Organizations and Economics

Judge Posner (2010) identifies organizational economics with the principal-agent problem and offers no definition of the crucial term organization, which leads him to force the principal-agent template on social formations that are not organizations and to neglect aspects of their operation that might be illuminated by alternative conceptions of organizational economics. This response offers an explicit characterization of organizations as central planning agencies, considers Posner’s examples in light of the problems of purpose, information, and control faced by all central planners, and draws upon an emerging capabilities theory of organizations to extend the scope of Posner’s analysis and suggest insights beyond those that flow from the principal-agent approach. Judge Posner (2010) treats organizational economics as a synonym for the principal-agent problem, as if the only issue arising in the design and evaluation of organizations was aligning the incentives of subordinates with the interests of their superiors. His perceptive discussion of a variety of private and public institutions through the lens of principal and agent illustrates not just the analytical power of this approach, but its limitations as well. Posner never defines the term organization explicitly, which leads him to see organizations where there are none, and in forcing the principal-agent template on social formations that are not organizations, he neglects other important aspects of their operation and the insights that might be gained from alternative conceptions of organizational economics. More than 70 years ago, Ronald Coase and Friedrich Hayek, each in his own way, illuminated the contrasts between two kinds of social order, distinguished by the role in each of human purpose. Spontaneous orders, as Hayek called them, are created by the voluntary interaction of individuals in pursuit of their own purposes, constrained by rules of general application. Their hallmark is the sharp separation of individual purpose from systemic outcomes, epitomized by the process of efficient allocation that results, unintended by any buyer or seller, from their interaction in markets governed by the rule that every reallocation must be undertaken consensually. Especially when they are broadly beneficial to their participants, the intricate patterns of behavior and social institutions that emerge from these structured interactions often create the illusion of design, ∗Email: [email protected].