The Slap of the Invisible Hand

The subprime crisis brought a structural problem to the surface: the risks brought by excessive specialization and the breakup of the value chains we have been observing in key industries such as automotive, consumer electronics, food, and pharma. Growing specialization is not a recent phenomenon. Since the days of Adam Smith's Invisible Hand, growth in international trade has pushed companies and nations to attain ever higher productivity and profits, i.e. deeper specialization. Thus the extension of market has led to the specialization and breakup of the value chain in the mortgage industry: separation of the pursuit and the evaluation of mortgage clients, and of the issuing and the handling of mortgages, the latter being further fragmented among various financial actors. This excessive specialization further weakened the already fragile US financial system, which could not withstand the shock of Bush's imprudent macroeconomic policies.
In the future, many companies (especially those operating in mature industries) will continue to seek higher specialization in order to reap economies of scale, to make use of ultra-specialized inputs and skills, and to have access, via external suppliers, to China's factors of production. But will they be able to face all the consequences, especially in terms of poor choice of collaborators and information asymmetry? Mattel's unsafe toy scandal has the same structural causes that were behind the subprime meltdown. Mattel took the strategic decision of focusing on design, marketing and distribution, while offshoring its manufacturing activities to China. When toys were found to be unsafe, Chinese suppliers pointed fingers at design problems, while Mattel pointed out that hazardous materials were used in the production of toys by local manufacturers. Governments strive to fill the gap caused by market failures, sometimes too early, sometimes (alas) too late. What are the public policies that can be devised to avoid reckless specialization in mature industries? Typical regulatory structures work on an action/punishment basis that ignores the human factor in business management. The starting point for any solution must therefore be able to acknowledge that managers and entrepreneurs are not only motivated by profit-seeking behavior, but also by the trust and respect they are able to build. Calling top managers to account on the issue of moral values can strengthen their social role and limit the collateral damage brought by relentless specialization.