Modeling Management: Antecedent Analysis

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As has become clear over the past month, mainstream New Keynesian (NK) theorists do not even try to inform their research with a recognizable treatment of management. This post demonstrates their negligence cannot be the result of a lack of guidance from the literature. What follows summarizes three schools of economic theory that provide antecedent analysis for generalized-exchange modeling. That earlier work could have powerfully instructed NK thinking.

Neoclassical Revisionists. The generalization of rational exchange from the marketplace to information-challenged workplaces enriches our understanding of two fundamental classes of management profit-seeking behavior. With respect to internal organization of large, specialized establishments, the introduction of the Kerr, Dunlop, et al. tenet that employees strongly prefer fair treatment by management makes rational workplace exchange, simultaneously optimizing labor pricing and on-the-job behavior, consistent with the payment of nonmarket labor rents. As a result of structurally compromised OJB measurement costs, rational employer-employee interaction occurs in the context of continuous LEV workplace equilibrium that dominates labor-market equilibrium and accommodates wage rigidities and involuntary job loss, microfounding policy-relevant macro theory.

With respect to firm management of capital assets, the generalization of rational exchange deepens our understanding of hold-up problems that are inherently associated with firm-specific investments. In particular, in its modeling of intertemporal choice balancing job destruction and wage rents, the two-venue theory identifies a hold-up class that plays critical roles in optimal management behavior. Both production-capacity increases (via new capital investment) and decreases (via layoffs and job downsizing) are made consistent with continuous equilibrium, an important achievement for analysis rooted in optimization and equilibrium.

Herbert Simon’s Organization Theory.  Simon was a giant in the systematic analysis of behavior inside large, complex establishments. His Administrative Behavior (1947) emphasized managerial decision-making, shaped both by inherent uncertainty and heterogeneous interests of the various classes of stakeholders in the large enterprise. Putting useful content into Chandler’s new corporate forms that became dominant in twentieth-century economies, Simon argued that the objective of top corporate leadership becomes a division of residual rents that is acceptable to competing stakeholder interests, including but not limited to equity owners. In support of that thesis, Simon famously defined satisficing behavior, rooted in bounded rationality. (See also Cyert and March (1963).)

With respect to workplace equilibrium, satisficing can also be extended to worker OJB, describing the “realistic-assumption” case in which myopic expectations governs employee acceptance or rejection of management prognoses of job destruction. Simon would have been pleased with this application of his behavioral goal because employee-employer trust plays a central role. For the most part, however, stabilization-relevant TVGE modeling is surprisingly unburdened by myopia. Indeed, for most of what interests macroeconomists, two-venue macro modeling with its dominant workplace equilibrium and chronic variable market disequilibrium permits, with little loss of its capacity to explain relevant evidence, the use of the neoclassical method of optimizing, continuous-equilibrium exchange. Indeed, generalized exchange microfounds more powerful coherent macro modeling than variants motivated by satisficing.

Beyond satisficing, Simon importantly provided analytical roots for formal workplace-equilibrium analysis. He argued that “role-personification” cognitive mechanisms motivate employee loyalty, defined as the general acceptance of management goals, in work environments generally perceived to be equitable. Simon understood that fair treatment is a necessary condition of employee-employer trust and that the loyalty rooted in trust plays a crucial role in the enterprise’s prospects.

Simon (1951) defined a “zone of acceptance”, which he later summarized: “An employment contract contains all sorts of implicit (and explicit) limitations that set boundaries to the range of actions the employee will be directed to perform. These boundaries define the ‘zone of acceptance’ within which an employee can be expected to obey orders. The zone of acceptance is also sometimes called a ‘zone of indifference’, for the choice among alternative behaviors, while of major importance to the employer, may be of little or no concern to the employee.” (Simon, 1991, p. 31)  If work speed-ups push employees outside their indifference zones, latent preferences to shirk are activated.

More generally, Simon and his colleagues, in modeling organizations, did important empirical work on the administration of and decision-making in complex, large firms. That evidence supports the existence of substantial worker zones of independence. “In most organizations, employees contribute much more to [firm] goal achievement than the minimum that could be extracted from them by supervisory enforcement of the (vague) terms of the employment contract. Why do employees not substitute leisure for work more consistently than they do? Why do they often work so vigorously for the welfare of the organization?” (Simon, 1991, pp. 32-33) Simon, unlike NK theorists, asks the right questions.

Personnel Economics. Lazear and Shaw (2007, pp.91-92) provide an overview of the personnel-economics modeling of workplace behavior: “Four primary building blocks from economics form the foundation of personnel economics: First, personnel economics assumes that both the worker and the firm are rational maximizing agents, seeking utility and profits. Of course, the economic approach allows for constraints or imperfections, such as imperfect information and transaction costs, and permits an individual’s utility to be influenced by a variety of factors such as personal identity, competition, and peer pressure. Second, personnel economists assume that labor markets and product markets must reach some price-quantity equilibrium, which provides discipline for our models. Third, efficiency is a central concept of personnel economics. In many circumstances in which inefficiencies arise, the economists pushes the analysis to another level by asking where equilibrating market forces might have failed, and asking what actions firms and/or workers might take to reduce the inefficiency. Fourth, personnel economists emphasize the use of econometrics and experimental design to identify underlying causal relationships.”

Formal separate-venue workplace analysis (Annable (1977, 1980, 1984)) slightly predates Lazear’s work (Lazear, (1979); Lazear and Rosen, (1981)). Personnel economics generally emphasizes how the economic method can help elucidate and guide the choices facing human-resource managers, while the Workplace-Equilibrium Project focuses on how the optimizing workplace choices by employers and employees uniquely microfound policy-relevant  macro theory.

The most significant difference between the personnel-economics and GEM two-venue modeling is rooted in the second building block. Personnel economics is constructed on the assumption of dynamic general market equilibrium, which then provides workplace modeling its dominant equilibrium. Generalized exchange, by contrast, is more ambitious, constructing a separate (workplace) venue of optimizing decision rules, constraints, and mechanisms of exchange in which to better embed their models. The marketplace-workplace venue separation becomes fundamental with the demonstration that general workplace equilibrium dominates general marketplace equilibrium. Indicative of this difference, Lazear never cites Kerr, Dunlop, and the other middle-20th century labor economists who were the first to analyze large-establishment workplace behavior from a (literary) neoclassical economic perspective.

Blog Type: New Keynesians Saint Joseph, Michigan

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