Knowledge and Decisions by Thomas Sowell / Знание и Решения от Томъс Соуел: Chapter 2 - Decision -Making processes

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Chapter 2


Decision-Making processes


Despite the fashionable practice of personifying "society" as a decider and actor, decision making in the real world can be understood only in the context of the actual decision-making units that exist, and the specific, respective sets of constraints and incentives within which each operates. These various decision-making units and processes are highly diverse, and have equally diverse implications. The persistence through the centuries of very different decision-making relationships, institutionally coexisting within even the most monolithic societies, suggests that there may be substantial advantages and disadvantages to each form of human organization, and that these vary with respect to different activities and decisions. Constitutionalism and pluralism in effect acknowledge and underscore this conclusion.


One of the basic distinctions among human relationships is between informal voluntary relationships, terminable at no cost beyond the loss of the relationship itself, and relationships enforced by designated institutions which can impose substantial penalties, which may range from breach-of-contract suits by a private business to execution for military desertion in wartime. The difference here is not in the seriousness or severity of the loss due to termination of a relationship. The distinction is in whether the loss is a contrived penalty to enforce the terms of the relationship, rather than a loss inherent in the loss of the relationship itself. Lovers are perhaps a classic example of an informal voluntary relationship-the loss of which may be far more devastat ing than, say, breaking a landlord-tenant lease agreement. Yet the landlordtenant lease agreement is no longer a voluntary arrangement after it has been signed, just as the relationship between lovers is no longer wholly voluntary once they are married.


Informal relationships need not be so direct as that between lovers. Language is a whole set of intricate relationships, evolved rather than designed, and its "rules" are obeyed without the necessity of any organizational entity capable of imposing penalties for disobedience. For students there may be grade penalties for improper use of the language, and social disapproval might be another penalty for others, but these are mild, incidental, and perhaps ineffective deterrents-certainly as compared to the staggering costs of substantially disregarding the rules of language. Anyone who was either incapable of understanding those rules, or perversely oblivious to them, would find himself in a two-way incomprehensibility with virtually everyone. Again, what is involved is a voluntary relationship, terminable at no cost beyond the loss of the benefits of the relationship itself, though that loss may be very large.


By contrast, organized institutional relationships carry contrived rewards and penalties as compensations for following or not following the terms of the relationship and the desires of the people involved in it. Economic organizations provide goods or services in exchange for money, political organizations provide their services in exchange for votes, and administrative organizations (government bureaucracies, private "non-profit" organizations, etc.) carry out their functions in exchange for such organizational rewards as prestige and such individual rewards as pay, power, and perquisites. It is not that these incentive mechanisms define what is economic, political, or administrative. Rather, they define what is organizational rather than informal or spontaneous. Within the category of organizations, there are then economic, political, and other subdivisions. Moreover, there are also informal (nonorganizational economic, political, etc.) activities, though these will not be a major focus here.


None of these categories is hermetically sealed or represents a mutually exclusive entity in any rigorous sense. All that is necessary here is to recognize a spectrum of human relationships, ranging from the most voluntary and informal (lovers) to the most organizationally structured and determined (a military draftee in combat). Different regions of this spectrum can then be discussed under different names, implicitly recognizing that these discontinuous designations apply in the real world to continuously varying complexes of characteristics. For example, a family may be regarded as an informal, voluntary relationship, because its cohesion and functioning are due primarily to incentives intrinsic to the relationship itself rather than organizational ly contrived, though these contrived incentives also enter, as in family law. The family also underscores the point that "informal" or "voluntary" does not necessarily imply weaker incentives. Family incentives are in fact so powerful as to cause defiance of severe legal penalties, and the law itself tacitly recognizes this-as, for example, in not attempting to force spouses to testify against one another. Other organizational entities likewise recognize that their formal incentives are weaker than informal family incentives. Anti-nepotism hiring rules are a common form of this recognition.


Comparisons of different kinds of human decision-making relationships and processes are to some extent comparisons of different kinds of decisions as well. If this ex post fact implied an ex ante unique relationship between kinds of decisions and kinds of decision-making processes, it would be both logically impossible and socially pointless to try to compare various relationships or institutions as decision-making mechanisms. The discussion that follows not only postulates in a theoretical sense, but assumes as a matter of fact, that given decisions can be made by any of a number of institutions. In this context, the empirical fact that families do not usually make decisions about fighting a war, and bureaucratic organizations typically do not decide matters of love, are merely things to be explained in terms of institutions' respective decision-making advantages. Under some circumstances, families have in fact made decisions about wars (vendettas, dynastic wars) and computer organizations have at least claimed to be able to make love matches. In short, the discussion proceeds on the premise that the institutional locus of particular decisions is not a constant but a variable, and concludes that it is a crucial variable from the standpoint of the well-being of society.




Among the advantages of informal relationships as decision-making entities is their low cost of decision making in terms of the time required for deciding, the cost of the requisite knowledge, and the ability to "fine tune" the decision to the problem or prospect at hand.


By the cost of a decision is meant the cost of the process of deciding, rather than the costs entailed by the decision itself. For inter-institutional cost comparisons of decision making to be meaningful, such comparisons must be made holding constant the "quality" (however defined) of the decision. This neither postulates as a matter of theory nor assumes as a matter of fact that institutions are equally good at deciding the same things. It merely says that inter-institutional differences in decision-making effectiveness may be equally well expressed as cost differences in producing given quality decisions or as quality differences at given costs. By expressing inter-institutional differences in terms of the cost of a given quality of decisions, the discussion avoids getting bogged clown in the complexities of weighing the respective advantages and disadvantages of different decisions themselves, and can focus on the cost of the process of achieving a given probability of satisfying a given set of values to a given extent.


Because informal decision making is not subject to such organizational requirements as written justifications, varying protocol observances vis-a-vis superiors, peers, and subordinates or the more stringent "due process" requirements found in legal organizations, the process of deciding tends to be less costly. A distinguished economist once observed that Lindbergh's flying across the Atlantic alone was less of a feat than if he had flown across the Atlantic with a committee.' Much of the cost of formal decision making is not a current outlay (in either financial or psychic terms) for the current decision, but rather an investment (again, in either financial or psychic terms) in "insurance" to protect oneself from future costs in terms of personal or business relationships with the other parties to the decision. Avoiding abrasiveness of manner, verbal misunderstandings, rnispercept ions of intentions, status threats, and the like, are costly. They are obviously costly in time and tension to the individual. They are costly in more directly tangible financial terms to an organization, which must screen its potential decision makers for their ability to meet these requirements, in addition to the intellectual qualifications for achieving a given quality of decisions. Obviously, as the list of requirements lengthens, the suitably qualified supply of people declines, and the pay required to hire them in competition with other organizations increases. These financial phenomena of institutions are essentially outward manifestations of the underlying psychic costs to individuals.


Informal decision making avoids much (though not all) of these "insurance" costs because less "insurance" is needed. In the extreme case, an individual makes a wholly private decision recognized by all to be legitimately within his arbitrary discretion (an individual watching television alone, a bachelor buying food for himself, etc.), and so he need not take any additional action to insure against adverse reactions from others. More commonly, the other parties to the informal decision-making process are already sufficiently familiar with one another, and have formed sufficiently settled opinions of one another, that "insurance" actions and processes are both less necessary and less effective.


In a sense, this conclusion merely pushes the question back in time rather than answers it. It says that informal relationships may involve lower current costs because of past investments in mutual familiarization. This in itself says nothing about total costs over the relevant time span. These total costs tend to be lower in informal relationships because the voluntary interactions that lead to familiarity are often pleasurable on net balance, or the interaction would not be chosen and sustained. For friends, kin, or lovers to acquire a given level of familiarity, sufficient to reduce mutual "insurance" costs by a given amount, is likely to cost less than for a detective agency, a credit bureau or an investigative reporter to acquire an equal amount of personal information. The simple fact that the latter groups must be paid salaries to ferret out information suggests that the pleasure of familiarizing themselves with the subject is insufficient to compensate the effort.


The lower information cost of informal relationships can be illustrated by the financing of small, single-proprietor businesses. Here, the crucial variable in determining the prospects of success of a given business of this sort is the character, ability, perseverance, and other personal attributes of the wouldbe owner-operator. Banks seldom finance the establishment of such businesses, which are typically financed by the individual himself, and/or his friends, family or neighbors-i.e., all people with lower costs of acquiring the necessary information. It is not literally impossible for a bank or other organization to acquire equivalent information, but the cost of doing so would be far higher. A financial institution could not simply ask those familiar with the prospective owner-operator for an assessment of him, for they would have insufficient personal stake in the accuracy of the assessment to make it reliable, and their probable bias in his favor would not be offset by a bias in favor of safeguarding their own money. More effective methods of acquiring retrospective personal information about investment applicants-or information in advance about the pool of people from whom prospective investment applicants are likely to come-would involve methods (such as electronic listening devices) whose illegality would greatly increase their cost. The acquisition of the same information through informal relationships is of course not illegal, and is therefore less costly for this reason as well as because of the lower psychic costs of interaction among self-selected people.


Some organizations are able to tap information produced by informal relationships. Employers who hire new employees by word-of-mouth referrals from existing employees get around the problem confronting banks-namely, that those with the most relevant information have insufficient stake in the accurate communication of that knowledge. Employees who value their own future relationship with the employer will not want to recommend someone else who is likely to be a substandard employee. Reliance on such information, even by employers with personnel departments and the supposedly "scientific" selection procedures at their disposal, implies at least some areas in which the organization implicitly recognizes its cost disadvantages vis-a-vis informal relationships.


"Old boy" networks among professional colleagues with stakes in good future relationships with one another are likewise informal sources of knowledge that would be prohibitively expensive for an organization to acquire through purely organizational methods, especially in professions where the relevant characteristics are highly personal-temperament, drive, imagination, intellectual discipline-and therefore cannot be objectively specified or definitively measured by such formal devices as university degrees. Recurrent complaints of "chaotic" referral and hiring methods in such professions ignore this cost advantage of informal relationships. That this advantage can be of major proportions is attested to by (1) the persistence of such referral methods despite repeated attempts at internal reform' or even externally imposed legal requirements, as under "affirmative action,"3 (2) the dissatisfaction reported by both employers and employees using alternative and more "objective" or "rational" procedures,' and (3) the willingness of employing organizations to pay the price of constricting their own options by limiting their employee choices to those other organizations in which they have sufficiently good informal information sources, thereby balkanizing a market that might easily be many times larger.'


Observers' intellectual disdain and/or moral condemnation for practices which utilize the cost advantages of informal relationships often proceed on the implicit assumption that knowledge is either economically free or theoretically "given" in some cohesive block equally accessible to all. In reality, knowledge can be enormously costly, and is often widely scattered in uneven fragments, too small to be individually usable in decision making. The communication and coordination of these scattered fragments of knowledge is one of the basic problems-perhaps the basic problem-of any society, as well as of its constituent institutions and relationships.'


Informal relationships are not only able to acquire much knowledge at lower cost than formal organizations in some cases, but are generally able to apply it in a more specific or "fine tuned" fashion in making decisions. Among the reasons are that informal decision making is more likely than formal procedures to be incremental rather than categorical, individualized rather than "package deals," and episodic rather than precedential.


Because informal relationships are, by definition, relatively freer of rules than are formal organizations, the former can more readily determine to what extent to do something-whether consumption of a good, work at an occupation, or involvement with another person-rather than simply whether to do it or not. Thus, for example, personal relationships have many subtle gradations from formality to intimacy, as compared to official relationships among members of an organizational hierarchy-relationships which tend to have fewer gradations and fewer nuances in the relationships between any two official positions (except insofar as these are modified by informal relationships among incumbents). A "foolish consistency" is less often necessary in informal relationships. The youngest child in a family may be a privileged character with respect to one set of rules (decorum, errors) and yet more strongly controlled than his older siblings with respect to others (safety, money). Even in cultures normally thought of as male-dominated, there are substantial areas of family decision making where a husband would seldom dream of questioning his wife's decisions, even though such decisions may include budgeting the bulk of his income.' The specialization benefits of such reciprocal or interchangeable subordination are sacrificed in a neatly hierarchical organization, where a vice-president outranks a janitor for all purposes-again, except insofar as incumbents may choose to behave otherwise so as to appropriate some of the advantages of informal relationships in a formal organization.


The lengths to which this can be carried in practice may be illustrated by the fact that even under the extreme hierarchic subordination of slavery, there were often skilled, experienced or trusted slaves whose judgments on major economic decisions were relied on by slaveowners to a greater extent than the judgments of the white overseer8-so much so that a disaffected coalition of such slaves could cost on overseer his job.9 The slaveowner's overriding interest in the economic efficiency of his enterprise was thus sufficient to cause him to violate both the principle of hierarchical subordination and the prevailing racial ideology, in order to appropriate the gains arising from the advantages of informal relationships.


Decisions made through informal relationships can be more readily individualized than in an organization bound by its own rules. A child who is ill, grieving or otherwise temporarily impaired in whatever way, can be given special attention and exemptions from normal requirements incrementallyto precisely the extent, for just so long, and for only those activities to which his special needs require, in the judgments of his parents or siblings. He can be "special" for some purposes but not for others, for to be too special would impair his own personal relationships with others, as well as the general life of the family. Formal organizations have parallel attempts to allow for illness or injury, for example, but its benefits are generally available to people who fall within categories verbally described in advance, rather than according to an ex post judgment of the overall nature and severity of their individual disability. Thus, for example, a worker suffering a minor injury of a sort described in the rules may receive a windfall gain, while another worker psychologically devastated by the ending of a love affair is expected to continue carrying out all duties as if nothing had happened. Here it is not a question of a misjudgment by management-which would be paralleled by similar parental misjudgments-but of the inherent anomalies of hierarchical organizations. Again, in some instances incumbent officials may choose to somehow modify organizational rules in order to obtain the gains of informal relationships but this modification is not inherent in hierarchical organization, is in fact in conflict with it, and consequently its scope is likely to be more severely limited the more hierarchical the organization. Soldiers in combat are not given time off after receiving "Dear John" letters.


Informal decision making thus allows a fungibility of highly disparate factors in terms of their net effects, viewed retrospectively. The proverbial "advantage of hindsight" can be utilized by informal processes. But formal organizational decision making tends toward a prospective categorical specification of factors to be taken into account in specific, programmed ways. Each has its advantages and disadvantages. The advantages of informal relationships tend to be greatest in decisions which turn on individual personal or circumstantial differences of a sort which cannot be explicitly or exhaustively specified in advance, which may result from too wide and varied an assortment of influences to list in advance, or even to convey in any logically compelling way after the fact, and which require a large amount of highly individual information at low cost.


Informal relationships permit decisions to be individualized in another sense as well. Each decision can be considered in relative isolation rather than as part of a take-it-or-leave-it "package deal." A series of love affairs can be varied as to personality types, duration, intimacy, or intensity, but at the other end of this spectrum marriage in a no-divorce system with powerful sanctions against extra marital affairs-it is a "package deal" with respect to time and with respect to the whole set of personal characteristics of the partner. If one has had enough-temporarily or permanently-of the sensitive introspective type, or the flighty madcap type, one can look for other qualities in subsequent partners, but if one relationship is going to be permanent, an entirely different set of characteristics may be preferable within that constraint. The same principle applies to less personal decisions. Driving a car between two cities is a continuously reviewable, variable or even can- cellable decision. Taking an airplane between the same two cities is a "package deal." Once the plane is airborne, the passenger's second thoughts about alternative destinations, side trips, companions who would add to the pleasure of the journey, optimal arrival time, or whether the trip was a bad idea in the first place, have no effect on the flight, unless he is prepared to incur the cost of hijacking the aircraft. No small part of the appeal of the automobile, which social critics are quick to attribute to irrational drives, derives from its incremental and continuously reviewable decision-making potential-which is curtailed to varying degrees by alternative transportation modes.


In economic transactions, package deals are often vulnerable. The Ford Motor Company's loss of its early supremacy in the automobile industry to General Motors turned on its insistence on offering the famous Model T as a "package deal," involving not only a given mechanism but also an unchanging body style and a single color (black), whereas General Motors supplied cars in a variety of annually changing models and in virtually every color of the rainbow. For a producer to offer a package deal is to gamble that he is correct simultaneously in his assessment of the acceptability to the consumer of all of the elements in the package. Even a small "package" presents serious problems in this regard. If the producer's chances of being right on each of three variables is 75 percent for each variable, his chances of being right on the whole package are less than half (27 out of 64).10 The variety of models of many products is one response to the hazards of trying to guess what specific combination of characteristics will appeal to the consumer. The inability of the producer to know precisely what the consumer wants is a basic fact of life under any economic system. Different varieties of the same basic product are one way of dealing with this inescapable fact, and not an arbitrarily imposed "waste" as sometimes claimed. The consumer can be presented with a single take-it-or-leave-it "package" only under some form of monopoly, private or governmental.


Informal decision-making processes permit individualized decisions in another sense as well. Decisions are not as likely to become precedents constraining future decisions. Choosing cereal for breakfast today does not prejudice one's option to choose eggs tomorrow or to skip breakfast entirely the next day. The variability and reversibility of informal decisions not only allows corrections of past judgments and adaptations to current desire for variety; it allows future planning to take place at lower cost. The more adaptability exists for a given kind of decision, the less risky it is to make plans for the future, and therefore the more likely it is that more people will make more plans in such areas. Dates are more likely to be made in cultures where this implies little beyond a short-run commitment to be at a certain place at a certain time, than in cultures where overt expressions of interest in an indi vidual of the opposite sex, or subsequent displays of affection toward such individuals imply matrimonial intentions-and where failure to follow through brings social ostracism or even risk to life and limb. Foreign investments are more likely to be made in a country where the proceeds can be withdrawn at will in convertible currency than in a country where legal barriers make this impossible or political barriers make it costly. Similarly, the existence of such instruments of future decision variability and reversibility (i.e., nonprece- dence) as brakes and steering wheels is all that makes most people willing to ride in automobiles at highway speeds. Liquidity of assets and the existence of options markets serve similar functions in the economic sphere.


The prices paid for things which modify or nullify the precedential element of decision making is a tangible indicator of the value of nonpreceden- tial processes. The extra costs involved in options markets, and the foregone earnings on more liquid assets are fairly obvious costs. In the case of an automobile, the unwillingness to be bound by past decisions as to direction and velocity is reflected in the cost of brake systems and steering systems. A less tangible but no less real cost is paid by those who forego or curtail social interaction with the opposite sex in cultures where this becomes precedential. Another way of looking at all these things is that the huge costs paid to get out of precedents implies an even higher cost of being bound by these precedents.


Informal relationships are not mere minor interstitial supplements to the major institutions of society. These informal relationships not only include important decision-making processes, such as the family, but also produce much of the background social capital without which the other major institutions of society could not function nearly as effectively as they do. Language has already been mentioned as an informally produced system. Morality is another major item of background social capital, without which the cost of operating everything from credit cards to courts of law would be far more expensive-perhaps prohibitively so. The same could be said for hygiene, civility, and other informally transmitted characteristics without which many (or all) formal organizations would incur huge costs of operation, if they could operate at all.


Informal relationships or decision-making processes are not categorically superior to more formal relationships or processes. Lovers do get married. People not only rent, but lease and buy. Astronauts go up in rockets with neither brakes nor steering wheels. Clearly there must be some offsetting benefits in more structured relationships and precedential decisions-or rather, benefits peculiar to such relationships, which may in any given instance be greater than, equal to, or less than, the benefits of informal decision-making processes.




Among the many variables impinging on one's happiness and well-being, some require relatively frequent adjustments while others do not, and some derive much of their value precisely from their constancy. Obviously, formal organizations would not exist if informal relationships met all human needs.


The apportionment of decision making as between informal and formal processes involves a trade-off of flexibility for security. A's flexibility is B's uncertainty as to what A will do. The cost to B of this uncertainty cannot be measured in terms of A's most likely prospective action nor in terms of A's retrospectively observed action. The cost of uncertainty to B is the cost of preparing for a range of possibilities of A's behavior. Depending upon the cost of these precautions to B and the value of flexibility to A, it may be possible for both sides to become better off by signing a contract awarding money to A for agreeing in advance to follow a given course (or restricted range of courses) of conduct. In short, a more rigidified process may be made preferable to both sides. Total risk can be reduced in some cases by rigidity, just as it is reduced in other cases by flexibility.


In many cases a much broader kind of rigid agreement may be in order. Society itself may need to guarantee that certain relationships will remain rigid and inviolate in all but the most extraordinary circumstances. Much socially beneficial prospective action will not take place, or will not take place to the same extent, without rigid guarantees. The heavy investment of emotion, time, and resources necessary to raise a child would be less likely in a society where the child might at any moment, for any capricious reason, be taken away and never seen again. Such behavior is rejected not only for its retrospective injustice but also for its prospective effect on parental behavior. Not only will the state forebear from such behavior; it will use severe sanctions against private individuals who do such things (kidnappers). This rigid legal framework of parent-child relationships provides the protective setting within which the most flexible kinds of parent-child social relationships may develop. Formal and informal processes are not mutually exclusive but mutually supporting.


Similar considerations apply across a spectrum of other social arrangements, particularly those involving long and large individual investments of efforts for prospective personal and social benefits. Property rights introduce rigidities into the use of vast amounts of many resources-by excluding all but the legal owner(s) from a serious voice in most of the decisions made about the disposition of the resources-on the assumption that such losses as are occasioned by this rigidity are more than offset by the gains in prospective behavior by people acting under these guarantees.


Someone who is going to work for many years to have his own home wants some fairly rigid assurance that the house will in fact belong to him-that he cannot be dispossessed by someone who is physically stronger, better armed, or more ruthless, or who is deemed more "worthy" by political authorities. Rigid assurances are needed that changing fashions, mores, and power relationships will not suddenly deprive him of his property, his children, or his life. Informal relationships which flourish in a society do so within the protection of formal laws on property ownership, kidnapping, murder, and other basic matters on which people want rigidity rather than continuously negotiable or modifiable relationships.


Formalized and rigidified decision-making processes (or frameworks for processes) are not only social investments in certain behavior patterns; they are direct consumer goods as well. Peace of mind and a sense of independence and dignity are immediate psychic dividends from operating under known rules, applicable to all, rather than being personally assessed and controlled by other individuals. Informal decision-making processes flourish only where such assessment and control are in the hands of those biased in favor of the individual concerned-e.g., family, friends, and lovers. Similar informal processes in the hands of strangers might be intolerable. In short, the comparison is not solely between two different kinds of institutional processes-formal vs. informal-but between two different kinds of processes engaged in by two different kinds of people.




Economic decisions may be made through informal processes or through structured organizations. If the lawn needs mowing, the homeowner may do it himself, tell his son to do it, pay his son to do it, pay another individual to do it, or contract with a lawn-care firm to do it. Similarly he may grow his own vegetables, buy them from a local farmer, or from a store, or buy them already prepared at a restaurant. The theoretical spectrum, ranging from the most informal to the most formal decision-making processes, is far greater than is likely to be encountered in the real world. Why this is so is worth analyzing in order to understand the peculiar advantages and disadvantages of more formal and less formal economic processes.


Theoretically, the various components which typically make up a product could all be bought separately and assembled either by the consumer or by other persons hired by him to perform that service on a one-time basis as needed-the way he hires a plumber or electrician when he needs their services. There is no inherent need for a firm to exist to sell him a finished product. By the same token, there is no need for workers to be employed by such a firm. Theoretically, they could sell their services directly to those who want them, as plumbers, doctors, and shoe shine boys ordinarily do.


For some products and to some extent, there is much consumer assembly of finished products. Stereo systems often contain amplifiers, speakers, turntables and tape decks, each made by a different manufacturer and assembled with knowledge purchased from the publisher of a do-it-yourself book. A whole pre-assembled stereo system may also be purchased at most department stores. A similar range exists among cameras. The view camera used by professional photographers is usually sold as a camera body with no lens or shutter, and with nothing to hold the film. All these essential components are typically available in a wide variety of types and brands, all of which are to be assembled by the photographer into a functioning camera. At the other end of the spectrum is the "Instamatic" camera with all these components preselected, preassembled, and preset for a specific focusing distance, lens opening and shutter speed selected by the manufacturer, who is in effect selling a "package" that includes not only physical items but also the application of elementary knowledge of picture taking settings.


From this it is clear that one reason for the existence of a business firm is to economize on the production or application of knowledge. Any user of an "Instamatic" camera could acquire as much knowledge as is used in presetting the lens and shutter by purchasing an elementary book on photography and investing a few hours in reading it. Since the consumer sees people all around him with adjustable cameras, he knows that it is neither impossible nor probably very difficult to acquire such knowledge. His is therefore an informed choice to purchase the knowledge from the camera manufacturer, rather than produce this knowledge himself from a book. This is a perfectly rational choice where the camera firm can produce the quantity of knowledge needed (for casual snapshots) at a lower cost than the consumer. From the point of view of society at large, fewer resources are used to produce a given product or to achieve a given end result.


One of the reasons the firm has lower costs than the consumer would have is that it engages in fewer transactions in proportion to its volume of output. A consumer who wished to hire a photographic expert to tell him at what distance to focus his lens would have to determine the likely sources of such experts and the means of determining their expertise, as well as not buying more expertise than he needed, and other such problems. The cost of hiring the expert, spread over one or two cameras would be much higher per camera (or per picture) than when a camera manufacturer hires experts to guide its decisions on thousands of cameras. Similar considerations apply to the hiring of many kinds of workers (including management) and to the hire or purchase of specialized equipment.


In the theoretical extreme, each worker could hire various fractions of his time to various employers, as some workers do in practice to some extent. But theoretically the worker would be ready to sell the tiniest fraction of his time to different employers or to change employers at any given instant of the working day when the fluctuations of the labor market might offer a marginally higher wage rate somewhere else. Such behavior would, of course, involve very high transactions costs to the worker-and to the employer, who would have to be constantly prepared to fill vacancies at a moment's notice. Contractual and semicontractual arrangements, including "adequate notice" customs, reduce these transactions costs, at the cost of reduced institutional flexibility in the quantity and quality of labor employed, and in the quantity and quality of work obtainable from given workers in a situation where "instant firing" is often not a feasible option. That many firms voluntarily chose to accept such costs of institutional rigidity implied in having "regular employees"-even before union or legal pressures for job security-suggests that transactions costs would be substantial otherwise. That other firms had to wait for such outside pressures suggests that the relative weights of those costs and benefits vary from situation to situation.


As in the general question of the relative advantages of formal versus informal procedures, the point here is not to determine which is better categorically. On the contrary, the point is to suggest why there is a trade-off. The particular terms of that trade-off, and the way those terms vary incrementally, is likely to be far better known to those directly involved than to others operating on general principles.


Even after acquiring the formal institutional structures implied where firms sell to consumers, economic processes still retain substantial elements of incremental rather than categorical decision making. The consumer, by choosing among firms to patronize, implicitly weighs the effectiveness of different sets of workers and managers, rewarding some with fuller, more sustained employment, and forcing others to work less or not at all-despite any institutional guarantees-for lack of consumer demand can force the institution itself out of business. Even where the consumer chooses to buy prepackaged products, his range of choice among such products and retailers of products usually prevents his being forced into the kind of take-it-or-leave-it "package deal" choices common in such fields as politics, where he must vote for one candidate's whole "package" of positions on foreign policy, civil liberties, ecology, race relations, monetary policy, etc. The almost continuous revision of most economic decisions adds a temporal flexibility not found in political systems with fixed terms of office, where recall and impeachment are costly options.


Because economic transactions often involve repeated satisfaction of the same desires, there is continual feedback from those most knowledgeable about the extent to which a given product or service is satisfactory-namely, the consumers. Moreover, this is not merely abstract knowledge but knowledge conveyed in a monetary form, conveying persuasion as well as information.


Economic transactions, whether through formal or informal processes, have as a serious disadvantage the possible disregard of affected interests not party to the transactions. A sale of coal to an electric generating plant may represent a mutually advantageous transaction from the point of view of the coal company and the electric company, and yet create millions of dollars worth of costs in dirt and lung disease which are not represented in the decisions as to the kind of coal to use, the location of the plant, or the presence or absence of devices to reduce harmful emissions. Theoretically, with a perfectly functioning and costless legal system, all these costs would be felt in the form of damage liabilities, which would be foreseen at the time of the economic transaction-leading to the same kinds of decisions as if the excluded third parties had in fact been included." The external costs in some economic processes, and the high transactions costs of organizing thousands of scattered individuals, create special problems for affected third parties. Viewed as a social process, the problem with such economic processes is that the transacting parties are not coextensive with the affected parties.


Another problem with an economic system is that different people have varying amounts of money with which to convey their consumer preferences to producers. For many social critics, this invalidates any hope of an optimal use of resources via market processes. However, this may be a more formidable problem in theory than in practice. When groups of consumers compete for the same products, each of the competing groups usually includes a wide range of income levels, so that a rich-versus-poor competition need not be involved. Moreover, even where such a competition is involved, lower income consumers often bid goods and resources away from the affluent, through sheer numbers, even if not to the theoretically optimal extent. Much of the outcry against middlemen ("developers," "commercial interests," etc.) who would redirect resources from a "higher" to a "lower" use is implicitly a protest against large numbers of lower-income people whose collective wealth is bidding shoreline, forest, and lakeside property away from a use favored by higher-income people to uses more consonant with the tastes and individual resources of lower-income people: typically higher density use, substituting apartment buildings for individual houses, hotels for rustic cabins, automobile access roads for backpack trails, etc. The middlemen, as such, typical ly have no bias toward any particular use, but only toward making moneya charge bitterly made by critics, despite the inconsistency of that charge with blaming the middlemen for a particular end result.




Political and legal institutions provide the rigidities-"rights"-people want in some vital areas of their life, where they reject both the transactions costs and the indignity of having to submit to, or negotiate with, those who might challenge or threaten their possession of their home, their children, or their life. Constitutional systems attempt to sharply demarcate these areas of basic rights from other areas in which the discretion and flexibility of individual choice and interpersonal negotiation may achieve whatever arrangements are deemed mutually satisfactory by the individuals concerned. In short, Constitutional political and legal systems attempt to limit their own scope to areas in which they have a relative advantage as decision-making processes, leaving other areas to other decision-making processes, whose advantages may be either in the quality of the decisions or in the personal dig'nity implied by free choice.


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