Econ 508 Presentation Federalism and the M-form Hypothesis

1. Econ 508 PresentationFederalism and the M-form Hypothesis How the Study of Comparative Economic Systems Relates to the Corporate Sector by Matt Holian 2/28/06

2. Motivation “A central theoretical question is how organization makes a difference to economic performance.” -- Maskin, Qian and Xu“Organizing an economy in order to best get information is just as relevant in centrally planned economies as it is in private firms.” -- Belton Fleisher (from F. Hayek)I will discuss some of the similarities between firms and economies from an organizational perspective. Organizational problems are pervasive and they all share some common features.

3. Outline • Taxonomy of corporate structures (U-form, M-form and H-form) • The M-form Hypothesis • What is behind the M-form Hypothesis? Part I - motivating employees • Example: USSR and China • What is behind the M-form Hypothesis? Part II – optimal decentralization • Example: The U.S. Federal System • Conclusion

4. I. Taxonomy of corporate structures (M-form, H-form and U-form) U-form – “one organization,” made up of a collection of different functions, no one of which can conduct business separately. H-form – a collection of many different unrelated U-form organizations. M-form – a collection of many different related U-form organizations. # of organizations U - - - - - M - - - - - H related unrelated

5. Examples of M-form and U-form “A classic example of the U-form was the Ford Motor Company before the Second World War. In those days, Ford was organized into a number of functionally specialized departments: production, sales, purchasing, and so on. In other words, the various departments carried out complementary tasks; none was independent of the others. By contrast, General Motors under Alfred Sloan became the prototypical M-form; GM comprised (and still comprises) a collection of fairly self-contained divisions, e.g. Chevrolet, Pontiac, and Oldsmobile” - Maskin et. al (p. 360) Today, Ford also owns Lincoln, Mercury, Mazda, Volvo, Jaguar, Land Rover and Aston Martin.

6. II. The M-form Hypothesis “…the organizational and operation of the large enterprise along the lines of the M-form favors goal pursuit and least cost behavior more nearly associated with the neoclassical profit maximization hypothesis than does the U-form organizational alternative.” - Williamson, p. 134 Williamson’s contention was that all firms would have to become M-form if they grew large in order to allow the manager to efficiently use information.

7. III. What’s behind the M-form Hypothesis? Part I Maskin et. al formalize Williamson’s theory. They explain how having better access to information enables organizations to reward employees for effort by using performance incentives. This in turn enables organizations to increase productivity. This idea is related to a bigger theme we explored this quarter – providing good incentives.

8. IV. Example: U.S.S.R. vs China • Maskin et. al frame the discussion in terms of the organization of the former USSR and China since 1970s. • Russia was a U-form (managers had control over industries) • China is an M-form (control over geographic regions)

9. V. What’s behind the M-form Hypothesis? Part II “…corporate managers must strike a careful balance in an M-form. On the one hand, they must encourage competition between divisions for capital and recognition. On the other hand, they must encourage cooperation in those areas where synergies exist between divisions in order to obtain higher overall levels of performance. M-forms that are able to strike this balance will outperform both large U-forms and all H-forms. This, in a nutshell, is Williamson’s M-form Hypothesis.” - Barney and Ouchi So in addition to being able to use performance incentives, M-forms can be optimally decentralized in order to use the forces of cooperation, as well as competition.

10. VI. Example: The U.S. Federal System “…federation designers must strike a careful balance in an M-form. On the one hand, they must encourage competition between cities for residents and recognition. On the other hand, they must encourage cooperation in public goods areas where synergies exist between cities in order to obtain higher overall levels of performance. M-forms that are able to strike this balance will outperform both large U-forms and all H-forms. This, in a nutshell, is Williamson’s M-form Hypothesis.” In economics, the upshot of the 1972 Oates theorem is that lower levels of government should have authority when spillovers in public good provision are few, but higher levels of government should have authority over those public goods that have big spillovers.

11. VII. Conclusion As we have seen, many issues, such as rewarding employees for effort, and harnessing the forces of cooperation as well as competition, are present in very different types of organizations. References: • Barney, Jay B. and Ouchi, William G.Organizational Economics • Fleisher, Beltoncomment in course E508, OSU, winter 2006 • Maskin, Quin and XuIncentives, Information and Organizational Form • Oates, Wallace Fiscal Federalism • Williamson, Oliver Markets and Hierarchies