Wednesday, 21 March 2012

Institutions and the Economy: Cooperation, Compliance and Strategic Action as Bye-Products of Interactions and Intersections

Though the previous comments only scratch the surface of how actors are motivated in confined social spaces, I move here to the second main issue I have raised: that such spaces rarely stand on their own, independent of larger network, institutional, cultural or historical trends. A simple example is that while
cooperation or compliance depends strongly on particular interpersonal relations and their history, it also depends on the overall configuration of social networks in which people are situated. Thus, while two actors’ previous relations partly determine whether they cheat one another, it is also important whether the overall network that contains both is dense, so that news of malfeasance spreads quickly, or sparse, so that it could long be concealed.

But network structure is itself problematic, and can be seen as an outcome of larger social processes, if we rise to higher altitudes and observe “from the air” how networks have been constructed over time. In this regard, considerations of social boundaries, coupling and decoupling, are central, and have entered social theory in many different guises. The general and most overarching commonality in arguments about coupling and decoupling is the need to understand how resources, information and influence do or do not move among well-defined and self-reproducing spheres of social structure. This emphasis is often conceived in terms of individual rational action, that is, how individuals can coordinate spheres or move across them to benefit themselves, but can also be seen in more macrostructural perspective, where one needs to understand what boundaries and linkages are in order to explain why societies function as they do.

These two emphases illustrate a duality between structure and agency. One example is my work on the “strength of weak ties”, which concerns well-defined, cohesive groups connected to one another, if at all, by weak ties between members of different groups. From the strategic point of view, the individual with many such ties to other groups can turn diverse and non-redundant information to his own advantage, as in competition with others for desirable jobs. But note also that having a presence in multiple networks can mute and muddle one’s sense of identity and interests, as first one network, then another, becomes more salient. The ambiguity that results can be confusing for an actor, but may also confer advantage in the form of inscrutability to others, as in the “multivocality” and resulting “robust action” on the part of Cosimo de Medici.

One larger-scale implication is that social structures deficient in weak ties would be fragmented, and find collective action difficult, which might mean a failure to mobilize politically; conversely, the fact that weak ties channel novel information to new groups links the number of such ties to overall community outcomes such as scientific progress. The relevant units could just as well be collectivities like firms, and that one should pay attention to the “structural holes” formed in the network by absence of certain connections. It is important to emphasize the advantage to individual actors or firms from exploiting such holes, and bridging across actors that could otherwise not be in contact with one another. This focuses more sharply than my work on weak ties on how this advantage relies on manipulating structural features of the network, rather than merely collecting resources (such as information) for one’s own use. In this regard, it is better to understanding power and compliance, based on control of uncertainty. Sustaining this control over time depends, however, on preventing structural holes from being closed up, an aspect that requires more sustained analysis.

Economic anthropology has broached similar topics in different language, noting that in many societies, all goods are not commensurable with one another, and can be divided up into mutually exclusive sets of those which are. Such a set is called a “sphere of exchange”. Goods or services not commensurable cannot be exchanged in part because people do not understand how to think about such an exchange, or consider it highly inappropriate. All societies, however technically advanced, retain such distinctions; most of us, for example, could not conceive the appropriate price at which to sell our children.

Because one sure source of profit in exchange comes from exploiting counterparts’ ignorance of usual exchange ratios, a Norwegian anthropologist Barth highlighted the ability to breach previously separated spheres of exchange as a crucial element of economic success. He gives the example of the Fur, a Sudanese tribal group in which wage labor was considered shameful (i.e. labor and money were incommensurable), and certain products like millet and the beer that could be made from it, were produced mainly to be exchanged for communal labor as in mutual help for housebuilding. In a separate sphere of exchange, food, tools and other commodities were exchanged for money. Arab merchants, outsiders to this social system, arrived and hired local workers to grow tomatoes, a cash crop, paying them with beer. The value of the tomatoes far exceeded the cost of the beer, but this was unclear to the workers since in this setting neither beer nor labor would be exchanged for cash. Because the traders were not bound by the group’s moral injunctions to keep the spheres separate, they could exploit the “structural hole” formed by their connections into two separated spheres. Barth defined “entrepreneurship” precisely as the ability to create such new transactions.

A nearly identical conception of “entrepreneurship” has come independently from Austrian-school economist Israel Kirzner. In some ways Kirzner borrowed from fellow Austrian Joseph Schumpeter, who had previously defined entrepreneurship as the ability to create new opportunities by pulling together previously unconnected resources for a new economic purpose. Kirzner’s formulation is closer to that of Barth, however, in that he defines the entrepreneur as someone who connects previously isolated markets by arbitrage. While the arbitrageur needs the Schumpeterian trait of alertness, he plays a different role from Schumpeter’s swashbuckling entrepreneur who disrupts the existing equilibrium and shakes up the economic landscape with innovation, opening new opportunities. Kirzner’s entrepreneur is, by contrast, a grey figure who spots price discrepancies across markets, which are a disequilibrium in the general picture, and profits by linking the markets and re-establishing – not disrupting -- a general equilibrium characterized by price uniformity. Having made obvious to everyone the failure of linkage that led to his profits, he could not then further profit from this opportunity and would have instead to find some new discrepancy to exploit.

Barth and Kirzner both, then, see the entrepreneur through the lens of optimistic midcentury modernization theory. He spots inefficiencies, and simultaneously profits from and remediates them. In the end, the drag on economic progress imposed by differential prices or the inability to exchange certain commodities against one another, is cleared away and the economy can move full speed ahead. Uniform prices are established and previously disconnected elements of markets are brought together so that factors of production can find their optimum use through the unhampered mobility and perfect information that this optimum requires.

But this diverges from the empirical reality of entrepreneurs, who, if they in fact recognize that their advantage lies in sitting astride disconnected chunks of social structure and monopolizing the ability to coordinate whatever flows among them, could hardly be expected to step aside cheerfully and invite any and all to join in this coordination. Here the Schumpeterian image of the entrepreneur as larger-than-life seems more suitable -- such as the Rockefellers and the Carnegies, who had to be legally restrained from their favorite activity, the “restraint of trade” (a special case of what White calls “blocking action”). Correspondingly, we should not expect the Arab traders of Barth’s Sudanese case to go quietly into the good night of arbitrage, but instead try to parlay their advantage into prominence and local power, depriving others of the same opportunity.

This is a case where power in the economy does not rest on legitimacy, but rather flows from what Weber thought of as the rather boring source of a “constellation of interests”, a position of monopoly. What made it seem boring, however, was the tacit assumption that this position resulted from some previously given situation, a “natural monopoly” so to speak; whereas in fact, for the cases I have described, it results from existing structure and active agency. The entrepreneur has no chance without a fragmented structure, so that flows among chunks would be a source of profit. But to prime the pump of these flows is non-trivial, and requires not only the cognitive brilliance highlighted by the tradition of Austrian economics, but also the ability to mobilize social resources through networks of solidarity and obligation. Monopoly positions are actively created in situations where other outcomes are technically plausible. Yet, especially in situations where legitimacy is important, the mobilizer who sits at the center of disconnected networks may need to act behind the scenes so as not to appear excessively self-interested; this is part of what Padgett and Ansell, in their analysis of the rise of the Medici, call “robust action”. The combination of mobilization strategy and structural conditions that make centralization and expansion possible is what cries out for theoretical analysis from economic sociology.

Note that the feat of bridging differentiated spheres depends on the spheres first being separate. In analyzing the evolution of societies over time, a typical theme of comparative sociology, has been the movement from homogeneous structures to ones with a high level of functional and structural differentiation. In political sociology, this differentiation has occupied a place in theory that is related to our problem of explaining the success of economic entrepreneurs. A central question has always been how political leaders manage to assemble the resources required to organize a system of power, that coordinates larger numbers of people into what they all recognize as a single political unit. An analysis of the rise of what is called “centralized bureaucratic empires” is instructive. The argument is that for such empires to be sustainable, two conditions were necessary: leaders had to have purely political goals autonomous from other social formations or institutions; and the society had to have developed “limited but pervasive differentiation” in its various institutional spheres. That is to say that economic, political, legal, religious, educational and cultural activities had to have become relatively detached from families and households, and taken on a life of their own, typically measured by the extent of specialized roles and professional identities.

Differentiation is prerequisite, in this argument, because without it, the resources that would-be rulers need to draw on to build and sustain their power are locked up or embedded in undifferentiated kinship or other socially-defined groups, and cannot be mobilized. Historically, economic thought has taken liquid resources as the normal situation, but in fact, analysis of how this liquidity arises is one of the most difficult and important tasks for social theory. To the extent that land, labor or other items construable as commodities cannot be alienated freely, but are part and parcel of complexes of obligation and symbolic meaning, rulers are stymied. Differentiation creates what is refers to as “free resources”, that can be appropriated and moved from one sphere to another by those with the will and wit to do so. This is because specialized sectors could not evolve in the first place without detaching resources from their primordial social sources, and once so detached, even though now in the service of specialized role-occupants, the resources are understood to be alienable. And the first rulers who could appropriate food or other goods in kind from putative “subjects”, moved these goods out of their normal subsistence circuit for purposes of their own and turned this newly profitable transaction to the purpose of expanding their political enterprises. All successful taxation has this quality, and it is no accident that systematic analysis of the rise of modern states focuses on this in detail (for the case of Western Europe).

Thus the argument that there is something to gain for those who can bridge discrete social units can be posed at different levels of generality. In the discussions of weak ties or “structural holes”, the units were concrete networks of individuals or organizations. With “spheres of exchange”, the units were defined as the boundaries around certain types of exchange defined by the set of items commensurable against one another. In its formulation, the units are the institutional spheres of a society. Any of these might be analyzed in a discussion of mobilizing for either economic or political advantage. Successful economic entrepreneurs most likely engage in bridging at multiple levels.

Samuel Insull, for example, whom I and collaborators have studied in detail in our analysis of the early American electricity industry, was one of the few early leaders of the industry to have extensive social contacts into the separated networks of tinkerers/inventors, financiers, and politicians at both local and national levels. The way he moved resources back and forth among these networks could also be described at a more abstract institutional level: he was the first to successfully mobilize political resources in the interest of economic formations in his particular industry. He also applied innovative financial instruments, and accounting techniques such as balloon depreciation, in such a way as to support his particular favored path of technical development. Although Insull shared these innovations within a relatively closed and elite circle, he actively combated attempts of those outside that circle such as sponsors of isolated generation, municipal ownership or decentralized provision. His legacy was one of highly monopolized generation of power, consistent with the argument that successful entrepreneurs do all they can to prevent others from following in their footsteps. Many of the characteristics of the huge holding companies that Insull and his collaborators controlled by the late 1920s were similar to those described as “centralized bureaucratic empires”.

More recently, one can argue that the spectacular success of Silicon Valley’s information technology industry could not have occurred without the development of a new type of financing. The older model was one in which financiers were largely decoupled from the industries which they supported, knowing little of the technical detail, and standing apart from their social and professional circles. In such a model, the only information required was the likelihood of loan repayment, which could be gauged from a general perusal of balance sheets with an assumption of stable markets over the relevant time horizon. This model did not lend itself to rapid technical change, which could not be adequately evaluated with the usual financial tools. Instead, from the 1960s on in Silicon Valley, a new model appeared which facilitated innovation: engineers and other industry members themselves took their windfall profits and became financiers. In alliance with traditional and new sources of wealth, they created the concept and practice of “venture capital”, in which financiers were members of or closely linked to technical networks, took substantial equity positions in newly financed firms, sat on boards of directors, and sometimes played active management roles.

The original breach of spheres – moving large profits out of the industry itself, or the families of its members, into financial circles and institutions, made the financial innovators fabulously wealthy, because they could now deploy these funds not simply in the firms that produced them, but into promising innovations originating elsewhere. Moreover, initial successes attracted huge new inflows of funds from limited partners such as pension funds and wealthy individuals, themselves with no obvious connection to technical circles, just as 19th century American banks funded economic expansion by drawing in funds from beyond the kinship groups that set them up on behalf of industries whose advance could no longer be sustained by family funds alone.

But those who executed this strategy had no grand plan, but rather were clear-headed enough to take advantage of unique structural opportunities that were presented to them. The “traitorous eight” who left William Shockley’s transistor lab in the 1950s to form Fairchild Semiconductor went on to set the pattern that would dominate much of Silicon Valley’s economy, and to take a central role in their own right. But, as with Cosimo de Medici, the structure that permitted them to do so resulted from a conjuncture of more or less unrelated historical events, such as Shockley’s atrocious management style, and the peculiar equity-vesting arrangements of Fairchild which presented strong incentives for them to cash out and start new enterprises such as Intel and other now well-known “Fairchildren”.

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