We live at a time when humanity is steadily moving away from riskier forms of self-sufficiency to safer and more productive forms of mutual interdependence. Consequently, the future of ERM will be concerned with building “whole of organization” approaches to pursuing opportunities and managing threats. The “secret sauce” to getting buy-in across an organization is creating virtuous cycles that help people feel connected through ever-increasing levels of believing in and trusting each other.
“The Industrial Revolution started and made its biggest strides in England because of her uniquely inclusive economic institutions. These in turn were built on foundations laid by the inclusive political institutions brought about by the Glorious Revolution. It was the Glorious Revolution that strengthened and rationalized property rights, improved financial markets, undermined state-sanctioned monopolies in foreign trade, and removed the barriers to the expansion of industry. It was the Glorious Revolution that made the political system open and responsive to the economic needs and aspirations of society. These inclusive economic institutions gave men of talent and vision such as James Watt the opportunity and incentive to develop their skills and ideas and influence the system in ways that benefited them and the nation. Rich nations are rich largely because they managed to develop inclusive institutions at some point during the past three hundred years. These institutions have persisted through a process of virtuous circles. Even if inclusive only in a limited sense to begin with, and sometimes fragile, they generated dynamics that would create a process of positive feedback, gradually increasing their inclusiveness.” - Daron Acemoglu and James Robinson, Why Nations Fail, The Origins of Power, Prosperity, and Poverty (2013).
The previous section put forth the idea that for ERM to be successful, it needs to be tied to a specific and compelling purpose that becomes a shared belief. To illustrate this concept, we explained that the Industrial Revolution took place in England and not elsewhere in the world because the intellectual and working classes aligned on two core ideas: (i) acquiring knowledge through science and reason; and (ii) increased knowledge should be used for the benefit of all, not just a subset of society. Consequently, England began building institutions of mutual interdependence in which people had the freedom to think and experiment (i.e. take “positive risk”) while at the same time building systems that minimized the potential for harm (i.e., avoid “negative risk”).
There is more to learn about the Industrial Revolution beginning in England and for that, we turn to a book entitled Why Nations Fail - The Origins of Power, Prosperity, and Poverty (2013) written by two economists, Daron Acemoglu (at MIT) and James Robinson (at the University of Chicago). Acemoglu and Robinson provide additional evidence to support Joel Mokyr’s theory (set forth in his book The Enlightened Economy) that the Industrial Revolution represents a key turning point in human history. Go back to 1589 in England - two centuries before the Industrial Revolution - and one finds no shared belief system uniting society. 1589 is the year that William Lee showed Queen Elizabeth I the first knitting machine. The queen refused to give Lee a patent, claiming that doing so would deprive her people of work. The queen’s true concern was that this labor-saving device presented a threat to her station in life.
Acemoglu and Robinson explain that Queen Elizabeth’s attitude was emblematic of the times because the world was dominated by economic and political institutions that were extractive. That is, institutions pulled wealth from one segment of society for the benefit of another segment and this extraction was supported by concentrating unconstrained power in the hands of a few who can thwart the growth of a more pluralistic society. Think about Europe’s approach to the exploring New World. For example, the Spanish strategy for conquering Peru and Mexico was to capture the king, take his wealth, and then torment him until he would tell his people to surrender. The natives were then organized into a system of forced labor that extracted and transported local resources such as precious metals back to Europe. This system of setting up extractive institutions enriched Europe while impoverishing the natives of North America.
Contrast the above example with what happened in a different part of the Americas. In Jamestown, the indigenous people refused to become slave labor. Consequently, to make the Jamestown colony successful, the Virginia Company was forced to incentivize labor amongst its colonists by offering them land and a vote in the general assembly. The end result was the initiation of a virtuous cycle that led to the emergence of a semi-democratic system that would over time become the political and economic institutions of the modern United States.
The point is that institutions (including business organizations) are simply durable forms of association that serve a common purpose and the character and purpose of the institution matters. The Virginia Company example illustrates what happens when institutions become inclusive. Providing incentives to colonists in Virginia led to Maryland settlers being given their own land and having their own say in the state legislature. By the 1720s, the inhabitants of all 13 colonies achieved similar rights. In short, inclusive institutions encourage and make it possible for more people to feel involved and valued. The positive feedback generated by feeling included and valued creates what is known as a virtuous cycle.
A key take-away from Acemoglu and Robinson’s writing is that in the span of human history, we don’t have much experience in building and developing inclusive institutions that are proficient in pursuing positive risk. Until the last 200 years, human history has been dominated by extractive institutions which are propelled by vicious, not virtuous, cycles. The subprime mortgage crisis in the United States that occurred between 2007 and 2010 is an example of a vicious cycle and the general tendency for institutions to tend toward being extractive. There, the vicious cycle started with a decline in housing prices that caused more homeowners to incur financial distress as the market value of their home dropped below their mortgage. Once “underwater,” distressed owners began walking away from their mortgage obligations thereby increasing the number of defaults and foreclosures. This, in turn, lowered housing prices further from over-supply, reinforcing the vicious cycle and causing additional harm. In this example, the foreclosures reduced the amount of cash flowing into banks and if, over time, banks are not adequately capitalized, economic activity slows, unemployment increases, and the ultimate number of foreclosures increases.
The COVID-19 pandemic is another example of the interplay between virtuous and vicious cycles. Material increases in COVID-19 cases create a vicious cycle where there is less testing capacity, longer turnaround times, and overwhelming demands imposed on public health staff and the healthcare system. On the other hand, widespread practices of mask wearing, social distancing, washing hands, and avoiding risky indoor spaces creates the momentum for virtuous cycles of improved public health.
A frequent criticism of risk management practices today is that they don’t help the organization increase the potential for making good things happen. Judging from history, senior leaders should understand that present inadequacies in current risk management practices are tied to a more fundamental problem in that we don’t have much experience in building inclusive institutions that are fueled by virtuous cycles. In the next few sections, we will break down virtuous cycles more to focus on how they help inclusive organizations build cognitive and social immunity so that risk management practices are more impactful.
The previous section put forth the idea that for ERM to be successful, it needs to be tied to a specific and compelling purpose that becomes a shared belief. To illustrate this concept, we explained that the Industrial Revolution took place in England and not elsewhere in the world because the intellectual and working classes aligned on two core ideas: (i) acquiring knowledge through science and reason; and (ii) increased knowledge should be used for the benefit of all, not just a subset of society. Consequently, England began building institutions of mutual interdependence in which people had the freedom to think and experiment (i.e. take “positive risk”) while at the same time building systems that minimized the potential for harm (i.e., avoid “negative risk”).
There is more to learn about the Industrial Revolution beginning in England and for that, we turn to a book entitled Why Nations Fail - The Origins of Power, Prosperity, and Poverty (2013) written by two economists, Daron Acemoglu (at MIT) and James Robinson (at the University of Chicago). Acemoglu and Robinson provide additional evidence to support Joel Mokyr’s theory (set forth in his book The Enlightened Economy) that the Industrial Revolution represents a key turning point in human history. Go back to 1589 in England - two centuries before the Industrial Revolution - and one finds no shared belief system uniting society. 1589 is the year that William Lee showed Queen Elizabeth I the first knitting machine. The queen refused to give Lee a patent, claiming that doing so would deprive her people of work. The queen’s true concern was that this labor-saving device presented a threat to her station in life.
Acemoglu and Robinson explain that Queen Elizabeth’s attitude was emblematic of the times because the world was dominated by economic and political institutions that were extractive. That is, institutions pulled wealth from one segment of society for the benefit of another segment and this extraction was supported by concentrating unconstrained power in the hands of a few who can thwart the growth of a more pluralistic society. Think about Europe’s approach to the exploring New World. For example, the Spanish strategy for conquering Peru and Mexico was to capture the king, take his wealth, and then torment him until he would tell his people to surrender. The natives were then organized into a system of forced labor that extracted and transported local resources such as precious metals back to Europe. This system of setting up extractive institutions enriched Europe while impoverishing the natives of North America.
Contrast the above example with what happened in a different part of the Americas. In Jamestown, the indigenous people refused to become slave labor. Consequently, to make the Jamestown colony successful, the Virginia Company was forced to incentivize labor amongst its colonists by offering them land and a vote in the general assembly. The end result was the initiation of a virtuous cycle that led to the emergence of a semi-democratic system that would over time become the political and economic institutions of the modern United States.
The point is that institutions (including business organizations) are simply durable forms of association that serve a common purpose and the character and purpose of the institution matters. The Virginia Company example illustrates what happens when institutions become inclusive. Providing incentives to colonists in Virginia led to Maryland settlers being given their own land and having their own say in the state legislature. By the 1720s, the inhabitants of all 13 colonies achieved similar rights. In short, inclusive institutions encourage and make it possible for more people to feel involved and valued. The positive feedback generated by feeling included and valued creates what is known as a virtuous cycle.
A key take-away from Acemoglu and Robinson’s writing is that in the span of human history, we don’t have much experience in building and developing inclusive institutions that are proficient in pursuing positive risk. Until the last 200 years, human history has been dominated by extractive institutions which are propelled by vicious, not virtuous, cycles. The subprime mortgage crisis in the United States that occurred between 2007 and 2010 is an example of a vicious cycle and the general tendency for institutions to tend toward being extractive. There, the vicious cycle started with a decline in housing prices that caused more homeowners to incur financial distress as the market value of their home dropped below their mortgage. Once “underwater,” distressed owners began walking away from their mortgage obligations thereby increasing the number of defaults and foreclosures. This, in turn, lowered housing prices further from over-supply, reinforcing the vicious cycle and causing additional harm. In this example, the foreclosures reduced the amount of cash flowing into banks and if, over time, banks are not adequately capitalized, economic activity slows, unemployment increases, and the ultimate number of foreclosures increases.
The COVID-19 pandemic is another example of the interplay between virtuous and vicious cycles. Material increases in COVID-19 cases create a vicious cycle where there is less testing capacity, longer turnaround times, and overwhelming demands imposed on public health staff and the healthcare system. On the other hand, widespread practices of mask wearing, social distancing, washing hands, and avoiding risky indoor spaces creates the momentum for virtuous cycles of improved public health.
A frequent criticism of risk management practices today is that they don’t help the organization increase the potential for making good things happen. Judging from history, senior leaders should understand that present inadequacies in current risk management practices are tied to a more fundamental problem in that we don’t have much experience in building inclusive institutions that are fueled by virtuous cycles. In the next few sections, we will break down virtuous cycles more to focus on how they help inclusive organizations build cognitive and social immunity so that risk management practices are more impactful.
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