slight return

A talk on professional services

If you’ve been a reader since last October, you can be excused reading this post - see you Friday - because it consists of my prepared remarks for a panel session at the LSE on “The Captured Economy”. The next step is probably to write it up properly, so if anyone has comments or resources on things like 1) the troubling erosion of professional standards in law, accounting and consultancy, 2) the equally troubling erosion of capacity in planning authorities and 3) the mechanisms by which so many veto points (which I argue are seen by the prof servs industry as revenue opportunities) have proliferated, do please pass them on! I met a load of interesting people at that conference, many of whom are also working on the vexed question of “why is it so difficult to build anything”, so watch this space.

Hi, my name’s Dan Davies, I’m an author and consultant.  And the subject we’re talking about today seems to be relevant to both halves of my professional life.  My last book was called “The Unaccountability Machine” and it was about decision making systems and the ways in which they are rearranged to systematically protect the people within them from outside feedback.  And in my day job, I provide consultancy services in the field of financial regulation, which is of course one of the more notorious areas in which the governance and legal system becomes a source of rent extraction.

And there’s an interaction between the two.  The thesis I’d like to advance today is that there is a problem in modern industrial economies – particularly, but by no means only in the Anglosphere or the common law countries – with respect to the professional services industries.  By which I mean lawyers, accountants and consultants – management consultants in the well-known sense, but also all of the small and various firms which make up the “miscellaneous business services” sector that accounts for almost 20% of Britain’s exports.

It's a business model issue.  Professional services firms have bills to pay like anyone else; people have billable hours targets and partners are expected to generate fee income and bring in clients.  And although rent extraction isn’t all that professional services firms do, it’s certainly one thing that they do.  The profit motive here is always incipiently a problem, because if it’s unregulated, then it means that every potential source of rent extraction in the system will, eventually, become an actual extracted rent, and that every rent extraction opportunity will be exploited to the largest possible extent.  I’ll come back with some motivating examples in about a minute, but first I want to really clearly set out why I think this is a problem, but also why I think it’s particularly a problem here and now, and why I think it’s getting worse at a fast enough rate to be a cause for concern.

It is basically a matter of regulation and capacity.  One thing that we know about the structure of modern industrial (post-industrial?) economies is that large fields of activity which had previously been within the boundaries of the state have been delegated and outsourced.  There are a lot of issues with respect to that, whole books have been written about the conflicts of interest and erosion of state capacity, but what I want to focus on right now is the effect on the public sector’s information and knowledge. 

Talking in general terms, there’s what cyberneticians and information theorists call a problem of “transduction”. When something is placed outside organisational boundaries, that has an immediate and profound effect on the organisation’s ability to have knowledge about it.  The information is no longer just there, it has to be collected via a conscious effort and decisions have to be taken about how much resources to spend on this, what to observe and how to format it.  Effectively, even in the best case, when you privatise something you’ve put a massive information-reducing filter between the public sector bodies responsible for it, and the actual activity.  And unfortunately the worst case is much more common – that would be the case where nobody recognised that there would be a problem of this kind, so everything is left to ignorance, the information processing system of last resort.

Let’s make this a bit more concrete, with an old chestnut of a question – why do infrastructure projects cost so much to build these days?  As a good management consultant, I’m going to use the “five whys” technique here.  So:

Why does infrastructure cost so much? Because the planning inquiry process takes a long time and generates tens of thousands of pages of documentation.

Why does it take so long and generate so many reports? Because of the need to avoid even slower and more expensive litigation. 

Why is litigation such a risk? Among other reasons, because professional services firms market their services to take advantage of any imperfection in the consultation process to allow a do-over for anyone who lost the argument in the original inquiry.

Why is any small imperfection a potential basis for litigation?  Because a standard has been allowed to develop which effectively makes it a de facto legal requirement for every possible impact of a project to be the subject of a professional report.

Why has this standard been allowed to develop?  Well now, there’s an interesting question.

It’s not that anyone has necessarily set out to manipulate things to reach this way.  It’s self-organising.  In the immortal words of Stafford Beer, the father of management cybernetics, “The Purpose Of A System Is What It Does”, and all of the best-paid people in infrastructure are pretty happy – maybe not happy, but it pays the bills – with how things have developed.  You can imagine a sort of multi-generational sitcom, where the grandparents are protesting against the power cables, the parents are the civil servants trying to commission the project and the kids have just joined the graduate training scheme at the contractor company that’s writing all the reports.

What’s happened here – and I should emphasise that although I’ve taken the example of planning, I could tell a similar story, write a similar sitcom about dozens of other areas where governance has developed to provide stable and growing fee income to prof servs firms – is that the people who ought to be managing the structure of the system and deciding on the tradeoffs between efficiency and legitimacy, consultation and coercion, can’t perform that function. 

Specifically they can’t because they don’t understand what’s going on, because the knowledge in the system is outside the boundaries of their organisation, because all of the economic, engineering and environmental knowledge which used to be in the civil service is now in the private sector.  They’re not able to gainsay the services firms, who will always push more fee income; they’re not able to make a convincing judgement that processes have to be limited.  And they’re scared of litigation, faced with people on the other side who love litigation because that’s their job.

It's interesting to consider a counterexample – let’s think about tax.  “Tax schemes” are the very paradigm of professional services rent extraction; they’re literally marketed as products, they have a very visible and real cost, and they come into being because someone sits down at a desk, going through the tax code like a prospector panning for a golden nugget.

But! The tax authorities are much better at dealing with tax schemes.  They have powers and anti-avoidance rules these days, but much more importantly they have an active intelligence capability to make them aware of what schemes are being marketed, and a lively and active engagement with the profession.  Their information environment is much richer, which is the basis of their greater capability. 

So, I’m coming to the end of time here – I’ll just restate this.  The professional services sector is where you find the people who have the role of rent extraction.  Maybe ninety per cent of their job is benign and helpful, giving advice on navigating a complicated world. But they also do the equivalent of regulatory gold mining, and this is an activity that has to be “regulated” – in both the normal sense, and the wider engineering sense of “prevented from getting out of control”.  To successfully regulate this industry requires a level of information and understanding, and it’s that gap which is the missing capability, in my view.