Frost, Firms and Fences

SOMETHING there is that doesn't love a wall.........................Robert Frost, Mending Wall

Physicists call it entropy. But there are also lots of things that do love walls, including neighbors, cells, cultures, nations and firms. Which is to say, all those things that like to live in a state of relatively low entropy. We build fences to keep order in and disorder out.

Matthew Yglesias, my second favorite economics writer, writes about economist Ronald Coase and the theory of the firm:

Ronald Coase, one of the most distinguished economists in the world, died yesterday at the age of 102. He's well-known both for the depth of his insights and for the relatively accessible nature of his two major papers on "The Nature of the Firm" and "The Problem of Social Cost." I feel that the social cost paper gets discussed more frequently among the educated public because it seems to have important political implications, but it's also not always clear what those implications are (Kevin Bryan has a good discussion here) but the "Nature of the Firm" more tickles my fancy...

So why does that happen? If markets are so great, what's with all the bosses and colleagues and meetings and internal office politics?

Coase says that basically we have firms for the same reason that big-time law firms are so expensive to hire. It turns out that writing comprehensive enforceable contracts is really hard. To actually specify what will happen in every conceivable situation would be an enormous drag on resources. To cope with the real-time complexities of the business world, you need two things that markets and contracts can't provide. One is leadership. You need people who can survey a situation, think a minute, and then issue some directions that everyone carries out. Ideally those leaders will make the right call. But typically even picking a sub-optimal strategy will be better than doing nothing at all as you have additional rounds of discussion and bargaining. The other—related—thing that you need is teamwork and team spirit. A workplace where everyone is obsessed all the time with the exact parameters of their job rather than being willing to pitch in and solve problems is going to be a dysfunctional one.

Which is to say that even in a market economy, the most successful practitioners aren't going to be organized along market principles. Instead they're little islands of central planning.

I like the whole article, but principle is extremely deep. Markets are really good at allocating resources among competitors but not so hot at fostering cooperation. This is a huge blind spot even for many who love Coase.

Some have pointed to Microsoft's employee rating system as the reason Microsoft has seemed so slow and uncertain of foot in recent years. Because emplyees are being constantly rated against other members of their work groups, they are competitors more than cooperators. My own emplyer has a similar system, and completely aside from any effects on morale and cooperation, it sucks up a huge fraction of management time every year.

I'm not sure that good fences make good neighbors, but they do seem to be necessary for lots of purposes.


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