On the Irrationality of Large Organizations
Mises, in Human Action, explained that the functionaries within planned economies could make even tangentially rational decisions about the value of factors and intermediate goods, only through implicit pricing: they relied on the market prices of goods in the pre-state socialist economy, or in countries in the outside world, as an imperfect reference point for their own valuation. But the further removed the reference point, in time or space, the less relevant it was as a guide to the real values of things immediately within the purview of the planner, and the more imperfect as a basis for valuation within the planned economy. Rothbard, in Man Economy and State, developed the idea further. The valuation problem did not stem from state versus private ownership, as such, but from the fact that there was only one owner. For that reason, a fully vertically integrated firm, or a single private cartel that owned the entire economy, would fall victim to the very same rational calculation problem as a centrally planned state socialist economy. The more steps in the production chain that are integrated vertically into one firm, the more the market price system is replaced by internal administration. But even the management of a vertically integrated corporation must have reference to implicit prices, based on market prices outside the corporation--just like the planners of a state-owned economy. And the larger the corporation, the larger the island of planning; and consequently, the further the planners are removed from explicit market prices and the more imperfect an approximation those market prices are to the actual valuation of goods within the firm. The larger the firm, the more it took on the internal characteristics of a planned economy and was subject to the calculation problem.
So the rational calculation problem isn't a purely qualitative threshold. It's a quantitative relationship that applies to all organizations, and increases with size. That isn't a problem in the free market, Rothbard argued, because the market sets maximum limits to feasible size. The firm will be unable to grow beyond the point at which increased economies of scale cease to offset the increased internal difficulties resulting from the calculation problem.
But we don't live in a free market. We live in a state capitalist economy where the state has cartelized most industries: by anti-competitive regulations; by subsidies to operating costs that render corporations artificially profitable at sizes far above maximum economy of scale; and by subsidies to capital- and skill- and R&D-intensiveness that artificially increase the minimum feasible size and otherwise raise entry barriers. We live in an economy, in short, where the average corporation has all the internal inefficiencies and irrationalities of a planned economy--but is able to survive because the taxpayers foot the bill for so many of the diseconomies of scale.
And the calculation of value is not the only problem besetting such large organizations. Another is the distortion of information flow within large organizations, described brilliantly by R.A. Wilson.
….in a rigid hierarchy, nobody questions orders that seem to come from above, and those at the very top are so isolated from the actual work situation that they never see what is going on below....
He described it as the "burden of nescience" confronting the "burden of omniscience":
Every authoritarian logogram divides society, as it divides the individual, into alienated halves. Those at the bottom suffer what I shall call the burden of nescience. The natural sensory activity of the biogram--what the person sees, hears, smells, tastes, feels...--is always irrelevant and immaterial. The authoritarian logogram, not the field of sensed experience, determines what is relevant and material…. The person acts, not on personal experience and the evaluations of the nervous system, but on the orders from above….
Those at the top of the authoritarian pyramid, however, suffer an equal and opposite burden of omniscience…. They must attempt to do the seeing, hearing, smelling, tasting, feeling and decision-making for the whole society.
But a man with a gun is told only that which people assume will not provoke him to pull the trigger. Since all authority and government are based on force, the master class, with its burden of omniscience, faces the servile class, with its burden of nescience, precisely as a highwayman faces his victim. Communication is possible only between equals. The master class never abstracts enough information from the servile class to know what is actually going on in the world where the actual productivity of society occurs…. The result can only be progressive disorientation among the rulers.
Or as Kenneth Boulding put it, large organizations tend to create false images in the minds of decision-makers, with those at the top of the hierarchy living in completely imaginary worlds.
Because of the cartelizing policies described above, because the cartelized sector is able to pass its taxes on to the consumer (those it actually pays, after disproportionate tax breaks to the largest and most capital-intensive firms), and because the competitive sector is taxed to subsidize the monopoly sector, the state capitalist "commanding heights" tend to crowd out all competing forms of bottom-up organization. As Paul Goodman described it in People or Personnel, even non-profits and cooperatives are infected with the pathologies of corporate-bureaucratic organizational culture: status-salared "professional" management, high overhead, mission statements, etc. This hegemonic form preempts all other models of bottom-up organization:
[The] genius of our centralized bureaucracies has been..., as they interlock, to form a mutually accrediting establishment of decision-makers, with common interests and a common style....
In brief, ...the inevitability of centralism will be self-proving. A system destroys its competitors by pre-empting the means and channels, and then proves that it is the only conceivable mode of operating.
The irrationality of large organizations stems from the fact that, for any human being to make optimally efficient decisions, he must internalize all the positive and negative effects of his decisions. In a large hierarchy, the consequences of the irrational and misinformed decisions of the parasites at the top are borne by the people at the bottom who are actually doing the work. And the actual producers, who know what's going on and experience the consequences of decisions made by others, have no direct control over the decision-making. The typical large organization, in fact, is so large that the transaction costs of tracking the positive and negative consequences of a decision and aggregating the data for the relevant decision maker are greater than the potential savings from any decision.
As a result, the organization must replace what Goodman called "intrinsic motivation" (direct experience of the consequences of one's actions, or gratification by the nature of the work itself) with "extrinsic motivation" (administrative incentives and penalties):
In my opinion, the salient cause of ineptitude in promotion and in all hiring practices is that, under centralized conditions, fewer and fewer know what is a good job of work. The appearance of competence may count for more than the reality, and it is a lifework to manufacture appearance or, more usually, to adapt to the common expectation. Just as there is reliance on extrinsic motives, there is heavy reliance on extrinsic earmarks of competence: testing, profiles, publications, hearsay among wives, flashy curricula vitae. Yet there is no alternative method of selection. In decentralized conditions, where a man knows what goes on and engages in the whole enterprise, an applicant can present a masterpiece for examination and he has functional peers who can decide whether they want him in the guild....
....What swells the costs in enterprises carried on in the interlocking centralized systems of society, whether commercial, official, or non-profit institutional, are all the factors of organization, procedure, and motivation that are not directly determined to the function and to the desire to perform it....
But when enterprises can be carried on autonomously by professionals, artists, and workmen intrinsically committed to the job, there are economies all along the line. People make do on means. They spend on value, not convention. They flexibly improvise procedures as opportunity presents and they step in in emergencies. They do not watch the clock. The available skills of each person are put to use. They eschew status and in a pinch accept subsistence wages. Administration and overhead are ad hoc. The task is likely to be seen in its essence rather than abstractly.
Ursula Leguin might have been thinking of Goodman's intrinsic and extrinsic motivation when writing this passage in The Dispossessed:
Atro had once explained to him how this was managed, how the sergeants could give the privates orders, how the lieutenants could give the privates and the sergeants orders, how the captains... and so on and so on up to the generals, who could give everyone else orders and need take them from none, except the commander in chief. Shevek had listened with incredulous disgust. "You call that organization?" he had inquired. "You even call it discipline? But it is neither. It is a coercive mechanism of extraordinary inefficiency--a kind of seventh-millennium steam engine! With such a rigid and fragile structure what could be done that was worth doing?" This had given Atro a chance to argue the worth of warfare as the breeder of courage and manliness and weeder-out of the unfit, but the very line of his argument had forced him to concede the effectiveness of guerrillas, organized from below, self-disciplined. "But that only works when the people think they're fighting for something of their own--you know, their homes, or some notion or other," the old man had said. Shevek had dropped the argument. He now continued it.... He explained to Atro that he now understood why the Army was organized as it was. It was indeed quite necessary. No rational form of organization would serve the purpose. He simply had not understood that the purpose was to enable men with machine guns to kill unarmed men and women easily and in great quantities when told to do so.
When the people doing the productive labor of the organization own it, identify with its goals, and internalize all the consequences of their decisions, it can be organized rationally on bottom-up principles. Under such circumstances, the productivity of labor skyrockets--just check out the results of worker self-management in Spain, described by Sam Dolgoff in The Anarchist Collectives. And the productive process will often be improved in all sorts of ingenious ways. The main source of productivity-enhancing innovation is not (despite what Schumpeter and Galbraith claimed) the "technostructure" or the R&D department of a giant corporation. As Barry Stein observed in Size, Efficiency, and Community Enterprise, most enhancements to productivity come from small changes to the process, or incremental improvements to the machinery, that are best identified by those engaged directly in the production process. And when they have the ability to make such changes directly, on their own authority, instead of submitting them to a "suggestion box" to be digested by six echelons of committees, the result is breathtaking flexibility and innovation. The producers' co-op is made to order for producing such an effect.
Unfortunately, such an organization is incompatible with milking workers of surplus product. Given a goal that has no intrinsic meaning to the people serving it, the organization must adopt exploitative methods. Leguin was right: under these circumstances, an authoritarian, top-down institution, based on command and central planning, is the only thing that will answer to the job.