Thoughts on Spontaneous Order
comment from a troll Bryan Caplan entry, I find,
I’ve long since lost all patience with Hayek. His original, true ideas could have been five good blog posts
Personally, I think that the concept of spontaneous order takes more than five blog posts. The fact that Cato Unbound is devoting a whole issue to it is indicative. In it, John Hasnas writes,
constructed orders have a designated final decision maker; spontaneous orders do not. ..What makes the state the state is its power to stop evolution. In short, spontaneous orders are systems of individual choice. Constructed orders are systems in which there is an official organ of collective choice.
The question this raises is whether a designated final decision maker can defer to a spontaneous order. This relates to a difficult question from Robin Hanson, which is why would a small firm ever have a comparative advantage. If a firm happens to be large and complex, the CEO has the option of running the firm in a decentralized way. Instead, large firms are usually run in centralized fashion, with consequent disadvantages, or so it would seem. Some possible explanations:
1. CEO’s are biased to think that they can outperform decentralized decisions. Just as Progressives are biased to think that government can fix imperfect markets. Or just as people feel safer driving cars than taking planes, because they are in control when they drive cars. Or just as people believe that they can outperform market index funds by making “smart” stock market picks.
The advantage of this story is that it is quite plausible to believe that people, particularly people as egotistical as CEO’s, over-rate their competence. A disadvantage is that one has to explain why the market does not punish such overconfidence.
2. Firms are primarily status games, not profit-maximizing entities. Large firms give people an opportunity to compete for globally high status positions with a relatively low probability of achieving those positions. Small firms allow people to obtain locally high status positions with relatively high probability. People differ in their tastes for these games, as well as in their tastes for stability and security (large firms) vs. novelty, risk, and opportunity (small firms). Thus, both small and large firms can exist within the ecosystem. Presumably, large firms will tend to be found in industries where large firms have a comparative advantage. It is not in the interest of managers of large firms to try to run divisions in a way that replicates the behavior of small firms, because that would be throwing away their comparative advantage.
When I started at Freddie Mac in late 1986, the company was at that inflection point where it had passed the size of a small tribal entity. The CEO noticed and mourned the fact that it was attracting more people who were focused on job titles. This was a sign that as the company grew, the status game had shifted to something broader, in which formal titles held more meaning..
3. Risk issues.
If a big company decentralizes, there is no effective way to control the risk that an individual unit creates. Look at what happened to AIG as a result of its Financial Products unit. One can argue that AIG suffered from too little bureaucracy. A better-managed entity would have put some bureaucratic roadblocks in front of the folks who wrote all those credit default swaps.
Robin asks why a firm cannot simply give a division the same set of incentives that it would face if it were a separate entity Well, if Financial Products had been a separate entity, without AIG’s AAA rating to trade on, it would never have gotten started. Perhaps that is the right outcome. But one can also envision circumstances in which a division could have exploited AIG’s AAA rating without taking excessive risk, and in that case making decisions as if all entities have to be able to operate as if they were separate from the parent company would yield the wrong answer.