The Economics of Effective Leadership

What do economists know about leadership?

The answer – surprisingly, for a field prone to make bold behavioral predictions and policy recommendations covering almost every facet of human activity – is, “rather little.” The concept of leadership, beyond the setting of incentives and sanctions, is largely absent from economic theories, teaching and empirical research. For instance, in economic theory, a CEO is hard to distinguish from a mid-level manager who sets production targets and compensation packages. The notion of charismatic, visionary and persuasive leaders—though present in human history and literature, from Julius Ceasar to Abraham Lincoln to Steve Jobs (and, perhaps, even to Donald Trump?)—lies outside the realm of mainstream economics.

This is changing, however, as a greater number of economists are beginning to study the many ways in which leaders influence the groups, organizations and nations they lead. This research often brings the rigorous and careful methodology and theories of economics to address whether “conventional wisdom” regarding leaders is really consistent with their true influence.

For example, many people believe that national leaders influence economic growth—if you are an American Republican you cite growth under Reagan, while if you are a Democrat you cite growth under Obama, as evidence of this. But, did they really cause economic growth during their terms? Both men came to power during recessions, so maybe conditions were set to improve regardless of who assumed office. And, maybe part of the reason both men won their elections is because economic conditions were bad, but set to improve, and voters wanted a change. It is very difficult to tell what leaders do and do not cause, since they are not selected at random nor appointed at random points in time. To get at this question, a pair of economists, Benjamin Jones and Benjamin Olken, used a clever approach. They looked at cases in which a national leader died due to natural or accidental causes while in office—that is, a random change in leadership. Sure enough, they found that leaders do, in fact, appear to influence economic growth. But, establishing this relationship required thinking like an economist, for the right places to look in the data.

Another conventional wisdom about leaders is that unethical leaders create unethical groups—reflected in the popular saying, “a fish rots from the head.” But, is this true? This relationship is even harder to establish than the one above, since it is difficult to observe which leaders and organizations are those with widespread unethical conduct. Such conduct is typically hidden from view, and only observable in the rare instances in which there is a scandal or criminal investigation, as with the recent attention on FIFA. But, even in this case, where there seems to be widespread corruption in the organization and among its executive leadership, is it corrupt leadership that really produced the unethical conduct, or are other factors of the organization’s structure or environment responsible for corruption at both low and high levels? Again, economists have provided an answer, though this time using the experimental methods of behavioral economics. By using a task that allows them to statistically identify unethical conduct, and by randomly assigning leaders to groups, researchers at the University of Zurich were able to establish that, indeed, unethical leaders produce unethical groups.

While the above findings are cases in which economic research on leadership confirms things that people widely believe, there are other instances in which this research has produced some surprising findings, including some that challenge economic theory.

For example, we typically think that important leaders—such as national political leaders—are elected and re-elected based on their competence, ability and positive effects on society. After all, this is what the “rational” voters in economic theory would produce as the outcomes of their elections. Unfortunately, it turns out not to be the case. Leaders are often elected and re-elected merely due to, for example, characteristics of their facial features or due to economic factors over which they have no control, like the worldwide price of oil. In fact, one recent study by researchers at the University of Lausanne demonstrated that children spending a bit of time looking at pictures of political candidates and selecting which candidate they would like as the “captain” of an imaginary ship, yielded accurate predictions of election winners. So, while we like to think that our selection of corporate and political leaders results from thoughtful deliberation that picks the best candidate, we may really do so based on a childish preference for some kinds of faces over others.

It also turns out that, in contrast with how economists typically think people in organizations are motivated, leaders are often as effective in motivating workers through their words and rhetoric than by “hard” incentives such as pay. In some cases, like where a common vision needs to be instilled in a team as a way of motivating them to pursue it, words can even be a much more powerful motivator than incentives.

So, if you are a leader of any group—whether it be a small local club, a firm, or a political movement—the economics of effective leadership is a growing research area that is producing important concrete findings that are relevant for you and for those you lead. As this research continues, it will highlighting further effective strategies, as well as pitfalls, for how you will be evaluated as a leader and for your ultimate success.

This is an English version of a commentary that appeared in the Neue Zürcher Zeitung, on December 23, 2015, in German: https://www.nzz.ch/meinung/kommentare/was-oekonomen-zu-leadership-sagen-1.18667315