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My pet theory of capitalism

November 19, 2011 Leave a comment Go to comments

[Thinking out loud, usual caveats on speculative reasoning etc. This line of thought was inspired by a Karl Smith post about a month ago, but I take a different angle here]

Something I have been thinking about recently is why it is the case that government is often so incompetent at delivering services. I don’t think it is fully explained by the profit motive in the private sector, but rather by a more general feature which I want to term ‘institutional decay’. I think that any institution geared towards providing a particular good/service, be it public or private, will tend towards incompetence over time.

The processes and systems of an institution are designed for various parts of production and delivery that are specific to the particular challenges at a particular point in time. I don’t see any reason why smart, creative and dedicated people in government can’t do this better than in the private sector. But the costs of designing and implementing such systems are significant and largely fixed. It is very difficult for an institution to change its systems unless it is under some kind of existential threat (e.g. bankruptcy), as people get used to working under the system and don’t want it to change, and the senior people who are responsible for the system take it as a kind of personal affront if the system isn’t the right one for the job anymore. Even if the system is initially designed very well, the evolving challenges of how to deliver the product/service successfully will eventually render it obsolete. This is just as true for an enormous private corporation as it is for an NHS hospital. In a competitive capitalist economy, innovative new systems and processes don’t have to jump over all the internal hurdles inside existing institutions in order to be implemented – you can start a new firm, or go to a smaller company with a plan for how they can better serve their customers. And if you are innovative and serve customers better, you will grow and challenge the incumbents.

The second reason I think this is that even if the challenges of delivering a particular product are stable over time, institutions will become sclerotic under the pressure of internal rent-seeking behaviour. A few months ago I read Mancur Olson’s superb book ‘The Rise and Decline of Nations’, in which he describes how under conditions of stability the political institutions of a nation will tend towards creating distributional factions that co-opt the political process towards producing private goods for particular factions rather than public goods which benefit all. It’s a follow-up to his extremely influential book ‘The Logic of Collective Action’, which is also on my ever-lengthening reading list. Anyway, the point is that there is no reason to think Olsonian rent-seeking and ensuing sclerosis is restricted to the public sphere. It can occur in any institutional setting with distributional features, and the logic of collective action applies just as much to departments within companies as to political lobbying groups.

So I think we have a kind of dilemma: existing institutions tend towards incompetence under conditions of changing consumer needs and challenges of production, and also under conditions of stability as distributional factions tend to solidify and lead to incompetent and fractious governance.

The difference with a competitive capitalist system is that the dynamics of institutional decay can be overcome through the creation of new institutions. And if you look through history at how those companies praised for their innovation and dynamism almost never fail to eventually fail, this view of the world looks quite plausible to me.

Categories: Economics
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  1. April 12, 2012 at 10:35 am

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