Planning fails because the rules ruled

It takes a strong ideologue to believe that a centrally planned economy can work for more than a few years, and then only if people in a planned economy are willing to sacrifice for the cause, for example, to win a war. But few realize that planning also fails on an organizational and even personal level. If instead they adopted real-world selection rules, they could reduce the high costs associated with planning.

Planning fails at all levels for two main reasons: insufficient information and insufficient incentive. The first is often called knowledge problemand the latter can be understood as time consistency problem. Planners, like central bankers, may claim that they will behave in a predetermined way in the future, but they may back off and, for example, allow high inflation instead of recession risk, although they promised to keep inflation low. In the same way, people know that eating piggy will create health problems in the future, but an extra serving of slop would be good right now, so they break the promise they made to themselves to “eat right.”

Both scenarios can be viewed as “principal-agent” problems, as costs associated with a mismatch between the incentives of employees and owners. In the first, central banks are agents willing and able to damage the interests of the principals, market participants, because they will not be punished for this. In the second, the present self is an agent willing and able to harm the future self, the principal.

In any case, planning fails where the rule can work more. successively by reducing agency costs. For example, in monetary policy Taylor rule will reduce agency costs by reducing the freedom of action of politicians. Similarly, just like swear banksvarious independent diet programs create monetary barriers to overeating.

Coaching planning in terms of agency costs helps to understand why planning at the organizational level also often fails. Of course, the knowledge problem component exists even within organizations. The management of an organization, like Stalin’s bean counters, may not have enough information at the right time to create a plan that transcends actions that would have arisen spontaneously anyway. The presence of agency costs cements the deal by raising the very real possibility that self-serving managers and/or employees may thwart any top-down plan for their own gain.

Simply put, you can know what to do but have no reason to do it, or you can have every reason in the world and not know what to do.

Let’s be clear. Organizations should try to anticipate future conditions and prepare for unforeseen circumstances, but it would be a categorical mistake to confuse this activity, sometimes colloquially called planning, with central planning, which is criticized by Austrian economists and which failed in the USSR, Cuba and North Korea. Such planning attempts to move an economy, organization, or person from point A to point Z along a predetermined path that is often written into detailed five-year planning documents that take on the force of law, human resources mandate, or habit. .

Planning seems really logical and even necessary, until you realize that the real world doesn’t care about planners’ plans. The real world is ruled by rules, by which I mean selection algorithms. The clearest of these algorithms is evolution through natural selection. Organisms compete in the real test of reproduction, and each generation becomes more and more like the best contenders in that test until conditions change. Then, in the replay game, competitors with a different set of features, better suited to the new environment, begin to thrive.

Armen Alchian noted in a 1950 article that similar selection algorithm culls commercial organizations, albeit on the basis of profitability rather than reproductive success. In Alchian’s words, “Those who are aware positive profit survivors; those who suffer losses disappear.” In this view of the world, the success of an organization does not depend on planning or even accurate forecasting, but is simply a stochastic function of matching the environment, that is, the needs of consumers. Few business historians like Alchian’s article because the first section replaces stories about the “great business leader” with his simple selection rule and random results.

The second section of Alchian’s article, however, suggests that businesses are not simple organisms whose success depends entirely on how well their DNA matches the environment. Organizations can change their behavior. But how can an organization know that it is changing for the better, that its changes will increase, let alone maximize, the likelihood of achieving positive profits (or other goals in non-profit and government institutions)? Moreover, the profitability depends on the efficiency relative competitors whose costs and strategies may be unknown and even unknowable? “Even in a world of stupid people,” Alchian wrote, “there will still be profit.”

Managers and their gurus such as Al Chandler and Peter Drucker suggest that organization owners put the “best” leader available (the toughest topic itself) in charge and let him or her be “decisive.” Then comes the “managerial science” of when, how, and to whom to delegate decision-making authority.

Generally speaking, the most successful organizations move decision making to the level where information is best presented and incentives strong. The US Marines, for example, use three-man fireteams who are ordered to complete a specific task but not told how to achieve it. These battlegroups are part of larger units with similar tasks from above, but without micromanaging.

As David H. Friedman writes in Corps Business, “Marine Corps leadership principles are built on simple truths about human nature and the uncertainties of a dynamic environment.” Even with the flawless operation of modern communications, some “leader” in the rear cannot at any moment know whether a particular detachment should move forward or sit back. Moreover, he does not have a significant skin in this particular part of the battle. Thus, the squad leader makes the decision or delegates it, depending on the tactical situation.

While organizations should not jump straight into top-to-bottom Marine-style management, they should consider delegating decision making to those with the best information and the most incentives to behave in a way that optimizes profits in a world of uncertainty. the distribution or likelihood of achieving other goals, such as winning battles, minimizing losses, or increasing donations.

The type of organization and employee requires special attention. Drucker popularized the idea that knowledge workers, who make up the majority of the workforce today, are particularly difficult to micromanage. They shouldmanage yourselfhe argued, especially as they often know more and may even be smarter than their superiors. To think about Dilbert and his spiky boss, For example. But even the smartest boss in the world can’t know everything and will often rationally ignorant or seemingly innocuous but ultimately important details. No one is partly perfect because no one bets every part of every game.

What then should organizational leaders do? Think like classical liberals and coordinate your incentives carefully! Give workers autonomy by allowing them to make decisions where they have more important information. And give them a share of the property by paying pay for efficiencypreferably by committing to support real wages with KOLA. Or, even better, tie compensation to the achievement of a goal. (However, they need to be careful because employees usually produce exactly that they are interested in production.) They must then allow their workers to fight the enemy and spontaneously adapt to changing competitive situations. An organization can still fail, but it is less likely to fail, other things being equal, than an organization with a rigid top-down plan.

Robert E. Wright

Robert E. Wright

Robert E. Wright is a senior fellow at the American Institute for Economic Research. He is the (co)author or (co)editor of over two dozen major books, book series and edited collections, including the AIER collections. The Best of Thomas Paine (2021) and others. Financial exception (2019). He also (co-authored) numerous articles for important journals, including American Economic Review, Business history overview, Independent Review, Private Enterprise Journal, Finance Reviewas well as Southern Economic Review. Robert has taught courses in business, economics, and politics at Augustana University, New York University’s Stern School of Business, Temple University, the University of Virginia, and elsewhere since receiving his Ph.D. in history from SUNY Buffalo in 1997.

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