Models of change - How innovation happens
Nov 5, 2012

An interesting article appeared yesterday in NYTimes titled “A Capitalist’s Dilemma, Whoever Wins on Tuesday” . While the title appears to be topical about elections, it is broader and more applicable to the modern times we live it. In fact, it resonates well with what I have been saying all along.

Long time readers of my blog know that I have been a proponent of innovation along three layers: Systems of record, systems of change, and systems of innovation. The first group focuses on efficiencies, the second one of better outcomes, and the third one on disruptive changes. Clayton Christensen (He is most famous for his book, innovators dilemma) seems to say something similar, but from economic perspective.

In his worldview, as a finance professor, he sees three uses for investments:

In fact, this thought process is not new. In the classical Marxism, the concept of inherent contradiction in capitalism alludes to something similar. As capital gets accumulated, it leads to efficiencies, which reduces the need for people causing depression in demand and so on. Modern economists (Example: Galbraith) focused on how to break this depression cycle by creating disruptive industries. Fortunately, US managed to come out of depression by empowering innovations.

The current situation is this: There is lot of capital available. In fact, tons of it. The reason why is not being used is neither the regulation (which is what the right wing economists want us to believe), nor the lack of demand (which is actually true – but simulating demand for a long term cannot be a short term measure). [I may be out of my depth as an economist here – I am only rationalizing and could be entirely wrong, but it makes for an interesting narrative.]

What is the problem is systemic issue. See how we measure the ROI similarly in all industries. In India, the real-estate ROI has sucked away any investment, which itself might have created a positive effect for real-estate. Instead, it became a short-term “slash and burn” operation that extracted ROI from real- estate at the cost of empowering innovations.

According to Clayton Christensen, the problem here is the way we have been measuring the financial returns: ROCE (Return on capital employed), RONE (Return on net assets), and IRR (Internal rate of return). They can reduce the investment and still make good ratio. Or, invest only in quick wins and get good metrics.

So, what is the prescription? According to the professor:

  1. Deal with the abundance of capital – by investing in the right skills.
  2. Change the metrics – so that we use the capital for the right tasks
  3. Change the capital gains taxes to promote the right investments
  4. Change the politics to focus on the empowering innovations.

Of course, I can see the following criticism:

  1. The right wing people will see it as a way for the government meddling in picking winners and choosers and shaping the behavior.
  2. The left wing people will see it as a violation of social contract which is to focus on helping the people in need, the poor and the elderly.

Recently, there have been growing calls for investment in infrastructure, however muted they may be. Let us see how it goes after these elections.