Tag: Economics

How managing a bad economy is similar to driving a car through a construction zone.

Yesterday, driving with my family in the car, there were several times when traffic ground to a complete stop due to merging lanes in construction zones. Logically I knew this didn’t have to happen if everyone within the system both had access to all information (e.g. the left lane is closed ahead) and drivers were incentivized to slow down instead of attempting to pass each other and cause clogs up ahead. The fact that it does happen and continues to happen even with full access to information (e.g. signs, cones, traffic patterns, news radio, Internet access, and CB broadcasts) could mean that drivers are incentivized to slow down the entire system in order to make sure they get ahead first.

In Mission Impossible III, Tom Cruise’s character explains his job as a traffic pattern analyst and how the act of one person’s brakes can send ripples through the entire traffic system. This is exactly what is happening in a lane-merging event when drivers are responding to brake lights and eventually stopping instead of everyone simply slowing down, merging, and passing through the lane at a reasonable rate. The less brake lights are used, the faster a group of cars will move through a slow-down event. This is because, again, of a lack of information. The driver doesn’t know whether the car in front of them is going to simply slow down and then re-accelerate or if it is going to come to a complete stop. They only have one metric to go on, the brake light.

These ripples in the traffic system mimic other waves in science and finance. We know that by reducing the speed of the vehicle and braking less, we reduce the rapid stops and starts. By doing this we are not only reducing the amplification of the wave pattern, but also changing the the frequency. The wave goes from a high-pitched baby scream to a low bass wave. Once the frequency has been adjusted (e.g. less braking, more steady movement), over time, the speed of the vehicle can be increased. The most efficient traffic is one without waves at all, with cars constantly moving, all at the same pace, but this will never occur. While I would love to fix traffic slowdowns by implementing car-to-car communication systems or a third metric to the brake lighting system, I am simply using traffic as an metaphor for economics as a whole.

It may sound counter intuitive to say that the fastest way to move through a downturn is to slow down, but that’s because it depends on how you decrease your speed. We know that brake lights cause other drivers to slow down which don’t use the brake lights such as simply letting off the gas or downshifting. Aware drivers or smart cars will also adjust in a more subtle way and while traffic may slow down overall, it may not stop and will certainly be in a better position to begin increasing speed once the bottleneck has been passed. If we could understand what the “break lights” in the economy were and how people respond to them, we may be able to help reduce their use and get the economy moving forward again with less starting and stopping.

Examples of break lights in the economy are stock selloffs, layoffs, and inventory cuts. Speculators will sell a stock before they think it will go down, which then actually causes the stock to go down, which causes other investors to also sell until the price is enticing enough for people to buy back in. Companies will layoff workers in anticipation of a downturn, even if they are not currently experiencing one. And in fear of not being able to sell current inventory, companies will stop buying goods in order to not be ‘caught with the bag.’ These are all drastic measures that cause ripple effects in the economy, slowing it down and helping to cause the very thing they are trying to avoid.

What if instead, companies simply ‘switched gears’ or ‘let off the gas’ during an economic slow down instead of braking? Wouldn’t these companies be best poised for re-accelerating in an economic up turn? Using the prior examples of stock, layoffs, and inventory cuts, here are some examples of what companies could do differently. Shareholders could simply hold stock and stop buying for a period of time in order to coast through a down turn. Companies could use any excess employees as salesman, research analysts, or focus groups for innovation to create new ideas or help find new customers. And instead of cutting inventory, companies could increase the diversity of what they buy in order to market to areas of the market that in a good economy didn’t make sense, but now does.

In fact, most successful companies already do this. Ford Motor Company outlasted hundreds of other car manufacturers not because it was better, but because it was willing to change. Groupon was originally an online collective action and fundraising company called The Point, which pivoted and began offering discounts via email. Google continually innovate and pays it’s engineers to create side projects and yet continues to grow in spite of the economy. Compare this to the pharmaceutical industry that has increased advertising spending over research and is now in crises as their development cycle has run it’s course. Another example is Southwest Airlines, which for most of its history did not layoff it’s workers and remained profitable while it’s peers went through bankruptcy proceedings. Layoff alternatives like early buyouts, early retirements, across-the-board budget cuts, hiring freezes, and eliminating overtime pay only serve to hurt the top performers – the rest of the company is only there for a paycheck anyway. It all comes down to proper management and leadership.