Toyota’s massive vehicle recall marks an enormous setback for the giant car maker. Japanese cars were supposed to be of the highest quality, and the Toyota production system had become renowned for its combination of efficiency and quality. What went wrong? At one level, the problem was the drive for growth, which strained the company’s culture, so that its commitment to affordable quality came under pressure. But one can also view what happened in a more general way.
One source of Toyota’s eventual problems was technological complexity. Decades ago, an automobile, while a complex feat of engineering, was still a relatively manageable piece of machinery. Basic maintenance and repair was something that did not require advanced training, and US’ post-World War II generations of teenagers grew up fiddling with their cars, serving as their own mechanics. Since then, the automobile has become increasingly complex, with more and more electronics being built into the system, and software becoming an essential part of what makes a car run. Hybrid vehicles have added to this trend of greater complexity.
One can view Toyota’s problem as one of failing to keep up with complexity. It continued to make high-quality engines, with superb designs. But the failure came in what could be viewed as a peripheral part of the system, the accelerator pedal. A car is much more than its engine, and while attention has certainly been paid to seats, cup holders, control switches and every part of the car, at levels of sophistication and detail unimagined 50 years ago, the result has been that production has become ever more demanding.
This increased complexity does not stop inside the vehicle. Regulations, competition and the greater challenges of maintenance and repair have meant that the automobile is part of a large service system, which encompasses dealers, other authorized repair shops, rental organizations and the users themselves. A successful car maker has to operate inside and manage this complex service system. Managing means dealing with entities outside corporate boundaries, and being able to gather and use information effectively from many possible sources. Clearly, some of Toyota’s problem stemmed from its failure to manage well the increased complexity of production, and some from its failure to manage well its service system, which was giving it warning signals, which did not get the attention they deserved.
Wall Street’s breakdown was, of course, more spectacular than Toyota’s. Its problems also involved a component of unbridled greed and malfeasance that is absent in the auto maker’s case. But there are parallels between the two sets of problems. A root cause of the financial crisis was changes in the mortgage market. Mortgages used to be originated by banks and similar financial services firms that held them till they were paid off. The mortgage business was like cars in the 1950s. You could look under the hood, and identify the problem without being extraordinarily well-trained or sophisticated.
With the invention of mortgage-backed securities, which were part of a more general class of collateralized debt obligations (CDOs), this part of finance changed. You could no longer tell what was under the hood. The equivalent of the car becoming more and more complex had taken place, with these new financial products. The CDOs’ components meanwhile included undetected bad mortgages. The ability to transfer those CDOs to others expanded the system, and pushed it further beyond the control of the producers of these securities. Just as Toyota did not heed signals from its service system, or did not realize the extent of its obligations, the originators of the securities thought that any problem would be someone else’s to deal with, since the CDOs had been passed on. Australian cities ended up holding indigestible slices of subprime US mortgages.
One cannot push the parallels between cars and CDOs too far. The products and their uses were different, as were the markets and institutions that made up the systems in which value was created—transportation services in one case, risk management services in the other. The incentives were also different, with Wall Street being subject to some particularly perverse distortions. But the common features of both cases, now affecting many markets, and very much here to stay, are the increased technological complexity of the products, which made managing their production to maintain quality harder, and the expansion and complexity of the service system within which the products were to be used.
There is no easy fix for this new complexity. Businesses have to live with it, and develop information infrastructures that generate good early warnings of potential trouble. They have to operate in networks that they do not fully control, but which can affect their profits quite dramatically. And they have to work harder to make and sustain quality products. Business leaders who figure this all out will be the winners of the future.
Nirvikar Singh is a professor of economics at the University of California, Santa Cruz. Your comments are welcome at email@example.com