Christos N. Pitelis School of Management, University of Bath

Governance Innovation for Sustainable Global Value Creation

24th October 2014, Room 144 Jubilee Building, University of Sussex

Aims

• Discuss resource allocation and resource creation perspectives on governance (corporate, public and supra-national) innovation for economic sustainability.

• Build on extant theory and practice to develop a framework for sustainable economic performance and the requisite governance structures to achieve this.

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Resource Allocation

• Value Creation is the result of efficient allocation of scarce resources (capital, labour, land, and less often knowledge), brought about through:

• ‘rational’ utility maximizing behaviour by economic agents (such as profit maximisation)

• ‘optimal’ market structures, such perfect or competition or contestability

• Major Variants

– Conventional ‘neoclassical’– Transaction cost

K. Arrow

L. Robbins

R. Coase O. Williamson

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Resource Allocation: Building Blocks

‘Old’ Theories

• Competition is type of market-industry structure.• Technology is given in the short-run but market

structure (such as perfect or imperfect competition) can affect technological change in longer run.

• Perfect competition and comparative advantage-based free trade can, under conditions of perfect competition, optimise global resource allocation and foster value and wealth creation.

J. Bain

D. Ricardo

A. Marshall

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Resource Allocation: Building Blocks (cont.)

‘New’ Theories

• External economies (location), increasing returns, innovation and human resources matter (‘new endogenous growth theory’)

• ‘Strategic trade’ policies workable (but could be ineffective and/or undesirable) – ‘strategic trade theory’.

• Revisit and formalise ideas from Kaldor and Pasinetti

R. Lucas

P. Romer

P. Krugman

N.Kaldor L.Pasinetti

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Resource Allocation and Corporate Governance

•Maximise shareholder value

-This follows from the argument that under certain assumptions, maximisation of profits/shareholder value maximises the value of the firm as a whole.

-It requires solving the ‘agency’ challenge between managers and shareholders.

Resource Allocation and Corporate Governance: Critique

• Numerous other agencies, archetypically between capital and labour (Marx) and more recently between other stakeholders (Cyert and March) ignored.

• Coincidence between shareholder value maximisation and firm value maximisation can only be shown under very restrictive assumptions – in other readings static profit maximisation can prejudice inter-temporal profit maximisation.

Resource Allocation and Public Governance

• Maximise consumer surplus

- this follows from the idea that (under very restrictive assumptions) the consumer surplus (a proxy for ‘consumer welfare’) is only maximised under conditions of perfect competition and that departures from perfect competition constitute ‘structural market failure’;

- policy prescription is to solve such market failures by fostering perfectly competitive/contestable market structures.

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Resource Allocation Public Governance: Critique

• The issue of static versus dynamic (inter-temporal) efficiency is underexplored.

• Link between consumer surplus and sustainable value creation and capture is quite tenuous.

• Exclusive focus on markets (non-market institutions – organisations are seen as the result of market failure) is limiting.

• Perfect competition-promoting public policies are subject to problems of ‘second best’, and often naive, and unrealistic (Baumol, Penrose)

W. Baumol

Resource Allocation: Supra-national Governance

• Kindleberger’s ‘Hegemonic Stability’ Hypothesis

-it states that a Hegemon/imperialist power emerges in order to solve supra-national market failures by providing international public goods.

-it underscores ’Washington consensus’-type policies based on perfectly competitive markets and comparative-advantage-based free trade provided under ‘conditionality’ by a Hegemon-inspired and controlled supra-national organisations (IMF, World Bank...).

Resource Allocation and Relations Between Governance Types

• Shareholder value-based corporate governance, consumer surplus-maximising public governance and comparative advantage free trade-based supra-national governance are all aimed to correct market failures and to foster ‘rational’ optimising behaviour

• In the above context, one reinforces the other, and together they create value by achieving efficient allocation of scarce global resources through shareholder value maximising firms in perfectly contestable sectors trading freely on the basis of their comparative advantages.

Resource Allocation: An Overall Critique

…Alas it is all a myth...

• ‘Perfect competition/contestability cannot exist, static ‘rationality’ can diverge from inter-temporal rationality, consumer surplus maximisation in the short run can prejudice consumer surplus in the long run, comparative advantage free trade assumes mythical perfect competition, resource allocation need not lead to sustainable value creation, a Hegemon may pursue hegemonic rents (after all, who hegemons the hegemon?), etc.

• In short, conventional efficient resource allocation-based governance theory is a horrible mess…But can we do better?

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Resource Creation

Common themes

• Focus on resource-knowledge creation and innovation in the context of uncertainty and change.

– Procedural-bounded rationality and learning, self-interested and altruistic economic agents.

– Imperfect markets and hierarchies, institutional failures.

H. Simon D. North

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Resource Creation: Variants

• Resource-capabilities-based, Austrian, Shumpeterian, evolutionary.

• Behavioural, Marxist.

K. MarxJ. March

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Resource Creation: Building Blocks

• Competition is a process.

• Innovation can be seen as ‘creative destruction’.

• Co-operation matters.

• Competition and co-operation (co-opetition) may foster innovation.

• Technology and innovation are key sources of value and wealth creation.

J. Schumpeter

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Resource Creation: Implications

• Co-opetition and innovation foster value and wealth creation and economic performance.

• Transient monopoly can be incentive for, and a reward to, successful innovators – it allows value appropriation/capture.

• Big business competition (alongside small firm creation and growth) is best for innovation.

E. Penrose

Resource Creation and Corporate Governance

• Not directly linked in literature.

• Could be suggested that it is in line with co-opetition and innovation, hence value creating stakeholder-based governance.

Resource Creation and Corporate Governance: Critique

• Unclear who are the stakeholders, how they add value, precise mechanisms of coordination-conflict resolution, etc.

• In all, still rather imprecise and not fully developed.

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Resource Creation and Public Governance

• Developmental-industrial policies by the government promoting maximisation of nation-wide value and wealth creation through resource creation (not just efficient allocation).

– It follows from idea that innovation and other factors can help create value, in addition to value created through efficient resource allocation.

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Resource Creation and Public Governance: Critique

Limited focus on determinants of value and wealth creation (other than innovation), little consideration of value capture “agency” – “regulatory capture”.

Resource Creation and Supra-national Governance

• Not directly linked.

• It could be suggested that plurality of supra-national entities and organisations (such as G20, the BRICs bank), alongside ‘Beijing consensus’ and/or ‘Geneva-consensus’-type developmental and trade policies, are more in line with resource creation view.

Resource Creation and Supra-national Governance: Critique

• …Quite underdeveloped mostly because not directly linked.

• Beijing consensus criticised for neo-imperialism, Geneva consensus in infancy, both in need for proper conceptual foundations...

Resource Creation and Governance Types

• Not coherent yet.

• It could be argued that stakeholding at the firm, public and supra-national levels is best for global value creation though co-opetition, innovation, pluralism and diversity...

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Overall Conclusion: Critique

No agreed framework on nature and determinants of

value creation, no consideration of value capture, of

economic sustainability and of the role of corporate,

public and supra-national governance within such a

framework.

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Governance for Sustainable Global Value Creation

Objectives

• Develop a conceptual framework for Value Creation by exploring its nature and determinants.

• Address the issue of value capture.

– Discuss the link between value capture and sustainable value creation;

– Discuss sustainability – compatible governance (corporate, public, supra-national);

– Discuss types of advantages-capabilities required for each objective, and actors in determining the division of labour between them.

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Main Tenets

Innovation, knowledge and resource creation (including efficient resource allocation), in the context of:

• Procedural-bounded rationality and learning, socially embedded phronesis, decency, dignity, and self/mutual-respect;

• Imperfect markets, hierarchies and institutional failures.

Determinants and Actors of Value Creation at Firm, Meso and National Levels

27Private

Public PolityInstitutional and Macroeconomic environment -

Governance and Policy mix

Unit CostEconomies, Returns to Scale

Technology &Innovativeness

Infra-structure& Strategy

NATION

SECTOR-REGIONIndustry Conduct- structure and regional - locational milieu

FIRM

Value Added- Creation

Human and otherResources and Capabilities

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Value Capture

• The appropriation of created value by economic agents

– Extensive literature on value capture at the level of the individual, firm and industry, but little on strategies for regional, nation-wide and supra-national appropriation of value/wealth.

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Creating and Capturing Region and Nation-wide Value/Wealth

• Similar factors as at firm level, appropriately reinterpreted and applied (plus institutional, macroeconomic and regional-sectoral milieu);

– Require appropriate public-private-polity/civil society interactions and co-ordination.

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Economic Performance through Value and Wealth Creation and Appropriation

• Superior performance requires superior ability to appropriate value – wealth.

- Value – wealth appropriation usually requires value creation and co-creation.

• Possible ‘trade-offs’ – impact on economic sustainability.

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Supra-National Governance for Economic Sustainability

• Sustainability: when the satisfaction of an objective in the present does not undermine the longer-term satisfaction of the same objective

• and/or where the pursuit of one group’s interests does not undermine the pursuit of system-wide interests – the two often related.

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Dimensions of Sustainability

Economic, Social, Environmental

• Sustainability here equals goodness, equals greenness;

• Sustainable Global Value Creation (SGVC) alternative welfare criterion to Pareto efficiency (neoclassical economics) and/or nationwide innovation (“systems of innovation”).

V. Pareto

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Constraints on Economic Sustainability

• The Key Constraint:

– Differing objectives (such as pursuit of value appropriation) by different groups, organisations, nations ‘agency’ and need for objective alignment.

Also time inconsistencies, mistakes.

E. Phelps

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Constraints on Economic Sustainability (cont.)

• Instances:

– Intra-County: Monopoly, Regulatory capture – corruption;

– Inter-Country: Protectionist and strategic trade policies, especially by more powerful countries (not least the Hegemon), market power/structural market failure as a condition for FDI by MNEs.

W. Baumol

G. Stigler

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A Hierarchy of Agencies

Economic sustainability requires addressing hierarchy

of agencies between (at least):

• Firm and its shareholders-stakeholders;

• Nation and firm;

• Individual nations (including the Hegemon) and the

world.

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Some Requirements for Sustainability

General• Put in place requisite governance structures at all

levels (corporate, public, supra-national)-pro competition (Hayek)

Specific

• Intra-Country (Hegemon included)

– Fight corruption (e.g., regulatory capture, MNEs capture, rent seeking)

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Some Requirements (cont.)

• Supra-National (enlightened Hegemony)

– Recognise ‘infant’ entrepreneur, industry, firm cluster and economy argument –as promoters of longer-term value creation

– Tolerate ‘strategic trade’ by emerging economies, not by developed ones

– Recognise that need for ‘level playing field’ requires tolerance of apparent inequities in favour of worse-off

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Possible Solutions to Governance for Economic Sustainability

• Enlightened self-interest-based corporate governance -but in short supply

• Public policy-regulation (but regulatory capture)

• Global hegemony (but failures of hegemony–top-down, thus limited sustainability)

• Pluralism and diversity-stakeholding – more bottom-up and sustainable (thus preferable) – but adequate?

• An accountable supra-national monitor (international organization), modelled on the Blair and Stout corporate Board – but trust, capture?

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Conceptual Basis for a Public-Private-Polity Partnership (PPPP)-based Governance

• Value creating market, ecosystem and institution creation and co-creation, based on comparative advantages and capabilities, and suitable private, public, and polity (social) entrepreneurship.

- Development of supporting institutions, organisations, policies, implementation and regulation capabilities.

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Comparative Advantages of PPPs

• Private – comparative advantage to capture (profit) from value creating advantages.

• Public – comparative advantage in legitimacy, institutional, macroeconomic and overall context for value creation (subject to satisfying value appropriation needs of state principals – functionaries).

• Polity-‘Civil Society’ (e.g. NGOs, consumer associations) – comparative advantage in creation of “social capital” and sustainability?

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Proposition

In the context of:

• Co-opetition and Innovation-knowledge promoting governance, and

• Recognition of the ‘hierarchy’ of agencies

– PPPPs can help generate ‘mutual stewardship’ and ‘monitoring’ and serve as a policy for supranational governance for sustainable value creation.

• This requires resource/value-creation-focused mutually reinforcing corporate, public and supra-national governance.

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Summary – Conclusions

• Enlightened self-interest-based corporate governance (self-regulation) and national government regulation policies can be helpful, but are not sufficient (given self-interest – value capture).

• Diversity and pluralism, to include networking, ecosystems and ‘social capital’ and clusters, can help engender ‘mutual stewardship’ and can serve as an approximation for supra-national governance for SGVC (sustainable global value creation).

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Summary – Conclusions (cont.)

Accountable ‘supra-national monitor’, modelled along the lines of Blair and Stout’s corporate Board, might be useful to mould and enable the process to marry direction to democracy – these could include an ‘International Agency for Economic Sustainability’

• In the long term, however, the critical factors for sustainability are investments, institutions and structures that promote phronesis-based decency, dignity, and self/mutual respect. ‘Globalisation’ and winner takes all-type ideologies undermine this…