Column Number 13: Golden principles trump policy opportunism

Kai-Alexander Schlevogt   |  Wed, 11/19/2008 11:17 AM  |  Management

Parents easily find themselves in the following tight spot: After they have taught their child a rule and the sanctions for breaking it, the naughty offspring violates it. Facing the weeping kid, the amateur lawmakers are tempted not to punish it. What is the resolution to their homely quandary?

The leaders of nations and corporations often need to extricate themselves from the same predicament. The subprime mortgage plight that triggered a world economic crisis serves as vivid illustration. Clearheaded policymakers for long touted free markets and committed themselves not to intervene. But when major financial institutions faced bankruptcy, many an opportunistic politician reneged on his solemn liberal pledge and bailed them out.

Undoubtedly, it is right to break an outdated rule. But a true leader must stick to what I call "golden principles". These are valid behavioral guidelines designed in anticipation of the very situation that subsequently occurred. He who fails to enforce sound rules will suffer from three unintended policy consequences, which are interrelated (see illustration).

1. Inconsistency trap

Smart parents understand that if they become soft after their child has transgressed a family commandment, they lose credibility and invite irresponsible action. The same logic applies elsewhere. A shrewd terrorist knows that in a democracy, politicians most likely will go back on their commitment never to negotiate with those who take hostages. He thus is encouraged to use this pressure tactic. Likewise, corporate veterans in the U.S. learned that the tough language of a public choice politician, claiming he will never bail them out, is mere rhetoric.

This induces what I call "adverse growth": Managers feel free to pursue risky projects that promise considerable returns, expecting that others will cover the losses. In some countries, speed cameras only catch offenders traveling up to a certain limit. This prompts speeders to accelerate, in order to escape detection. Such action is diametrically opposed to the outcome the cameras were to produce.

Likewise, executives have a strong incentive to make their company "too large" to be allowed to go bankrupt. They spin an intricate web of activities affecting the whole economy, especially those sectors that hurt the public. Using the Chinese stratagem of "increasing quantity by adding bad fish", they inflate revenues by complementing their offering with inferior and possibly toxic products.

Followers are likely to lose confidence in a leader who habitually makes U-turns. This proves particularly costly in a crisis, when the masses long for a steady hand. In mid-November 2008, the U.S. treasury secretary announced he would not use his US$700 billion rescue pool to purchase toxic financial assets. This was despite the fact that he had secured funding by promising such action. No wonder many investors panicked after the unexpected policy reversal.

2. Slippery slope

Leaders ignore the thin edge of the wedge at their peril. Once a curious camel has put its nose into a tent, the whole body is likely to follow! Politicians succumbing to the fallacy of the last move savor the moment they announce a rescue package and declare victory. The media will portray them as heroes, lauding their courage and decisiveness. If they are lucky, share prices will rise for a day or two. But if the fundamental problems have not been solved, the downward spiral will soon resume.

By bailing a company out, politicians open the floodgates. Even if the first rescue package was small, they set a dangerous precedent that is likely to unleash an avalanche of bailouts. Managers will quickly conclude that extortion works and smell blood. After the successful "proof of concept" phase, they just have to reiterate the following highly effective script: "If you do not help us, there will be a global financial meltdown". Many a frightened politician will pour money on them shortly after the scary prognosis.

Here is what I call the "danger of incrementalism": Humans often feel an urge to continue along a path for reasons of congruency. It is often sufficient for persuaders to get a foot in the door; then their prey may overshoot. Without a goal post, the public will never know when global financial problems have been solved. At least in theory, this enables policymakers to justify a never-ending flood of bailouts.

During the financial crisis, political leaders seemed to engage in a battle of egos with anthromorphized markets. They possibly recalled the famous chicken game from the James Dean movie Rebel without a cause and endeavored not to blink first. Thus, they successively increased their stakes. Many suffered the winner's curse of overpaying. In the worst case, politicians opting for mega-solutions could count on "heroic failure", which bestows honor upon them despite defeat.

3. Subversive perceptions of unfairness

When leaders change rules in the middle of the game, many a follower will cry foul play. The virtuous will liken the inequity of such policy reversals to the injustice of an amnesty. This will undermine trust in the impartiality of his leaders. He might even lose faith in the political and economic system.

Financiers who put their houses in order after subprime losses will deem the state-sponsored bailouts of competitors unfair. The ordinary citizen will find it inequitable that his taxes are used to rescue superrich bankers who pulverized the retirement savings of a generation. He will fume when learning that AIG executives embarked on a lavish corporate retreat in California that cost $440,000 shortly after pleading poor and receiving a huge bailout package from the U.S. government.

A conservative investor will become angry when the state uses his taxes to help those who pursued risky deals and pocketed large gains earlier. Frugal homeowners will wonder why those who did not make required mortgage payments should be rescued. After their initial outrage, even many prudent individuals might resolve not to be fooled again and behave recklessly, too.

The unintended consequences of policy opportunism are grave indeed. The greatest systemic danger in the game of capitalism is failure not being punished. The founder of modern Singapore, Lee Kuan Yew, demonstrated the positive effect of an iron commitment: He told the executives of Singapore Airlines at its inception that he will never bail the company out. Unlike many pampered national carriers, it prospered because its leaders knew that there is no emergency exit!

 

"Prof. Kai on Strategic Leadership" Column Number 13. Kai-Alexander Schlevogt (D.Phil. Oxford) is a professor of strategy and leadership at the National University of Singapore (NUS) Business School and author of The Art of Chinese Management (Oxford University Press). Email: schlevogt@schlevogt.com; website: www.schlevogt.com.

Copyright © 2008 The Jakarta Post - PT Bina Media Tenggara. All Rights Reserved.