A Guest Review of Tim Harford’s [amazon_link id=”1408701529″ target=”_blank” ]Adapt:Why Success Always Starts With Failure[/amazon_link]

By Keith Wade, Chief Economist, Schroders

Tim Harford’s latest book is an appeal for more experimentation in government policy, business and life. The complexity of the modern economy and society means that efforts to solve our problems are often thwarted by the interactions and unforeseen consequences which unfold on any chosen path. We should accept the limits to our wisdom and be a little more humble in our approach to problem solving. Viewed from the wreckage of the post financial crisis economy such an argument has great appeal.

To highlight the complexity of the modern economy Harford begins with the case of someone trying to build a toaster from scratch. An extraordinary project which demonstrates the effort involved in bringing together the resources needed to construct a simple household appliance – the modern toaster contains more than four hundred components and sub components – and illustrates the extraordinary level of specialisation present in today’s world economy.

In the light of such intricacy, Adapt goes on to argue for an experimental approach to decision making where policymakers and businesses are open to the idea that a single line of attack is unlikely to succeed. Instead, a more experimental and adaptive method is needed where decisions are reached through a process of trial and error.  One consequence of this is that we should be more tolerant of failure as it is part of the evolutionary process through which we reach solutions.

Harford marshals an impressive array of evidence to support his case from the Iraq conflict, where an adaptive approach to the insurgency which responded to local conditions ultimately triumphed over the top down strategy of the Pentagon, to the development of the Spitfire fighter plane where a civil servant was prepared to go against conventional wisdom and take a flyer on a different approach to stopping Hitler’s bombers. More recently he cites the so called “randomistas” in development economics who have pursued a series of trials to capture the best approach to tackling poverty. In short it is a call for more decentralised and less top-down decision making.

Such an argument is hard to disagree with and, of course, underpins the market economy where thousands of experiments are carried out every day by individuals and businesses, whether they know it or not. “The market fumbles its way to success as successful ideas take off and less successful ones die out”.

Of course, the argument is not new and has been expounded by others, most recently by John Kay in “The truth about markets”. Where Adapt succeeds is in its ability to draw together the conclusions of different fields to tell a coherent story. Harford acknowledges his debt to Kay and others, but goes on to develop his case by examining the shortcomings of markets and the experimental approach. Here he draws on the experience of engineers in learning from industrial accidents to identify situations where a market driven experimental approach may prove very costly.

Experiments are fine in a world where failure does not cause much damage. Many situations are like this where the creative destruction of the market can be contained i.e. most businesses can fail safely without bringing down the entire economy. However, there are others where this is not the case and failure can have catastrophic consequences. The financial crisis of 2008 was one searing reminder of the danger of allowing markets free reign as the failure of Lehman Brothers threatened to bring down the entire banking system and world economy.

From Harford’s perspective the banking crisis was not caused by any particular action by an individual or institution, but by the nature of the financial system itself which had become “tightly coupled”. This is an engineering term used to describe systems which are closely linked so that rather than absorbing shocks they magnify them until they ultimately spiral out of control. Here Adapt goes into the world of industrial accidents and the experience of the nuclear industry where engineers have grappled for years with tightly coupled systems.

In the lead up to the financial crisis, products such as credit default swaps made the system more tightly coupled as they enabled banks to move risks off their balance sheets and take on more and more risks. The problem was compounded by the fact that the authorities did not know where the risk had ended up (mostly in the insurance industry) and so did not know how to short circuit the problem as the banking system blew up. Harford’s message to those trying to build a better banking system today is that human error cannot be avoided so the challenge is to build structures which can withstand shocks rather than exacerbate them.

It is hard to find fault in such a wide ranging and cogent analysis which deserves to be widely read. However, there is an elephant in the room. In accepting the case for more experimentation and more decentralisation how do we account for the rise of China? The world’s second largest economy arguably represents the triumph of top down planning over the free market. As the West struggles in the aftermath of the financial crisis the contrast with fast-growing China has become even starker. Perhaps because it might warrant another volume, Adapt does not address the rise of China. An omission certainly, although not one which detracts from a brilliant book in which ideas sweep superbly across the economic landscape.

[amazon_image id=”1408701529″ link=”true” target=”_blank” size=”medium” ]Adapt: Why Success Always Starts with Failure[/amazon_image]