Millennium Post

Bringing order

Analysing the importance of hierarchy and monitoring in addressing the Public Goods Dilemma

In the article in January 2020, I had discussed the role of Police Patrol and Fire Alarm oversight and in that context, I had linked issues of oversight with that of shirking and free riding. I had briefly touched on the concept of hierarchy relevant to this oversight as propounded by Ronald Coase, Alchian – Demsetz and Williamson. However, supervision and monitoring is a much broader area and I will expand on this in the following manner-

Discuss the various analytical frameworks related to hierarchy in more detail,

Apply these to our problems of Public Goods Dilemmas. More specifically, what type of organisational structure would be best suited to different public goods dilemmas.

Analytical Frameworks

Hierarchy: Discussion in Economics and Political Science

One such framework is the literature on hierarchy. There are two distinct views in this literature. One, where management designs an incentive system of rewards and punishments which motivates the employees to work towards organisational goals. The Principal-Agent theory is reflective of this approach. Coase's theory referred to above is also squarely a part of this approach. We may recall that Coase had propounded that firms exist to internalise the transaction costs of operating in the market. In other words, the entrepreneur replaces the price mechanism for coordinating production within the firm.

Alchian Demsetz's approach also belongs here, though they differ with Coase in that they saw a firm as a set of voluntary contracts rather than a Principal-Agent relationship. Williamson's analysis also places a great deal of importance on hierarchy just as Coase did. His analysis, like Coase's, took transaction as a unit of analysis. He had concluded that a hierarchy is better placed than markets to perform the coordination mechanism.

The other approach to hierarchy emphasises the leadership role of the management. It highlights the Manager's job as one of motivating and inspiring others beyond what incentives can do. Here, the emphasis is on leadership which can bring about cooperation in hierarchies. This approach is found more in political science discussions than in the economics of organisation.

Political Economists such as Gary Miller have synthesised these approaches and argued that while hierarchy is important, it is because of market failures. Market failure, in turn, is caused by externalities (Alchian – Demsetz), information asymmetry (Williamsons, Akerlof) and monopolies (Alchian – Demsetz). When markets fail, individuals' interest diverges from collective or social interest and results in Public Goods Dilemma situations with an inefficient Nash equilibrium and sub-optimal outcomes. Hence, the importance of supervision and monitoring in organisations or even small administrative settings cannot be overstated.

Contractual v/s Behavioural approach

Terry Moe in a paper titled "New Economics of Organisation" written in 1984 distinguished between contractual and behavioural approach to the analysis of organisations. The contractual paradigm which is the current paradigm in the economics of organisation owes its ancestry to Ronald Coase. The other contributions in this paradigm are Alchian – Demsetz, Williamsons, Akerlof, etc., as noted above. On the other hand, the behavioural paradigm owes its ancestry to Herbert Simon. We may recall that Simon challenged the rational choice theory by stating that individuals did not have the wherewithal to imagine all the outcomes and then rank them in order to their preference. Instead, he proposed that individuals have bounded rationality since they have limited information and knowledge as well as competitive skills. Since individuals are boundedly rational, they will behave accordingly in organisations as well as and routinise their actions based on their superiors' directions. The work of Simon was taken forwarded by Cyert and March whose book "A Behavioural Theory of the firm" in 1963 moved away from the neoclassical model of the firm. This theory emphasised concepts such as adaptive learning, programme behaviour, etc., rather than profit maximisation, transaction costs, information asymmetry etc.

It may be noted that the research on supervision and monitoring in various organisational setups, in both Economics and Political Science, has diverged from the original neoclassical model. We all know that the neoclassical model makes assumptions such as perfect information, infinite number of firms, free entry and exit of firms, zero transaction costs, etc. There is no role for organisations, the Government or the public bureaucracy. On the other hand, has not given enough importance to issues such as hierarchy and public bureaucracy. Research in political science has focused on issues such as voting, social choice, leadership, etc., but

What is the way out? Application to various Public Goods Dilemmas

From the above discussion, it appears that any Government would have the following broad options while designing an organisational structure to supply public goods.

Category 1: Creating a hierarchical public bureaucracy within the government/firm.

Category 2: Outsource the job to another private agency while keeping the supervision and monitoring functions with itself.

Category 3: Create non-hierarchical voluntary contracts for various equal and horizontal units to sign up.

In the first category would be public goods such as law and order or national defence, where it may be best to operate within the government hierarchy. Typically these public goods and their outcomes would be difficult to measure. Further, a hierarchy would be better placed to overcome coordination problems as opposed to a market mechanism.

In the second category would be public goods such as highway construction, water supply, electricity supply or garbage collection where the outcomes are easy to measure. Not only that, it will bring forth more efficient outcomes as a result of competition amongst various private agencies who supply the public good. However, the supervision/monitoring role would be performed by the government/firm.

In the third category would be public goods like inter-State water-sharing arrangements or international agreements such as controlling fisheries in oceans, regulating world trade etc.

Revisiting the International and Domestic Arenas

Recall that we had discussed the public goods dilemma in the international arena in the areas of world trade, climate change and financial crisis. In such a situation, it would be best for any organisation tasked with the supply of global public goods to have a series of non-hierarchical voluntary contracts. This is precisely what happened with the setting up of multi-lateral agencies such as the WTO, UNFCC and G20.

Similarly, if we recall, we had looked at air pollution, water pollution and deforestation in the domestic arena. In the case of air pollution, one can measure the extent of the outcome (through PM 2.5 and PM 10 levels in the air) and hence the category two stated above would be best placed to supply the public goods. However, in the case of water, while some aspects can be measured (for example the biological load of the water), other aspects require a lot of coordination amongst various agencies. Hence, a hybrid of category two and three discussed above would be best placed to overcome such situations. Lastly, in the case of forest conservation, there is already a hierarchical structure in place running forest schemes viz., forest bureaucracy. However, with the Joint Forest Management Programme, elements of category two were also introduced with the creation of Forest Protection Committee, which was tasked with various functions such as use, monitoring and rejuvenating the forests.

Another way out of the supervision/monitoring dilemmas is bargaining between individuals or actors. This is a voluntary non-hierarchical contract between equal players and can resolve public dilemmas. In these cases, coordinated action is achieved by contracting between equal members rather than by hierarchical authority.

This takes us back to Axelrod's "Evolution of Cooperation", where actors coordinate their actions to come to optimal solutions. Recall that a cooperative outcome results when there are iterated Prisoners' Dilemma situations where actors have to repeatedly interact with each other. Rather than a sub-optimal outcome which results in one shot Prisoners' Dilemma Game, in repeated iteration, cooperation evolves between actors.

Dr. Krishna Gupta is the Principal Resident Commissioner, Government of West Bengal. Views expressed are strictly personal

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