The Long View 2002-07-02: Innocence is no Excuse

John's specialty was business law: boring things like securities and the UCC. I can see why he turned to millennialism [kidding!]. In passing, he notes the securities law has a great deal more to do with regulation than legistation per se. This is true in my field as well. For example, 21 CFR 820, which governs current good manufacturing practice for medical device companies, is actually rather terse.

Later, John mentions one of the persistent, yet unremarked scandals of modern American finance, the 401k. It took me a long time to understand what John was getting at here. Comprehension finally dawned when I was reading about the former physicists turned programmers, known as quants, who make exorbitant amounts of money in Manhattan.

These physicists create ever more complicated models of asset pricing which are then fed into equally complicated trading programs that watch the market and continuously make trades based on the models. At first, I assumed that the various hedge funds were competing against each other. This seemed bizarre, they were all doing the same thing, and no one seemed to have a competitive advantage, yet they are all making money. Then I realized: they aren't making money off each other, they are making money off you [and me].

This is why John called the 401k a bubble machine; by privileging this kind of investment accout with tax-deferred status [and perhaps more importantly, legitimizing it as the way middle-class Americans save money], a continual inflow of money to the stock market was ensured. 401k programs get money every two weeks [or whatever pay period you have], and then that money is invested per whatever plan the fund managers set out. I imagine there is a great deal of discretion involved, but to the high-volume traders, this must seem like easy pickings.

When I realized this, I did the only rational thing: I hired some quants to be my financial gladiators.

Innocence is No Excuse

Sometime in the mid-1980s, I was writing an article about a new regulation from the Securities and Exchange Commission having to do with the Glass-Steagall Act, the Depression Era law that separated the businesses of commercial and investment banking. I did not know much about the subject, so I called the SEC for clarification. They were actually very helpful. Toward the end of the conversation, however, I asked for a citation to the Act in the US Code. It was as if I had asked for a citation to the Code of Hammurabi. "We don't have information like that!" the woman at the legal division said in shocked annoyance. She hung up on me.

It is notoriously the case that the law dealing with securities has little to do with actual legislation and everything to do with regulation. The whole edifice of insider-trading law was based on a short, cryptic statute prohibiting "fraud." The Congresses that passed the bulk of financial regulation legislation favored broad terminology. The reason was explicit: a precise law would let traders ignore the broader policies of the regulators. It is, by the way, no accident that the Congresses in question are called "Depression Era": federal policy probably extended what would have been a short, sharp slump after 1929 to cover the following decade.

The chattering classes are in the mood for a replay. Both the president and vice president are hounded in public for acts not normally considered illegal. The vice president, indeed, is being sued by pretty much the same people who made Bill Clinton's life a litigious misery. Reams of legislation are rolling through Congress to criminalize "schemes" and "devices" that defraud investors in no very precise way. There was a moment, during the Congressional panic over the collapse of the savings & loan industry, when some nitwit introduced a bill to mandate life imprisonment for "S&L kingpins." We are approaching that level of inanity now, but the real danger is not more vindictive criminal law.

The class-action bar wants a piece of this. There was good money to be made during the early '90s in suits brought in the name of shareholders. Corporations were shaken down for hundreds of millions of dollars because their officers made remarks that did not perfectly predict the future behavior of the stock. Some shareholders may have gotten a cut, but the suits were essentially rackets operated by lawyers in search of class-action fees. In a fit of sanity, Congress made it harder to bring such actions. Now there is serious pressure to put things back the way they were, or make them even worse.

I can only repeat that there is nothing mysterious about what is being called the "accounting scandals." John Kenneth Galbraith once remarked that recessions reveal what the auditors missed. They also reveal what the auditors tried to cover up. When equity prices rise, businessmen are geniuses. When prices fall, businessmen are crooks. The crookedness this time around is that some businessmen used accounting and other devices to prevent their companies' stock from falling.

There are systemic problems with the financial system, but they are not the ones that people are talking about. Frankly, there is too much money in it. Ordinary people should not be using equities markets as a savings vehicle. Consistent high rates of return are possible when only a small fraction of the people are in the market. When more money is invested, it's worth less. The extreme case is Japan, which is drowning from overinvestment.

The current "crisis of confidence" in US markets will dissipate in fairly short order. The curse of the 401K will not.


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Lean Manufacturing

As I mentioned yesterday, lean manufacturing didn't really take off in the US until the 1980s, despite being developed here first. I wonder whether this may be due to the baleful influence of Frederick Winslow Taylor. Taylor is an influential figure in US managament theory, but while he called his approach scientific management, there wasn't any real science to it.

Management theory came to life in 1899 with a simple question: “How many tons of pig iron bars can a worker load onto a rail car in the course of a working day?” The man behind this question was Frederick Winslow Taylor, the author of The Principles of Scientific Management and, by most accounts, the founding father of the whole management business.

Taylor was forty-three years old and on contract with the Bethlehem Steel Company when the pig iron question hit him. Staring out over an industrial yard that covered several square miles of the Pennsylvania landscape, he watched as laborers loaded ninety-two-pound bars onto rail cars. There were 80,000 tons’ worth of iron bars, which were to be carted off as fast as possible to meet new demand sparked by the Spanish-American War. Taylor narrowed his eyes: there was waste there, he was certain. After hastily reviewing the books at company headquarters, he estimated that the men were currently loading iron at the rate of twelve and a half tons per man per day.

Taylor stormed down to the yard with his assistants (“college men,” he called them) and rounded up a group of top-notch lifters (“first-class men”), who in this case happened to be ten “large, powerful Hungarians.” He offered to double the workers’ wages in exchange for their participation in an experiment. The Hungarians, eager to impress their apparent benefactor, put on a spirited show. Huffing up and down the rail car ramps, they loaded sixteen and a half tons in something under fourteen minutes. Taylor did the math: over a ten-hour day, it worked out to seventy-five tons per day per man. Naturally, he had to allow time for bathroom breaks, lunch, and rest periods, so he adjusted the figure approximately 40 percent downward. Henceforth, each laborer in the yard was assigned to load forty-seven and a half pig tons per day, with bonus pay for reaching the target and penalties for failing.

...

Yet even as Taylor’s idea of management began to catch on, a number of flaws in his approach were evident. The first thing many observers noted about scientific management was that there was almost no science to it. The most significant variable in Taylor’s pig iron calculation was the 40 percent “adjustment” he made in extrapolating from a fourteen-minute sample to a full workday. Why time a bunch of Hungarians down to the second if you’re going to daub the results with such a great blob of fudge? When he was grilled before Congress on the matter, Taylor casually mentioned that in other experiments these “adjustments” ranged from 20 percent to 225 percent. He defended these unsightly “wags” (wild-ass guesses, in M.B.A.-speak) as the product of his “judgment” and “experience”—but, of course, the whole point of scientific management was to eliminate the reliance on such inscrutable variables.

One of the distinguishing features of anything that aspires to the name of science is the reproducibility of experimental results. Yet Taylor never published the data on which his pig iron or other conclusions were based. When Carl Barth, one of his devotees, took over the work at Bethlehem Steel, he found Taylor’s data to be unusable. Another, even more fundamental feature of science—here I invoke the ghost of Karl Popper—is that it must produce falsifiable propositions. Insofar as Taylor limited his concern to prosaic activities such as lifting bars onto rail cars, he did produce propositions that were falsifiable—and, indeed, were often falsified. But whenever he raised his sights to management in general, he seemed capable only of soaring platitudes. At the end of the day his “method” amounted to a set of exhortations: Think harder! Work smarter! Buy a stopwatch!

The men who started lean manufacturing were engineers and statisticians, such as Henry Ford, Walter A. Shewhart [another success from Bell Labs!], and W. Edwards Deming. Unlike Taylor, they actually had a background in science and knew the value of experiments and good data. Taylor knew enough to talk about data, but he didn't really follow through, and inaugurated the Dilbert-esque practices of vacuous exhortation backed by spurious data that we all know and love.

Efficiency and Expertise

John D Cook links to a couple of zingers on efficiency in the workplace.

I've been thinking about these sorts of things a lot recently, but I really like it when somebody pokes holes in Malcolm Gladwell's foolishness. Yes, for God's sake, 10,000 hours of effort cannot make anyone into a genius. It sure can help you get better, but talent and luck matter as much, if not more.

The other is a bit more meaty. I've begun to suspect that American business has got much of the easy gains from efficiency improvements already. James Kwak apparently agrees. To be fair, once someone figured how to analyze work tasks formally, we discovered there was a lot that could be improved upon. And we did so. It is understandable that people think you can just keep on doing that ad infinitum. But it is probably wrong. There is definitely a point of diminishing returns, and the potential return is probably a lot less on creative knowledge work than it is on manufacturing processes. And even on manufacturing processes, sometimes you can't get any more efficient because it starts to get inhumane to work people that hard.

Kwak is right on in his description of how productivity works for knowledge workers like myself. I have a Blackberry, and I really like it, but I am glad that it is not linked to my work email because it would be really annoying. I pay for my own Blackberry, and I use it primarily for personal things. GPS, maps, Facebook, searching for words when I am in random places, and such. I do have my work appointments on it, because I need to be in a lot of places all day long, and it is a God-send for that. It is also handy for tracking down wayward team members via text message [Where are you? We are ready to start the experiment and you said you wanted to be here.] I use it for Pandora when I am working in strange places too. My Blackberry is completely useless for actual work tasks, because it is simply not powerful enough. I cannot run SolidWorks on it, and that is fine. As long as you know how to use your tools correctly, this should not be a problem.

Well, the efficiency expert may counter, all I need to assume is that a fixed percentage of your desk time is productive. But that’s still a big assumption. Maybe the real constraint on your daily productivity is mental energy, and you only have enough mental energy to do four hours of real work a day. Then your extra two minutes will all go to looking at pictures of cats with ungrammatical captions. Even more likely, maybe the real constraint is your internal sense of what a reasonable day’s work is. Many of us have either left early because we got a lot done or stayed late because we got little done. Maybe the real constraint is how much work your supervisor expects you to do. Maybe the real constraint is how much your colleagues get done, either for process reasons or simply because workplace norms are set by group as a whole. Maybe the real constraint is your motivation level. Maybe the real constraint is customer demand. (Another of LeBlanc’s examples is a cafe where the barista only spends half his time actually making a drink; the most plausible explanation is that you need to staff for potential demand, but actual demand fluctuates and is generally below potential demand.)

I am all for the idea that the real way to increase productivity is to not do things that don't matter. I think this idea is lurking in the background of most productivity improvements, but you should just say it out loud. The problem is that the tool set of efficiency studies comes from Operations Research, so you are forced to do silly things like estimate the proportion of time spent at your desk that is "productive" and try to maximize that. The problem here is trying to quantify something that not really quantifiable. Some unproductive time with Aristotle might clear that up.