrepreneurs establish in their companies: capital value. Once businesses master these two principles in combination, they can open new horizons of innovation and growth.

Key Takeaways and Actionable Insights

A fundamental advantage of Economics For Business over traditional business schools is the understanding of subjective value.

It’s hard for conventional businesses, and for the traditional instruction in business school, to fully embrace all the insights of subjectivism and the subjectivism of value. The traditional bias is towards numbers, quantification, prediction, and financial control.

Value is conflated with price and profit. Value is what customers will pay, cost is what the producer pays for inputs, and profit is the difference. Value is inherent in the thing that is produced. Finance and accounting are the numerical tools for computing these relationships.

When business embraces subjectivism, the value is not in the thing. Human minds bring value to the thing. Value comes ultimately from the consumer or end-user. They evaluate the offerings available to them and make value decisions, to part with their money (or not) to claim the value that’s offered.

Value is better thought of as a verb rather than a noun. It’s an emotional driver of decision-making.

Firms can’t impose their concepts of value on customers.

A key difference for the subjectivist approach is that customers alone determine value and producers can’t create it and sell it. Value is experienced by customers and, of course, experience lies entirely with them and can’t be reproduced or projected or simulated by producers.

That doesn’t mean that there’s no role in value generation for businesses. Steve Phelan broke down the firm’s value role into 3 parts: value imagination, value delivery and value capture.

Value imagination is a belief about the future — entrepreneurs imagine (or have a “hunch” about) a future in which a target customer experiences value from the producer’s offering, the goods and/or services they make available to customers. This imagination step is a major component of the entrepreneurial journey construct we employ at econ4business.com to help businesses generate value and grow. It’s creativity at work — where value creation starts.

Value delivery is implementation of the imagined value: designing the goods / services for commercial offering, assembling all the components required for implementation (including people in team roles as well as production assets) and taking the offering to the marketplace with a price and a value communication bundle.

Value capture concerns how much of the value experienced by the customer flows back to the producer. Typically, value production takes place in a system — perhaps including retail channels, or a wholesale partner, or a bank of financial partner. How much of the value flow do they take? Or how about competition, who might copy and undercut. Or suppliers who violate contracts or under-perform on contracted services. Entrepreneurs must pay close attention to value capture.

Subjective value thinking extends to business investment decisions.

Subjectivism applies not only to value but to the assets of a producing firm. The subjectivist approach understands assets as providers of potential services that customers might value. Most classes of assets (including people) can be assigned to multiple different uses and multiple configurations for the provision of different services. Entrepreneurship weighs up — evaluates — all the possibilities and assigns the assets to their greatest value generating uses.

Value calculus assesses the value-producing arrangements inside the firm.

Entrepreneurial producers of value face in two directions: outward to the market and customers, and inwards to the firm and its internal organization.

Looking inwards, producers must calculate which assets — including both human capital assets and physical assets — in which combination result in the greatest value for customers at the least cost. This requires an evaluation that assesses value flowing to the customer from the firm. Since value is subjectively determined by the customer, this calculation is extremely challenging. Peter Lewin called it subjective quantification, and Steve Phelan used the term value calculus. It’s a combination of qualitative and quantitative assessments that’s learned over time. It’s highly contingent on the (changing) value preferences of customers.

Internally, managers must combine their people assets and physical assets in a way that produces most value based on this uncertain and changing value calculus. Entrepreneurs and owners can’t be the decision-makers for everyone, and so the organizational technology must be designed for greatest value generation. Instructively, that organizational technology has been changing over time — from highly structured and divisionalized organizations to today’s more open, networked, and interconnected organizations.

The tool for capturing this value calculus is EVA — economic value added.

Capital is a value. In fact, Ludwig von Mises remarked that it was unfortunate that business ever coined the term capital goods, because it tends to make us think of capital as something solid and fixed. It’s not — it’s the result of the value calculus that Steve Phelan talks about.

Capital value can be measured, but not in the way that is captured on a P&L or a balance sheet — creating numbers that appear to be exact, and fixed and fully determined. Entrepreneurs must estimate capital value and the estimate is that of the valuer. They do so algorithmically — there’s a process and a routine but it’s not necessarily mathematical. It includes breaking down the asset combination into smaller and smaller components — perhaps individual people or teams, or perhaps divisions versus the entire company, or perhaps some set of components that can be thought of as an integrated grouping — and assessing their relative capital value contribution. Money values can be used since this helps the expression of relative value, but the algorithmic computation is never exact. Its validity is always in the eye of the valuer. The goal is to find costs that don’t add value, or don’t add as much value as other costs.

Accounting and finance — one looking to the past to measure what happened and one looking to the future to predict what will happen — offer objective-looking numbers, but they truly reflect the subjective value calculus of the entrepreneur in trying to allocate economic value added as accurately as possible.

Additional Resources

“An Austrian Theory Of The Firm” by Peter Lewin and Steven Phelan: Mises.org/E4B_176_PDF1

Austrian Capital Theory: A Modern Survey of the Essentials by Peter Lewin and Nicolas Cachanosky: Mises.org/E4B_176_Book

“Entrepreneurship in a theory of capital and finance — Illustrating the use of subjective quantification” by Peter Lewin and Nicolas Cachanosky: Mises.org/E4B_176_PDF2

175. Curt Carlson: Value Creation as a Life Skill

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Curt Carlson has devoted his life to value creation and innovation — VC&I as he sometimes characterizes it. He has been CEO of SRI, a “pure innovation” company where the business model was to create important new innovations that positively impacted the lives of many people. Examples of his innovations are Siri (ultimately sold to Apple) and HDTV (the technology that enables the streaming so many people enjoy today).

He started a consulting company called Practice Of Innovation, which established methods of innovation available to everyone and every firm. Now he teaches at University, aiming to develop a new generation of innovators.

He talks to Economics For Business (econ4business.com) about value creation and innovation as a life skill.

Key Takeaways and Actionable Insights

Value Creation is a complex adaptive system.

Value creation is a system of many agents, components, arrangements, technologies, constraints, and unpredictable emergent outcomes. There are a challenging number of variables, and there’s a requirement for highly integrated collaboration and recursive and iterative process, utilizing adaptive feedback loops and continuous readjustment. It’s hard — and quite rare — to get right and easy to get wrong.

The essential element of value creation is the mental model.

The mental model for value creation is solving important and meaningful problems for others. It shouldn’t be about launching a new business or a new technology, but about helping others. And, since people don’t think in terms of “I have a problem to solve,” the value creator must also understand the customer’s mental model. They experience dissatisfactions. They wish things could be better. They make trade-offs. They can’t always articulate what they want. They have to learn what to want, and value creators can help them to understand what they can want in the future.

Mental models are fundamentally important to the creation of value. We all have mental models of the way we’d like the world to work. The value creator is able to identify — “get inside” — others’ mental models and see the world the way others see it. This perspective is vital — the critical first step in the value creation process.

The calculus of value is subjective.

Value can only be defined by the individual who experiences it. Individuals make a mental calculation of value – it might include some numbers and some thoughts, feelings, preferences, and ideas. They are able to make this calculation in their own mind, even though the potential costs and benefits lay in the future.

The dimensions of value are many. When evaluating the purchase of a car, for instance, the price is part of the calculation, but so is the appearance and pride of ownership, the comfort, the gas mileage, the color of the seats, the cost of maintenance, and many, many more features and attributes and functional and emotional benefits.

Despite the difficulty and complexity, people are agile and adept at making this complex calculation. Value creators must be able to appreciate how customers make the subjective calculation — the calculus of value.

The removal of barriers to the experience of value is a good way to create it.

Convenience is often highly valued by customers. It represents the removal of barriers to value – easier to operate, less time taken, less physical or mental effort required. These are all valuable. The iPhone provided a more convenient way to enter data (responsive touch screen versus traditional keypad), and this played a big part in its adoption and success. The mental model is that people want to do things that are easy to do. They don’t want the clumsiness of a tiny keyboard on a phone. They don’t want to read a 20-page user guide for a new piece of software. They don’t want packages that are difficult to open or retail stores that are crowded and hard to shop. Identifying and understanding mental models like these gives skilled value creators their competitive advantage. If barriers are perceived negatively by customers, then create value for them by getting rid of barriers.

A need is not a problem to be solved. A need is a mental model. Reframing is the tool for understanding.

Curt uses the example of the slow elevator in a prestigious office tower. Residents complain. Engineers might try to solve the problem by re-engineering the elevator for greater speed. A value creator would try to identify the mental model of the complainers. That’s reframing. They are annoyed because they feel that their valuable time is being wasted; they’re bored for a few seconds. Understanding this mental model opens up the possibility for new value approaches. Add a digital screen in the elevator with a news feed so that people can use the time to catch up on the latest headlines. Or add a mirror so that they can use the time to check their clothes and hair before going into the meeting.

Most value creation challenges can be better addressed through reframing. In fact, Curt describes his innovation method as “relentless reframing”. The art of value creation is teasing out the customer’s mental model. Do it again and again, back and forth between the value creator and the customer, to get the understanding of the customer’s mental model right.

Value creation is coupled with innovation: VC&I.

The definition of innovation is not just the new idea or new product or new service. It’s the sustainability of any new solution once it’s delivered into the marketplace. Customers use it and prefer it, they pay enough for it to sustain the financial business model, they repeat their purchases and provide supportive comments and assessments. To be truly sustainable, the innovation must appeal to a lot of people, not just a few early adopters. The benefits must be greater than the costs to the user, based initially on their value calculus, and subsequently on their actual experience. And the offering must be better than competition. To get customers to change from a competitive offering, Curt says the degree of superiority must be 2X to 10X.

Curt uses the N-A-B-C process tool as a methodology for innovation teams.

On previous visits to the Economics For Business podcast, Curt has laid out the framework of his N-A-B-C model and how to use it. See our E4B graphic tool (Mises.org/E4B_175_PDF) and the Key Takeaways summary from the podcast #37 (Mises.org/E4E_37).

N = Need: Identifying and understanding the customer’s mental model, and perceiving the world as they perceive it, getting to their perspective of how the world can be improved. This is where relentless reframing applies.

A = Approach: Designing an innovative solution with a sustainable business model. The temptation is always to jump straight to the approach without truly understanding the Need, according to Curt. This always leads to error and requires a pivot.

B>C = Benefits Per Costs: This is the customer’s value calculus, very hard to get right as a result of its multi-dimensionality and combination of qualitative and quantitative measures.

C = Competition: What are the alternatives among which customers are choosing, whether direct or indirect – remembering that not buying anything is an alternative they’ll consider. Overcoming inertia requires a high degree of superiority.

Our econ4business.com toolkit (Mises.org/E4B_175_PDF) includes a full explanation of how to apply this tool.

Value Creation and Innovation is a life skill that can be taught to everyone.

Solving others’ problems is a deeply human activity. We’re all wired to do it for each other, every day. Value creation can be taught to kids of any age in school, and it can become a life skill. It can be taught to people studying any discipline in universities and colleges, from humanities to hard sciences, so that they can apply it in their field. It can be taught in every firm, whatever the line of business.

The resultant life skill is the mental model that life is about solving meaningful problems for others. It’s about understanding and appreciating others’ mental models. Reframing is the tool for gaining this understanding. Value creation is a fundamental capacity for everyone. They can make an impact on society by solving problems that matter.

Additional Resources

“N-A-B-C Innovation Process” (PDF): Mises.org/E4B_175_PDF

Curt Carlson on Innovation Champions: Mises.org/E4E_91

“Answering the Million Dollar Question (Part 1)—How Value Creation Forums Help Create Winning Research Proposals”: Mises.org/E4B_175_Article

174. Sterling Hawkins: Discomfort Is Your Most Valuable Feedback Loop

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Negative feedback loops are the ultimate source of value. Mises called it “uneasiness and the image of a more satisfactory state”. Bill Gates said that “Your most unhappy customers are your greatest source of learning”. Negative feedback loops give us the opportunity to improve our service delivery capacity, and the value proposition behind it. Sterling Hawkins has identified the ultimate feedback loop for personal performance. He calls it discomfort. We should seek discomfort, analyze it, understand it, and utilize it as an ultimate tool for improvement. His book is titled Hunting Discomfort (Mises.org/E4B_174_Book) and we talk to him about it on the Economics For Business podcast.

Key Takeaways and Actionable Insights

Discomfort is a feedback system.

There will always be physical, mental, emotional, or even spiritual discomfort in our lives. It’s necessary and useful. It signals to us how we are interacting with our environment. It keeps us oriented. Sterling’s case is that we shouldn’t try to avoid it, we should embrace it – he recommends that we actively practice hunting discomfort. Once we find it and embrace it we work our way through it, and the result is personal growth. We get better.

First, face reality.

The first discomfort Sterling outlines is facing reality. In business, we often say that it’s a great challenge to align the firm’s internal assessment of reality with what is actually going on in the external environment, especially in times of rapid change. We may just not see reality accurately. Our product may not be as well-liked by customers as our research tells us it is.

We can’t change reality, but we can change how we see it. We can change our belief structure. One way is to run many experiments where we can objectively and empirically measure results, and expand on what works and discard what doesn’t. We might find some things that work that we didn’t believe could. And we might find that we thought worked simply does not. Both represent valuable learning and provide us with a reality we can grasp.

Eliminate self-doubt.

Self-doubt is mentally wrestling with questions and beliefs and insecurities. It’s the world of “I might” rather than “I will”. Sterling’s advice is that self-doubt can be a gift. It indicates an unwillingness or inability to commit. And yet commitment is often associated with entrepreneurial success. It’s part of what Professor Peter Klein calls entrepreneurial judgment: the capacity to choose which action to take and to follow through with it.

Choose your commitment as wisely as you can – which includes choosing those actions not to take. Sterling’s metaphor is Get A Tattoo. It’s an irreversible commitment everyone can see.

Some people find discomfort in exposure.

If you commit, you might feel more exposure than you’re comfortable with. You might have to raise money, when it’s not your skill. You may have to make a presentation about which you’re not feeling 100& comfortable. You might be the only one expressing disagreement in a meeting full of groupthinkers.

Sterling’s recipe is to assemble a support group — he calls it your street gang. They’re supporters, subject matter experts, mentors. You’ll make your commitment to them, and they in turn will give you honest feedback, trust, and loyalty. You’ll still be committed but you won’t feel so exposed.

We take on greater and greater challenges — and that’s uncomfortable.

As businesses take shape and grow, the challenges only get bigger. We might get to the point where we want to avoid some of the big challenges. But that’s the wrong viewpoint. The alternative is to turn challenges into an opportunity to find new ways to utilize our resources — to use them as a portal to advance from the status quo to a new reality. The method is reframing. What if you tried the opposite of the status quo solution? What if you looked at the challenge through someone else’s eyes, using their mental model rather than your own – what would they do? What if you change the assumptions about the way you’re addressing the challenge? There are many ways to reframe challenges, and reframing can release you and give you new energy.

The greatest discomfort is uncertainty.

Economists talk endlessly about uncertainty in business. It’s a consequence of the unknowable future. But you own your own uncertainty — for entrepreneurs, it’s a feeling, not an economic concept. It’s subjective. We’re not only uncertain about outcomes, but about resources, about financing, about our capacity, about our partners. Uncertainty is multi-dimensional. It’s also guaranteed — we can’t avoid it.

Economists, therefore, say that entrepreneurs bear uncertainty. It’s what they do. It comes with the job. Sterling’s word is surrender: don’t fight or fear uncertainty, but accept it willingly as a cost. Give up resistance. Get into your discomfort zone. Entrepreneurs need to be doing hard things most of the time, however uncomfortable that might be.

Additional Resources

Hunting Discomfort. How To Get Breakthrough Results In Life And Business No Matter What by Sterling Hawkins: Mises.org/E4B_174_Book

Visit SterlingHawkins.com

173. Rene Rodriguez: Unleashing Voluntary Energy Via Influence

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How do we change others’ behavior? In business, it’s a challenge we face every moment. Can we persuade a customer to switch to our brand or service? Can we get the board or the C-Suite to approve our proposal? Can we convince a VC to fund our startup? The common denominator across all these tasks is influence. How do we make the case with sufficient influence? The solution lies in using tools informed by Neuroscience. Economics For Business talks with Rene Rodriguez about his book Amplify Your Influence (Mises.org/E4B_173_Book), and his research into the neuroscience behind influential interpersonal communication.

Key Takeaways and Actionable Insights.

Influence is a determinant of business success.

In the past, there was a classification distinction between “soft skills” in business management and the more highly respected quantitative capabilities of finance and strategic planning. Today, that is no longer the case. The ability to harness communication to change others’ behavior is fundamental to making progress in the business world, and an inability in this area means an executive or manager will be perceived as ineffective. Setting out a vision that no-one follows is fatal.

Influence is also the way to help people make better choices for themselves.

Influence can be considered by some to be manipulation, but there is absolutely no need for that perspective. Influence may be exerted to help people better evaluate the choices and options open to them. Influence is providing information that may not otherwise have been available to the audience, or that had not been considered in the most appropriate light. Influence unleashes what Rene Rodriguez terms “voluntary energy”; they are pleased and delighted to be offered a better decision-making path.

There is hard science behind the soft skills of influence.

Influence is applied neuroscience. Neuroscience explains how and why humans resist change. It’s a threat. The first reaction to any new information is often resistance. We don’t like to question what we believe we know, or abandon the guidelines on which we’ve been operating, or change the heuristics we use. It’s a common, shared trait.

That’s why influence is the “how” of leadership: influencing behavior change when the natural response is to resist it. It’s also the goal of marketing, teaching, managing, selling, and communicating.

It pays to learn a little bit about neuroscience for each of these actions.

The power to influence can be amplified by using three techniques.

As with any business tool, there are techniques that can be perfected to improve the performance in use. Rene highlighted three:

Sequencing: The brain processes information in certain sequences. First, it looks for threats (like “change” or “new ideas”) in order to sort between danger and safety. If it perceives a threat, it shuts down – no influential communication will get through, Next it seeks value – feelings of being valued, being engaged, being inspired. The right sequence of message delivery starts with a communication of positive value (so that the brain can believe it is in a safe place), followed by communication of caring, active engagement and inspiration.

Framing: people perceive their own reality through their own framing. If your frame of reference for pizza is high calories, excessive cheesy fat and too many carbohydrates, it doesn’t matter how delicious the pizza recipe Pizza Hut presents to you, you are going to be unreceptive. In the battle for attention and shared meaning, an influencer must set and claim the frame in advance of any message presentation. Communicators and innovators practice framing and reframing to improve their skills. For example, creative innovators always create the frame of solving a problem for others, requiring them to see the problem as others see it and experience it, and enabling the future communication of the solution as a relief of unease or removal of dissatisfaction or discomfort. Framing is based on empathy – seeing from others’ perspectives and aligning with their values. That’s why the Economics For Business value proposition design tool starts from “Who is the customer?” and “What is their need?”.

The tie-down: There needs to be a close. Our target audience’s brains are flooded with information from all directions at all times. We need to make our message stick. The tie-down is a tool to make sure the audience has the chance to understand what our information will mean to them, what value it can add to their lives, and how it will help them achieve their goals.

To ensure execution of the tie-down, Rene recommends that we all have an Influence Objective in mind: the specific action, thought or behavior we are aiming to influence. The tie-down is often a summary or emphasis of benefits, or a powerful takeaway or a “magic phrase”. It ties down our message in the audience’s brain.

The art of influence lies in storytelling.

Brain scans show that when we are caught up in a story told by a skilled storyteller, we stop daydreaming and become fully present. We become focused. We narrow our attention to what the storyteller is saying. There’s a response in positive brain chemistry, as well as empathy and trust — a neural coupling between the storyteller and the audience.

Stories help us organize data, discern value, and make better decisions. Influencers work hard at becoming good storytellers. Rene left us with a 10-step guide, which we provide as a free pdf.

Additional Resources

Amplify Your Influence: Transform How You Communicate and Lead by Rene Rodriguez: Mises.org/E4B_173_Book

“10 Steps to Amplify Your Influence” (PDF): Mises.org/E4B_173_PDF

172. Christian Sandström: Why Governments Can’t Act Entrepreneurially

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A strange strand of thought has emerged in European political economy circles that has been given the name of The Entrepreneurial State. The headline claim is that the state (i.e., nation state governments) can and should intervene in the economy to bring about innovation, and that, indeed, it is absolutely necessary for grand, mission-driven undertakings such as climate change amelioration and the commercial development of next-generation technologies. Economics For Business talked to Christian Sandström, co-editor with Karl Wennberg, of Questioning The Entrepreneurial State, a compendium of analysis by thirty-two leading economists (including friends of E4B such as Peter G. Klein, Samuele Murtinu, and Saras Sarasvathy) to demonstrate the fallacies of the case for an entrepreneurial state. There’s a lot of sound economics to be learned from Professor Sandström’s book.

Key Takeaways and Actionable Insights

There’s a warm climate in Europe for government solutions to perceived economic problems. “The entrepreneurial state” is one of the forms these solutions take.

Entrepreneurship is well-developed in Europe, and recognized as a growth accelerator. Nevertheless, since 2008-9, country-level growth rates have been below expectations.

Professor Mariana Mazzucato originated the concept of “the entrepreneurial state”, telling fellow economists that they were all wrong in expecting growth to come from private entrepreneurship. Only government has the scope and scale to act entrepreneurially at the level of lifting the growth rate of the whole economy, overcoming the barriers to the introduction and commercialization of new technologies, and tackling the great missions such as climate change amelioration. Historically, she claims, this precedence has always applied: the state leads innovation and private entrepreneurs follow to fine tune the details of marketplace adoption and implementation.

The ongoing failure of Green Deals represents just one illustration of the errors of the entrepreneurial state.

One essay in Professor Sandström’s book spotlights what he calls Green Deals: directed investments in various technologies aiming at so-called sustainable development. Public funds distort incentives in the market, making it “rational” for firms to pursue technologies without long-term potential.

One of his examples is a municipality in northern Sweden that accumulated billions of Swedish Krona in debt investing in industrial plant aiming to create car fuel from cellulose, with the ambition of creating an environmentally friendly substitute for gasoline, which would also result in new jobs and a regional resurgence in competitiveness. The process of extracting ethanol from cellulose proved to be more difficult than promised, and no technological breakthroughs occurred. The 2008 recession resulted in falling prices for ethanol, yet more public money was poured in. The end result has been a high debt burden on the municipality, no new jobs, and no reindustrialization for the region.

As Professor Sandström and his co-author Carl Alm conclude, this case and other similar cases stand in stark contrast to ideas about an entrepreneurial state successfully taking on risk and pursuing new technological opportunities.

There are fundamental reasons why governments can’t act entrepreneurially.

First, governments don’t operate in markets and they are not subject to market tests, like going out of business if they fail to meet customer needs. They bear no genuine entrepreneurial risk. They have no competitors and so no process of competitive refinement and improvement. Their entrepreneurial actions can’t be evaluated. In effect, they want to achieve innovation without entrepreneurship, which is an impossibility.

Governments lack the required competence for the tasks they claim to be able to undertake.

Peter Klein, Samuele Murtinu and Nicolai Foss introduce and explain the economic concept of ownership competence. Entrepreneurs operating in competitive markets have strong incentives (i.e., their own property and their own funds) to allocate resources that they own or control to the most productive applications and to generating the value that the market prizes most highly. Knowing what to own, when to own it (or dispose of it), and how to create value through ownership, all under conditions of uncertainty, requires a skill set that bureaucrats and public actors don’t have and can’t exercise. Public employees can’t exercise the ultimate responsibility that comes with ownership.

Bureaucrats can’t reproduce the human factors of entrepreneurship.

Saras Sarasvathy introduced us to the entrepreneurial method of business innovation in episode #131 (Mises.org/E4B_131). Entrepreneurs self-select into the role of uncertainty-bearing, and then initiate projects and advance through a process of market co-creation, making commitments and then adjusting those commitments based on feedback loops and customer responses. They develop a lived experience that enables them to identify new goals to pursue and new means for pursuing them along the pathway. Creativity and adaptability are more relevant to success than investing acumen and planning.

Governments can’t operate in this way. They place big bets, with quantitative goals and illusions of predictability of outcomes, and they pay with other people’s money. They are not capable of finding the serendipity that guides the entrepreneur.

Governments don’t understand the innovative generativity of new technologies.

Professor Sandström’s book includes quite extensive examination of what is identified as the Digital Platform Economy (DPE) — the digital entrepreneurial ecosystem of platform access to markets, data, algorithms, and cloud computing capacity (There’s a useful report on the DPE provided in the book at the end of episode 131. Digital platforms are enablers for entrepreneurial creativity and business building as a consequence of the access that they give to new business tools and the interconnections to resources, both human and material. The platforms are provided by private companies, and the resulting value creation is user and customer co-generated.

Governments misunderstand the Digital Platform Economy. They see platform providers as monopolistic owners of excessive market power to be regulated and taxed, and totally miss the value generation of hyper-connectivity between buyers and sellers, the complementarity of firms on both sides of the platform, the open access and the lowered transaction costs.

These digital platforms will do much more to encourage entrepreneurial growth than any government ever could.

Governments’ errors are repeated because there is no genuine evaluation of their activities, initiatives, and “missions”.

Professor Sandström investigated the way that the results of government innovation expenditures and initiatives are assessed. He found that most evaluations are conducted by consultants, paid by the hour and mindful of the opportunity for future business if their work is well-received by the government that employs them. Some other assessments are conducted by the government departments themselves.

Perhaps unsurprisingly, Professor Sandström could find only 5% of these assessments that were critical in any way (mostly simply to say that the desired results were not achieved).

Moreover, the assessments were economically incomplete. There was no identification or discussion of opportunity costs (what better uses could the funds have been put to) or of administrative costs, which are high since bureaucratic infrastructure grows with each new initiative.

The government’s best role is to remove itself as a barrier, and possibly to help remove additional barriers (for which it often bears responsibility in the first place).

Is there such a thing as innovation policy? Professor Sandström says no. He does point out that, in the Austrian tradition, removing barriers to entrepreneurship can help to create the type of environment in which innovation can flourish. This might involve the elimination of legislation and regulation that gets in the way. It could also include nurturing educational institutions to bring the right kinds of thinking and learned skills into the marketplace.

Any such initiative should be general and non-selective. Picking winners should be left to markets.

Additional Resources

Questioning the Entrepreneurial State: Status-quo, Pitfalls, and the Need for Credible Innovation Policy, edited by Karl Wennberg and Chris Sandström (PDF and ePub): View The Book

“The Digital Platform Economy Index” (PDF): View The PDF

Chris Sandström on Twitter: @ChrisSandstrom