with Aprajit Mahajan, David McKenzie and John Roberts
Anyone who has seen the TV show The Office knows about the impact of bad management on office productivity. David Brent (played by Ricky Gervais in the British version) is the notoriously incompetent manager who can do nothing right. Everything he touches goes wrong. Bad managers are also presumably a global problem: The Office has been exported to over 50 countries.
Economists have long puzzled over why there are such astounding differences in productivity across both firms and countries. For example, GDP per capita in the US is about 10 times that of India. A natural explanation for these productivity differences lies in variations in management practices. But many economists, as well as some policymakers and even business people, are sceptical of the importance of management in explaining these performance differences.
One reason for this scepticism is the complexity of management, making it hard to measure and quantify. However, recent work has focused on specific, measurable aspects of management practices, like performance monitoring and formal incentives. This involves down-playing the "soft skill” attributes of good managers – which can be difficult to measure, let alone change. For example, researchers have measured management practices across firms and countries, finding large gaps in management practices between developing countries and the US and Europe.
In this project we used field experiments to evaluate if these differences in management actually cause differences in performance. To do this we improved the management of a randomly selected group of large Indian textile firms and compared the impact to another randomly selected group of similar, control firms. In summary, we found better management led to massive improvements in productivity and performance. This suggests that bad management is a key factor holding back growth in developing countries like India.
India is barely managing
Our experiment in India involved 20 large textile firms. Each firm got a set of recommendations about its management practices based on an initial month of management diagnosis from a major international consulting firm. Then the treatment firms got four more months of free consulting, that helped them implement the recommendations.
We collected detailed performance metrics on output, inventory and quality to understand the effects of improved management for firm performance. The evidence suggests that Indian factories are typically disorganised, with inventories and spare parts chaotically organised, inadequate performance tracking, and extremely poor quality control.
The consultants started to address these issues by introducing the sort of basic operational practices that are standard in European, Japanese and US factories. These had a massive effect on performance, cutting quality defects by 50 per cent, inventories by 40 per cent, and increasing overall productivity by 10 per cent. This also increased firms’ profits by about $200,000, and by improving the ability of owners to expand their firms.
Our evidence suggests that one important factor was informational constraints – the Indian firms were not aware of the importance of common modern management practices. This is perhaps not entirely surprising. Management practices evolve gradually over time, with innovations like the Taylor's Scientific Management, Sloan's M-form corporation, and Toyota's lean production spreading slowly across firms and countries. For example, the US automotive industry took at least two decades to understand and adopt Japanese lean manufacturing. And the British fell behind the Americans in the 1800s by failing to adopt the American System of Manufacturing.
This of course begs the question: Why didn’t product market competition drive these badly managed firms out of business?
One reason is the reallocation of market share to well managed firms in India is restricted by span of control constraints on firm growth. In every firm in our sample all senior managerial positions are held by members of the owning family. The number of adult males available to fill senior positions thus becomes a binding constraint on growth. For example, the owner of one of these best managed firms in the sample told us the reason he could not expand was "no sons, no brothers”. Hence, well managed firms do not always grow large and drive unproductive firms out of the market if they lack male family members. Meanwhile, entry is limited by a lack of finance, while imports are restricted by heavy tariffs.
Learning from India's mistakes
There are three key policy takeaways from the study:
-- Competition and foreign investment drive productivity growth. These Indian firms are typically poorly managed because competition is restricted – for example Chinese imports face 50% tariffs – and foreign ownership is restricted. If these were made a lot easier Indian firms would be forced to catch-up with the world frontier on management practices.
-- Rule of law is essential for firms to grow. Many of India’s best managed firms cannot grow because of an inability to decentralise decision making to non-family members. This is because the courts are so overwhelmed that prosecutions against fraud are extremely hard, making owners wary of letting outside managers have much control over the firm. As a result owners do not give key management roles to non-family members, thereby missing out on job creation.
-- Basic management training would improve productivity. Many of the shortfalls with Indian management practices could be addressed through more widespread basic management training. For example, industry, government, and university provision of three-month operations management training courses.
While we ran our study in India, the available evidence on management practices suggests similar issues will arise in other developing countries. In particular, our suspicion is that Indian firms are likely to be better managed than most African firms (since these rarely export into world markets) making the potential impact of better management on development even greater there.
Nicholas Bloom is Assistant Professor of Economics at Stanford University; Aprajit Mahajan is Assistant Professor, Department of Economics, Stanford University; David McKenzie is Senior Economist in the Development Research Group at the World Bank; John Roberts is Professor of Economics, Strategic Management, and International Business, Graduate School of Business, Stanford University.
This article was originally published on www.VoxEU.organd has been edited for style. Reproduced with permission.