The Real Economy

Macro-micro coherence

Hector McNeill¹
SEEL

This is the first article of a duo, where I reconfigure the basis for the explanation of the logic of the Real Incomes Approach to Economics by integrating the methods of two leading practitioners in needs identification and decision analysis. These are Roger Kaufman and Ronald Howard. The result is, I hope, a more transparent explanation of how this macroeconomic policy can avoid the creation of winners, losers and those who remain in policy neutral impact states. The outcome is a positive systemic consistency where all within the social and economic constituencies benefit through the narrowing of the differences in real income levels while achieving a general growth in real incomes and a sustainable and rational growth path. A notable factor is that both Kaufman’s and Howard’s contributions have a lot to offer the increasingly important and growing field of constitutional economics.

This essay will explain, in the context of macroeconomic policy, an approach to discovering what is needed by the social and economic constituencies and then identifying how each individual and economic unit can identify the appropriate outputs and the most effective and efficient ways to produce these. A condition needs to be that existing macroeconomic policies should not constrain the allocation of resources at the level of the economic unit but should provide complete freedom for decision making and the maximization of the benefits resulting from operations.

In early 2014 came across the work of Roger Kaufman a leading American consultant on corporate change and performance enhancement. His focus is on effective needs assessment in the context of the needs of the constituency outside the dominion of the individual economic unit or company. Constitutional economics and indeed the Real Incomes Approach is an attempt to provide a more practical approach to the meeting of constituency needs through more effective microeconomic performance.

However, Roger Kaufman has, what I consider to be, a more transparent explanation of the link ups in terms of needs assessment than I have produced. I therefore present here another perspective on constitutional economics and the real incomes approach applying Kaufman’s structural analytical approach.

Roger Kaufman

Starting from the beginning

Before a policy comes into existence there will have been an awareness that there is a need to be addressed. This will establish what policy must address and this is accomplished by identifying the gaps in current provisions, or outcomes, and what is required to close the gap, that is, securing a desired output or change in provisions. This should be established before any final policy is conceptualized.

The imperative of defining need

In this context it is important to define “need” as a noun and not as a verb, thus usually the issue is a gap in results and consequences or provisions rather than a gap in resource availability or methods. Robert Kaufman ² has consistently emphasized this distinction. When “need” is used as a verb, it presupposes a solution before identifying the actual problem to be solved³ . When using 'need' as a verb (some action), an intervention has been selected prior to a clear definition of the actual gap in provisions or results that would be addressed.

On the other hand, once a gap, or need, is accurately identified, only then can a means or policy be sensibly designed by selecting the appropriate instruments that can help move the economy from the current to the desired results. Kaufman has formalized his approach into a methodology known as the Organizational Element Model (OEM) which identifies “need" not as gaps in products but rather gaps in outputs and then outcomes: from results from each level of activity within the firm to results delivered outside the organization to external client and societal results. Thus the model describes what the organization used, does, produces, and delivers and the consequences that all of this adds as measurable value for our shared society.

Used in this way, cost-consequences estimates may be made to prioritize closing gaps on the basis of the cost to meet the need as compared to the costs associated with ignoring the need.

Kaufman identifies three types, or levels, of needs: Mega, Macro, and Micro in "Change, Choices, and Consequences" published by HRD Press. However, I have substituted the world Mega with the word Macro to comply with current economic terminology and I have divided Micro into Micro and Sub-Micro. The following table, based on Kaufman’s approach, details the levels of needs and their definitions.

Kaufman's Organizational Elements Method adjusted to comply with current economic terminology

Name of the Organizational Element & Level of Planning	Brief Description
Outcomes/Macro	Results and their consequences for external customers, social and economic constituents, society in general
Outputs/Micro	The results an organization can or does deliver outside of itself
Products/Sub-Micro	The building-block results produced within an organization contributing to final output of that organization
Processes	The different components, ways, means, activities, procedures and methods used internally to create contributions to output
Inputs	The human, physical, and financial resources and organization can or does use

These levels of needs are also levels of planning for any organization and indicate a relationship between the levels. Alignment of objectives at each level is critical to ensure that planning translates into clear organizational operations and ensure that activities at each level add value back up the chain linking measurable to societal value-added. As a consequence, no level of results is any more important than the others. Rather, it is the alignment of all levels that is critical to achieving desired results. The take home message is that what is happening within the economic units throughout the economy is what generates the final macroeconomic outcome.

Macro Planning

Kaufman has developed a model for strategic thinking and planning he calls "Mega Planning", which in the context of this economics essay I have re-named this “Macro-Planning” in line with the table above. The main point here is that many organizational planning models incorrectly begin, and end, with internal or organizational performance and therefore fail to provide organizations a chance to plan how they deliver value outside of their organizations. Traditional planning ends with "Micro" level results, which are organizational results such as profits, shareholder value, executive bonuses, ratings, etc. While these are important measures of organizational performance, they do not indicate the impact of an organization on external clients and society.

Intentional naivety

Those who wish to promote an acceptable image often express their purpose in a form of intentional naivety. Their presumptive position is "you can trust us, we are doing the right thing". This includes, of course, the use of motherhood statements. All along, however, they intend to do the opposite and this practice needs to be rejected. Many corporations abuse their "freedom" to secure their interests at the expense of others. One only needs to reflect on the behaviour of banks leading up to 2007, and corporations such as ENRON, and more recently, Volkswagen, to realize that the images built on propaganda were dependent on politicians, regulators and the public in general believing their messages of intentional naivety. Intentional naivety can help make people feel comfortable but it is dangerous.

The current financial crisis arose, not as a result of government debt but rather because of private debt and the uncontrolled issuance of money by the private banking system. This included, since the mid 1970s, the generation and sale of derivatives and recently turned out to have been sold on the basis of fraud and to be worthless. The derivatives saga impacted local authorities who lost a considerable amount of money creating problems for governments causing considerable social prejudice. In terms of transactions between banks and other financial advisory practices and the private sector, some class actions are now being brought forward that involve cases where banks worked in collaboration with their own consultancy organizations specializing in "corporate restructuring" who purposely degraded the corporate valuations leading to them being sold to the banks who in turn then sold them on at their true value. Such fraudulent activities also permeated the LIBOR quotations affecting contracts worldwide and there have been other issues associated with prejudice created by the unethical behaviour of "debt or interest-based financial intermediation". The lack of constitutional economic controls since 2007 now finds private debt to have risen and is now higher than it was before the crisis. In addition interest rates for private investment in the productive (real) sector are higher than they should. Most money has, under quantitative easing and low interest rates, been applied to fixed assets such as housing, commodities and stocks and bonds. An increasing proportion of stocks and bond values have been increased, not as a result of higher productivity and business prospects, but rather as a result of manipulation by companies buying back their own shares so as to push up the value of executive share allocations, often making up part of bonus packages, and increasing so-called "shareholder value". In the corporate sector the relatively low interest rates have increased the precariousness of borrowers whose "cash flow" has been increased by loans and debt leading to a "real incomes illusion". This has been assisted by an increasing use of credit cards in an attempt to alleviate the cost of living crisis, for some, by also providing them with a "real incomes illusion". The extent of financial fraud and malpractice reported in the media apparently is linked to the insistence by financial intermediaries that compensation be subject to "gag clauses" in legal settlements. This has created a fraud and malpractice awareness iceberg which hides a large proportion of cases.

Mother's Rule is an imperative

There is ample evidence to show that Roger Kaufman's axiom of "Mother's Rule", or what I have referred to as "Motherhood statements", should not be able to become a cynical propaganda based on an intentional naivety. The prejudice to the social and economic constituencies is too big. They need to be treated as universal values and policy objectives and an imperative for action supported by an appropriate constitutional legal and economic framework; the Real Incomes Approach provides the necessary foundation for this to become a reality.

"Macro Planning" starts with the question of "What kind of world do you want for your children and grand-children?" with responses distilled in terms of consequences. An Ideal Vision defines the measurable variables for Mega planning including survival, self-sufficiency, and quality of life. Kaufman refers to this as a system approach or "Mother's Rule" because if you ask just about any mother what kind of world they want for their children, they don't talk to means (corporate profit, money spent on social programs) but the survival, health, and happiness of their children.

Motherhood statements

When I first read Kaufman’s reference to “Mother’s Rule” I was reminded of a similar term “Motherhood statements” which are often used by politicians. They are used to build up a plausible gravity and seriousness in propositions by including desirable conditions as a policy intent whose value, in public, at least, no one would deny. When working at an international institution I was required to write policy propositions supporting EU-wide initiatives. Invariably the drafts would be returned to me from my head of unit with the question, “Where are the motherhood statements”. These were a required window dressing to “explain” what politicians are trying to achieve and to secure a positive image and support. However, when policies are examined they seldom support the very objectives that would have been assumed to be the objectives laid out as Motherhood statements.

The mistake made by politicians and interest groups is not to take conditions that would be included in Motherhood statements, seriously. As a result the policy will not deliver on these but might well benefit some sub-sector interest. So those hoping for more positive outcomes are exposed to yet another disillusionment resulting from policies not delivering on their promise. Kaufman uses the term “Mother’s Rule” for what I have referred to here as “Motherhood statements”. The difference is that Kaufman does not refer to these in a cynical fashion but rather considers these to be fundamental and serious questions. This marks out Kaufman’s work as unique in the sense that he is addressing fundamental constitutional issues which no one in their right mind would deny are of fundamental importance.

In this context Kaufman’s Macro Planning cannot be some cynical device to sell what a policy maker wants to do anyway but it becomes the basis for defining a vision and mission statement that map out exactly how an organization, of any type, will add measurable value to society. Kaufman's models is argued to be the first model for business planning that makes the business case for social responsibility and that establishes a data-based construct for organizational planning and evaluation that goes beyond the walls of the organization (see box on right).

Kaufman argues that since the Ideal Vision was derived by unsystematically asking culturally and geographically diverse populations "what kind of world do you want to help create for tomorrow's child" it is relatively universal. The general acceptance of the values presented would tend to gain unanimity of support.

Constitutional economics

One of the difficulties facing public choice models, an important component of constitutional economics, is that successful actions with traction only result from decisions that received unanimity of support. The Macro-Planning approach is conceived at such a level that it is easier to realize unanimity of support. This is the principle justification for the so-called minority principle substituting out majority principle electoral systems to avoid minority factions preventing unanimity (See The minority principle).

The specific case of the Real Incomes Approach to Economics

At the Macro Planning level it became clear that the current policy objectives and the mix of policy instruments⁵ face an impossible challenge. Given the diversity of conditions, needs, preferences, capabilities and access to resources conventional policies cannot accommodate the requirements of the social⁷ and economic⁸ constituencies. The evidence of this is that the track record of conventional policies is the creation of winners, losers and those who remain in a policy neutral impact state. The significant distinction of the Real Incomes Approach is that there is only one policy objective and measure of success, this is the maintenance or increase in real incomes. The power of this single measure is that all of the conventional policy objectives are subsumed in real incomes (See Why real incomes?). This prevents the common movements in policy indicators such as unemployment, inflation and growth moving in counterproductive, and for conventional economic theory, counter-intuitive directions. Thus a suggested Organizational Elements Model relevant to the Real Incomes approach is provided below. Element 1 at the macroeconomic policy level, needs to be coherent with elements 5 and 6 at the microeconomic level.

The Real Incomes Approach
The Organizational Elements of Price Performance Policy (based on Kaufman's OEM)

	Name of the Element & Level of planning & action	Brief Description
1	Macro-System	The state of real incomes distribution in the context everyone in the social and economic constituency.
2	Outcomes/Macro	Higher better distributed real incomes, higher employment, lower inflation, higher currency purchasing power, higher exports, import substitution, higher productivity
3	Outputs/Micro	Lower price performance ratios, competitive prices, accessibility to products and services
4	Products/Sub-Micro	Higher productivity, accumulated tacit knowledge, refined technique, better use of explicit knowledge
5	Processes	The ways, means, activities, procedures and methods used internally
6	Inputs	The human, physical, and financial resources used in the processes

Implications for supply chains

Having identified the need expressed as gaps in provisions we then need to ensure that the means to achieving the end of closing the gaps are the most effective and efficient. This is an altogether different question to the identification of needs. It is necessary to apply decision analysis so as to identify the lowest cost, least risky methods and processes by reviewing all of the feasible options. Here we pass from the domain where Roger Kaufman has contributed vital insights to another domain dominated by Ronald Howard of Stanford University. Howard coined the term decision analysis in the early 1960s. Although I studied systems engineering at Stanford, I only became aware of Howard’s work in 1985 while working with General Technology Systems and Prognos on a study of the potential contributions of information technology and telecommunications to the European Economy on behalf of the European Commission ITTTF. This will be the topic of the sequel to this article and is currently in preparation.

¹ Hector McNeill is the director of SEEL - Systems Engineering Economics Lab.
² Roger Kaufman was born in Washington D.C. Kaufman's professional work has covered many different industries focusing on human factors, training, and research. Concurrently with most of this work, Kaufman was a professor at Florida State University (FSU), from 1975–2003, In August, 2004, he became Distinguished Research Professor at Sonora Institute of Technology (ITSON) in Sonora, Mexico. He was co-founder of what is now the International Society for Performance Improvement (ISPI).
³ Kaufman, Roger, Alicia M. Rojas, Hannah Mayer (1993). Needs Assessment: A User's Guide. Englewood Cliffs, New Jersey: Educational Technology Publications, Inc.
⁴ Most lobbying activities in the political environment is by interest groups promoting their ready-made solutions to apparent problems. Their influence is often overbearing leading to an inadequate identification of the need and as a result a considerable amount of private sector initiative promoted by governments is misdirected, ineffective and inefficient in its solving priority issues which have not been identified.
⁵ Attempting to influence price stability (inflation), economic growth, unemployment, investment, exports, import substitution, exchange rates by using the instruments of money volume, interest rates, taxation, public expenditure and government debt.
⁶ On the social constituency side the distribution of income and the state of employment combined with many different domestic circumstances related to age, culture, family size and outgoings, again creates a situation where the relevance of centralized and unified policy instruments is also not obvious.
⁷ Economic units, depending upon the sector and technologies applied, all lie on different positions in relation to their investment cycles which can involve periods of between 2 to three years to approaching 25 to 30 years. The status of corporations in relation to capacity for production, capacity utilization, production run durations, production yields, cash flow, indebtedness, liquidity, size of order books, pricing strategies, labour conditions and human resources capabilities are amazingly different even for companies within the same sector deploying the same technologies and plant. It is therefore more than evident that it is difficult for centralized universally fixed interest rate-setting and other macroeconomic instruments to have any particular relevance to such a range of conditions.

Update: 19th October, 2015: Added the box entitled, "Intentional naivety".

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