What Went Wrong?

Corporate executives, private equity investors and management consultants quietly built a system that makes workers absorb the risks of the business cycle

Stafford Beer at der Universität St.Gallen (HSG). Media uploaded by HSG are released under CC-BY-SA 4.0.

Populism - defined as anti-pluralism - has exploded throughout the West in recent years. Although populists often stand a fighting chance in one of the two major games of politics (winning elections), they tend to crash and burn at the second game (governing competently). Why did populist narratives begin to resonate with large sections of the voting public around the 2010s?

Writer Dan Davies comes up with a very interesting answer in a book called The Unaccountability Machine, which was published in April 2024. It was long-listed for various book of the year awards. The book is partly a biography of Stafford Beer (1926-2002), a British management thinker and consultant, who developed a theoretical approach called cybernetics (the study of decision-making systems). The field has largely fallen into obscurity in recent decades. Davies takes a deep dive into cybernetics and then uses its tools to analyse what has gone wrong since the 1970s.

The book is a little complex - Davies says that he had no choice but to take the reader out into the weeds in order to explore cybernetics and variety engineering (building systems where control systems can handle diversity as well as other parts of a system). Despite the depth, there is one fairly straightforward theme running through the book, which connects the unintended consequences of a certain management philosophy and the populist counter-reaction.

There are interesting parallels between this theme and the contrast between hedgehogs (who try to impose one model of reality) and foxes (who are happy choosing between multiple models of reality), which has been a constant subject of this blog. Please note that Davies doesn’t frame the issue in quite those terms, although we will look for connections in this essay.

Davies writes that cybernetics founder Beer was concerned with variety and control. Variety is similar to information, but refers (rather imprecisely) to the number of states a system can experience. The core of Beer’s philosophy is based on the “principle of requisite variety,” which was coined by Ross Ashby (1903 - 1972), a psychiatrist who helped develop cybernetic theory. The law states that a regulator of a system must have as much variety as a system itself

Davies says that the best way of understanding this point is through a metaphor:

A train can really only go forwards and backwards, so it only needs a single handle. A car can make turns, so its control system requires a steering wheel to represent the added dimension. And an aeroplane needs a joystick rather than a steering wheel, because it can make two kinds of turns.

What are the implications of the principle of requisite variety? Davies says this (and please excuse the dense prose):

In the business environment, complexity (environmental variety) will naturally increase. In any given organisational structure, the variety which management systems can bring to bear also increases, but more slowly. At some point, the difference in growth rates becomes critical; the organisation needs to change its architecture so that variety is matched to variety at each level of decision-making.

Let’s use a metaphor to unpack it. Businesses are like planes. Management systems are the joystick. Environmental variety is turbulence in this metaphor. If turbulence increases past a certain point, there could be a crisis. For the full story, which gets significantly more complicated, please read the book itself!

We will skip over many of the details of Beer’s theorising about systems. All we need to know for the sake of today’s essay is that many of the regulatory functions that the thinker described are embedded in middle management in companies. You won’t often see a modest defence of middle management or bureaucracies, but Davies says that the main function of both is to deal with complexity.

If you want another metaphor, think of the way that an savings account for emergencies can act as a buffer for individuals and families when the hard times come. Having cash on hand might not be the world’s most exciting investment, but it can help families cope with unexpected shocks. Middle management is meant to work in a similar way, according to Beer’s management philosophy.

We can now come to Davies’ interpretation of Beer’s work to see what went wrong. Our story takes a strange turn. In the 1970s, Beer moved to rural Wales, just as the world was changing in non-cybernetic ways. The libertarian economist Milton Friedman wrote a massively influential essay on shareholder value in 1970, which reminded corporate executives that they can be fired for not putting profits first. The article’s simplified message about the importance of shareholder value spread like wildfire throughout the business world.

Publicly listed companies, led by General Electric, slowly began to demonstrate their commitment to shareholder value through their quarterly results. This led to some strange outcomes. For example, in 1997, General Electric closed a deal with a one-off gain of $2bn, which would have ruined its narrative by making a line on a chart look too bumpy. As a result, the conglomerate closed some factories, making 1,000 people redundant. This generated a one-off cost, but kept the line on the chart mapping quarterly results straight.

Something similar has happened with investors in the category we now call private equity (PE), who have engaged in leveraged buyouts (LBOs) in the name of shareholder value. These transactions involve an investor putting up a small amount of cash as the equity in a debt-funded deal (equivalent to paying a deposit in order to qualify for a mortgage). When the deal goes through PE firms load up the target’s company with debt to pay for the LBO. Davies says:

This is the bit that gets ordinary non-financial people worrying - you’re effectively using the company’s own cash and assets to pay for your acquisition of it.

PE backing can help companies concentrate, particularly when corporate executives are keen on perks like “private corporate jets, country club memberships and ridiculous expense accounts,” Davies says. LBOs also help if a company is run by a management team that is lazy, indecisive or that nurtures “back-scratching relationships with single large customers who are equally sclerotic.” A fanatical attention to servicing heavy debt loads after an LBO can be helpful in these circumstances, Davies says.

As a journalist covering mergers and acquisitions (M&A) in my day job, I might be biased, but I would also add that roll-up strategies - buying a bunch of small businesses and centralising their back-office functions - is a great use case for PE.

However, there is also a disadvantage. Highly leveraged balance sheets increase the risks of bankruptcy. Although PE firms mostly try to avoid bankruptcy, for obvious reasons, if it happens, they often only stand to lose the small deposit they put up at the beginning. Even then, the investors will often have paid themselves dividends to cover the equity investment in the LBO by the time the situation turns toxic.

In other words, the risks tend to be a little lopsided. In Davies’ words:

The people who are really at risk, though, are the ones who depend on the company continuing to exist as an ongoing entity - workers, suppliers, customers and managers. The little people.

Both listed companies and private companies started managing for shareholder value from the 1970s, with the trend accelerating from the 1980s. Executives were encouraged by management consultants, who sold the myth that it was possible to rent out management capacity as an alternative to paying salaries. As a result of these trends, which all pushed in a similar direction, middle management and bureaucracy have both slowly fallen out of fashion in the corporate world. Reams of jobs have been removed in the name of quarterly results and servicing debt.

Davies argues that we can use the tools of cybernetics to understand why this has been problematic. Middle management is meant to act as part of a regulatory system. Cutting it reduced companies’ capacity to deal with shocks, including the ordinary ups and downs of the business cycle. However, systems still need to absorb volatility and variety. Without an in-house buffer, corporate executives, PE investors and management consultants started to use companies’ workforces to absorb variety. Think of someone losing their job to make a line on a chart look prettier; and then multiply this by a staggeringly large number. At the same time, companies with large debt loads also faced increased risks of bankruptcy.

Unfortunately, though, redundancies and the threat of redundancies imported uncertainty, volatility and stress into ordinary people’s lives. Many experienced periods of poverty due to layoffs; and inter-generational wealth transfers became harder for many families. Nobody seemed to take responsibility for these events. Remember the people who lost their jobs to protect a line on a chart. Did anyone ever apologise to them? Probably not!

The results of this volatility have been dramatic. Did you know that 40% of Americans have been laid off at least once? And about 20m Americans get laid off per year? Davies notes research from economists Anne Case and Angus Deaton showing a sharp increase of “deaths of despair” in the US at the beginning of this century. The epidemic is concentrated among workers without university degrees, who have often turned to alcohol, drugs or even suicide to try and escape from falling wages, unemployment and under-employment.

Davies says that we should see the populist movements that began picking up steam around the world in the 2010s as “a scream” of protest by people who felt that something had gone wrong with the world without quite being able to put their finger on what it was. The leaders of these movements often promised a simpler world - something that cybernetics shows us is basically impossible. The world is becoming ever more complex,; and we need systems that can develop long-term stability in those circumstances, rather than fighting against a rising tide.

Although Davies doesn’t mention it, there is one populist campaign that got closer to analysing the issue in a more sensible way than most. This was Newt Gingrich’s hard-right campaign to be the Republican nominee for President in 2012. He ran against Mitt Romney, a private equity baron, who had made a fortune at Bain Capital. Please check out this news story from the time, which quotes Gingrich as saying that Romney’s playbook was to "leverage the game, borrow the money, leave the debt behind and walk off with all the profits."

It is interesting to note that Gingrich was careful to limit his attacks to one particular style of PE dealmaking, rather than private equity itself. Four years later, he joined a PE firm called JAM Capital Partners.

Any Democrats pondering their response to Donald Trump’s populism could do well to study Gingrich’s campaign, which attacked a particular form of capitalism from the right while remaining committed to a markets-based economy in general terms.

If most iterations of populism get the problem right but the answer wrong, what can we do to course correct? In a section of the book that was dying out for a discussion of hedgehogs and foxes, Davies discusses the dangers of management to optimise just one dimension, in this case shareholder value. He asks us to imagine an artificial intelligence (AI) system to maximise paperclip production - a metaphor developed by philosopher Nick Bostrom.

Imagine that you wanted to make an artificially intelligent paperclip-manufacturing machine. And then presume that, in order to make stationary more efficiently, you gave the AI in your paperclip machine the ability to modify itself and improve its intelligence. The ‘paperclip maximiser problem’ suggests that by doing this carelessly, you might accidentally destroy all human life in the universe…

By the mathematics of exponential growth, a point will quickly arrive when the paperclip machine is not only cleverer than its inventor, but cleverer by so many orders of magnitude that the difference is similar to that between a human and a fly…

If you’re going to create something that will become the dominant form of intelligent life in the universe, of course, you should have an idea what its priorities are. Because if its priorities are simply to make as many paperclips as possible, then that’s what it’s going to do. If the intelligence behind the paperclip factory is many orders of magnitude greater than any human intelligence, it will easily think of a way to allocate more resources than anyone had previously thought to paperclip production. The thought experiment tends to end with all life on earth extinguished and our bodies dissasembled molecule by molecule to provide raw materials for paperclips.

In other words, systems with just one goal will always tend to go crazy. Cybernetic theory shows us that we need a “red handle” to pull when that happens. What should it be? Davies says that the principle of requisite variety means that ultra-complicated solutions will also be doomed to failure.

However, Davies proposes borrowing just one policy suggestion from US Senator Elizabeth Warren as a way of installing a red handle. This is the idea that “any entity taking control of an operating company should have to guarantee its debts,” he says. In other words, if this change were adopted, bankrupting a company would hurt PE investors, as well as the company’s employees, suppliers, customers and other stakeholders.

The end goal of this suggestion is to return to pre-1970 form of economic practice, where the corporate sector absorbs volatility on behalf of the workforce. This approach is meant to protect the working class from the business cycle “rather than expecting them to soak up the volatility” on behalf of investors in companies.

Let me now try to summarise my take on Davies’ argument in one paragraph. From the 1970s, companies increasingly began to be run by hedgehogs with a mission to maximise shareholder value. They stripped away middle management, which reduced companies’ ability to cope with complexity or the business cycle. The pain was passed onto workers, but nobody ever explained why or apologised. Ordinary voters who felt the cards were stacked against them had an innate understanding that complexity was problematic. They started to vote for populists (anti-pluralists), who were themselves hedgehogs. Much of the populist appeal is based on a promise to make the world simple again, which is doomed to failure.

To conclude this essay, let us turn to Elon Musk’s populist project, the Department of Government Efficiency (DOGE), which is gleefully slashing the federal bureaucracy in the US. Stunts like asking employees what they achieved last week have been in the news. Musk has a hedgehog-like devotion to value creation, which is fine up to a point. However, it should be obvious to foxes that not every bureaucrat or middle manager will create as much value as a driven engineer at a fast-growing startup.

Cybernetics shows us the risks to Musk’s nihilistic hostility to bureaucrats and regulators, without even mentioning the conflict of interest of the owner of various regulated businesses threatening to fire regulators. The people whose jobs are at risk are meant to act as a buffer. We can see this clearly with the National Nuclear Security Administration, which looks after the US nuclear-weapons stockpile. Musk’s team fired 300 people in one day by email. After escorting them from the building, the agency realised it needed to rehire a number of them immediately in order to continue functioning. However, it had no way of getting in touch with them. This is not a sensible or serious way of keeping the population safe.

Davies’ use of Beer’s analytical tools suggests that importing massive amounts of uncertainty into the lives of public-sector workers (3m people in the US) is likely to backfire in unforeseen ways. Unfortunately, the upside is likely to be far less than Musk expects. Commentator Matthew Yglesias says that total personnel spending by the US federal government is about 0.2% of gross domestic product (GDP). At the same time, the budget deficit (6.3% of GDP) is rising fast as the population ages.

If Davies’ analysis is right, it is remarkable that Democrats have been so slow to use Trump’s reality TV catchphrase - “you’re fired!" - against him. Images of Musk gleefully wielding a chainsaw could easily be used as well, perhaps interspersed with people talking about losing their jobs in the public sector and the private sector for arbitrary reasons. Trump supporters who have lost their jobs should feature heavily. Musk’s frequent use of the smear NPC (it stands for “non-playing character”) to dismiss the significance of the little people or the views of his critics could easily backfire against him in the hands of a tactically aware opposition.

It is worth mentioning that Musk used to walk the streets of New York with emeralds in his pockets; and Trump inherited hundreds of millions of dollars from his father. Neither of them have had to live with the fear of arbitrary dismissal that they are so enthusiastic about for other people.

Combine this attack line with an analysis of Gingrich’s campaign against Romney, along with the policy suggestion about debt that Davies makes; and it would be perfectly possible to have a non-populist but emotionally engaging campaign that lines up a sensible analysis of what went wrong with a way of getting back on track.

Finally, have you read Davies’ book? Do you want to? Had you heard of cybernetics before reading this essay? Are you prepared to rethink your natural hostility to middle management as a result? I’d love to hear from you! The comments are open. See you next week!

Previously on Sharpen Your Axe

Two games of politics

Populists and governance

Unintended consequences

Hedgehogs and foxes

The business cycle

Emergency accounts as a buffer

Friedman and shareholder value

Exponentialism (part one and part two)

Value creation (part one, part two, part three and part four)

Nihilistic deregulation

Conflicts of interest

Aging populations

Further Reading

The Unaccountability Machine: Why Big Systems Make Terrible Decisions - How the World Lost its Mind by Dan Davies

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