Interlocking Complementarities and Institutional Change.

1. InterlockingComplementaritiesand Institutional Change. Ugo Pagano University of Siena and Central European University. 2010年制度经济学国际研讨会议程 （中国·济南·山东大学）

2. Interlocking complementarities • characterize both the evolutionary change of complex organisms and of most human institutions • imply that evolutionary change can go through long period of stasis • involve that change cannot rely only on the forces of natural selection and of economic competition

3. Natural species and economic institutions. • I will start by considering the case of natural species. • There is a clear analogy between single-gene models and standard neoclassical theory. • Institutional economics sees the economy like a complex organism characterised by a web of interlocking complementarities. • Studying these complementarities is the only way to understand economic systems and their possible institutional changes.

4. Evolutionary potential and complexity. In both natural and social domains, evolutionary change is constrained by the degree of complexity of the evolving units. The constraints are different but they are always there. Simple units, like viruses, are flexible and can easily mutate but simplicity itself constraints evolutionary possibilities. Complexity has obvious evolutionary advantages. More complex organism and organization can do more and fitter things. However, it comes at the cost of increased evolutionary rigidity. Most patterns and features of a complex natural or social body must be adjusted to each other.

5. Beyond single-gene models. • Important distinction between: -single-gene models (where there are not complementarities) - multiple-gene models with epistatic relations (the interlocking “complementarities” existing among different genes loci). • The view that selection leads necessarily to the selection of the fittest is related to the single-gene model and to the absence of epistatic relations or complementarities. • When we abandon the single-gene model, protectionism as well as taxes and subsidies can, sometimes, give outcomes superior to unconstrained competition.

6. Natural selection as a stabilizing force. • Natural selection is usually considered to be a force encouraging fitness-enhancing mutations. This is the case when there are no epistatic relations. • With epistatic relations natural selection may have a stabilizing role: if there are two complementary changes that would improve fitness together (but not alone), natural selection eliminates the individuals that start having one of the two mutations. • Example: new leaves ------> advantages to have both a different stomach and a different mouth.

7. Allopatric Speciation as Natural Protectionism. • In the case of complex organisms with many epistaticrelations, natural selection can easily favour situation of stasis (punctuated equilibria). • Major changes, such as those leading to the formation of a new species are likely to occur in “allopatric conditions” that is in some isolated periphery. • In allopatric conditions one of the complementary mutations is not eliminated by natural selection and the other mutations may eventually come about. Allopatric speciation can be seen as a form of protectionism for the infant industry of a new species.

8. Selection taxes and subsidies. • In nature, there aredifferent selective agents: • forces active in the environment (natural selection), • - a mate or a rival (sexual selection), • humans (artificial selection). • One selective agent may impose a tax or a subsidy on other selective agents. • Examples: • peacock tail: sexual selection taxes the adaptation of the peacock to the environment • human brain: sexual selection subsidies the development of human intelligence.

9. After one week in your country..... ........I cannot avoid to summarize the argument as follows: Evolution is not about one representative undifferentiated egg. Within the egg, the Pangu has woken up! Yin and Yang have started to interact as complementary opposites within greater wholes. Interlocking complementarities imply that each trait cannot be changed independently of the other. These interactions, which characterize the evolution of complex species, are even more relevant in the case of the evolution of institutions.

10. Pre-Pangu Economics. Unfortunately much neoclassical economics has organizations that behave like isolated genes without interlocking complementarities: • Property rights do not influence technology: whatever the nature of the owners, the same profit maximizing technology is chosen. • Technology does influence property rights: whatever the nature of technology, all the owners are equally suitable to run the firm. In the neo-classical theory the different traits do not influence each other, giving raise to different organizational typologies.

11. The neo-classical double neutrality assumption. “In a competitive equilibrium it does not matter who hires whom” Samuelson (1957). First neo-classical neutrality assumption: Productive forces do not influence the typology of ownership arrangements. Second neo-classical neutrality assumption: Ownership arrangements do not influence the nature of the productive forces.

12. Neoclassical economics ignores the two marxian interactions Productive Forces Relations of Production Relations of Production Productive Forces In Marx, the first direction of causation was much stronger than the second. This involved economic determinism and consequent prediction fallacies.

13. NIE: Going Beyond the First Neutrality Assumption. In a world of positive transaction costs, the nature of the assets (i. e. productive forces), which are employed in productions, influencesorganizational form and ownership arrangements. Firms’ ownership and control will tend to go to the most specific and difficult to monitor resources. In this way, more agency costs can be saved and firms would increase their efficiency.

14. An inversion of NIE: going beyond the second neutrality assumption The nature of the assets (productive forces) can be endogenously influenced by property relations and organizational form. If one happens to own or control an organization (s)he will not find it costly to become a relatively difficult to monitor and specific resource. The NIE argument can be inverted:property relations and organizational form are not only the outcome of the nature of the assets. They also influence their monitoring and specificity characteristics.

15. Interlocking complemetarities. Specificity and Monitoring Characteristics of Assets Property Rights and Organizational Form The most specific and difficult to monitor agents can save the greatest amount of agency costs when they control the organization. : The agents controlling the organization will tend to become the most specific and difficult to monitor :

16. Multiplicity of organizational equilibria . Because of complementarities between rights and technologies, different firms and different economies may be locked in different organizational equilibria. Examples: no rights of the workers no firm-specific and difficult to monitor labour Fordism: firm-specific and difficult to monitor labour long time employment Toyotism:

17. Institutional change: overcoming complementarity locks Similarly to the case of natural species, interlocking complementarities can block changes. Similarly to natural selection, in these situations, competition may produce a situation of stasis. Change may again rely on some form of initial protectionism for the infant institutions (allopatric speciation) or on some form of (political) subsidies, (analogous to those provided by sexual selection). We will consider two historical examples of these two ways of overcoming complementarity locks.

18. An example of allopatric speciation: the second industrial revolution Building and operating the railways and telegraph systems were best done by forming a new set of interlocking complementarities between: • technology using numerous high-agency-cost managers. b) managerial rights (fair promotion opportunities for junior managers; tenure for senior executives).

19. British failure in the second industrial revolution. In Britain according to Chandler "Because their firms grew slowly and because they hired only a small numbers of managers, the founders and their families remained influential in the affairs of the enterprise and so affected dividend policy.” Moreover, the aristocratic-capitalist dynasties kept the best job opportunities for family members or people coming from the same social background.

20. There was already an organizational equilibrium characterised by: a) technology with an intensive use of high-agency-cost family members; b) strong family rights in the firm The "frozen part" of the British organisational species did not melt under the technological shock. The speciation had an "allopatric" nature: managerial capitalism emerged in the U. S. and Germany, that is in the periphery and not at the center of capitalism. The allopatric speciation of managerial capitalism.

21. Japan before the occupation. • Large firms were organized in zaibatsu: Mitsubishi, Mitsui and Sumitomo and Yasuda. • The Zaibatsu were still mostly family controlled and originated from family firms. For instance, the Mitsui and the Sumitomo were two of the most powerful merchant families in Tokugawa Japan. • In the tradition of Japanese family system the whole emphasis was placed on the perpetuation more on the the perpetuation of the “family name" (Kamei) than on the continuity of blood lineage. • Managers had a role. They could be adopted and given the family name by appropriate marriage arrangements.

22. The American Occupation of Japan. • Japan’s sudden surrender implied that there was no time to make any agreement with the zaibatsufamilies. • The Americans interpreted the faithfulness to the family name as feudal ties that were the basis of Japanese militarism. • They expropriated the zaibatsu families, nationalised their property and tried to sell all the stock to small shareholders. • The final aim was to create an American-style capitalism based on the separation between ownership and control. Concentrations of ownership an power were considered to be dangerous. Banks’ ownership and cross-sharehoding were forbidden. Unions’ activities were (initially) encouraged.

23. The (Anglo-)American occupation of Italy: a case of missed changes. • In the Italian case trying to apply the American model based on separation of ownership and control would have been much easier. Many assets were already owned by the state and a law separating banks and industry already existed. • But the political situation was different…… • Italy had not suddenly collapsed but the liberation took two years. In the meantime the Italian “zaibatsu” families had all the time to make deals with the Anglo-American forces. • In the end, the Italian corporate governance system exited basically unchanged from the Anglo-American occupation.

24. (Un-)intended changes in Japan. • The war period and expropriation of the zaibatsu families had reinforced insiders’ feelings of job security and their specific investments in the companies. • The contradiction between these conditions and the system that the American intended to create became evident with the 1949 stock market crash. The crash made take-overs very easy: new owners unconstrained by implicit contracts could jeopardise workers’ job security and their firm specific investments. • As a result cross shareholding and banks ownership of the stock were tacitly allowed: the keiretsu system based on main banking, cross shareholding and job security, was born.

25. A political selection subsidy. • As the comparison with the case of Italy shows, a high political subsidy was necessary for the change of the Japanese system of corporate governance. • In Italy the situation was riper for the change but, since no political input came from the occupying forces, no change occurred. By contrast, in Japan, the role of policies of the occupying forces was analogous to that of sexual selection in the emergence of the human brain. • Politics created the conditions for the emergence of a new species whose evolution was inhibited by numerous interlocking complementarities. The dramatic events of the political domain produced a decisive subsidy for the emergence of a new organizational species. • The role of conscious human agency was important but, because of the pre-existing complementarities, it produced an unintended institutional innovation.

26. Post-Pangu Theory. • Interlocking complementarities characterise the laws of structure and change of complex units. • Without their analysis, we cannot study institutions and understand their potentialities for change. • Long time after the Pangu, also economists need to wake up!

27. Thank you for your attention!