Resumo Economics, Organization and Management.pdf

Economics, Organization and Management: a Review of Milgrom and Roberts S.

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What precisely does Miss Jones do on a Monday morning? With this innocent question, Professor Loasby raises the central dilemma of this fine book by Milgrom and Roberts1 (Loasby, 1995). It is a dilemma which is central to any question of management and organization: the dilemma between management as contemplation and management as action, the contrast between thoughts and deeds. The economic theory of coordination, which is admirably expounded here, is essentially contemplative: it is thoughts about the way in which the economic jigsaw is perceived to fit together. As a basis for managerial action it is seriously deficient, as any comparison with a practical management text would immediately show. Sadly, one must conclude, Miss Jones must complete her studies by looking elsewhere. Nonetheless, at least some of her education would benefit from close attention to the ideas contained here, even if the title is misleading; for the questions of coordination between organizations (primarily but not exclusively modern, for profit firms) and within organizations are central defining questions in modern society. They are the questions at the core of this book, for Milgrom and Roberts suggest that the key role of management within organizations is to ensure coordination (p. 114), while defining coordination as primarily an economic problem. In his review, Professor Loasby has dealt with these aspects of the text in detail; I will not tread the same ground again. Let me instead deal with some other broad issues relating to the view of the world adopted by Milgrom and Roberts, and why its link with managerial action is less than transparent and at best incomplete as a frame of reference.

"\j ' Economics. Orgamzatitm and Msnagnmit (Englewood Cliffs, NJ: Prentice Hall, Inc., 1992; xviii + 1 621pp.). 1

© Oxford Univenity Pros 1995

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J.

(School of Economic Studies, University of Manchester, Manchester M13 9PL, UK)

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The first clue we find is the treatment of bounded rationality which occupies a good deal of the text. Unless Miss Jones is of such lowly status that her actions are entirely circumscribed by given decision rules, unless she is in effect reduced to an automaton, her managerial tasks will involve discretion, conjecture and the independent gathering of information no less than the ability to communicate her beliefs and proposals to others. Of course, one central task in all organizational design is to simplify communication and establish a common language in which beliefs can be expressed. In knowing where to gather information, how to interpret it and how to communicate it, she will have to cope with complexity and the fact that whatever she strives to achieve, the outcome is unlikely to be a global optimum. For well known reasons, the language of optimization, through which economists typically discourse, will not match the reality of her problem. Now there is nothing intrinsically wrong with the optimization argument as a method of discourse: given choices, individuals can as well be assumed to exercise that privilege to the best of their abilities and to the best of their interests. In fact, as Milgrom and Roberts point out, the hypothesis of optimization should not be contentious precisely because it is so empty of empirical content (p. 42) it is simply not parsimonious enough. Rather, the issues are much deeper. How is the list of choices to be known? how is it to be discovered and rendered tolerably complete? How does the decisionmaker know the full consequences of each choice? These are central managerial questions and they have to be answered before choice can be rendered possible. Once answered, the hard work has already been done, making the choice the minor part of the problem. In truth, the list depends on the exercise of imagination, it is unlikely to be complete and two managers (or their decision-making groups) faced with the same circumstances may well imagine very different consequences from the same list. Indeed, the better manager is the one who creates a different list — a list which gives the firm sustainable competitive advantages. Yet in many of their examples, Milgrom and Roberts convey the view that all this is a matter of writing down, scaling and solving the relevant equations, while identifying the first order (and, of course, second order) conditions, and that all reasonable people would agree on what has been written down. As Schumpeter once suggested, when events are repetitive and environments are unchanged, time and logic may hammer home an optimal solution, and one can think of many situations where this luxury is granted. However, for many major managerial problems, this is not how it appears and, indeed, characterizing the solution to a coordination problem is not the same as solving that problem. In many cases, the equations cannot be written down because the basis to project beyond past

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experience is absent. Even if the relevant equations could be written down they cannot be solved: perhaps initial conditions cannot be identified, perhaps the measures are ordinal so that second order conditions become meaningless or perhaps non-linearities are too intrusive. In short, there are no grounds whatsoever for computational optimism whenever decisions are of a non-routine, non-repetitive nature. As soon as problems cross a threshold of complexity, hypothetical deductive arguments are replaced by procedurally more efficient induction and trial-and-error reasoning. The Olympian argument simply fails and the more discretion Miss Jones is allowed, the greater the potential failure. Reflecting the intrusiveness of bounded decision-making, much of this book is concerned with action when parties have incomplete information. A number of implications of bounded decision-making deserve much more emphasis than they are given. Managers must make decisions, and if they cannot be guided by rational maximization, they must be guided by other means. Here Milgrom and Roberts accept a practical reliance on rule-driven behaviour with the performance of any given set of rules often dependent on other rules in the firm. Perhaps they do not emphasize enough that rules make action possible by limiting what is known and, indeed, what can be known. They have an informative discussion of this interdependence in their treatment of organization and strategy as design variables. However, to characterize the design problem at three levels — organization structure, decision rules and behavioural objectives — does not take us all that far unless we can show how managers are to create such design attributes, appraise them and change them when their performance is unsatisfactory in some predetermined sense. What is certainly needed are detailed empirical investigations of behavioural rules, organizational structures and how they evolve. There are two examples we can draw upon here. Consider first their detailed and informative discussion of finance. Starting from the Modigliani— Miller theorem, they explain how this can fail, not trivially because of the tax treatment of dividends and capital gains, but substantively because the financial situation of the firm influences managerial incentives and gives signals to ill-informed outsiders on the strategies of the firm. But to go from this rich and informative discussion of why capital structure matters in the abstract is quite different from stating what the optimal capital structure is for any randomly chosen firm. Interestingly, the discussion is enriched by much case study material, as it is throughout the book, but none of this appears to have anything whatsoever to do with optimality. Indeed, a great strength of this book is the use of judiciously chosen case study material which indicates the structural problems and the nature of solutions — solutions which we have no grounds for describing as optimal. They are 493

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simply the practices which so far work better than the alternatives. Secondly, substantial parts of the book are concerned with questions of reward and incentive structures, employment relationships and labour contracts. Yet many managerial issues remain unilluminated by this emphasis on rewardperformance trade-offs. The productivity of individuals and teams, for example, surely depends as much on trust, loyalty and reciprocal commitments which permit effective learning and the accumulation of the skills which give the whole organization competitive advantages. In short, Miss Jones had better not ignore Milgrom and Roberts on these matters but she also must learn some other human skills to motivate, lead and distribute a sense of selfesteem. The economics of coordination as presented here is an important part of the problem but it is not the decisive part of the managerial problem. A second consequence of bounded rationality is the asymmetric distribution of information, the very fact which follows from the division of labour, distributed capabilities, limited competence and the complexity of problems. To Milgrom and Roberts, the consequences of the resulting information asymmetries are negative: the prevention of conditions to apply the theorems of welfare economics. They follow from guile and opportunism, hold up problems in the presence of specific assets, adverse selection and moral hazard, and the allocation of resources to signalling and selection. From a different viewpoint these asymmetries are entirely productive, and are the basis for economic progress. Necessarily, our world is a world of asymmetric information, and such asymmetries cannot usefully be judged as market failures when they are the very mainspring of the competitive process. Imperfections of knowledge from the evolutionary perspective are simply the necessary means for the world to be competitive at all. Thus, while one can only admire the precise discussion of moral hazard and adverse selection, of opportunism and guile, and the implications this has for the allocation of resources of labour and capital, one cannot but feel that a sense of perspective has disappeared. It is these 'imperfections' which have made progress possible; it is these imperfections which underpin the hope of successful innovation; it is these asymmetries which map the creative destruction of modern capitalism. Again, this is something that a Schumpeterian perspective readily incorporates. Hence we arrive at the third consequence of this boundedness of decisionmaking: it leads to differential behaviour. The elementary fact is competition as a process driven by the diversity of firms' behaviour: they do different things and respond to pressures in different ways. If competition is to be treated entirely as a solution to a coordination problem, the presence of diversity amounts to very little. However, to equate a state of coordination, whether by price or by other means, with a state of equilibrium is to mask 494

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the significance of diverse behaviour as the driving force behind economic change. This, of course, is the foundation of an evolutionary argument — individuals living in the same world but believing in and perceiving different worlds as a basis for action. The limits of the Milgrom and Roberts approach are particularly obvious when one reflects on the virtual absence of the entrepreneur throughout the book: the concept only appears in the last chapter in the context of the development of organizations. Differential behaviour is the essence of entrepreneurship and its exercise is fundamentally incompatible with equilibrium theory. Creativity, imagination, boldness, discovery and alertness are the issues, not the passive acceptance of choices defined by clearly specified constraints. To the manager who lives daily with competition as change and process, the equilibrium perspective must seem perfectly puzzling. Amongst many (Hayek included), Georgescu-Roegan (1967) has expressed this with particular force: 'a perfectly competitive industry involves no competition at all' while 'the most general form of competition among individuals concerns a differentiation of product, involving a little innovation, not cut-throat pricing'. Thus, the world is competitive to the extent that firms create differential behaviours which map into competitive advantages. Indeed, much of the discussion of labour contracts fits well with the process view of competition, individuals deliberately seeking to differentiate and advance themselves in the eyes of employees. As Milgrom and Roberts observe, rat races (or tournaments) can be a pretty vicious form of 'market selection', particularly when the scope for genuine differentiation is limited. Every colleague has a view on the artificial capabilities of others. Without question this is a rich and sensitive discussion of central institutions in modern capitalism. Miss Jones will have no difficulty in recognizing the issues and accepting the rationale for particular practices. If there is one weakness in the scope of this book in claiming to provide a general treatment of management, it is its excessive concern with price coordination, transfer prices and wage setting are the typical examples of the internal use of prices by managers, although quantity coordination is not entirely ignored. The behaviours which develop decisive cost or quality advantages, in particular technological change and organization design, receive, by comparison, negligible attention. Yet these are the behaviours which drive competition, which explain the changing market position of firms, industries and regions, and which unify a concern with entrepreneurship and asymmetric information. This is not to say, of course, that pricing behaviour is irrelevant; far from it — prices influence the surplus over costs which is available for the discretionary use of management. The most significant of these discretionary uses are undoubtedly investments in capacity, 495

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innovation and organization. For information asymmetry arguments, which Milgrom and Roberts make very clear, one cannot expect capital markets to behave efficiently when dealing with these particular behaviours. In short, from a perspective of the management of change, the problem is misperceived. Good management involves behaving better than ones rivals and converting those competitive advantages into expansion at the expense of rivals. At root, this is a question of the relation between variety generation, organization and management, and the role of selection processes in enhancing the relative importance of superior varieties of behaviour. Market processes are selection processes to be judged not by the rules of static efficiency but by their dynamic ability to select superior behaviours. Equally, the organization constitutes an internal selection environment in which alternative conjectures about rules can be tested and implemented. Hence, the firm is to be seen as an experimental as well as an allocative institution, and managers are to be seen much as surrogate scientists/technologists, as they are passive stewards of the resources at their disposal. All this raises quite different yardsticks with which to judge organizational design and managerial behaviours. Not only must managers seek to do the best they can with given knowledge and resources, they must also devote their attention to increasing their local knowledge and turning it into competitive advantage. All we know of knowledge generation in complex environments suggests that this proceeds by inductive trial-and-error means; that theory is too weak to predict outcomes; and that learning proceeds by a mix of actual doing and vicarious mental winnowing. The processes which Vincenti (1990), for example, has so clearly described with respect to the growth of engineering knowledge surely apply a fortiori to managerial knowledge. We would therefore expect such knowledge to grow incrementally and cumulatively within traditions of normal management practice, and that there will be the occasional paradigm shift as some radical new position is developed and diffused. All this we expect to be a process of variation and selection, a problem in evolutionary epistemology. Variation in managerial practice necessarily proceeds blindly. It is neither random nor unguided; it is simply that the full consequences of new practices cannot be completely foreseen. It is guided by managerial models which are embodied in the decision routines of the firm. The central empirical aim therefore is surely to discover the population of decision rules and how that population is augmented and diminished over time. All this points to the need to present the firm as an ever-evolving organization and the managerial problem is one of constraining and stimulating that evolutionary process. The firm must be efficient to survive today but unless it is suitably creative, it will not survive tomorrow. Management is 496

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Reference Georgescu-Roegan, N. (1967), 'Chamberlins' New Economics and the Production Unit' in R Kuenne (ed.) Monopolistic Competition Theory Studies in Impact, Wiley' New York. Loasby, B. J. (1995), 'Running a Business: an Appraisal of Economics. Organization and Management by Paul Milgrom and John Roberts,' Industrial and Corporate Change, 4, 503-521 Vincenti, W. (1990), What Engineers Know and Hou> They Know it, Johns Hopkins University Press. Baltimore.

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also judged by its ability to learn and to creatively break with existing practice. It is the recognition of the need to mix these diverse demands which is perhaps the greatest omission in this book. In short, resources and opportunities are not what they are; they are what individual managers and teams think they are, and their conjectures are probably invalid many more times than they are valid. Like all good evolutionary processes, there is an awful lot of waste and destruction for very little creation. It is precisely because managers and entrepreneurs have dared to think differently that the economic world of 1994 is not the same as the economic world of 1894. No one who reads this book can fail to admire the enormous skill and effort which has been deployed to synthesize a vast literature on the economics of coordination. From this perspective, the authors have written a definitive text which covers an important part of the space of management problems. If management were simply stewardship, that would be sufficient, but it is in the very nature of management that not all can be stewards: some must set strategy, define directions of change and be willing to do things differently. Over time, it is this dimension which makes the crucial difference between success and failure, between growth and stagnation, between prosperity and survival. To imply that Milgrom and Roberts are unaware of this would be wholly wrong. But consideration of this dimension does suggest that their last chapter should have come first.