Bounded Rationality or Skilled Performance?

15 July 2009 at 6:34 am 11 comments

| Nicolai Foss |

In my 2003 contribution to the Festschrift for Richard Nelson and Sidney Winter (here), I argued that Nelson and Winter’s main oeuvre, their 1982 book, An Evolutionary Theory of Economic Change, is much more about tacit knowledge than about bounded rationality. The notion of routines is intended to capture the firm-specific and tacit character of productive knowledge rather than heuristics, satistificing search, and the like (these may not be opposed, though).

I am reading Great Minds in Management at the moment (highly recommended!). In his chapter, “Developing Evolutionary Theory for Economics and Management,” Sidney Winter seems to agree:

Skill provides a compelling model of effective behavior that is different, and deeply different, from what we are told either by theories of rational decision or by behavioral theories featuring ‘bounded rationality.’ As far as I can see, the latter theories do not lead one to expect that the word ‘awesome’ will ever be needed to describe human behavior” (p. 533).

Indeed, as my frequent co-author, Teppo Felin, argues, bounded rationality is almost always about people’s foolishness (notably the heuristics and biases literature), rather than about how and why people actually cope, sometimes quite successfully, with most of the decision situations they confront. It is about decision failure, rather than decision success (possibly premised on the implicit assumption that the standard model of rational decision is the only existing model of decision success). The problem with Winter’s alternative, namely that of behavior as skilled performance, is that it seems unclear what are the available models. Skilled performance seems as arbitrary as bounded rationality.

Entry filed under: - Foss -, Management Theory, Recommended Reading.

Kline Mystery Solved Teaching Generation Me

11 Comments Add your own

  • 1. Joe Mahoney  |  15 July 2009 at 7:33 am

    Bounded rationality leaves room for genuine learning. Learning may be defined as the “detection and correction of error.” No mistakes: No learning. Without bounded rationality the entire decision tree of chess would be available in our heads and there would be no game to play as the final result is known in advance. I believe it a poor choice in language to say that a master chess player who loses a state-of-the-art match due to mistakes is foolish. The moves made are experiments by the master chess player (since bounded rationality precludes knowing fully the consequences of the moves). That we act, make mistakes, and learn can be wise. To do nothing and not make mistakes may be more foolish.

  • 2. JC Spender  |  15 July 2009 at 9:20 am

    The problem with arguing for the distinction between tacit knowledge and bounded rationality is that bounded rationality (BR), as typically used in our literature and especially in Nelson & Winter (1982), obviously embraces ‘tacit knowledge’ – even as this term is contested.

    For BR to be a helpful notion, one on which we can build, rather than a self-defining tautology that stops the conversation, we must unpack its different aspects. Joe points out that ‘foolishness’ is foolish too; to speak of it shuts down rather than opens up what is powerful about BR – that the limitations to our reasoning have economic consequences – and puzzling – in what ways?

    The ’Developing Evolutionary Theory’ chapter is especially revealing of how N&W brought ‘behaviorism’ together with ‘uncertainty’ – so it helps us unpack our use of BR.

    But it is also useful to be reminded that BR is not a new. It was, for instance, key to Hobbes’s work. There is an irreducible role for government (The Leviathan) only because our mental limitations prevent us from fully understanding the consequences for others of our actions as free individuals. It is ancient in the philosophical notion of our inability to enter God’s mind. Yes, Man is indeed foolish, but we can say more than that.

    The ‘behaviorist’ parent of N&W’s BR is Simon’s idea of habit – reasoning ‘frozen into intuition’ (1997:139). This appeals to a psychological/physiological model (Tolman’s) in which we ‘economize’ on conscious reasoning by deploying a different memorizing and computing part of the brain. But Simon presumes the unconscious, or wherever such computations are performed, operates according to the same rules of logical reasoning as the conscious mind (1997:131).

    I have argued this behavioral notion of ‘tacit’ can help us distinguish rules – fully reasoned – from routines – at least partially embedded into habit. N&W’s notion of organizational routines goes beyond the purely individual to embrace multi-person tacit knowledge (2005:534).

    Uncertainty is an entirely different matter. Winter’s struggle with Knightian uncertainty (2005:526) is blindingly honest – in the end he seems to let it go. Nelson is different and his determination to embrace the radical aspects of Schumpeter is equally clear. Which gets us to Joe’s argument that BR’s Knightian parent draws forth ‘genuine learning’ – though this is a pretty vague too.

    But following this line of thought I have long argued that Knightian uncertainty draws forth our imagination, along the lines suggested by John Locke, and that this is what stands behind Joe’s ‘genuine learning’. Imagination is not present in Simon’s model – effectively displaced by a focus on ‘search’ which comes through to March’s work.

    But if we admit imagination Knightian uncertainty can help us distinguish between rules – which do not call for the imagination in their implementation – and capabilities, which enable creative human beings to act under conditions of ‘genuine’ uncertainty.

    This sets up a two-by-two – a favorite first step to clarification.

    certainty imagination

    conscious rules capabilities

    embedded routines

    The empty box is not empty, of course, since imagination elides the distinction between conscious and embedded.

  • 3. JC Spender  |  15 July 2009 at 9:23 am

    OOPS – lost the formatting on the two-by-two.

    The axes are Certainty vs Imagination and Conscious versus Embedded.

  • 4. JC Spender  |  15 July 2009 at 10:29 am

    The more general point, of course, is that BR is an explicit critique of the ‘rationality alone’ Theory of Mind.

    To make BR tractable one has to adopt an alternative Theory of Mind.

    In N&W’s case they conflate or attempt to synthesize (a) Simon’s theory of mind as one with two defining ‘qualities’ – conscious and habitual reasoning (the latter surely embracing skills in spite of Sid’s comments), and (b) a Lockean or Knightian theory of mind, one that assumes two quite different qualities, ‘conscious reasoning’ and ‘imagination’.

    Even though quite different, either offers a workable critique of the ‘rationality alone’ model which today appeals to those who see the human mind as no more than a fleshy von Neuman computer.

    Many other theories of mind could be brought to this discussion and so provide an alternative micro-foundation to the analysis of our economic behavior. Prospect theory and emotional intelligence have put in appearances. Neurophysiology is attracting an increasing number of people. And so on, without limit – since our BR is not everyone else’s.

  • 5. Steve Phelan  |  15 July 2009 at 3:05 pm

    I think we give too much credit to N&W in the first instance. I always thought they were attempting to justify using evolutionary concepts (from biology) in economics.

    To do this, they had to cast around to find the economic equivalent of a gene and they settled on the concept of a routine. Animals cannot acquire the genes of other animals so it was important (for the theory) that routines could not be transmitted between organizations. The solution was to draw on Polanyi’s concept of tacit knowledge. Clearly something that is tacit cannot be transmitted.

    Armed with routines, N&W were able to introduce the biological equivalent of mutation to argue that routines could change over time within an organism..err..organization, enabling it to adapt to its environment. In turn, this could be modeled with a rudimentary, but revolutionary, simulation that could run on a new-fangled micro-computer.

    It was only later, with the rise of RBV, that the nexus between routines, resources, and knowledge started to be forged.

    Just my $0.02 worth

  • 6. Steve Phelan  |  15 July 2009 at 3:07 pm

    P.S. Why bounded rationality? Because evolution is a “blind watchmaker” not a rational planer.

  • 7. Nicola Lacetera  |  15 July 2009 at 3:52 pm

    The 1982 NW book was meant to be mostly a book about more “macro” phenomena –economic change, growth…and NW needed to define the actors in these processes, the firm, as not acting fully rationally but, essentially, searching locally. This is what generates search, selection, retention. Chapters 4 and 5 were providing a justifications for their view, but I guess, it did not really matter whether it was a BR, routines, or “skills” intepretation, as long as it was consistent with firms differing systematically. Then of course, if one wants to build a more managerial, micro theory, one has to be more precise, and this is what they (especially Winter) and many other scholars have tried to do over the past two decades. But I do not think we should search of an “evolutionary theory of the firm” in the 1982 book…

  • 8. jc spender  |  15 July 2009 at 4:02 pm

    Not sure I would agree with Steve here.

    Sid is clear that reading Alchian (1950) kicked open a door and gave him a way of thinking about the observed path-dependency of R&D decision-making.

    No question the N&W take on evolutionary theory is more Lamarkian than Darwinian, since adaptation takes place without a passing or a gestation. But again there’s some light between Dick and Sid. Were the process ‘blind’ a la Dawkins’s universal evolutionary thinking, that would undercut management’s role and head the analysis off towards population ecology. While Sid seems to go along with this, emphasizing evolutionary theorizing is about economics, adaptation and survival rather than management (2005:510), I can report Dick is insistent on management’s role and will have none of this ‘blind’ stuff.

    My sense is that the ‘gene’ metaphor, introduced as an explanatory device rather than to suggest anything substantive, has actually worked against N&W since, as Steve points out, for most readers it serves a Darwinian role, while the phylogeny/ontogeny distinction makes little sense in N&W’s Lamarkian framework.

    My sense is that it may make more sense to think of the individual firm as a species, related to other firms as we are to, say, chimps. This would echo Chamberlin who, I would argue, stands with Veblen in the background here, uncited. Each firm has its own share of historically contingent micro-foundations. It is not clear that anything meaningful can be transferred between firms – at best it is all about imitation a la Tarde.

    In general, though, I do not think we give N&W ‘too much credit’. Rather the opposite. Their project, as intimated in their book’s footnote 1 (1982:4), is about ‘coming to grips with uncertainty, or bounded rationality …’

    How many other people have tried to do this, to go beyond using BR as a term of art and vaguely citing Simon? N&W’s attempt to synthesize Simon and Knight was absurdly ambitious, far more so than Williamson’s attempt to make something of Simon’s notions.

    Whether we think N&W’s approach successful or not, it is surely a grand place to start for those interested in the N&W project but unwilling or unable to approach the same issues through the Austrian literature. It is interesting that N&W do little more that mention this literature (1982:41). They certainly do not critique it and show why further theorizing is necessary. Even more interesting is their inattention to Penrose’s 1953 critiques of Alchian’s notions of evolutionary economics.

    But the real curiosity is that the bulk of work being done in our field/s seems blissfully unaware of Simon’s 1947 critique of full rationality, let alone these responses. Yet we are told we are in the ‘age of innovation’ and so on. How are we to theorize this?

  • 9. jc spender  |  15 July 2009 at 4:12 pm

    Incidentally, cannot imagine what got into me when I was thinking about headings for the matrix’s columns – which I had omitted from my Lund ppt.

    Could be Reasoning versus Imagining along the top (the Knightian axis).

    Plus it may be better to have Conscious versus Heuristics on the vertical Simon axis. That would allow for purely mental sedimentation – essential what Simon had in mind in 1947 AND what we all now know about tacit knowledge from Polanyi.

    That would tempt me to put Situated in the fourth box – if pressed, I’ll explain.

  • 10. stevphel  |  15 July 2009 at 10:28 pm

    JC, I agree with your points. I agree that their project was ground-breaking – I am actually a big fan of N&W. I just don’t think the knowledge/RBV link was top of mind when the 1982 book was written.As Nicola indicates, Winter has developed these ideas in more recent papers but the original book was more macro than micro.

    As you point out, Alchian’s paper was actually heavily criticized in its day for not proposing a gene mechanism in firms. I think N&W were acutely aware that they needed to propose a Darwinian mechanism to survive the same challenge hence the invention of routines.

    P.S. Tell us more about your matrix…are heuristics always tacit (unconscious) in your model? Do you have an example of unconscious/tacit imagining? Dreaming of snakes followed by the ‘discovery’ of the double helix comes to mind.

  • 11. JC Spender  |  18 July 2009 at 4:44 pm

    Your comment about the knowledge/RBV link really has me thinking – especially once we observe how little attention was paid to N&W by the RBV pioneers.

    There’s more to say on this.

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