Why Politics Matters—for Business Schools

More than a century and a half ago, a Pennsylvanian traveling in Europe suffered much personal abuse and ridicule simply because he hailed from a state that had defaulted on its debt. Having just returned from Europe, I'm happy to report that I received kinder treatment, despite being from a place of similar financial havoc. But I still repeatedly faced two rather uncomfortable questions: Do you have any idea what you have wrought, and can you fix it? My answer was relatively simple: Yes, indeed, we (i.e., the U.S.) fully recognize our culpability in the massive global evaporation of wealth and jobs. And no, we really can't fix it until we can agree on just how we got here.

The ongoing debate about the origins of the financial crisis presents a vexing dilemma for business schools, especially as they gear up for the fall. As a faculty member at a leading business school, I have observed the anxiety that stems from the question of how exactly we are to teach the principles and practices by which to avoid a similar crisis down the road if we can't first get to the root causes of this one.

Three Perspectives on the Crisis That said, we do seem to be getting closer to deciphering the underpinnings of today's financial debacle. The debate now revolves around three primary schools of thought.

The technical perspective: Some contend that the crisis simply boils down to technical mistakes, independent of ethical considerations. In other words, this was a confluence of basic missteps: The Fed's monetary policy was far too loose; the banks should not have held so many risky synthetic instruments as assets; securitization tools should not have been available to absolve mortgage originators of accountability; and credit default swaps should have been transparent and traded in the open on fully regulated exchanges. The implications for management education are straightforward: Future crises can be avoided if businesspeople receive better training in advanced statistics, the analysis of systemic risk, and the design of financial instruments.

The managerial perspective: Those who subscribe to this view argue that the financial crisis is the direct result of misguided corporate governance and behavioral biases coupled with strong incentives for banks and financial institutions to take on too much risk. The core of this discussion is incentive-based pay and executive compensation. Are we willing to buy into the argument for retention of "the best and the brightest," or did pay structures amount to dangerous overcompensation that encouraged heedless risk-taking? Savvy managers and traders understand the potential reward for acting aggressively: If the worst you can do is zero and the best is an astronomically large number, then it becomes difficult to exercise restraint. If compensation structure and incentives are out of whack, then we should encourage corporate boards to design better executive contracts, cut incentives that drive excessive risk, and implement stronger risk-management processes.

The political perspective: A third approach points to a series of political missteps: Tax cuts led to big budget deficits financed by China. This contributed to a huge runup in the fiscal deficit, despite a lengthy economic expansionary boom. Unprecedented income inequality translated into political power that not only succeeded in treating income as capital gains but also defeated prudent regulation. As a result, competition policy went to sleep, allowing for the growth of a massive financial industry characterized by unbounded incentives for excessive risk-taking.

Politics and Management Education If, like me, you share this third view, one possible solution is for governments to dampen the incentives to take on too much risk. (The conservative jurist Richard Posner appears to propose modestly higher taxes on very large incomes for this reason in his recent book, A Failure of Capitalism.) Another is the enforcement of more competition in the financial markets, thus drying up the vast profits that allowed financial firms to fund the bonuses and preempting the "too big to fail" problem—in general, more regulation of the financial markets and less deference paid to financial innovation.

However, the political perspective is perplexing in terms of the design of graduate business curricula. The tendency has been to set political discussions aside since there is currently no obvious "pedagogical home" for them. Nor does the analysis of political questions contribute directly to a student's knowledge of core business functions like marketing, accounting, and finance.

Financial crises are the children of troubled politics, yet management education often eschews political questions. This is a fundamental flaw of most, if not all, business schools. If such questions are left unaddressed, we will produce business leaders with limited perspectives who may not be equipped to deal with the pressing issues of the day. In other words, we must make the case to our students that the political questions, while difficult, are critical to the practice of business—even if this kind of analysis may not appear to serve their immediate self-interest.

As we move deeper into the 21st century, environmental and demographic constraints will put a premium on innovation as a driver of economic growth. Yet, no matter how much we may want to believe there are simple pathways to innovation, today's crisis surely damages the claim that deregulated markets encourage financial innovations that lead to better social and economic outcomes.

The crisis has reshaped the financial landscape, shifting the value of management education toward pedagogies that strengthen students' understanding of the fundamental relationships in society—how managerial, technical, ethical, and political elements work together. This is not an easy thing to teach, but not to confront the politics of the crisis would be pedagogy with both eyes held shut.

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