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The economics of organization
390
Book
rmews
experimental economists. In short, all economic experiments are tests of rationality. Hence, what the collective evidence is starting to demonstrate is that certain types of decision making situations (or experiments) are such that when people are put in them, they basically act as if they were maximizing (i.e., the experiment ‘works’), while others fail to substantiate that hypothesis. The role of experimental economics may well be to characterize the types of experiments (or theories) we can expect to ‘work’ and hence to outline those economic situations in which optimization (or game theoretical equilibria) will emerge. What we may expect to find is some threshold of complexity such that below that threshold optimizing theories work while above it, satisficing theories work. Experimental evidence, however, may give us better insights into which satisficing rules are used. Reference Schotter, Andrew, Cambridge).
1981, The economic
theory
of social institutions
New York
James D. Amsterdam,
Hess, The Economics of 1983) viii + 288 pp., $35.00.
(Cambridge
Umverslty
Press,
Andrew Schotter University, New York
Organization
(North-Holland,
To write a textbook in a new and rapidly expanding field is attractive and challenging. There are no previous models from which to take off or to be judged by, but there is the risk of rapid obsolescence. A first textbook also sets its own range and limits. That the economics of organization is a new subject appears from the references, which although including Bernoulli (1730) and Coase (1937), are all from the fifties, sixties and seventies. To impress the reader with the flavour of organization theory, James Hess uses the ingenious device of presenting first a caricature of organizations as in the textbooks of micro-economics. The traditional they appear entrepreneur is cast in the role of a coordinator ‘who contacts artisans who can cut and sew slippers to produce a finished slipper from leather he supplies. To minimize transportation the coordinator rents a building which the artisans can use. Finally, he arranges to sell the hand-sewn leather slippers to door-to-door salespersons for a specified number of dollars per slipper. The coordinator matches the number of hides with the number of slippers and buys hides to be delivered to his building. Production begins. The coordinator’s role at this point is as an accountant to keep track of the payment due to the workers. Has the coordinator created an organization or
Book reviews
391
a market? Is he an organizer or a marketeer?’ (p. 2). He is the latter, for an organizer must ‘purchase the right to tell any person what actions should or should not be taken’ (p. 3). The benefits and limits of authority are a main course in the menu of topics and approaches that make up this text. The others are: costs and value of information and communication in organizations, budget planning through transfer prices or quotas, the incentive problem (principals and agents, expedients and incentives) and the costs and benefits of multi-level organizations (hierarchial supervision and loss of control). By way of dessert one finds collective choice theory presented as an organizational problem (formal organization of decision making, alternative requirements of formal organization). In addition to these are a number of chapters on related subjects such as resource allocation in general, market allocation, transaction costs, markets and uncertainty, and behaviour in the face of uncertainty. Perhaps these were added to make up the number of pages that publishers of texts stipulate. On the other hand there is at least one subject that I would have liked to see included: careers in organizations. The probabilities of promotion, the length of stay in various ranks and the utility of careers may depend on these and other factors as does the mobility of personnel between organizations. The proper study of organization begins in chapter 7: Why are there bosses?. The answer, given in the summary, merits repetition. ‘In summary the authority vested in the employer is mutually beneficial for the following reasons. Division of labor into a sequence of small tasks performed by specialized workers is productive because it allows the workers to accumulate task-specific skills, minimize set-up costs, and facilitate technological progress. When work involves synchronized labor of various types, the measurement of effort either by observing output or monitoring workers is difficult, so inspectors of labor inputs are desirable. The individual who holds the position of inspector has an advantage over the workers in efficiently acquiring information about the uncertain aspects of production. The workers’ inability to verify the inspector’s conclusions about the state of nature prevents the use of a contingency contract for employment of labor and thus narrows the choice of employment contracts to those which prespecify a work assignment independent of the state of nature or those which give the inspector authority to unilaterally adjust the assignment to best correspond to the state. Under very general conditions the ex post flexibility provided by an authoritative contract makes it desirable to incorporate the role of director with the role of monitor in the position of the boss!’ (p. 97). The question of the economically optimal degree of authority is studied in Chapter 8, mainly in terms of a well-chosen example. Here an equilibrium
392
Book reviews
system of job markets is developed with ‘authority as a primary ingredient’ (p. 110). ‘The market mechanism which matches workers and jobs also determines the equilibrium terms of authority.’ This equilibrium model bears fruit in comparative statics. Hess is at his best in presenting intricate topics such as hierarchical supervision and loss of control (ch. 14). This chapter builds on work by Williams, Calvo and Wellisz and Beckmann [instead of Beckmann’s (1978) book, an earlier article is utilized]. It offers a good example of Hess’s skill in putting together arguments from diverse sources and recasting them in more convenient form (and using his own terminology). It presents the production function approach to hierarchical management, derives the optimal span of control as solution to an allocation problem and gives the details of a Cobb Douglas specification. Returns to scale are shown to depend on the structure of wages in the hierarchy, and it is analyzed how the optimal number of hierarchical levels depends on the parameters of the problem. This is contrasted to a model with ‘loss of control’ as formulated by Williamson into which the comparative statics of the earlier model is carried over. ‘Beckmann’s formulation makes this loss of control more flexible, but does not really explain why all labor inputs into the supervision process do not fully succeed in controlling subordinates. Williamson argues that the informational imperfection of supervision is the reason for this loss of control. However, Mirrlees (1976) and Calvo and Wellisz (1978) present models which seem to indicate that informational difficulties alone cannot lead to this loss of control. It appears that the loss of control depends on exactly how the informational difficulties arise when supervisors try to prevent shirking. In order to explore effort, shirking, and supervision, we must introduce preferences for labor and income!’ (p. 214). Hess presents the Calvo/Wellisz model of individual utility maximization (the choice between shirking and working) and derives the conclusion that ‘this system of organization cannot lead to a finite positive size hierarchy’ (p. 215) unless a certain ‘composition of probability (of shirking being detected) and effort functions’ goes to a limit 2 1. In this way the state of the discussion is presented authoritatively and as far as possible in the contributors’ own words. But the author refrains from attempting an integration of his own. I think this is a wise choice, since a textbook is not the place to try out new ideas unless they are readily derived from the work presented. This is a graduate text. The prerequisites are not heavy: some microeconomics and the ability and patience to follow mathematical reasoning. The author is to be congratulated on his ability to make the required mathematical models as transparent and explicit as possible, finding the right way between excessive complication to bring home tine points and oversimplification that leaves out essential matters. The book can be read
Book reviews
with profit by any trained economist. buyers as well, despite the high price.
393
I wish
it many
readers
and
many
References Beckmann,
1978, Rank in organizations
(Springer,
Heidelberg)
Martin Beckmann Technische Universitlt, Munich Brown University, Providence, RI
Alfred Breton and Ronald Wintrobe, The Logic of Bureaucratic Conduct: An Economic Analysis of Competition, Exchange, and Efficiency in Private and Public Organizations (Cambridge University Press, Cambridge, 1982) xi + 195 pp., $29.95. This book develops a theory of bureaucratic behavior using the analytical structure of neoclassical economic theory, while viewing bureaucracy through a competitive framework in both private firms and government bureaus. It addresses issues of bureaucratic conduct by focusing on the subordinate-superior roles of bureaucrats as based on exchange and competition, rather than authority. The authors spend nearly six of the eight chapters of the book developing their theory and presenting the concepts that they use as building blocks for their model of bureaucracy. They start with the premise that a bureau is simply any hierarchical organization, and that a single model can analyze bureaucratic conduct in both the private and public sector. Thus, while governments supply public policies and corporations supply private policies, both these types of policies can be modeled similarly. Their first main building block is a theory of selective behavior which addresses the conditions that motivate bureaucrats to choose to be sometimes efficient and sometimes inefficient in implementing their superiors’ policies, and how that influences formal cost curves. Through their capacity for selective behavior, bureaucrats can use strategies such as alterations in the flows of information as they move vertically and laterally through the hierarchy, variations in information leakage to external stakeholders, and variation in the speed of implementing the policies. This capacity for selective behaviour is defined by the price and quantity of informal labor services that bureaucrats can deliver. Informal services are defined as those that are not codified in formal contracts, and they are executed through networks of contacts. These networks constitute the informal structure of the bureau, and are surrogate markets through which trade and exchange takes
Book
rmews
experimental economists. In short, all economic experiments are tests of rationality. Hence, what the collective evidence is starting to demonstrate is that certain types of decision making situations (or experiments) are such that when people are put in them, they basically act as if they were maximizing (i.e., the experiment ‘works’), while others fail to substantiate that hypothesis. The role of experimental economics may well be to characterize the types of experiments (or theories) we can expect to ‘work’ and hence to outline those economic situations in which optimization (or game theoretical equilibria) will emerge. What we may expect to find is some threshold of complexity such that below that threshold optimizing theories work while above it, satisficing theories work. Experimental evidence, however, may give us better insights into which satisficing rules are used. Reference Schotter, Andrew, Cambridge).
1981, The economic
theory
of social institutions
New York
James D. Amsterdam,
Hess, The Economics of 1983) viii + 288 pp., $35.00.
(Cambridge
Umverslty
Press,
Andrew Schotter University, New York
Organization
(North-Holland,
To write a textbook in a new and rapidly expanding field is attractive and challenging. There are no previous models from which to take off or to be judged by, but there is the risk of rapid obsolescence. A first textbook also sets its own range and limits. That the economics of organization is a new subject appears from the references, which although including Bernoulli (1730) and Coase (1937), are all from the fifties, sixties and seventies. To impress the reader with the flavour of organization theory, James Hess uses the ingenious device of presenting first a caricature of organizations as in the textbooks of micro-economics. The traditional they appear entrepreneur is cast in the role of a coordinator ‘who contacts artisans who can cut and sew slippers to produce a finished slipper from leather he supplies. To minimize transportation the coordinator rents a building which the artisans can use. Finally, he arranges to sell the hand-sewn leather slippers to door-to-door salespersons for a specified number of dollars per slipper. The coordinator matches the number of hides with the number of slippers and buys hides to be delivered to his building. Production begins. The coordinator’s role at this point is as an accountant to keep track of the payment due to the workers. Has the coordinator created an organization or
Book reviews
391
a market? Is he an organizer or a marketeer?’ (p. 2). He is the latter, for an organizer must ‘purchase the right to tell any person what actions should or should not be taken’ (p. 3). The benefits and limits of authority are a main course in the menu of topics and approaches that make up this text. The others are: costs and value of information and communication in organizations, budget planning through transfer prices or quotas, the incentive problem (principals and agents, expedients and incentives) and the costs and benefits of multi-level organizations (hierarchial supervision and loss of control). By way of dessert one finds collective choice theory presented as an organizational problem (formal organization of decision making, alternative requirements of formal organization). In addition to these are a number of chapters on related subjects such as resource allocation in general, market allocation, transaction costs, markets and uncertainty, and behaviour in the face of uncertainty. Perhaps these were added to make up the number of pages that publishers of texts stipulate. On the other hand there is at least one subject that I would have liked to see included: careers in organizations. The probabilities of promotion, the length of stay in various ranks and the utility of careers may depend on these and other factors as does the mobility of personnel between organizations. The proper study of organization begins in chapter 7: Why are there bosses?. The answer, given in the summary, merits repetition. ‘In summary the authority vested in the employer is mutually beneficial for the following reasons. Division of labor into a sequence of small tasks performed by specialized workers is productive because it allows the workers to accumulate task-specific skills, minimize set-up costs, and facilitate technological progress. When work involves synchronized labor of various types, the measurement of effort either by observing output or monitoring workers is difficult, so inspectors of labor inputs are desirable. The individual who holds the position of inspector has an advantage over the workers in efficiently acquiring information about the uncertain aspects of production. The workers’ inability to verify the inspector’s conclusions about the state of nature prevents the use of a contingency contract for employment of labor and thus narrows the choice of employment contracts to those which prespecify a work assignment independent of the state of nature or those which give the inspector authority to unilaterally adjust the assignment to best correspond to the state. Under very general conditions the ex post flexibility provided by an authoritative contract makes it desirable to incorporate the role of director with the role of monitor in the position of the boss!’ (p. 97). The question of the economically optimal degree of authority is studied in Chapter 8, mainly in terms of a well-chosen example. Here an equilibrium
392
Book reviews
system of job markets is developed with ‘authority as a primary ingredient’ (p. 110). ‘The market mechanism which matches workers and jobs also determines the equilibrium terms of authority.’ This equilibrium model bears fruit in comparative statics. Hess is at his best in presenting intricate topics such as hierarchical supervision and loss of control (ch. 14). This chapter builds on work by Williams, Calvo and Wellisz and Beckmann [instead of Beckmann’s (1978) book, an earlier article is utilized]. It offers a good example of Hess’s skill in putting together arguments from diverse sources and recasting them in more convenient form (and using his own terminology). It presents the production function approach to hierarchical management, derives the optimal span of control as solution to an allocation problem and gives the details of a Cobb Douglas specification. Returns to scale are shown to depend on the structure of wages in the hierarchy, and it is analyzed how the optimal number of hierarchical levels depends on the parameters of the problem. This is contrasted to a model with ‘loss of control’ as formulated by Williamson into which the comparative statics of the earlier model is carried over. ‘Beckmann’s formulation makes this loss of control more flexible, but does not really explain why all labor inputs into the supervision process do not fully succeed in controlling subordinates. Williamson argues that the informational imperfection of supervision is the reason for this loss of control. However, Mirrlees (1976) and Calvo and Wellisz (1978) present models which seem to indicate that informational difficulties alone cannot lead to this loss of control. It appears that the loss of control depends on exactly how the informational difficulties arise when supervisors try to prevent shirking. In order to explore effort, shirking, and supervision, we must introduce preferences for labor and income!’ (p. 214). Hess presents the Calvo/Wellisz model of individual utility maximization (the choice between shirking and working) and derives the conclusion that ‘this system of organization cannot lead to a finite positive size hierarchy’ (p. 215) unless a certain ‘composition of probability (of shirking being detected) and effort functions’ goes to a limit 2 1. In this way the state of the discussion is presented authoritatively and as far as possible in the contributors’ own words. But the author refrains from attempting an integration of his own. I think this is a wise choice, since a textbook is not the place to try out new ideas unless they are readily derived from the work presented. This is a graduate text. The prerequisites are not heavy: some microeconomics and the ability and patience to follow mathematical reasoning. The author is to be congratulated on his ability to make the required mathematical models as transparent and explicit as possible, finding the right way between excessive complication to bring home tine points and oversimplification that leaves out essential matters. The book can be read
Book reviews
with profit by any trained economist. buyers as well, despite the high price.
393
I wish
it many
readers
and
many
References Beckmann,
1978, Rank in organizations
(Springer,
Heidelberg)
Martin Beckmann Technische Universitlt, Munich Brown University, Providence, RI
Alfred Breton and Ronald Wintrobe, The Logic of Bureaucratic Conduct: An Economic Analysis of Competition, Exchange, and Efficiency in Private and Public Organizations (Cambridge University Press, Cambridge, 1982) xi + 195 pp., $29.95. This book develops a theory of bureaucratic behavior using the analytical structure of neoclassical economic theory, while viewing bureaucracy through a competitive framework in both private firms and government bureaus. It addresses issues of bureaucratic conduct by focusing on the subordinate-superior roles of bureaucrats as based on exchange and competition, rather than authority. The authors spend nearly six of the eight chapters of the book developing their theory and presenting the concepts that they use as building blocks for their model of bureaucracy. They start with the premise that a bureau is simply any hierarchical organization, and that a single model can analyze bureaucratic conduct in both the private and public sector. Thus, while governments supply public policies and corporations supply private policies, both these types of policies can be modeled similarly. Their first main building block is a theory of selective behavior which addresses the conditions that motivate bureaucrats to choose to be sometimes efficient and sometimes inefficient in implementing their superiors’ policies, and how that influences formal cost curves. Through their capacity for selective behavior, bureaucrats can use strategies such as alterations in the flows of information as they move vertically and laterally through the hierarchy, variations in information leakage to external stakeholders, and variation in the speed of implementing the policies. This capacity for selective behaviour is defined by the price and quantity of informal labor services that bureaucrats can deliver. Informal services are defined as those that are not codified in formal contracts, and they are executed through networks of contacts. These networks constitute the informal structure of the bureau, and are surrogate markets through which trade and exchange takes