Organizations and markets

One cannot discuss organizations as coordinators of human action without referring to another powerful coordinating mechanism in modem societies: markets. In fact, the currently popular denigration of organizations is the obverse face to the acclamation of markets as the ideal mechanism for economic and social integration. The dissolution of the Soviet Union was widely hailed as a clear demonstration of the superiority of the market over centralized planning as a social organizer. Subsequent events have taught us that the matter is a good deal more complex than that. Markets do indeed seem to work, in modem industrial economies, more effectively than central plans. But as the Russian, and even our own, experience shows, markets only work effectively in the presence of a healthy infrastructure, and in particular, in an environment of effi-ciently managed business firms and other organizations. Markets complement organizations; they do not replace them.

Visitors from another planet might be surprised to hear our society described as a market economy. They might ask why we don’t call it an organizational economy. After all, they observe large agglomerations of people working in organizations. They encounter large business firms, public agencies, universities. They have learned that 80 percent or more of the people who work in an industrialized society work inside the skins of orga- nizations, most of them having very little direct contact, as employees, with markets. Consumers make frequent use of markets; most producers are embedded in large organizations. Our visitors might well suggest that, at the least, we should call our society an organization-and-market society.

In neoclassical economics, organizations are dealt with in “the theory of the firm.” But the business firm of economic theory is a pitifully skeletonized abstraction. It consists of little more than an “entrepreneur” who seeks to maximize the firm’s profits by selecting a manufacturing volume and price, and to do so, uses a production function (which relates outputs to inputs) and a cost function (which prices these outputs and inputs as a function of volume). The theory says nothing about the technology that underlies the firm’s production function, the motivations that govern the decisions of managers and employees, or the processes that lead to the maximizing decisions. In particular, it does not ask how the actors acquire the information required for these decisions, how they make the necessary calculations, or even, and this is the crux of the matter—whether they are capable of making the kinds of decisions postulated by utility-maximizing or profit-maximizing theory. The “entrepreneur” of economic theory makes static decisions in a fixed framework, bearing little resemblance to the active innovator who launches new enterprises and explores new paths.

Much of this book is devoted to filling out (and correcting) this impoverished description of organizations. Major attention will be given (beginning in Chapters IV and V) to the ways in which people actually make decisions, and how their decision-making processes are molded by limits on their knowledge and computational capabilities (bounded rationality). Other chapters (especially Chapters VI and IX) will seek to explain how the members of organizations are motivated to act in support of the organizations’ goals, and how they acquire organizational loyalties.

In recent years, there has been some attempt, under the label of the “new institutional economics,” to find a place in economic theory for real organizations. The key idea is to regard most organizational phenomena as contract. The new institutional economics tries to explain how organizations operate by analyzing the employment contract and other explicit or implied contracts that individuals have with organizations.

Although this approach represents an improvement over the skeleton it replaces, it also has grave limitations. In actual fact, all of us who are employees of organizations are governed in our actions not only by our immediate personal gain but (to an important extent) by an intent to con- tribute to the accomplishment of the goals of the organization. It is only possible for organizations to operate successfully if, for much of the time, most of their employees, when dealing with problems and making decisions, are thinking not just of their own personal goals but of the goals of the orga- nization. Whatever their ultimate motivations, organizational goals must bulk large in employees’ and managers’ thinking about what is to be done.

The new institutional economics tries to explain these motivations as produced by enforcement of the employment contract through authority and rewards for good performance. But it is well known that a system of sanctions and rewards can produce, by itself, only minimally productive performance. Hence a realistic theory of organizations must explain the other sources of motivation to advance organizational goals. Succeeding chapters will have a great deal to say about these motivational issues, and especially about the nature and psychological roots of organizational loyalty.

Source: Simon Herbert A. (1997), Administrative Behavior, Free Press; Subsequent edition.

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