W O R L D V I E W

Why businesspeople don't necessarily make great economists.

A Country Is Not a Companyby Paul Krugman

College students who plan to gointo business often major in eco-nomics, but few believe that theywill end up using what they hear inthe lecture hall. Those students un-derstand a fundamental truth: Whatthey learn in economics courseswon't help them run a business.

The converse is also true: Whatpeople learn from running a busi-ness won't help them formulate eco-nomic policy. A country is not a bigcorporation. The hahits of mind thatmake a great business leader are not,in general, those that make a greateconomic analyst; an executive whohas made $1 billion is rarely theright person to turn to for adviceabout a $6 trillion economy.

Why should that be pointed out?After all, neither businesspeople noreconomists are usually very goodpoets, but so what? Yet many people(not least successful business execu-tives themselves) believe that some-one who has made a personal for-tune will know how to make anentire nation more prosperous. Infact, his or her advice is often disas-trously misguided.

I am not claiming that business-people are stupid or that economistsare particularly smart. On the con-trary, if the 100 top U.S. business ex-ecutives got together with the 100leading economists, the least im-pressive of the former group wouldprobably outshine the most impres-sive of the latter. My point is thatthe style of thinking necessary foreconomic analysis is very differentfrom that which leads to success inbusiness. By understanding that dif-ference, we can begin to understandwhat it means to do good economicanalysis and perhaps even help somebusinesspeople become the greateconomists they surely have the in-tellect to be.

Let me begin with two examplesof economic issues that I have foundbusiness executives generally do notunderstand: first, the relationshipbetween exports and job creation,and, second, the relationship be-tween foreign investment and tradebalances. Both issues involve inter-national trade, partly because it isthe area I know best but also becauseit is an area in which businesspeople

seem particularly inclined to makefalse analogies between countriesand corporations.

Exports and JobsBusiness executives consistently

misunderstand two things about therelationship hetween internationaltrade and domestic job creation.First, since most U.S. business-people support free trade, they gen-erally agree that expanded worldtrade is good for world employment.Specifically, they helieve that freetrade agreements sueh as the recent-ly concluded General Agreement onTariffs and Trade are good largely be-cause they mean more jobs aroundthe world. Second, businesspeopletend to helieve that countries com-pete for those jobs. The more theUnited States exports, the thinkinggoes, the more people we will em-

Paul Krugmar} is a professor of eco-nomics at Stanford University inPalo Alto. California. His last HBRarticle was "Does Third WorldGrowth Hurt First World Prosper-ity}" (July-August 1994).

40 DRAWINGS BY CHRISTOPHER BING

ploy, and the more we import, thefewer jobs will he available. Accord-ing to tbat view, the United Statesmust not only have free trade hut al-so be sufficiently competitive to geta large proportion of the jobs tbatfree trade creates.

Do those propositions sound rea-sonable? Of course they do. This sortof rhetoric dominated the last U.S.presidential election and will likelyhe heard again in the upcoming race.However, economists in general donot believe that free trade createsmore jobs worldwide (or that its ben-efits should be measured in terms ofjob creation) or that countries thatare highly successful exporters willhave lower unemployment thanthose that run trade deficits.

Why don't economists subscribeto what sounds like common senseto businesspeople? The idea that freetrade means more glohal johs seemsobvious: More trade means more ex-ports and tberefore more export-related jobs. But there is a problemwith that argument. Because onecountry's exports are another coun-try's imports, every dollar of exportsales is, as a matter of sheer mathe-matical necessity, matched by a dol-lar of spending shifted from somecountry's domestic goods to im-ports. Unless there is some reason tothink tbat free trade will increasetotal world spending - which is nota necessary outcome - overall worlddemand will not change.

Moreover, heyond this indis-putable point of arithmetic lies thequestion of what limits the overallnumber of jobs available. Is it simplya matter of insufficient demand forgoods? Surely not, except in the veryshort run. It is, after all, easy to in-crease demand. The Federal Reservecan print as much money as it likes,and it has repeatedly demonstratedits ability to create an economicboom when it wants to. Why, then,doesn't the Fed try to keep tbe econ-omy booming all tbe time? Becauseit believes, with good reason, that ifit were to do so-if it were to createtoo many johs - the result would heunacceptable and accelerating infla-tion. In other words, the constrainton the number of johs in the UnitedStates is not the U.S. economy's abil-

W O R t D V I E W

ity to generate demand, from exportsor any other source, but the level ofunemployment that the Fed thinksthe economy needs in order to keepinflation under control.

That is not an abstract point. Dur-ing 1994, the Fed raised interestrates seven times and made no secretof the fact that it was doing so tocool off an economic boom that itfeared would create too many jobs,overbeat tbe econo-my, and lead to infla-tion. Consider whatthat implies for the ef-fect of trade on em-ployment. Supposethat the U.S. economywere to experience anexport surge. Suppose,for example, that theUnited States agreedto drop its objections to slave labor ifChina agreed to buy $200 billionworth of U.S. goods. What would theFed do? It would offset the expan-sionary effect of the exports by rais-ing interest rates; thus any increasein export-related jobs would be moreor less matched hy a loss of johsin interest-rate-sensitive sectors ofthe economy, such as construction.Conversely, the Fed would surely re-spond to an import surge by lower-ing interest rates, so the direct lossof johs to import competition wouldbe roughly matehed hy an increasednumber of jobs elsewhere.

Even if we ignore the point thatfree trade always increases worldimports by exaetly as much as it in-creases world exports, there is stillno reason to expect free trade to in-crease U.S. employment, nor shouldwe expect any other trade policy,such as export promotion, to in-crease the total number of jobs inour economy. When the U.S. secre-tary of commerce returns from a tripabroad with billions of dollars innew orders for U.S. companies, hemay or may not be instrumental increating thousands of export-relatedjobs. If he is, he is also instrumentalin destroying a roughly equal num-ber of jobs elsewhere in the econo-my. The ability of the U.S. economyto increase exports or roll back im-ports has essentially nothing to dowith its success in creating jobs.

Needless to say, this argumentdoes not sit well with business audi-ences. (Wben I argued on one busi-ness panel that the North AmericanFree Trade Agreement would haveno effect, positive or negative, on thetotal number of jobs in tbe UnitedStates, one of my fellow panelists -a NAFTA supporter - reacted withrage: "It's comments like that thatexplain why people bate econo-

Many people believe thatsomeone vs ho has made apersonal fortune will knowhovs to make an entirenation more prosperous.

mists!") The job gains from in-creased exports or losses from im-port competition are tangible: Youcan actually see the people makingthe goods that foreigners buy, theworkers whose factories were closedin the face of import competition.The other effects that economiststalk ahout seem ahstract. And yet ifyou accept the idea that the Fed hasboth a johs target and the means toachieve it, you must conclude thatchanges in exports and imports havelittle effect on overall employment.

Investment and theTrade Balance

Our second example, the relation-ship between foreign investmentand trade balances, is equally trou-bling to husinesspeople. Supposethat hundreds of multinational com-panies decide that a country is anideal manufacturing site and startpouring billions of dollars a year intothe country to build new plants.What happens to tbe country's tradebalance? Business executives, al-most without exception, believethat tbe country will start to runtrade surpluses. They are generallyunconvinced by tbe economist's an-swer that such a country will neces-sarily run large trade deficits.

It's easy to see where the business-people's answer comes from. Theythink of their own companies andask what would happen if capacity

HARVARD BUSINESS REVIEW January-February 1996 41

in their industries suddenly expand-ed. Clearly their companies wouldimport less and export more. If thesame story is played out in many in-dustries, surely this would mean ashift toward a trade surplus for theeconomy as a whole.

The economist knows that justthe opposite is true. Why? Becausethe balance of trade is part of thebalance of payments, and the overall

A country thatattracts a lot of foreign

investment will necessarilyrun a trade deficit.

balance of payments of any country-the difference hetween its total salesto foreigners and its purchases fromforeigners - must always be zero.' Ofcourse, a country can run a tradedeficit or surplus. That is, it can buymore goods from foreigners than itsells or vice versa. But that imbal-ance must always he matched by acorresponding imbalance in the cap-ital account. A country that runs atrade deficit must be selling foreign-ers more assets than it buys; a coun-try that runs a surplus must be a netinvestor abroad. When the UnitedStates buys Japanese automohiles, itmust he selling something in re-turn; it might be Boeing jets, hut itcould also he Rockefeller Center or,for that matter. Treasury bills. Thatis not just an opinion that econo-

W O R L D V I E W

mists hold; it is an unavoidable ac-counting truism.

So what happens when a countryattracts a lot of foreign investment?With the inflow of capital, foreignersare acquiring more assets in thatcountry than the country's residentsare acquiring abroad. But thatmeans, as a matter of sheer account-ing, that the country's importsmust, at the same time, exceed its

exports. A country thatattracts large capital in-flows will necessarily runa trade deficit.

But that is just ac-counting. How does ithappen in practice? Whencompanies build plants,they will purchase someimported equipment. The

investment inflow may spark a do-mestic boom, which leads to surg-ing import demand. If the countryhas a floating exchange rate, theinvestment inflow may drive up thecurrency's value; if the country'sexchange rate is fixed, the resultmay he inflation. Either scenariowill tend to price the country's goodsout of export markets and increaseits imports. Whatever the channel,the outcome for the trade balanceis not in doubt: Capital inflowsmust lead to trade deficits.

Consider, for example, Mexico'srecent history. During the 1980s, no-body would invest in Mexico and thecountry ran a trade surplus. After1989, foreign investment poured inamid new optimism about Mexico'sprospects. Some of that money was

spent on imported equipment forMexico's new factories. The rest fu-eled a domestic boom, which suckedin imports and caused the peso tobecome increasingly overvalued.That, in turn, discouraged exportsand prompted many Mexican con-sumers to purchase imported goods.The result: Massive capital inflowswere matched by equally massivetrade deficits.

Then came the peso crisis of De-cember 1994. Once again, investorswere trying to get out of Mexico, notin, and the scenario ran in reverse. Aslumping economy redueed the de-mand for imports, as did a newlydevalued peso. Meanwhile, Mexicanexports surged, helped by a weakcurrency. As any economist couldhave predicted, the collapse of for-eign investment in Mexico has beenmatched by an equal and oppositemove of Mexican trade into surplus.

But like the proposition that ex-panded exports do not mean moreemployment, the necessary conclu-sion that countries attracting foreigninvestment typically run trade defi-cits sits poorly with business audi-ences. The specific ways in whichforeign investment might worsenthe trade balance seem questionableto them. Will investors really spendthat much on imported equipment?How do we know that the currencywill appreciate or that, if it does, ex-ports will decrease and imports willincrease? At the root of the busi-nessperson's skepticism is the fail-ure to understand the force of the ac-counting, which says that an inflow

42 HARVARD BUSINESS REVIEW Ianuar>--Ffbruary 1996

of capital must - not might - be ac-companied by a trade deficit.

In each of the above examples,there is no question that the econo-mists are right and the business-people are wrong. But why do thearguments that economists findcompelling seem deeply implau-sihle and even counterintuitive tobusinesspeople?

There are two answers to thatquestion. The shallow answer is thatthe experiences of husiness life donot generally teach practitioners tolook for the principles tbat underlieeconomists' arguments. Tbe deeperanswer is that tbe kinds of feedhackthat typically arise in an individualhusiness are both weaker than anddifferent from the kinds of feedbackthat typically arise in the economyas a whole. Let me analyze each ofthese answers in turn.

The Parable of the ParalyzedCentipede

Every once in a while, a highlysuccessful husinessperson writes ahook about what he or she haslearned. Some of these books arememoirs: They tell the story of a ca-reer through anecdotes. Others areambitious efforts to describe theprinciples on which the great per-son's success was hased.

Almost without exception, thefirst kind of hook is far more suc-cessful than the second, not only interms of sales but also in terms of itsreception among serious thinkers.Why? Because a corporate leadersucceeds not hy developing a general

W O R L D V I E W

theory of tbe corporation hut hyfinding the particular product strate-gies or organizational innovationsthat work. There have been somebusiness greats who have attemptedto codify what they know, but suchattempts have almost always beendisappointing, George Soros's booktold readers very little about howto be another GeorgeSoros; and many peo-ple have pointed outthat Warren Buffettdoes not, in practice,invest the Warren Buf-fett Way. After all, a fi-naneial wizard makesa fortune not hy enun-ciating general princi-ples of financial mar-kets hut by perceiving particular,highly specific opportunities a bitfaster than anyone else.

Indeed, great business executivesoften seem to do themselves harmwhen they try to formalize whatthey do, to write it down as a set ofprinciples. They begin to hehave asthey think they are supposed to,whereas their previous success washased on intuition and a willingnessto innovate. One is reminded of theold joke about the centipede whowas asked how he managed to coor-dinate his 100 legs: He started think-ing about it and could never walkproperly again.

Yet even if a business leader maynot he very good at formulating gen-eral theories or at explaining whathe or she does, there are still thosewho believe that the businessper-

son's ability to spot opportunitiesand solve problems in his or her ownbusiness can be applied to the na-tional economy. After all, what thepresident of the United States needsfrom his economic advisers is notlearned tracts but sound adviceabout what to do next. Why isn'tsomeone who has shown consistent-

A corporate leadersucceeds by finding theright strategies, notby developing a theory ofthe corporation.

ly good judgment in running a busi-ness likely to give the president goodadvice about running the country?Because, in short, a country is not alarge company.

Many people have trouble grasp-ing the difference in complexity be-tween even the largest business anda national economy. The U.S. econo-my employs 120 million people,ahout 200 times as many as GeneralMotors, the largest employer in theUnited States, Yet even this 200-to-lratio vastly understates the differ-ence in complexity between thelargest husiness organization andthe national economy. A mathe-matician will tell us that the num-ber of potential interactions among alarge group of people is proportionalto tbe square of their number. With-out getting too mystical, it is likely

HARVARD BUSINESS REVIEW January-February 1996 43

that the U.S. economy is in somesense not hundreds but tens of thou-sands of times more complex thanthe biggest corporation.

Moreover, there is a sense inwhich even very large corporationsare not all that diverse. Most corpo-

The U.S. economy is theultimate conglomerate,

vs ith tens of thousands ofdistinct lines of business.

rations are built around a core com-petence: a particular technology oran approach to a particular type ofmarket. As a result, even a huge cor-poration that seems to be in manydifferent businesses tends to be uni-fied by a eentral theme.

The U.S. economy, in eontrast, isthe ultimate nightmare conglomer-ate, with tens of thousands of utterlydistinct lines of husiness, unified on-ly because they happen to be withinthe nation's borders. The experienceof a successful wheat farmer offerslittle insight into what works in thecomputer industry, which, in turn,is probably not a very good guide tosuccessful strategies for a chain ofrestaurants.

How, then, can such a complexentity be managed? A national econ-omy must be run on the basis of gen-eral principles, not particular strate-gies. Consider, for example, thequestion of tax policy. Responsiblegovernments do not impose taxestargeted at particular individuals orcorporations or offer them specialtax hreaks. In fact, it is rarely a goodidea for governments even to designtax policy to encourage or discour-age particular industries. Instead, agood tax system obeys the broadprinciples developed by fiscal ex-perts over the years - for example,neutrality between alternative in-vestments, low marginal rates, andminimal discrimination betweencurrent and future consumption.

Why is that a problem for busi-nesspeople? After all, there are manygeneral principles that also underliethe sound management of a corpora-

tion: consistent accounting, clearlines of responsibility, and so on.But many husinesspeople have trou-ble accepting the relatively hands-off role of a wise economic policy-maker. Business executives must beproactive. It is hard for someone

used to that role to real-ize how much more dif-ficult - and less neces-sary-this approach is fornational economic policy.

Consider, for example,the question of promot-ing key business areas.Only an irresponsibleCEO would not try to

determine which new areas wereessential to the company's future;a CEO who left investment deci-sions entirely to individual manag-ers running independent profit cen-ters would not be doing the job. Butshould a government decide on a listof key industries and then activelypromote them? Quite aside fromeconomists' theoretical argumentsagainst industrial targeting, the sim-ple fact is that governments havea terrible track record at judgingwhich industries are likely to be im-portant. At various times, govern-ments have been convinced thatsteel, nuclear power, synthetic fuels,semiconductor memories, and fifth-generation computers were the waveof the future. Of course, businessesmake mistakes, too, hut they do nothave the extraordinarily low hattingaverage of government because greathusiness leaders have a detailedknowledge of and feel for their in-dustries that nobody-no matter howsmart-can have for a system as com-plex as a national economy.

Still, the idea that the best eco-nomic management almost alwaysconsists of setting up a good frame-work and then leaving it alonedoesn't make sense to businesspeo-ple, whose instinct is, as Ross Perotput it, to "lift up the hood and get towork on the engine."

Going Back to SchoolIn the scientific world, the syn-

drome known as "great man's dis-ease" happens when a famous re-searcher in one field develops strongopinions about another field that he

or she does not understand, such as achemist who decides that he is anexpert in medicine or a physicistwho decides that he is an expert incognitive science. The same syn-drome is apparent in some husinessleaders who have been promoted toeconomic advisers: They have trou-hle accepting that they must go hackto school before they can make pro-nouncements in a new field.

The general principles on whichan economy must be run are differ-ent - not harder to understand, butdifferent-from those that apply to abusiness. An executive who is thor-oughly comfortable with businessaccounting does not automaticallyknow how to read national incomeaccounts, which measure differentthings and use different concepts.Personnel management and laborlaw are not the same thing; neitherare corporate financial control andmonetary policy. A business leaderwho wants to become an economicmanager or expert must learn a newvocabulary and set of concepts, someof them unavoidably mathematical.

That is hard for a business leader,especially one who has been verysuecessful, to accept. Imagine a per-son who has mastered the complexi-ties of a huge industry, who has runa multibillion-dollar enterprise. Issuch a person, whose adviee on eco-nomic policy may well be sought,likely to respond by deciding tospend time reviewing the kind ofmaterial that is covered in freshmaneconomics courses? Or is he or shemore likely to assume that businessexperience is more than enough andthat the unfamiliar words and con-cepts economists use are nothingbut pretentious jargon?

Of course, in spite of the examplesI gave earlier, many readers may stillbelieve that the second response isthe more sensible one. Why doeseconomic analysis require differentconcepts, a completely different wayof thinking, than running a husi-ness? To answer that question, Imust turn to the deeper differencebetween good business thinking andgood economic analysis.

The fundamental difference be-tween business strategy and eco-

continued on page 48

44 HARVARD BUSINESS REVIEW January-February iy96

nomic analysis is this: Even thelargest business is a very open sys-tem; despite growing world trade,the U.S. economy is largely a closedsystem. Businesspeople are not usedto thinking about closed systems;economists are.

Let me offer some noneconomicexamples to illustrate the differencehetween closed and open systems.Consider solid waste. Every year, theaverage American generates abouthalf a ton of solid waste that cannothe recycled or burned. What happensto it? In many communities, it issent somewhere else. My town re-quires that every resident subscribeto a private disposal service hut pro-vides no landfill site; tbe disposalservice pays a fee to some other com-munity for the right to dump ourgarbage. This means tbat tbe garbagepickup fees are higher than theywould be if the town set aside a land-fill site, hut the town governmenthas made that choice: It is willing topay so that it won't have an unsight-ly dump within its borders.

For an individual town, thatchoice is feasible. But could everytown and county in the UnitedStates make the same choice? Couldwe all decide to send our garbagesomewhere else? Of course not(leaving aside the possibility of ex-porting garbage to the Third World).For the United States as a whole,the principle "garbage in, garbageout" applies literally. The countrycan make choices about where tobury its solid waste but not aboutwhether to bury it at all. That is, interms of solid waste disposal, theUnited States is more or less a closedsystem, even though each town is anopen system.

That's a fairly obvious example,Here is another, perhaps less obvi-ous one. At one point in my life, Iwas a "park-and-ride" commuter:Every morning, I would drive to alarge parking garage and then takepublic transportation downtown.Unfortunately, the garage was notlarge enough. It consistently filledup, forcing late commuters to con-tinue driving all tbe way to work, Isoon learned, however, that I couldalways find a parking space if I ar-rived by about 8:15.

In this case, each individual com-muter constituted an open system:He or she could find a parking spaceby arriving early. But tbe group ofcommuters as a whole could not dothe same. If everyone tried to get aspace hy arriving earlier, the garagewould only fill up sooner! Com-muters as a group constituted aclosed system, at least as far as park-ing was concerned.

What does this have to do withhusiness versus economics? Busi-nesses - even very large corpora-tions-are generally open systems.They can, for example, increase em-ployment in all their divisions si-multaneously; they can increase in-vestment across the board; they canseek a higher share of all their mar-kets, Admittedly, the borders of theorganization are not wide open. Acompany may find it difficult to ex-pand rapidly because it cannot at-tract suitable workers fast enough orbecause it is unahle to raise enoughcapital. An organization may find iteven more difficult to contract, be-cause it is reluctant to fire good em-ployees. But we find nothing re-markable in a corporation whosemarket share doubles or halves injust a few years.

By contrast, a national economy-especially that of a very large coun-try like the United States-is a closedsystem. Could all U.S. companiesdouble their market shares over thenext ten years?' Certainly not, nomatter how much their manage-ments improved. Forone thing, in spite ofgrowing world trade,more than 70% ofU.S. employment andvalue-added is in in-dustries, such as retailtrade, that neither ex-port nor face importcompetition. In thoseindustries, one U.S. company can in-crease its market share only at theexpense of another.

In industries that do enter intoworld trade, U.S. companies as agroup can increase their marketshare, but they must do so by eitherincreasing exports or driving downimports. Any increase in their mar-ket share would therefore mean a

move into trade surplus; and, as wehave already seen, a country tbatruns a trade surplus is necessarily acountry that exports capital. A littlearithmetic tells us that if the averageU.S. company were to expand itsshare of the world market by as littleas five percentage points, the UnitedStates, which is currently a net im-porter of capital from the rest of theworld, would have to become a netexporter of capital on a scale neverbefore seen, if you think this is animplausible scenario, you must alsobelieve that U.S. companies cannotincrease tbeir combined share of themarket hy more than a percentagepoint or two, no matter how wellrun they are.

Businesspeople have trouble witheconomic analysis because they areaccustomed to thinking about opensystems. To return to our two exam-ples, a businessperson looks at thejobs directly created by exports andsees those as the most importantpart of the story. He or she may ac-knowledge that higher employmentleads to higher interest rates, butthis seems an iffy, marginal concern.What the economist sees, however,is that employment is a closed sys-tem: Workers who gain johs from in-creased exports, like park-and-ridecommuters who secure parkingspaces by arriving at the garage early,must gain those positions at some-one else's expense.

And what about the effect of for-eign investment on the trade bal-

Will a business leadervs ant to revievs^ materialtaught in freshmaneconomics courses?

anee? Again, tbe business executivelooks at the direct effects of invest-ment on competition in a partieularindustry; the effects of capital flowson exchange rates, prices, and so ondo not seem particularly reliable orimportant. The economist knows,however, that the balance of pay-ments is a closed system: Tbe inflowof capital is always matched hy the

48 HARVARD BUSINESS REVIEW January-February 1996

trade deficit, so any increase in thatinflow must lead to an increase inthat deficit.

Feedbacks in Business andEconomics

Another way of looking at the dif-ference between companies andeconomies may help explain whygreat business executives are oftenwrong about economics and whycertain economic ideas are morepopular with businesspeople thanothers: Open systems like eompa-nies typically experience a differentkind of feedback than closed sys-tems like economies.

This concept is best explained hyhypothetical example. Imagine acompany that has two main lines ofbusiness: widgets and gizmos. Sup-

Even the largest business isa very open system;

a national economy is aclosed system.

pose that this company experiencesunexpected growth in its sales ofwidgets. How will that growth affectthe sales of the company as a whole?Will increased widget sales end uphelping or hurting the gizmo busi-ness? The answer in many cases willhe that there is not much effect ei-ther way. The widget division willsimply hire more workers, the com-pany will raise more capital, andthat will be that.

The story does not necessarily endhere, of course. Expanded widgetsales could either help or hurt thegizmo husiness in several ways. Onone hand, a profitable widget busi-ness could help provide the cashflow that finances expansion in giz-mos; or the experience gained fromsuccess in widgets may he transfer-able to gizmos; or the growth of thecompany may allow R&D effortsthat benefit both divisions. On theother hand, rapid expansion maystrain the company's resources, sothat the growth of widgets maycome to some extent at the gizmodivision's expense. But such indirect

W O R L D V I E W

effects of the growth of one part ofthe company on the success of theother are both ambiguous in princi-ple and hard to judge in practice;feedbacks among different lines ofbusiness, whether they involve syn-ergy or competition for resources,are often elusive.

By eontrast, consider a nationaleconomy that finds one of its majorexports growing rapidly. If that in-dustry increases employment, itwill typically do so at the expense ofother industries. If the country doesnot at the same time reduce its in-flows of capital, the increase in oneexport must be matched by a reduc-tion in other exports or by an in-crease in imports because of thebalance of payments accounting dis-cussed earlier. That is, there will

most likely be strongnegative feedbacks fromthe growth of that exportto employment and ex-ports in other industries.Indeed, those negativefeedbacks will ordinarilyhe so strong tbat theywill more or less com-pletely eliminate any im-

provements in overall employmentor the trade balance. Why? Becauseemployment and the balance of pay-ments are closed systems.

In the open-system world of busi-ness, feedbacks are often weak andalmost always uncertain. In theclosed-system world of economics,feedbacks are often very strong andvery certain. But that is not thewhole difference. The feedbacks inthe business world are often posi-tive; those in the world of eeonomicpolicy are usually, though not al-ways, negative.

Again, compare the effects of anexpanding line of business in a cor-poration and m a national economy.Success in one line of husiness,which expands the company's finan-cial, technological, or marketingbase, often helps a company expandin other lines. That is, a companythat does well in one area may endup hiring more people in other areas.But an economy that produces andsells many goods will normally findnegative feedhacks among economicsectors: Expansion of one industry

pulls resources of capital and laboraway from other industries.

There are, in fact, examples of pos-itive feedbacks in economics. Theyare often evident within a particularindustry or group of related indus-tries, especially if those industriesare geographieally concentrated. Forexample, the emergence of Londonas a financial center and of Holly-wood as an entertainment center areclearly cases of positive feedbackat work. However, such examplesare usually limited to particular re-gions or industries; at the level ofthe national economy, negative feed-back generally prevails. The reasonshould be obvious: An individual re-gion or industry is a far more opensystem than the economy of theUnited States as a whole, let alonethe world economy. An individualindustry or group of industries canattract workers from other sectors ofthe economy; so if an individual in-dustry does well, employment mayincrease not only in that industrybut also in related industries, whichmay further reinforce the success ofthe first industry, and so on. Thus ifone looks at a particular industrialcomplex, one may well see positivefeedback at work. But for the econo-my as a whole, those localized posi-tive feedbacks must he more thanmatched by negative feedbacks else-where. Extra resources pulled intoany one industry or cluster of indus-tries must come from somewhere,which means from other industries.

Businesspeople are not accus-tomed to or comfortable with theidea of a system in which there arestrong negative feedbacks. In partic-ular, they are not at all comfortablewith the way in which effects thatseem weak and uneertain from thepoint of view of an individual com-pany or industry - such as the effectof reduced hiring on average wagesor of increased foreign investmenton the exchange rate - become cru-cially important when one adds upthe impact of policies on the nation-al economy as a whole.

What's a President to Do?In a society that respects business

success, political leaders will in-evitably - and rightly - seek the ad-

50 HARVARiD BUSINESS REVIEW January-February 1996

vice of husiness leaders on many is-sues, particularly those that involvemoney. All we can ask is that boththe advisers and the advisees have aproper sense of what business suc-cess does and does not teach abouteconomic policy.

In 1930, as the world slid into de-pression, John Maynard Keynescalled for a massive monetary ex-pansion to alleviate the crisis andpleaded for a policy hased on eco-nomic analysis rather than on theadvice of hankers committed to thegold standard or manufacturers whowanted to raise prices by restrictingoutput. "For-though no one will be-lieve it - economics is a technicaland difficult subject,'" Had his ad-vice been followed, the worst rav-ages of the Depression might havebeen avoided.

Keynes was right: Economics is adifficult and technical suhject. It isno harder to be a good economistthan it is to be a good business exec-utive, (In fact, it is probably easier,because the competition is less in-tense,) However, economics andbusiness are not the same suhject,and mastery of one does not ensurecomprehension, let alone mastery,of the other. A successful businessleader is no more likely to be anexpert on economics than on mili-tary strategy.

The next time you hear husiness-people propounding their viewsabout the economy, ask yourself.Have they taken the time to studythis suhject? Have they read whatthe experts write? if not, never mindhow successful they have been inhusiness. Ignore them, because theyprobably have no idea what they aretalking ahout.

1. There are actually two tecbnical itioos to this statement. One of them involveswhat are known as "unrequited transfers":gifts, foreign aid, and so {)n. The other involvesprofits and interest payments from past invest-ments. These qualifications do not change themain point.

2. Strictly speaking, one should talk of compa-nies that produce in the United States. It is cer-tainly possihle for companies based in theUnited States to increase their world marketshare hy acquiring foreign suhsidiaries.

3. "The Great Slump of 1930," reprinted inEssays in Permasion (New York: Norton, 1963).

Reprint 96108

Forget EPS, ROE and ROI.EVAls What Drives

Stock Prices.

Look what happens whm a compcm)' adopls EVA

EVA® — Economic Value Added — is afinancial tool that tells you how much yourcompany is beating the total cost of capital,and what to do about it if you're not.

EVA is also a performance measurementtbat best accounts for changes in sharevalue. Why? Because what drives a compa-ny's share price is the amount by whichearnings, properly measured, exceed or fallshort of the cost of the capital required toproduce those earnings. That's preciselywhat EVA shows you.

•'We calcukited our EVA hack to 1984and found an aln?ost perfect correlationuitb stock price." siiysJmiK'^Uiienim.CFO oiCommunications Services at AT&T.

EVA is your company's after tax profitsfrom operations less the cost of all capitalemployed to produce those profits: not justthe cost of debt, but the cost of equity capi-tal as well. When EVA is used as part of atotal financial management system, it canhelp shape ever\' corporate decision, from acompany acquisition or divestiture to proj-ect budgeting, product development..,evenincentive compensation.

More and more companies such asEquifax and Briggs & Stratton are using EVA

to guide their decision making. If you're notusing EVA to help you decide whether to buy acompetitor, sell a division or build a new plant,then how can you be sure your decisions aremaximizing your shareholder value?

Wovt am you be sure?You can turn to the corporate advisory

firm that developed EVA, Stern Stewart & Co.can do for you what we have done tor dozensof Fortune 500 companies and scores of oth-ers. Our EVA'' financial management servicecan give you the tools and training to inte-grate an EVA management framework intoyour corporate culture.

Just measuring EVA isn't enough. Youneed to adopt it. EVA brings a new kind offinancial discipline to companies, it encour-ages managei^ to act like owners and boostsshareholder fortunes in the process,

EVA® — The Real Key to CreatingWealth'"' For more information, contactAlEhrbar at (212) 261-0748.

•••'-j ',i

Stern Stewart & Co.THE EVA''COMPANY

e All ri^Ls re*rwd for Stem Sitwart S (ji. KVA* a 3 ivgislmid trademaA nf Stem Stewan & Co, jn the I S and Moxi