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Risk Makers and Risk Takers

May 27, 2010

Yesterday, Phil Palin made the case in the HLSwatch blog for the importance of public private partnerships in promoting homeland security, and, in particular, pursuing successful efforts to resolve the Deepwater Horizon crisis in the Gulf of Mexico. He offered a fairly conventional view of the role of the private sector as innovator and creative risk-taker. He also offered an altogether too common view of the public sector, which he described as risk averse.

Those of you who follow HLSwatch closely will no doubt have observed that Phil and I agree far more often than we disagree despite having very different backgrounds and political leanings. Today, then will be an exception to that trend. While I arrive at the same conclusion as Phil–resolving crises requires concentrated effort and cooperation, often among people with different objectives, I think a compelling case can and should be made that the roles played by the public and private sectors before, during, and after a disaster operate much differently than Phil described them.

Let’s start with the notion that risk-taking is a particular strength of the private sector. This view is typically associated with the classic case for entrepreneurship, which holds that the people who create companies and build enterprises do so at great personal risk. Historically, these risks involved the possibility of losing the entrepreneur’s own capital and reputation. This view holds that failure is not an option for a real entrepreneur because it equals financial and reputational ruin.

As Malcolm Gladwell pointed out in the January 18, 2010 issue of The New Yorker, real entrepreneurs rarely see themselves as risk-takers. Indeed, they prefer the sure thing. Risk is for chumps. Confidence comes from seeing an opportunity with clarity, and knowing how to leverage one’s competence to meet the need before or better than anyone else can. Skilled entrepreneurs loath risk, and go to great lengths to minimize and control it.

In their book Switch: How to Change When Change Is Hard, Chip and Dan Heath, outline successful strategies for managing individual and organizational change. In essence, their approach is about minimizing or controlling the sense of dread that accompanies risk aversion, which represents the biggest impediment to successful change.

One of the case studies they use to illustrate their approach involves BP. Like most major oil companies, BP invests heavily in exploration. Finding new fields is a classic risky proposition. Most companies drill many test wells before they find one good producer.

As the Heaths tell the story, when BP took stock of its operations it saw the costs and consequences of drilling dry holes rising faster than theirs and their shareholders’ tolerance for the risks associated with their conventional (and above average) strategies for striking oil. After reviewing the processes they used to decide where and when to drill test wells, they identified a way to improve the success rate dramatically. To discourage their exploration managers from making bad bets, they adopted a simple stratagem to sum up their approach: “Drill no dry holes.” When failure is not an option, success is not assured. But the strategy BP adopted paid off, and BP made their already good record of exploration success even more exceptional.

Minimizing risks is not just a question of mindset though. Companies pursue many strategies to hedge their bets. A skilled entrepreneur prefers to play games where skill matters more than chance. When chance plays a role, a good entrepreneur always covers her bets. But is it realistic to apply assumptions about the risk taking behavior of entrepreneurs to large, multinational corporations and their executives? Is the chairman or CEO’s risk the same as that of an entrepreneur embarking on a new venture? Clearly, the answer is no. If we have learned anything from global financial crisis, it is that those at the top of the socioeconomic pyramid rarely face a genuine risk of ruin. As a consequence, to the extent that they really are risk takers, they may operate more like gambling addicts than careful bettors.

This raises another question then. If a large corporation does not operate in the same way an entrepreneur does by selecting the game to play, deciding when and where to play it, and knowing when to hold or fold his hand, how then does a big enterprise avoid making bad bets? One way is to hire the right people. Another is to write the rules of the game. Sometimes these strategies are hard to distinguish from one another, especially when it comes to hiring talented people who have an intimate knowledge of the rules by which the game is played and special access to those who interpret and enforce them. Questions about whether or not BP engaged in such conduct have been raised.

If BP can find people in government willing to exchange public service for the prestige associated with offering their specialized knowledge and access in return for higher salaries, then we should scrutinize them and the public sector as well. Assuming the ex-public servant was skilled at what she did, jumping at the opportunity to make a better salary in the the private sector is a classic case of pursuing self-interest over the public interest. That does not make our former public servant a bad person, but neither does it make the company she joined a good corporate citizen.

When public servants pursue the public interest, they really have just two options for promoting the public good. They and their agencies can participate or they can regulate. By participate, I mean engaging in the production or delivery of goods or services used by others. When we look at the sorts of activities that fall under this ambit, we see monopoly enterprises that may be protected from competition but little else. The risk of failure and loss is everywhere. In fact, the risks are so big and so endemic that we need special rules to indemnify the government and its agents against inadvertent harm done to individuals for the benefit of the protecting the people as a whole.

In those instances where we expect the government to regulate on our behalf to preserve or protect a public good, the risk of failure is no less real than it is in instances where the government participates as a market actor. Indeed, much of the backlash over regulation arises from the perceived risks of involving those unfamiliar with or at a distance from transactions in decisions about them, particularly when they themselves have very little on the line in comparison to the market participants. As I have already noted, companies consequently expend no small effort to understand or influence how government and its agents perform the regulatory role. In many instances, this amplifies the risk by presenting opportunities for agency capture even when individuals do not pass through the revolving door.

As far as sweeping generalization go, I think it is unwise to suggest that companies are better positioned as partners because of the risks they take. Likewise, it seems foolish to assume that government and those elected and appointed to serve the public interest will always put their own interests above those of the public they serve. Indeed, the nature of the risks faced by individuals, companies, industries, and communities that go to the heart of public interest are so big that neither the public nor private sector can manage them alone. As such, neither is necessarily better positioned than the other to remedy the situation when things go wrong.

So far this analysis has focused on behavior that influences public and private actors before a crisis becomes apparent. When people recognize the risk of something bad happening has been realized, they clearly have different expectations of how public and private actors should respond. These expectations shape the roles each party plays and influence the allocation of responsibility when all is said and done.

In the case of the Deepwater Horizon crisis, clearly there is plenty enough blame to go around. But worrying about that right now just gets in the way of capping the well and remedying the damage. Getting the job done requires both the public and private sectors to recognize that a crisis is defined not by the realization of risk alone, but also by the loss of confidence in the capacity of those responsible for problems to fix them. By now it has become all too clear that we are in this mess together, and we have no choice but to work together to get out of the trouble we are in.

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