Firm Inefficiency

Economists are often stereotyped as claiming that firms are very economically efficient, i.e., that they very effectively minimize costs and maximize profits. This is a common source of derision of economists by other social scientists. And it is true that efficiency is the standard assumption made in textbooks and in math models. But over time I’ve been persuaded that it is often far from an accurate assumption. (And I doubt that most older economists believe it.)

I’ve been persuaded by a steady accumulation of plausible examples of widespread persistent inefficiencies. No one example is overwhelmingly obvious – all have stories for why they are only apparent inefficiencies. But added all together, they persuade me. Some examples:

  1. Threats Help Productivity – When firms face more competition, they often have big bursts of productivity. But if increases were possible, why not do them before?
  2. Long-Lasting Deadwood – Firms often keep employees who are widely known within the firm to not be pulling their weight relative to other employees. They tend to be fired during a downturn, or after a takeover.
  3. Not Invented Here – Firms are famously reluctant to adopt changes that appear to have been developed elsewhere, preferring instead changes for which someone internal can take credit.
  4. Shooting Messengers – Many firms greatly discourage passing bad news up to bosses. GM was just exposed as such a firm via a safety issue. Those who do pass bad news up are punished as if they were personally a big cause of the bad news.
  5. Yes Men – If bosses keep quiet about their opinion, they can evaluate subordinates via comparing employee opinions with boss opinion. But bosses consistently forgo this by telling subordinates lots of opinions and punishing those who question such opinions.
  6. Mergers & Acquisitions – Firms that buy and merge with other firms seem to consistently lose money.
  7. Poison Pills – Rules that discourage takeover attempts by financially penalizing such attempts prevent investors from getting more for their shares.
  8. Overpaid CEOs – It is far from clear that firms actually earn more when they hire more expensive CEOs.
  9. Too Many Meetings – It is widely believed that most firms hold too many meetings that go on too long with too many people.
  10. Too Many Interviews – It is hard to find much evidence that interviews add info on job performance. So why do candidates go through so many interviews?
  11. Biased Evaluations – Bosses consistently give lower evaluations to people they didn’t hire, relative to people they did hire. Yet official evaluations don’t correct for this.
  12. Excess Credentials – People consistently feel pressure to hire people whose credentials make them look good on paper, relative to people they believe would do a better job.
  13. Few Experiments – Firms tend to be reluctant to do experiments, such as to find preferred product variations. Experiments would force them to admit they don’t yet know.
  14. Few Track Records – Meetings are full of people making predictions on decision consequences, but firms almost never keep formal track records to rate accuracy.
  15. Reward Braggarts – Firms consistently neglect people who don’t toot their own horn, even when their superior features are widely known.
  16. Allow Info Silos – Groups and divisions with a firm are allowed to keep a lot of info secret within their group. Yet if the firm works together toward a common goal, what can be the benefit of keeping such secrets?
  17. Predictable Consultants – Management consultants are often hired at great expense to give advice that is quite predictable given the opinions of those who hired them.
  18. Little Telecommuting – Telecommuting seems to save big on costs, yet is not adopted much.
  19. Discrimination – Fat women are paid less, tall men paid more, in social jobs.
  20. Cubicles – They seem to reduce productivity more than they save in office space costs.
  21. I’ll add more here in response to suggestions.

My working hypothesis to explain these inefficiencies is that the people and supporting coalitions closest to them tend to gain from them, and that selection pressures on political coalitions are often much stronger than selection pressures on firms.

If many of these inefficiencies are real, then yes government regulators can also see them, and yes it might not be that hard for smart sincere people to design regulations to increase welfare by correcting for them. However, government regulatory agencies are also “inefficient” in many ways, leading them to choose and enforce regulations which differ from those that would most increase welfare. To judge if we are better off giving regulators more powers over firms, we must judge the relative magnitudes of these two types of inefficiencies.

Note that firm efficiency may still be a reasonable assumption to make in models, even if it is not an accurate assumption. Modeling is always a tradeoff between realism and understanding.

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  • Ilya Shpitser

    Robin do you have any suggestions for local moves we can try to do to reorganize society such that small coalition pressures can be made to do useful work?

  • johnnycoconut

    I love this post and your thinking! I’d love to know what the last sentence of 13 is supposed to say.

  • Dave Lindbergh

    I’d add “insensitivity to costs”. Working for a small firm that does business with large firms, I’m constantly amazed that we are able to buy capital equipment (scientific instruments, etc.) at 10% to 30% of the price routinely paid by large firms. My anecdotal impression is that large firms work hard to squeeze costs out of production, but are very insensitive to cost when buying for R&D or management.

    I attribute it to “cover your ass” buying – nobody ever got fired for buying IBM/Microsoft/whatever – the big brand name. Even if the price is 4x higher. The more technical and obscure the equipment, the more I see this.

    On a slightly different topic, I am always surprised to see large firms with all the inefficiencies listed above, yet those firms remain profitable and keep growing. There must be some huge benefits to size that offset these costs. I do wonder where they come from.

    • Dean Jens

      That last paragraph is the traditional economists’ argument for firm efficiency, and, as Robin notes, there are arguments for each of the points that they aren’t actually inefficient. (There’s a finance literature suggesting that poison pills may be valuable commitment tools to improve the bargaining position of shareholders to get a better price from an acquiring company, for example, and CEO pay may have positive indirect effects, especially at companies where CEOs are almost always hired from the inside, e.g. in “tournament” models.) To remain profitable, though, you don’t have to outrun the bear, just the slowest camper; if every other large firm is going to develop some of these internal patterns, competitive pressures may only lead to the selection of those firms that are slightly less bad in these terms.

      I would note in this context, though, that I have wondered whether in some markets in which big firms dominate the advantage to “size” comes in large part through the use of coordination failure as a commitment tool. A small company might find every potential customer trying to bargain it down to gross cost, where it can’t cover overhead, while a larger company makes sure that customer-facing employees clearly lack authority.

    • Philip Goetz

      In biotech, scientific instruments often cost more to purchase than they would to build by hand, and the software to run them may cost about a third as much per license as it would cost to hire somebody to write new software.

      Some firms with government contracts that allow a profit that is a fixed fraction of the cost of executing the contract seem insensitive to the cost of things that the government will pay for and that will increase their allowable profit.

      • Dave Lindbergh

        Yes! I’m in biotech, and I’ve personally made several instruments for our own use because it was far cheaper than buying them (even counting my expensive time). And I’m building more.

        Yet most biotechs aren’t running on cost-plus contracts; they’re running on VC money, (more rarely) reinvested profits, or fixed-dollar NIH grants (most rarely).

        So – why do these crazy prices persist over many years?

        At the risk of driving these comments off-topic, I’d really like to know the answer – we’ve been thinking about manufacturing some of the instruments I’ve built, because we could sell them at 1/5th to 1/10th of the “going prices” and still have good profit margins.

        Every other firm I’ve seen do that quickly ends up getting bought by one of the “big” equipment suppliers (Fisher, VWR, etc.), and then…somehow…the product ends up costing as much as everyone else’s.

        It is hard to avoid concluding that there is something fishy going on in this market.

        I wonder if perhaps something “bad” would happen to a firm that introduced inexpensive instruments but refused to sell out.

        I’m a bit afraid to find out – I like being independent.

  • notlars

    I wonder if this is a local maximum.

    1. To borrow the logic of Bryan Caplan’s case against education, perhaps doing things differently is more efficient, but doing so would be “weird.” Thus, just like someone with ability goes to a “real” college instead of offering to prove abilities to an employer, so a firm that could do things differently doesn’t because it would alienate prospective suppliers/customers/employees.

    2. Alternately, though less likely, the inefficient package might be the best compromise: because it’s not maximally efficient, prospective employees know they have some leeway to slack, which they consider part of their compensation package. Changing it according to Robin’s examples above might repel such employees and attract more efficient but also more transient employees.

    • Dean Jens

      The recent posts about telecommuting (also offered on this list) certainly has trouble with your second suggestion; a lot of these items, in fact, are things that would make many employees prefer to work somewhere else (if they can find a somewhere else that is better).

      I know someone quite well who wants to do her job well and is sometimes frustrated by employer policies that she perceives as punishing her for helping the company, rewarding her for slacking or hurting the company, or even making it impossible to do things that would help the company. These are the sorts of things for which “internal politics” might be a good answer.

  • Sid K

    Robin, since you are a fan of The Wire, I’d like to point out that many of these inefficiencies are highlighted in the show; most clearly inside the Baltimore Police Department. Especially points #2,4,5,13,14,15,16.

  • pluviosilla

    You could add so-called “efficiency wages” to the list. Corporations pay higher than market wages, because internally there is no market discipline and performance is difficult to measure. Employees who know they are likely making more inside than they could outside will fear dismissal. Like draconian punishments under ineffective law enforcement regimes, this raises the stakes in order to compensate for infrequency of punishment and loose accountability. The corporation, after all, is a type of collective action and functions in some ways like a small island of socialism with a comjmand economy. Anyway, that’s how corporate work life feels to *me*.

    • “Efficiency wages” is a story for why something that looks inefficient, namely excess wages, is actually efficient.

      • pluviosilla

        Efficiency wages might be a good way of making the best of a bad situation, but were transaction costs to fall enough, firms could contract with individuals instead of hiring them, at which point we could gladly do without “efficiency wages”.

      • justin

        The same is potentially true about most items on your list though. (1) could be rationalized by risk aversion, (2) by employee morale, and so forth.

    • Philip Goetz

      If corporations pay higher than market wages, what determines market wages?

      • pluviosilla

        Markets include individual contractors and small businesses as well as corporations. I think Akerlof came up with the idea of efficiency wages and has data to support it. There may be academics that dispute his findings. I don’t know. There’s a lot of anecdotal evidence that total compensation exceeds what you can make contracting as an individual (although the salary component is higher for a contractor). The steady employment you enjoy when working for big bureaucratic firms also has a monetary value. If the corporation could calibrate their needs perfectly and turn worker salaries on and off like a water tap, they’d employ workers more intermittently, much as you hire a plumber when needed. You don’t put him on your payroll just because you need to change your water heater.

  • Andrew Swift

    Organizing human beings to be productive is like the famous analogy of herding cats. The most efficient way of herding cats would look terribly inefficient but still be the best. Cats (and people) are inherently chaotic — the fact that you can point out seemingly overwhelming inefficiencies is more of a testament to the nature of humanity than it is to the inefficiency of business.

    That said, there are companies (Apple, Mars) that manage to do things differently. This comes from the vision of the founders.

    My mother in law is French, and she’s a great cook. Her recipes have only a few ingredients, but she knows what the result is supposed to be like, so she is able to make incredible food.

    Most companies are not run by visionaries and most people in the world do not have a very clear vision. Firm inefficiency is just another way of noticing that.

    • IMASBA

      You’re right that it is like herding cats. I do think Robin is aware that competitive private sector efficiency is only meant to be taken as less inefficient than a private monopoly or central planning, but he is right to point out economists do not make that point very clear when communicating with the public and some economists have seemingly all but forgotten about it.

      The point about visionaires is false though, I believe. There are very few visionaries heading companies and even those few cannot get around things like office politics and market fluctuations outside of any one person’s control. Excessive success of a company is always more due to luck than the vision of the founders or leaders.

      That should be really #19 on Robin’s list: not only is performance hard to measure, people greatly overestimate potential performance (though I’m reminded of a blog by Robin where he said the very rich got very rich by having mental superpowers, instead of 90% luck and 10% mental abilities that are more advanced, but only slightly so, than those of the average college educated person, so perhaps Robin hasn’t figured this one out himself yet: he himself is probably more intelligent and resourceful than half the billionaires out there, but he doesn’t know it).

      • Andrew Swift

        I probably should have used a different word… visionary sounds grander than what I meant. In my experience companies tend to reflect the personality of the controlling person or people. When that person is willing to go against conventional wisdom, exceptional situations become possible. However, such companies are outliers.

        I agree that people vastly overestimate potential performance. That is a much simpler way to phrase the point I was originally trying to make.

        I read (in “The Economic Naturalist”) that increases in efficiency lead to windfall profits for early adopters. I think that many of the very rich at this time in history are lucky in the sense that they were able to capitalize on the vast efficiency gains that come with technological advances.

        You could say that such a person knew to strike when the iron was hot, but at the same time, there are people striking everywhere, all the time, and of course many of them will be in the right place and the right time by sheer luck.

        I have often thought that most scientific and technological advances are inevitable… once X-rays were discovered, someone was bound to find a way to use them. Etc.

        But, the geniuses get there first and they deserve their merit. I don’t think it’s fair to say that Einstein was just lucky, but it’s true that someone else would sure have made the same leaps if he hadn’t.

        Within the scope of what’s possible, some people will stay comfortable, and some people will strike out and look for the unknown. Some people will just try random stuff and get lucky, but my guess is that those people are relatively few in number.

      • IMASBA

        Einstein didn’t become a billionaire (in any case you cannot patent a law of physics, only an application) and most billionaires and multimillionaires today made their money being a hired executive (of which most economists and Robin too in this blog, admit that they are vastly overpaid) or by getting lucky on the stock market and a disproportionate number started with a high amount of capital to begin with. it is true that you need to take risks but what separates risk takers who fail from risk takers who succeed is a lot of plain luck.

        If we could all be a bit more realistic about his companies could avoid having to worry so much about picking “top performers” and fostering internal competition.

  • NQM

    Heck, persistent inefficiency even shows up in corporate architecture:

  • Tige Gibson

    #6 and #7 seem to be contradictory. If a company is going to lose money by merging/being acquired, how is that going to increase shareholder value?

    Anyway from my experience, companies that need a merger or takeover need to do so because they have been losing money which isn’t going to automatically change after being acquired, while the company doing the takeover must believe it will extract a value which the current ownership has failed to accomplish.

    Even in a case where the target has used up its capital to develop a product and just needs more money to get it to market, there isn’t much reason to believe that either company has the capability to do the new task based on what they were doing before.

    • Daniel

      Number 6 is saying that buying other companies is, on average, a waste of money.

  • This is a common source of derision of economists by other social scientists. And it is true that efficiency is the standard assumption made in textbooks and in math models.

    You pose, without resolving it, a conundrum: how do inefficient firms survive under competitive markets?

    Barring structural inevitability (which seems implausible, since some of these inefficiencies developed recently), the conclusion seems straightforward: oligopolistic markets aren’t

    Their efficiency was apparently assumed by many economists, this being the foundation for their belief in the efficiency of firms. Can you tell me assumption wasn’t, in fact, derisible?

    • j

      Economies of scale are large enough that you can be far less efficient that is possible while still being more profitable than a smaller/newer competitor

      • Ilya1981

        This is especially true as society is in the process of exhausting its major sources of growth:
        Hence being more efficient at scale becomes ever more important. Developed societies seem to be moving along the path predicted by Schumpeter.

    • brendan_r

      It’s actually in the super competitive industries that inefficiency is most obvious, because competitive means homogeneity, and homogeneity let’s you cross-compare and isolate differences that must stem from mundane efficiency rather than technology, customer captivity, scale, etc.

      Also, the point is more significant, because regardless of how things are modeled, economists know oligopoly affords opportunities for inefficiency. That companies in super competitive markets can exist for years despite gross inefficiency is the more surprising realization.

      • Do these competitive markets have high entry costs?

      • Philip Goetz

        Walmart and McDonalds are super-competitive and super-efficient.

      • brendan_r

        Yes, of course. I didn’t mean efficiency was lower in competitive industries. I meant that variation in firm efficiency is easier to measure in competitive industries.

    • Weaver

      The “textbook” answer is that economies of scale outweigh the benefits of price signalling for firms, for a certain range. Then firms tend to slow down again beyond that point.

      Larger firms may be better placed to exploit rent seeking and political patronage too.

      • IMASBA

        That and the fact that there really are “structural inevitabilities”. A firm can survive when it wastes resources on office politics because all humans who get office jobs are geared towards office politics.

  • Sebastian_H

    I’m not sure if this is what you’re implying, but part of the reason firms do well is because they manage political coalitions as well or better than most alternative large scale organizational structures–see for example government agencies, militaries, or cooperatives. So they more effectively minimize costs and maximize outputs than most alternative structures. That isn’t to say they do so perfectly. But they do so better.

    • John Joseph Driscoll

      Where can I find information on alternative structure management of political coalitions?

  • efalken

    When I was with a large bank, we brought in a consultant for a $500k engagement. It was to put in place a program the execs wanted. Part of that was to make sure we were doing it right (aka like others), and part was it made the decision to go forward seem more objectively informed, more credible.

  • reader

    These inefficiencies are basically the same as “dumb things that happen in big companies,” so if you want more examples, look to Dilbert

  • xyzxyzxyz

    Many of these are good examples but some are blinkered by not seeing the wider picture. Take the Deadwood example.

    Most deadwood employees are not doing nothing they are just doing less than they could: stuck in a cul-de-sac, using outdated methods or are demotivated. The purely economic decision by the firm has to factor in the costs of making an employee redundant, and being able to find and train someone who will be significantly better. The company also takes a PR hit as a company that makes staff redundant is seen as weak. The morale of the remaining staff might well be hit “they fired that nice guy Joey who’s got a couple of kids and a mortgage, … the bosses don’t give a #### about us” .

    The economic discount factor makes sure that a future gain has to be pretty strong to counteract the considerable present costs of firing this guy and getting a replacement.

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  • brendan_r

    Persistent predictable losers. In the electronics contract manufacturing space, for example, there are many small firms which have failed to earn their cost of capital for a decade straight.

    Same among community banks; there exist community banks whose overheads are so high that even in the total absence of credit losses their ROE would be less than 10%. And they often stay this way for years.

    In most boring, mature industries, there are dozens of inadequately scaled firms happy to earn positive but below cost of capital returns indefinitely, with no plausible hopes or plans to ever do anything as valuable for shareholders as simple liquidation would be.

  • brendan_r

    That list has got me thinking about Sam Walton’s biography, relevant in a few ways.

    Walton made it a point of pride to avoid many of these pitfalls. Rather than being phobic of others’ innovations, he wanted to copy any good idea his competitors had. He’d wander around the smallest retail outlets, sticking his head in every nook and cranny, looking for ideas. Big into experiments. Also, young walmart actively avoided college grads, i.e. rabidly anti credentialist. He’d interview low level sales associates to learn what’s working, etc. Meetings were short, and *must* reach conclusion on the issue of the day to preclude the necessity for further meetings.

    Walton would’ve never been hired to CEO a firm. Too self-effacing, lacking credentials, far too brusque w/ outsiders, etc. The only way a guy like that gets to run a big company is to build a big company.

    The most promising econ ideas, I think, are those that let you abstract away big complicated problem components. Ex:

    NGDP level targeting lets you forget about how money affects interest rates, which in turn affects C+I+G+X in complicated ways, etc. Building full scale macro models isn’t going so well. But why not forget about the whole thing, create a NGDP futures market, and starting pumping M into the system til the futures matches your goal.

    And here, as robin often suggests, just make it easier for raiders to buy inefficient firms, and we can forget about the intractable problem of modeling all these ways firms fail efficiency wise.

    But obviously these sorts of simple solutions don’t interest many people.

  • Geoff Brown

    Efficiency is in the eye of the beholder, imo. Alignment of incentives creates the focus of efficiency efforts. Currently, access to capital and debt markets draws the largest incentives. So to the victor goes the spoils, irregardless of their other shortcomings. My prediction is that once capital and debt markets are allowed to rise and fall with perceived risk rather than managed by a bureaucrat the hammer will come down on the majority of these ‘inefficiencies’.

    • Paul Laroquod

      That can never happen because it’s impossible to get into a position to change those laws without the assistance of people and organisations that could never maintain their grip on world affairs if the risks of their behaviour were ever truly accounted for.

      Why bother advocating solutions that you must know are purely impossible? There is a greater chance of a worldwide socialist revolution than of the greatest beneficiaries of ‘capitalism’ ever allowing a truly honest assessment of economic risk.

      • Geoff Brown

        I agree they will never allow it. But systemic collapse will happen none the less. It will happen, not through bond vigilantism or activism, but through the oldest of human frailties, complacency.

      • Paul Laroquod

        And then they’ll just build another system, with even more sophisticated lies. Worked the last time!

  • carribeiro

    “Larger is better” syndrome. Many companies (and economists) believe that economies of scale are everything. A simplistic birds eye view is to blame here; easy to see large scale redundancies and optimization opportunities, but very hard to see the infinite small scale mismatches, not mention pure waste. Large companies are perfect hiding places for all sorts of inefficiency.

  • carribeiro

    “Self serving agendas”. That seems obvious and I was surprised not to see it on the list. Not everyone is aligned with the company’s best interest. The higher one is, the worse the effect is.

  • Stefan

    hierarchical structures perform poorly compared to flatter structures in some business domains (e. g. software), yet they have to be maintained in order to turn a profit to the investors.

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  • truth_machine

    Economists say these things because of ideological and more direct forms of corruption. The lie that private industry is efficient goes hand in hand with the lie that government is not (and “is the problem”).

    • Sure sounds like you’ve done quite a bit more reading of progressive rants than actual articles on economics…

      • Economists are almost unanimous on the efficiency of production for the market compared with centralism.

        The evidence doesn’t justify this unanimity; it’s an ideological fad. Fifty years ago, the ideological fad was that the Soviet Union would overtake the West or at least represented a more efficient means of industrialization than capitalism.

      • IMASBA

        It’s not just a fad: the calculation problem in all its variants is an old concept and it makes a lot of sense as an argument against (total) central planning. Of course that does not mean the current form of capitalism is the most efficient system possible. There used to be some debate about the Soviet Union overtaking parts of the West, but never on a per-work-hour basis in the long run.

      • I don’t think the calculation argument has the slightest merit. It assumes that the market somehow combines all the available information, when in fact market behavior is based on vastly simplified heuristics. A central planner doesn’t need to combine all the information, it can use heuristics–and the market itself can do no more than that.

      • Weaver

        The heuristics are convergent. That’s the beauty of it. Faulty information is selected against.

        No such benefits for your central planner.

      • Why can’t central planners create convergent heuristics? Why can’t their degree of convergence be made to exceed that provided by the market?

      • IMASBA

        The market basically uses all of our brains to do its calculations and in doing so it even has access to each and every one’s unique personal utility functions for a variety of goods and services. So it’s not just a computationally expensive process, it also requires access to personal utility functions, so even in the ideal case a central planner would be probing personal utility functions and in essence that would mean the central planner is merely nudging a market in a certain direction.

      • My point is that the market does not (as Hayek ridiculously supposed) have “access” to our personal utility functions: it only “accesses” our pursuit by means of our heuristics. So, there’s no prima facie reason that the central planner can’t develop better heuristics.

      • IMASBA

        There are no “better” heuristics and a central planner cannot replace them because they are unique to each person (and change over time as well). A central planner might some day be able to simulate 7 billion realistic heuristics, but the difficulty is in simulating the exact heuristics of living people and aataching them to the right people, that’s simply impossible without probing/communication of/with all 7 billion people and that would pretty much result in a market.

      • Weaver

        Exactly. Done perfectly, this impossible system would merely generate prices like the market prices.

      • Q. What is the heuristic a heuristic for? A. It is an estimate of our individual utility functions. It is only a very approximate estimate.

        The heuristics used by a central planner would attempt to estimate massed utility functions. It could never do this perfectly, but neither do the heuristics economic actors employ allow anywhere near perfection in estimating personal utility functions.

        There’s no apparent reason that the heuristics used to predict mass utility functions could not be improved indefinitely, whereas the individual utility functions used by consumers will probably forever remain highly imperfect.

        [You seem to be assuming that the only way to predict mass utility functions is by duplicating the (faulty) predictions of individuals of their own utility functions. Hayek naively assumed that personal utility functions are directly expressed in market behavior.]

      • IMASBA

        Heuristics of massed utility functions do not work because people are so different. If half of the people wants a 1 bedroom home and the other half wants a 3 bedroom home you’re not going to make anyone happy by giving everyone a 2 bedroom home. Even if you know half wants 1 bedroom and the other half wants 3 bedrooms you still need information about every person out there to know to which of the two halves of the population they belong. You need this information for an everchanging and very long list of goods and services. It’s just undoable, even if your heuristics are better than that of the people themselves (ie. you know that 25% of the people who say they want 1 bedroom really woulkd be happier with 2 you need to know those people by name).

      • Heuristics of massed utility functions do not work because people are so different.

        I don’t see how you could possibly know this; or even how it could possibly be true, given the possibility of refining the heuristics infinitely. (Your example only excludes the simplest heuristic, averaging. Whatever the heuristics are, they probably won’t be simple.) The heuristic depend on the growth of our knowledge about the nature of the similarities and differences among humans.

        [Hayek, on the other hand, presented a rigorous argument, but it depends on a false assumption of direct individual access it one’s utility function.]

        It’s true that no heuristic will get everything right. But neither do markets! (Let’s not forget that capitalism is still beset by economic crises, which expose the flaws of the market in avoiding overproduction and the like.)

        I think it is further true that planners (ideally) will plan for less variety of product, and endless variety is the enemy of planning and friend to the market. But others in this forum, including R.H. himself, have agreed that great benefits would accrue if we could coordinate to limit excessive variety.

      • Glen Raphael

        > “Let’s not forget that capitalism is still beset by economic crises, which expose the flaws of the market in avoiding overproduction and the like.”

        Wait, how do you figure that? Are you claiming that capitalism is MORE beset by “economic crises” than alternative systems that are presumably LESS self-correcting? If so, can you provide some evidence or argument to that effect?

        (Or are you comparing capitalism to a theoretical perfectly-managed utopia that could never actually exist and saying the actual world as observed falls short of utopia, so it must have “flaws” and then choosing somewhat arbitrarily to attribute any observed real-world “flaws” to the “capitalism” part of the actual world?)

      • Are you claiming that capitalism is MORE beset by “economic crises” than alternative systems that are presumably LESS self-correcting?

        Yes. Soviet Russia didn’t have depressions; it forged ahead during the international Great Depression. (The Soviet Union, moreover, was about the furthest thing from a perfectly managed utopia.)

      • IMASBA

        Command economies are indeed less prone to strong economic swinging motions, they tend to stagnate or slowly decline. Of course free market economies keep growing on average and after sufficient time even a free market economy at the bottom of a crisis is more wealthy and technologically advanced than a command economy. So not having crises sounds better than it actually is.

        Capitalism, one form of a free market economy, does eventually result in high economic inequality (the poor masses can be pushed all the way down to subsistence level) and therefore has its own major long term problem.

      • Many capitalist economies both stagnate and suffer from crises. The universal is that capitalist economies suffer crises; planned economies don’t. Planned economies have not necessarily stagnated (e.g., China, which only has a quarter of the world’s population).

        I hold crises a worse evil than inequality. Economic crises lead to war. Planned economies are not economically expansionist.

      • IMASBA

        Modern China is no more a command economy than Germany, at least not in those areas of the economy that bring in the most money. China is already experiencing its first real estate bubble (welcome to the capitalist world I guess).

        You are right that crises are psychologically and sociolgically important: it feels worse to go from $10.000 to $9.000 than from $5.000 to $6.000, even if you know it’s temporary. But still that $9.000 really does buy you better health care and education. Inequality piles on to that.

      • It is hard to be clear on China as there’s much secretiveness and complexity. But the areas responsible for China’s growth is planned infrastructure. Private industry is NOT responsible for most of China’s growth.

        The way the real-estate bubble is handled will be telling. But at present, this is just one of many threats to the Chinese economy that have been propagandized by capitalist economists; best bet, it will too turn out to be nothing much. That China has not experienced depressions is a strong argument that there is something very different about its economy, which has grown where almost everyone else has floundered (and again, has NEVER YET experienced depression).

        Let me give you an example of how the Chinese economy is run. It’s not by itself a dispositive argument, but it shows how radically different China is than Germany. At every factory, there is a Communist Party operative with the power to veto ANY decision by management. [This would surely horrify capitalist economists–and probably you too.]

      • Does North Korea count as a planned economy? They’ve had crises. Australia hasn’t had a recession in a very long time, which Scott Sumner attributes to their central bank targeting 4% inflation.

      • Glen Raphael

        In the 1930s USSR, as many as 20 million people died due to famine and killings related to that “forging ahead” which also made use of massive amounts of slave labor. If that’s what it means to have fewer “flaws” and “not have depressions”, I think I’d rather keep the flaws. (There was quite a lot less starving-to-death in the US during that period, in large part because “capitalism” generally doesn’t make it illegal for farmers to eat their own crops or for starving people to flee starving areas.)

      • The Soviet Union made a wreck of Russian agriculture. This is well-known: forced collectivization of agriculture was a disaster.

        Nobody here is defending all aspects of the Soviet economy. I’m only saying it proves that business cycles are not inevitable. How can the economic benefits of planning be separated from the political risks? You’re implying they can’t; we disagree, but it’s a different question.

      • Glen Raphael

        Calculation of GDP includes G, spending by government. A sufficiently powerful government is able to force the unemployed at gunpoint to work in labor camps and arbitrarily go into debt to increase G enough to make the calculated apparent value of GDP appear to increase even if they have to *destroy value* to do it. Perhaps they pay people to dig holes and fill them up again, or build factories that make trucks that are worth less than the components that go into them. This doesn’t mean there’s no business cycle and doesn’t mean the government interventions that *masked* the business cycle has made people better off compared to nonintervention.

        People in capitalist countries suffered and starved in the 1930s; people in communist ones did too – and in larger numbers. So where’s the difference that makes a difference?

        You have yet to show there WERE “economic benefits of planning” in this case. The fact that the soviet union ruined agriculture isn’t a “political risk”, it’s an ECONOMIC risk – and one at the very core of the problem with socialism. People take better care of resources where there is ownership, profit, and a system of relative-value prices providing accurate information about scarcity and need.

      • IMASBA

        “I don’t see how you could possibly know this; or even how it could possibly be true, given the possibility of refining the heuristics infinitely.”

        It’s not the heuristics that are the problem, it’s the information gap. You might be able to come up with realistic heuristics but you have to connect them to individuals (who are born and die and whose personalities change throughout their lives).

      • The same information can be described in different ways. Some of the individual information will be lost, but our individual heuristics also fail to capture most of the information about our utility functions.

      • IMASBA

        “The same information can be described in different ways.”

        Undoubtedly, but how will you gather it in the first place without having something that is a market in all but name?

      • A market does seem to have unique self-corrective mechanisms (perhaps, I haven’t actually seen this established), but it corrects only as a statistical average, often over long periods of time: depressions are self-corrections.

        But this process of self-correction is itself highly inefficient, Darwinian process.

        I see no argument (do you?) that only a market can evaluate utilities. (Capitalist firms, after all, perform accurate market surveys before marketing.) The basic ways a sound planned economy would do this are by ultra-democratic institutions, science, and surveys. [I’m not setting out to design the details of a planned economy; only to refute the established dogma that markets are a priori more efficient government.]

        Despite the Soviet economy being incompetently run, it had a functioning economy which for a long stretch performed spectacular feats of growth. The Soviet economy at least partly proved that you don’t need a market. (Although, I admit, more of a market than they had would have actually been useful in a backward country like Russia was initially.) Its flaws lay more in a paucity of innovation, not in a gross failure to coordinate production (as Hayek would have to claim).

      • Weaver

        Its not a matter of heuristics, its a matter of information. As IMASBA says, the amount of information needed is literally astronomical.

        Also, I think you’re using “heuristics” in an underdefined way here.

      • Brutal Honesty

        You should spend some time reading about Big O Notation.

        Even given perfect starting data and perfect control, some problems are not solvable for large sets with known technology.

        Some are not even soluble with speculative technology given the estimated energy and remaining time of our universe.

        There’s also the problem of mistakes. Many small uncorrelated mistakes are generally not serious. Large centralized mistakes are often catastrophic. There were famines resulting in deaths of 10s of millions in India, China and Russia – all due to central planning by people with government connections but no farming experience.

      • Weaver

        Unless you’re Iain M. Banks’ Culture….no…the maths is obscene and requires nigh-omniscience. IMABSA spells it out below.

        I’d sooner grant you warp drive than an efficient central planner.

        (I’ll glide over the vast incentives to corrupt, neglect, or control the central planning process. How well does central planning resist public choice theory now?)

      • brendan_r

        Why again did that fad for public ownership of production die out?

        More seriously, if the evidence seems ambiguous it’s because the industries that get the most attention are those look least like perfect competition, i.e. operating systems and their increasing returns to scale, communications and their large minimum efficient scale, and medicine where value is hard to judge and people have stubborn intuitions.

        That each of these industries (except the IT ones) are heavily regulated everywhere makes the public/private question even harder to evaluate.

        The clearer the empirical evidence is that a particular industry is more efficiently run privately – farming, manufacturing, delivering physical goods – the less likely it is we think about it often.

        Further, once you know the processes that make such industries better run privately, the existence of those same processes in other industries is at least a strong hint that some private structure is ideal.

    • Weaver

      Yes, the maths and the statistical evidence disagrees with you because of “corruption and ideological” reasons.

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  • noop

    many of these are due to the control (execs) vs. ownership (shareholders) split.

    • Martin Cohen

      Shareholders don’t own – they just have shares. The high execs use “shareholders” to justify doing what benefits themselves.

  • vijayboyapati

    Peter Klein has some very interesting research showing there are limits imposed on organizations by the problem of economic calculation: This is an application of Mises’ work on economic calculation applied to socialist economies and why it is so problematic for them to allocate capital without squandering it.

    • Joe Peric

      Many large corporations that are arguably monopolistic seem too fall apart right when they appear to be the strongest and most threatening force. Part of this has to do with legislation, but I believe another has to do with economic calculation. By monopolizing one or more horizontal slices of a market, they lose market pricing and that brings about (gross) inefficiencies.

  • MHC

    I think this is an interesting list, but I’d be worried about generalizing from the American experience without some international data. Just as an example, maybe the “shooting messengers” problem is a result of the culture of optimism that prevails in the US. Similarly, maybe there are problems that American companies don’t have (that others do) b/c of peculiarities of American culture. So either you’d need to tie this back to some sort of general bias framework like prospect theory, or you’d need to investigate them more thoroughly to understand why they are there.

  • MHC

    A better example of the cultural issue is probably #15. This is true in the US, but I’ve been told that the opposite problem prevails in Japan in that people do not take enough individual credit for firms to be able to figure out what contributions people actually made.

  • TT TY

    This “Modeling is always a tradeoff between realism and understanding” made my day! I liked your post (:
    “Overpaid CEOs – It is far from clear that firms actually earn more when they hire more expensive CEOs.” – I’m not sure if you were sarcastic or not

    • Brutal Honesty

      Evidence is clear that firms that pay CEOs the most have the worst long term performance. See Buffett, Bogle and Lynch.

      • IMASBA

        In any case, even if $11 million per year really motivates more than $10 million per year it’s simply not going to make much of a positive difference for the business. No CEO has an IQ of 300 plus an eidetic memory, perfect relations with each one of his 100.000 employees and no enemies on the board, while a CEO would need all those things to truly deliver what he’s being paid for.

      • TT TY

        Then why is this continuing the same? If I had a biz and I knew about these stats I would change the CEO if is overpaid. Don’t you? Maybe this is not the whole story, maybe the biz loses money but the owner gain more under the table, therefore a high paid CEO is actually good for the biz owners.

      • IMASBA

        If you had a business there would be roughly two scenarios: 1) you are a shareholder of a public company in which case trying to cut CEO pay would bring you into conflict with the executives, which will disrupt the business and might very well cost you more of your dividend than the 0.5% or so you could gain by cutting the CEO’s pay in half (and that’s if you were to succeed), 2) you have a private company in which case you yourself are the CEO or you are a friend/colleague of the on the board who owes a lot to the CEO.

        CEO pay will likely continue to rise until individual shareholders start really feeling the lost dividend enough to aggressively fight any further pay raises.

      • Kyle

        CEOs of really great, growing companies often don’t need to be paid as much as CEOs of failing companies (their stock performance helps cover it, especially if they’re a founder). Bad situations often require higher wages to bring someone in. I don’t know about this at the CEO level, but I’ve seen it at my job (Anthony Bourdain talked about it for chefs in kitchen confidential, too).

      • IMASBA

        So high CEO pay is caused by fools who don’t know about regression toward the mean and the million other, largely random, factors that actually dominate company performance instead of the CEO?

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  • riemannzeta

    This strikes me as lazy, audience-pandering blogger commentary. I would expect this from most bloggers, but I know Robin is capable of more. There is an academic literature (and in more than one discipline) for nearly every item on this list. What is the point of this post? Yes, when people work together all sorts of failure modes ensue.

    • But where is the academic literature that puts all these things together and then tries to take stock and make sense of them together? Does it make sense attribute this all to random mistakes, or are there plausible systematic explanations of the whole pattern of mistakes?

      • riemannzeta

        I sort of had the impression that that was what New Institutional Economics was supposed to be about.

      • NIE is an approach to explain things. Thats not the same as putting all the puzzles in front of you on the table and what best explains them all together.

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