Author Archive

Behavioral Contract Theory

| Peter Klein |

The December 2014 issue of the Journal of Economic Literature contains a nice review article on “Behavioral Contract Theory” by Botond Köszegi. Abstract below, ungated version here.

This review provides a critical survey of psychology-and-economics (“behavioral-economics”) research in contract theory. First, I introduce the theories of individual decision making most frequently used in behavioral contract theory, and formally illustrate some of their implications in contracting settings. Second, I provide a more comprehensive (but informal) survey of the psychology-and-economics work on classical contract-theoretic topics: moral hazard, screening, mechanism design, and incomplete contracts. I also summarize research on a new topic spawned by psychology and economics, exploitative contracting, that studies contracts designed primarily to take advantage of agent mistakes.

12 December 2014 at 1:08 pm 1 comment

On Classifying Academic Research

| Peter Klein |

Should academic work be classified primarily by discipline, or by problem? Within disciplines, do we start with theory versus application, micro versus macro, historical versus contemporary, or something else? Of course, there may be no single “optimal” classification scheme, but how we think about organizing research in our field says something about how we view the nature, contributions, and problems in the field.

There’s a very interesting discussion of this subject in the History of Economics Playground blog, focusing on the evolution of the Journal of Economic Literature codes used by economists (parts 1, 2, and 3). I particularly liked Beatrice Cherrier’s analysis of the AEA’s decision to drop “theory” as a separate category. The Machlup-Hutchison-Rothbard exchange helps establish the context.

[T]he seemingly administrative task of devising new categories threw AEA officials, in particular AER editor Bernard Haley and former AER interim editor Fritz Machlup, into heated debates over the nature and relationships of theoretical and empirical work.

Machlup campaigned for a separate “Abstract Economic Theory” top category. At the time of the revision, he was engaged in methodological work, striving to find a third way between Terence Hutchison’s “ultraempiricism,” and the “extreme a priorism” of his former mentor, Ludwig Von Mises (see Blaug, ch.4). He believed it was possible to differentiate between “fundamental (heuristic) hypotheses, which are not independently testable,” and “specific (factual) assumptions, which are supposed to correspond to observed facts or conditions.” The former was found in Keynes’s General Theory, and the latter in his Treatise on Money, Machlup explained. He thus proposed that empirical analysis be classified independently, under two categories: “Quantitative Research Techniques” and “Social Accounting, Measurements, and Numerical Hypotheses” (e.g., census data, expenditure surveys, input-output matrices, etc.). On the contrary, Haley wanted every category to cover the theoretical and empirical work related to a given subject matter. In his view, separating them was impossible, even meaningless: “Is there any theory that is not abstract? And, for that matter, is there any economic theory worth its salt that is not applied,” he teased Machlup. Also, he wanted to avoid the idea that “class 1 is theory, the rest are applied … How about monetary theory, international trade theory, business cycle theory?” He accordingly designed the top category to encompass price theory, but also statistical demand analysis, as well as “both theoretical and empirical studies of, e.g., the consumption function [and] economic growth models of the Harrod-Domar variety,” among other subjects.  He eschewed any “theory” heading, which he replaced with titles such as  “Price system; National Income Analysis.” His scheme eventually prevailed, but “theory” was reinstated in the title of the contentious category.

9 December 2014 at 2:35 pm 1 comment

An Information Flow Diagram from 1922

| Peter Klein |

We’ve featured some cool vintage diagrams before, such as the New York and Erie Railroad organizational chart and the diagrams of the Mundaneum. Here’s an information flow diagram from 1922, represented as a cutaway view of the Washington Star newspaper offices. As Jason Kottke notes, it provides “a fascinating view of how information flowed through a newspaper company in the 1920s. Raw materials in the form of electricity, water, telegraph messages, paper, and employees enter the building and finished newspapers leave out the back.”

evening-star-building

1 December 2014 at 11:15 am Leave a comment

PhD Strategy Syllabi

| Peter Klein |

Russ Coff has assembled an impressive list of syllabi and reading lists for PhD courses in strategy, innovation, research methods, and related subjects. Feel free to send him additional suggestions. Many useful references here for faculty and students teaching or taking these courses, and for anybody wishing to learn more about classic and contemporary literature in strategic management research.

25 November 2014 at 9:21 pm 2 comments

It’s the Economics that Got Small

| Peter Klein |

Joe Gillis: You’re Norma Desmond. You used to be in silent pictures. You used to be big.

Norma Desmond: I *am* big. It’s the *pictures* that got small.

Sunset Boulevard (1950)

John List gave the keynote address at this weekend’s Southern Economic Association annual meeting. List is a pioneer in the use by economists of field experiments or randomized controlled trials, and his talk summarized some of his recent work and offered some general reflections on the field. It was a good talk, lively and engaging, and the crowd gave him a very enthusiastic response.

List opened and closed his talk with a well-known quote from Paul Samuelson’s textbook (e.g., this version from the 1985 edition, coauthored with William Nordhaus): “Economists . . . cannot perform the controlled experiments of chemists and biologists because they cannot easily control other important factors.” While professing appropriate respect for the achievements of Samuelson and Nordhaus, List shared the quote mainly to ridicule it. The rise of behavioral and experimental economics over the last few decades — in particular, the recent literature on field experiments or RCTs — shows that economists can and do perform experiments. Moreover, List argues, field experiments are even better than using laboratories, or conventional econometric methods with instrumental variables, propensity score matching, differences-in-differences, etc., because random assignment can do the identification. With a large enough sample, and careful experimental design, the researcher can identify causal relationships by comparing the effects of various interventions on treatment and control groups in the field, in a natural setting, not an artificial or simulated one.

While I enjoyed List’s talk, I became increasingly frustrated as it progressed, and found myself — I can’t believe I’m writing these words — defending Samuelson and Nordhaus. Of course, not only neoclassical economists, but nearly all economists, especially the Austrians, have denied explicitly that economics is an experimental science. “History can neither prove nor disprove any general statement in the manner in which the natural sciences accept or reject a hypothesis on the ground of laboratory experiments,” writes Mises (Human Action, p. 31). “Neither experimental verification nor experimental falsification of a general proposition are possible in this field.” The reason, Mises argues, is that history consists of non-repeatable events. “There are in [the social sciences] no such things as experimentally established facts. All experience in this field is, as must be repeated again and again, historical experience, that is, experience of complex phenomena” (Epistemological Problems of Economics, p. 69). To trace out relationships among such complex phenomena requires deductive theory.

Does experimental economics disprove this contention? Not really. List summarized two strands of his own work. The first deals with school achievement. List and his colleagues have partnered with a suburban Chicago school district to perform a series of randomized controlled trials on teacher and student performance. In one set of experiments, teachers were given various monetary incentives if their students improved their scores on standardized tests. The experiments revealed strong evidence for loss aversion: offering teachers year-end cash bonuses if their student improved had little effect on test scores, but giving teacher cash up front, and making them return it at the end of the year if their students did not improve, had a huge effect. Likewise, giving students $20 before a test, with the understanding that they have to give the money back if they don’t do well, leads to large improvements in test scores. Another set of randomized trials showed that responses to charitable fundraising letters are strongly impacted by the structure of the “ask.”

To be sure, this is interesting stuff, and school achievement and fundraising effectiveness are important social problems. But I found myself asking, again and again, where’s the economics? The proposed mechanisms involve a little psychology, and some basic economic intuition along the lines of “people respond to incentives.” But that’s about it. I couldn’t see anything in these design and execution of these experiments that would require a PhD in economics, or sociology, or psychology, or even a basic college economics course. From the perspective of economic theory, the problems seem pretty trivial. I suspect that Samuelson and Nordhaus had in mind the “big questions” of economics and social science: Is capitalism more efficient than socialism? What causes business cycles? Is there a tradeoff between inflation and unemployment? What is the case for free trade? Should we go back to the gold standard? Why do nations to go war? It’s not clear to me how field experiments can shed light on these kinds of problems. Sure, we can use randomized controlled trials to find out why some people prefer red to blue, or what affects their self-reported happiness, or why we eat junk food instead of vegetables. But do you really need to invest 5-7 years getting a PhD in economics to do this sort of work? Is this the most valuable use of the best and brightest in the field?

My guess is that Samuelson and Nordhaus would reply to List: “We are big. It’s the economics that got small.”

See also: Identification versus Importance

23 November 2014 at 2:58 pm 8 comments

Bottom-up Approaches to Economic Development

| Peter Klein |

Via Michael Strong, a thoughtful review and critique of Western-style economic development programs and their focus on one-size-fits-all, “big idea” approaches. Writing in the New Republic, Michael Hobbs takes on not only Bono and Jeff Sachs and USAID and the usual suspects, but even the randomized-controlled-trials crowd, or “randomistas,” like Duflo and Banerjee.  Instead of searching for the big idea, thinking that “once we identify the correct one, we can simply unfurl it on the entire developing world like a picnic blanket,” we should support local, incremental, experimental, attempts to improve social and economic well being — a Hayekian bottom-up approach.

We all understand that every ecosystem, each forest floor or coral reef, is the result of millions of interactions between its constituent parts, a balance of all the aggregated adaptations of plants and animals to their climate and each other. Adding a non-native species, or removing one that has always been there, changes these relationships in ways that are too intertwined and complicated to predict. . . .

[I]nternational development is just such an invasive species. Why Dertu doesn’t have a vaccination clinic, why Kenyan schoolkids can’t read, it’s a combination of culture, politics, history, laws, infrastructure, individuals—all of a society’s component parts, their harmony and their discord, working as one organism. Introducing something foreign into that system—millions in donor cash, dozens of trained personnel and equipment, U.N. Land Rovers—causes it to adapt in ways you can’t predict.

19 November 2014 at 11:25 am 2 comments

Opportunity Discovery or Judgment? Fargo Edition

| Peter Klein |

In the opportunity-discovery perspective, profits result from the discovery and exploitation of disequilibrium “gaps” in the market. To earn profits an entrepreneur needs superior foresight or perception, but not risk capital or other productive assets. Capital is freely available from capitalists, who supply funds as requested by entrepreneurs but otherwise play a relatively minor, passive role. Residual decision and control rights are second-order phenomena, because the essence of entrepreneurship is alertness, not investing resources under uncertainty.

By contrast, the judgment-based view places capital, ownership, and uncertainty front and center. The essence of entrepreneurship is not ideation or imagination or creativity, but the constant combining and recombining of productive assets under uncertainty, in pursuit of profits. The entrepreneur is thus also a capitalist, and the capitalist is an entrepreneur. We can even imagine the alert individual — the entrepreneur of discovery theory — as a sort of consultant, bringing ideas to the entrepreneur-capitalist, who decides whether or not to act.

A scene from Fargo nicely illustrates the distinction. Protagonist Jerry Lundegaard thinks he’s found (“discovered”) a sure-fire profit opportunity; he just needs capital, which he hopes to get from his wealthy father-in-law Wade. Jerry sees himself as running the show and earning the profits. Wade, however, has other ideas — he thinks he’s making the investment and, if it pays off, pocketing the profits, paying Jerry a finder’s fee for bringing him the idea.

So, I ask you, who is the entrepreneur, Jerry or Wade?

11 November 2014 at 4:53 pm 15 comments

Older Posts


Authors

Nicolai J. Foss | home | posts
Peter G. Klein | home | posts
Richard Langlois | home | posts
Lasse B. Lien | home | posts

Guests

Former Guests | posts

Networking

Recent Posts

Categories

Feeds

Our Recent Books

Nicolai J. Foss and Peter G. Klein, Organizing Entrepreneurial Judgment: A New Approach to the Firm (Cambridge University Press, 2012).
Peter G. Klein and Micheal E. Sykuta, eds., The Elgar Companion to Transaction Cost Economics (Edward Elgar, 2010).
Peter G. Klein, The Capitalist and the Entrepreneur: Essays on Organizations and Markets (Mises Institute, 2010).
Richard N. Langlois, The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy (Routledge, 2007).
Nicolai J. Foss, Strategy, Economic Organization, and the Knowledge Economy: The Coordination of Firms and Resources (Oxford University Press, 2005).
Raghu Garud, Arun Kumaraswamy, and Richard N. Langlois, eds., Managing in the Modular Age: Architectures, Networks and Organizations (Blackwell, 2003).
Nicolai J. Foss and Peter G. Klein, eds., Entrepreneurship and the Firm: Austrian Perspectives on Economic Organization (Elgar, 2002).
Nicolai J. Foss and Volker Mahnke, eds., Competence, Governance, and Entrepreneurship: Advances in Economic Strategy Research (Oxford, 2000).
Nicolai J. Foss and Paul L. Robertson, eds., Resources, Technology, and Strategy: Explorations in the Resource-based Perspective (Routledge, 2000).

Follow

Get every new post delivered to your Inbox.

Join 277 other followers