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For a different view on the foundations of cooperations, see online Perspective 2, Evolutionary foundations of cooperation.

Online Perspective 2
Evolutionary foundations of cooperation

Part B Organizational economics and management

The logic of group behavior in business and elsewhere
In following chapters, we introduce the usefulness of markets as means of generating a form of cooperation, through trades, or buying and selling. However, as is evident inside rms, not all human cooperation is through markets. People often act cooperatively in groups or, as the case may be, in rms. In this section, we make use of the rationality principles developed in Part A, applying them to the organization of groups and rms. The focus of our attention is on the viability of groups such as families, cliques, communes, clubs, unions, and professional associations and societies, as well as rms, in which individual participation is voluntary to cohere and pursue the common interests of the members. We consider two dominant and conicting theories of group behavior, both of which take a partial view of complex life and yield insight about groups. They are the common-interest theory and the economic theory of group behavior, with the economic theory the focus of the rest of the chapter because it is founded on the premise of rational behavior developed in Part A. This economic theory of groups helps us understand why rms are organized the way they are and why owners and workers alike can share a common interest in rms employing tough bosses.

Common-interest logic of group behavior

All theories of group behavior begin by recognizing the multiplicity of forces which affect group members and, therefore, groups. This is especially true of what we term the common-interest theory. Many present-day sociologists, political scientists, and psychologists generally share this point of view, which has been prominent at least since the time of Aristotle in the fourth century BC. The determinants of group

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behavior most often singled out are the leadership quality of specic group members and the need among group members for afliation, security, recognition, social status, or money. Groups such as clubs or unions form so that members can achieve or satisfy a want that they could not satisfy as efciently through individual action. All these considerations are instrumental in affecting group cohesion, which, in turn, affects the strength of the group and its ability to compete with other groups for the same objectives. From the perspective of this theory, when people join rms, they accept the rms objective and pursue it because everyone else wants the same thing, leading to self-enforcing group cohesion. The common-interest theory views the group as an organic whole, much like an individual, as opposed to a collection of individuals whose separate actions appear to be group action. According to the theory, the group has a life of its own that is to a degree independent of the individuals who comprise it. Herbert Spencer, a nineteenth-century sociologist, often described the group as a social organism or as a superorganic entity (Spencer 1896). It was probably the social-organism view of groups that Karl Marx had in mind when he wrote of the class struggle and predicted that the proletariat class would bring down bourgeois capitalism and, in its place, erect a communist society. Aristotle probably had the same view of groups in mind when he wrote, Man is by nature a political animal. Two major reasons are given for viewing groups as social organisms. First, a group consists of a mass of interdependencies, which connect the individuals in the group. Without the interdependencies, there would be only isolated individuals, and the term group would have no meaning. Individuals in groups are like the nodes of a spiders web. The spiders web is constructed on these nodes, and the movements in one part of the web can be transmitted to all other parts. Similar to the process of synergism in biology, the actions of individuals within a group combine to form a force that is greater than the sum of the forces generated by individuals isolated from one another. The group must, so the argument goes, be thought of as more than the sum total of its individuals. This argument is often used to arouse support for labor unions, for example. Union leaders argue that unions can get higher wage increases for all workers than individual workers can obtain by acting independently. The reason is that union leaders efciently coordinate the efforts of all. Environmental groups make essentially the same argument: with well-placed lobbyists, the environmental group can have a greater political impact than all the individuals they represent could have by writing independent letters to their representatives at different times. Second, groups tend to emerge because they satisfy some interest shared by all the groups members. Because all share this common interest, individuals have an intrinsic incentive to work with others to pursue that interest, sharing the costs as they work together. Aristotle wrote, Men journey together with a view to particular advantage (Ethics, 1160a) and Arthur Bentley (18701957), recognized as an

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intellectual father of contemporary political sciences and group theorist, mused, There is no group without its interest The group and the interest are not separate If we try to take the group without the interest, we simply have nothing at all (Bentley 1967, 21113). Having observed that a common interest can be shared by all of a groups members, the adherents of this theory of group behavior argue that a group can, with slight modication, be treated as an individual, meaning that the group can maximize its well-being. The implicit assumption is made that this will be true of large as well as small groups. This latter deduction prompts many economists to take issue with this approach to analysis of group behavior.

The economic logic of group behavior

Mancur Olson (193298), on whose (1971) work this section largely rests, agrees that the common interest can be inuential and is very important in motivating behavior but mainly the behavior of members of small groups. However, he, like so many other economists, insists that a group must be looked upon as a composite of rational individuals as opposed to an anthropomorphic whole, and that the common interest, which can be so effective in motivating members of small groups, can be impotent in motivating members of large groups: Unless there is coercion in large groups rational self-interested individuals will not act to achieve their common or group interest (Olson 1971, 2, emphasis in the original). Furthermore, he contends, These points hold true when there is unanimous agreement in a group about the common goal and the methods of achieving it (1971, 2). To understand this theory, we rst examine the propositions upon which it is founded, and then consider some qualications.

Basic propositions
Using economic analysis, people are assumed to be as rational in their decision to join a group (a rm or club) as they are toward doing anything else; they will join a group if the benets of doing so are greater than the costs they must bear. These costs and benets, like all others relevant to any other act, must be discounted by the going interest on borrowed funds to account for any time delay in the incurrence of the costs and receipt of any benets and by the probability that the costs and benets will be realized. There are several direct, private benets to belonging to groups, such as companionship, security, recognition, and social status. A person also may belong to a group for no other reason than to receive mail from it and, in that small way, to feel important. A group may serve as an outlet for our altruistic or charitable feelings. If by common interest we mean a collection of these types of private benets, it is

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A private good is any good or service the benets of which are received exclusively by the purchaser.

easy to see how they can motivate group behavior. Entrepreneurs can emerge to sell these types of private benets, as they do in the case of private golf clubs or WeightWatchers. The group action is then, basically, a market phenomenon that is, based in straightforward exchange of private goods. However, the central concern of this theory is a common interest that is separate and detached from the diverse private interests of members of the group. The problem arises because the public, or common, benets that transcend the entire group cannot be provided by the market, and can be obtained only by some form of collective action. That is, a group of people must band together to change things from what they would otherwise be. Examples include the common interest of an environmental group in getting antipollution A public good is a good or service the legislation passed; the interest of labor unions to benets of which are shared by all members secure higher wages and better fringe benets than of the relevant group if the good is provided could be obtained by the independent actions of or consumed by anyone. laborers; the interest of students to resist tuition increases, etc. These are examples of the common interest being a public (or collective) good, as distinguished from a private good.

Small groups
Small groups are not without their problems in pursuing the common interest of their members. They have a problem of becoming organized, holding together, and ensuring that everyone contributes her part to the groups common interest. This point is relevant to Fred and Harrys (or Crusoe and Fridays) problems of setting up a social contract considered in chapter 1, and it can be understood in terms of all those little things that we can do with friends and neighbors but that will go undone because of the problems associated with having two or three people come together for the common good. For example, it may be in the common interest of three neighbors Fred, Harry, and now Judy for all to rid their yards of dandelions. If one person does it, and the other two do not, the person who removes the dandelions may nd his yard full of them the next year because of seeds from the other two yards. Even though Fred, Harry, and Judy may not ever agree to work out their common problem (or interest) cooperatively, there are several things that make it more likely that a small group will cooperate than a large group. In a small group everyone can know everyone else. What benets or costs may arise from an individuals action are spread over just a few people and, therefore, the effect felt by any one person can be signicant. (Fred knows that there is a reasonably high probability that what he does to eliminate dandelions from the border of his property affects Harrys and Judys welfare.) If the individual providing the public good is concerned about the welfare

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of those within his group and receives personal satisfaction from knowing that he has in some way helped them, he has an incentive to contribute to the common good; and we emphasize that before the common good can be realized, individuals must have some motivation for contributing to it. Furthermore, so-called free riders are easily detected in a small group. (Harry can tell with relative ease when Fred is not working on, or has not worked on, the dandelions in his yard.) If one person tries to let the others shoulder his share, the absence of his contribution will be detected with a reasonably high probability. Others can then bring social pressure (accompanied by the sting of a cost) to bear to encourage (if not force) him to live up to his end of the bargain. The enforcement costs are low because the group is small. There are many ways to let a neighbor know you are displeased with some aspect of his behavior. Finally, in small groups, an individual shirking her responsibilities can sometimes be excluded from the group if she does not contribute to the common good (although this would be difcult in the dandelion example) and joins the group merely to free ride on the efforts of others. In larger groups, such as nations, exclusion is usually more difcult (more costly) and, therefore, less likely. The problem of organizing group behavior to serve the common interest has been a problem for almost all groups, even the utopian communities that sprang up during the nineteenth century and in the 1960s. Rosebeth Kanter, in her study of successful nineteenth-century utopian communities, concluded:
The primary issue with which a utopian community must cope in order to have the strength and solidarity to endure is its human organization: how people arrange to do the work that the community needs to survive as a group, and how the group in turn manages to satisfy and involve its members over a long period of time. The idealized version of communal life must be meshed with the reality of the work to be done in the community, involving difcult problems of social organization. In utopia, for instance, who takes out the garbage? (Kanter 1973, 64)

Kanter found that the most successful communities minimized the free-rider problems by restricting entry into the community. They restricted entry by requiring potential members to make commitments to the group. Six commitment mechanisms distinguished the successful from the unsuccessful utopias: 1 sacrice of habits common to the outside world, such as the use of alcohol and tobacco or, in some cases, sex 2 assignment of all worldly goods to the community 3 adoption of rules that would minimize the disruptive effects of relationships between members and nonmembers and that would (through, for example, the wearing of uniforms) distinguish members from nonmembers

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4 collective sharing of all property and all communal work 5 submission to public confession and criticism 6 expressed commitment to an identiable power structure and tradition. Needless to say, the cost implied in these commitment mechanisms would tend to discourage most potential free riders from joining the society. By identifying the boundaries to societies, these mechanisms made exclusion possible. As Kanter points out, the importance of these commitment mechanisms is illustrated by the fact that their breakdown foreshadowed the end of the community. The cattlemens associations formed during the nineteenth century suggest other means of bringing about collective behavior on the part of group members. At that time, cattle were allowed to run free over the ranges of the West. The cattlemen had a common interest in preventing a tragedy of the commons i.e. ensuring that the ranges were not overstocked and overgrazed (remember the discussion of the tragedy of the commons in chapter 1) and in securing cooperation in rounding up the cattle. To provide for these common interests, cattlemen formed associations that sent out patrols to keep out intruders and that were responsible for the roundups. Any cattleman who failed to contribute his share toward these ends could be excluded from the association, which generally meant that his cattle were excluded from the roundup or were conscated by the association if they were rounded up (Dennen 1975). The family is a small group, which by its very nature is designed to promote the common interest of its members. That common interest may be something called a happy family life, which is, admittedly, difcult to dene. The family obviously does not escape difculties, given the prevalence of divorces and even more common family feuds. At present its validity as a viable institution is being challenged by many sources; however, it does have several redeeming features that we think will cause it to endure as a basic component of the social fabric. Because of the smallness of the group, contributions made toward the common interest of the family can be shared and appreciated directly. Family members are able, at least in most cases, to know personally what others in the group like and dislike; they can set up an interpersonal costbenet structure among themselves that can guide all members toward the common interest. Most collective decisions are also made with relative ease. However, even with all the advantages of close personal contact, the family as a small group often fails to achieve the common interest. Given the frequent failure of the family, realized in divorces or just persistent hostilities, the failure of much larger groups to achieve their expressed common objectives is not difcult to understand.

Large groups
In a large-group setting, the problems of having individual members contribute toward the development of the common interest are potentially much greater. The

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direct, personal interface that is present in small groups is usually lacking in larger groups; and because of the size of large groups, the public good they produce is spread over such a large number of people that no one sees his actions as having a signicant effect on anyone, even themselves. As a result, no one perceives either personal benets from his contribution, or benets for others. Even when an individual can detect benets from his actions, he must weigh those benets against the costs he has to incur to achieve them. For a large group, the costs of providing detectable benets can be substantial. This can occur not only because there are more people to be served by the good but also because large groups are normally organized to provide public goods that are rather expensive to begin with. Police protection, national defense, and schools are examples of very costly public goods provided by large groups. If all people contribute to the public good, the cost to any one person can be slight; but the question confronting the individual is how much he will have to contribute to make his actions detectable, given what all the others do. In the context of a nation (a very large group indeed) suppose there are certain common objectives to which we can all subscribe, such as a specic charitable program. It is, in other words, in our common interest to promote this program (by assumption, for purposes of argument). Will people be willing to voluntarily contribute to the federal treasury for the purpose of achieving this goal? Certainly some people will, but many may not. A person may reason that although he agrees with the national objective, or common interest, his contribution will have no detectable effect in achieving it. This explains why compulsory taxes are necessary, and why philanthropic contributions are an almost nonexistent source of revenues for all governments worldwide (Olson 1971, 13). The general tenor of the argument also applies to contributions that go to organizations such as World Vision, a voluntary charitable organization interested mainly in improving the diets of impoverished people around the world. Many readers of these pages will have been disturbed by scenes of undernourished and malnourished children shown in TV commercials for World Vision. But how many people ever actually contribute so much as a dollar? Needless to say, many do give. They are like Harry, who is willing to dig, voluntarily, some of the weeds from his yard. On the other hand, a very large number of people who have been concerned never make a contribution. There are many reasons for people not giving, and we do not mean to understate the importance of these reasons; we mean only to emphasize that the large-group problem is one signicant reason. True, if all members of a large group make a small contribution toward the common interest, whatever it is, there may be sizable benets to all within the group. But, again, the problem that must be overcome is the potential lack of individual incentives from which the collective behavior must emerge. In large

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groups, the Prisoners Dilemma problems we highlighted in talking about a twomember group, Fred and Harry, are ever present and magnied, again because the larger the group, the less detectible are the consequences of individual behavior and the less monitoring of behavior can be done. Through appropriate organization of group members, the common interest may be achieved, even if the membership is large. The organization of a large group can be construed as a public good, and making the organization workable is likely to incur costs for two reasons. First, there are a large number of people to organize, which means that even if group members are not resistant to being organized, there will be costs associated with getting them together or having them work at the same time for the same objectives. Second, some individuals may try to free-ride on the efforts of others, which means it will cost more to get people to become members of the group. Further, each free-rider implies a greater burden on the active members of the group. If everyone waits for the other guy to take the initiative, the group may never be organized. Organizational costs often prevent students who complain about the instructional quality of the faculty or some other aspect of university life from doing anything about it. The same costs block people who are disgruntled with the two major political parties from forming a party among those who share their views. The probability of getting sufcient support is frequently very low, which is another way of saying the expected costs are high. The free-rider problem may emerge in the workplace as worker absenteeism for a variety of reasons, including sickness, real or feigned (Barham and Begum 2005, 157). The Confederation of British Industry found that, in 2006, the British economy lost 175 million days of work from absenteeism, which continued to escalate beyond what could be attributable to understandable reasons, such as illness.2 Not surprisingly, the rate of absence for sickness was higher in the public sector than in the private sector (perhaps attributable in part to the pressure of private rms to avoid losses and make a prot). Consistent with the logic of collective action as developed in this chapter, another study found that the rate of absences for illness during the survey week was 29 percent higher in private rms with 500 workers than in rms with fewer than twenty-ve workers (Barham and Begum 2005, 154). Economist Stephen Levitt and journalist Stephen Dubner (2005) report on their ndings from the sales data collected by Paul Feldman, who sold bagels on the honor plan for many years in Washington, DC. Feldman would leave bagels early in the morning at gathering places for ofce workers. The workers were initially
2

As reported by the consulting rm of Smith & Williamson in 2008, with the report accessed on January 7, 2009 from www.mondaq.com/article.asp?articleid=52770.

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asked to leave their payments in open baskets. Because the money often was taken from the baskets, Feldman made wooden boxes with slits in the top for depositing payments. Initially, in the early 1980s, when he started his bagel business, Feldman suffered a 10 percent loss of bagels (that is, he received no payment for 10 percent of the bagels he left). After 1992, his losses of bagels began a slight but steady rise. By 2001, he reached 13 percent over all companies, only to go back down to 11 percent during the two years following 9/11. (Levitt and Dubner speculate that the 15 percent decline in the nonpayment rate possibly could be attributed to the fact that many of his DC customers were connected to national security with a heightened sense for doing what was right.) Relevant to the logic of collective action, Feldman found that honesty measured by payments received for bagels was marginally affected by rm size: An ofce with a few dozen employees generally outpays by 3 to 5 percent an ofce with a few hundred employees (Levitt and Dubner 2005 and 2006, 49). We have to suspect that the difference in the payment rate between small and large ofces might be greater were the required payment higher than the price of a bagel.

The relevance of market prices in large-group settings

Of course, because of scarcity, people everywhere share the common interest of ensuring that the available resources are used efciently, which means for those things people desire most and in the most cost-effective manner. If resources are used efciently, most wants can be satised than otherwise. How do you get large groups of consumers to contribute to the common good of efciently using resources through their buy decisions? One means of encouraging conservation and smart purchases in large-group settings is the pricing system. As to be discussed in chapter 3, when electricity or gasoline becomes scarce and the market supply contracts, the prices of those products rise, and consumers are induced to curb their consumption of those goods by reducing their purchases for those uses that are valued more highly than the higher prices. Restrict prices from rising when products become more scarce, and consumers will fall into the largegroup trap: they will continue to buy as if nothing had happened to the scarcity of the products. Consumers can reason that their continued consumption at old levels will have no impact on the overall availability of the product, which means they will not conserve when the greater scarcity of the good indicates that they should. In December 2003, for a variety of reasons, California suffered through a serious reduction in the supply of electricity, with threatened brownouts. Peoples common interest was to conserve on electricity consumption, but government authorities held the price of electricity at its old level. The result was to be expected: very little in the way of conservation. People lit up their Christmas trees

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and other decorations as if nothing had happened. However, when oil supplies dropped sharply in the rst half of 2008, the average price of gasoline in the country soared in the state to nearly $5 a gallon, and guess what happened? People did what was really in their common interest; they curbed their consumption of gasoline in a multitude of large ways (driving less and parking their large SUVs and RVs) and small ways (reducing the frequency with which they accelerated rapidly when stoplights turned green).

Qualications to the economic theory

Obviously, there are many cases in which people in rather large groups appear to be trying to accomplish things that are in the common interest of the membership. Early in the civil rights struggle, the League of Women Voters pushed hard for passage of the Equal Rights Amendment to the Constitution; labor unions work for minimum wage increases; the American Medical Association lobbies for legislation that is in the common interest of a large number of doctors; and many charitable groups work fairly effectively for the public interest. Several of the possible explanations for this observed behavior force us to step outside the standard economic arguments about public goods. First, as Immanuel Kant, an eighteenth-century philosopher said, people can place value on the act itself as distinguished from the results or consequences of the act (1781). The act of making a charitable contribution, which can be broadly dened to include picking up trash in public areas or holding the door for someone with an armful of packages, may have a value in and of itself. This is true whether the effects of the act are detectable to the individual making the charitable contribution or not. To the extent that people behave in this way, the public good theory loses force. Notice, however, that Olson, in formulating his argument, focused on rational, economic man (or woman) as opposed to the moral man (or woman) envisioned by Kant. We expect that as the group becomes larger, a greater effort will be made to instill people with the belief that the act itself is important. Second, when the Homo sapiens brain was forming eons ago, people lived in small to moderate-size groups, with maybe 25 to 150 members, for purposes of protection, survival, and sharing shelter and food supplies. The human brain can be hardwired to cooperate with other tribe members, perhaps inclined to think of the relevant group as small, no matter its actual size, which can lead to viable voluntary cooperative behavior in groups larger than the economic theory of groups would suggest. Third, the contribution that a person has to make in group settings is often so slight that, even though the private benets are small, the contribution to the common interest is also small and can be a rational policy course. This may explain,

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for example, student membership in groups such as a local Chamber of Commerce. All one has to do in many situations is to show up at an occasional meeting and make a small dues payment. Further, the private benets of being with others at the meetings and nding out what the plans are for the association can be sufcient incentive to motivate limited action in the common interest. Fourth, all group members may not share equally the benets received from promotion of the common interest. One or more persons may receive a sizable portion of the total benets and, accordingly, be willing to provide the public good, at least up to some limit. Many businessmen are willing to participate in local politics or to support advertising campaigns to promote their community as a recreational area. Although a restaurant owner may believe that the entire community will benet economically from an inux of tourists, he is surely aware that a share of these benets will accrue to him. Businessmen may also support such community efforts because of implied threats of being socially ostracized. Fifth, large organizations can be broken down into smaller groups. Because of the personal contact with the smaller units, the common interest of the unit can be realized. In promoting the interest of the small unit to which they belong, people can promote the common interest of the large group. The League of Women Voters is broken down into small community clubs that promote interests common to other League clubs around the country. The national Chamber of Commerce has local chapters. The Lions Club collectively promotes programs to prevent blindness and to help the blind; members do this through a highly decentralized organizational structure. Quite often, a multiplicity of small groups is actually responsible for what may appear to be the activity of a large group. Large rms almost always divide their operations into divisions and then smaller departments. The decentralization that is prevalent among voluntary and business groups tends to support the economic view of groups. Sixth, large groups may be viable because the group organizers sell their members a service and use the prots from sales to promote projects that are in the common interest of the group. The Sierra Club, which is in the forefront of the environmental movement, is a rather large group that has members in every part of North America. The group receives voluntary contributions from members and nonmembers alike to research and lobby for environmental issues. However, it also sells a number of publications and offers a variety of environmentally related tours for its members. From these activities, it secures substantial resources to promote the common interest of its membership. The American Economic Association (AEA) has several thousand members. However, most economists do not belong to the AEA for what they can do for it; they join primarily to receive its journal and to be able to tell others that they belong both of which are private

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benets. The AEA also provides economists with information on employment opportunities. Seventh, the basic argument for any group is that people can accomplish more through groups than they can through independent action. This means that there are potential benets to be reaped (or, some may say, skimmed off) by anyone who is willing to bear some of the cost of developing and maintaining the organization. A business rm is fundamentally a group of workers and stockholders interested in producing a good (a public good, to them). They have a common interest in seeing a good produced that will sell at a prot. The entrepreneur is essentially a person who organizes a group of people into a production unit; she overcomes all the problems associated with trying to get a large number of people to work in their common interest by providing workers with private benets that is, she pays them for their contribution to the production of the good. The entrepreneur-manager can be viewed as a person who is responsible for reducing any tendency of workers to avoid their responsibilities to the large-group rm. The general point that emerges from our discussion of incentives within small and large groups is that, as a group grows in size, shared values can become progressively inconsequential in motivating people to act cooperatively. This means that as a group grows, alternative mechanisms incentives and organizational and nancial structures must be developed to supplant the power of shared values in achieving the shared goals (with the shared goals including such matters as rm protability, worker job security, social and environmental ends). Effective management can be construed as nding ways to overcome the large-group problems, which often reduce to Prisoners Dilemmas. Of course, disincentives that discourage people from doing anything working or contributing to a groups welfare can be as important for management and public policies as incentives. Online, we provide several additional readings that complement the analyses developed in this chapter:
*

In online Reading 2.1 for this chapter, we show how disincentives can affect, and even limit, public benets going to disadvantaged groups. In online Reading 2.2, we show how rational-behavior precepts can be used to conceptualize optimum management snooping on workers who may be using work time to play games and shop online. In online Reading 2.3, we explain how the varying risk aversion across people helps explain why rms tend to be owned by capital investors, not workers. Finally, in Reading 2.4, you will nd an explanation from economists and political scientists, specializing in public choice economics (or the application of economic theory to politics), for why so few eligible voters vote and why many voters are ill-informed about prominent policy issues.