Paul Krugman calls 1913 the high-water mark of the First Global Economy. He notes, that over the preceding century, the world economy had been transformed by technology and the widespread acceptance of the belief that free markets, with secure property rights, were the best way to achieve economic progress.
After 1913 the market atrophied -- long-distance trade shrunk, private international movements of capital virtually disappeared, and a third of the world rejected private property.
How does one explain this reversal? Perhaps, more importantly, how does one explain the even more astonishing reversal of fortune that, at the start of the 21st century, the world has returned to more or less the same ideology of free markets, small governments, and sound money that prevailed at the beginning of the 20th.
The answer to the first question must be that bureaucracies replaced alternative institutional arrangements, primarily markets in the first half of the 20th century because they outperformed them. How? Presumably, or so Alfred Chandler argues, because of technological innovations that led to massive economies of scale and/or scope.
What were the changes in technology that caused bureaucracies to out-perform markets? Here the surprising answer is changes in organizational arrangements themselves. That is: changes in organizational design, personnel systems, operational engineering, accounting systems, and control technologies. This answer reflects the currently fashionable view among economists that the comparative advantage of institutional arrangements boils down to a question of information costs and that actual arrangements are solutions to information problems &emdash; the costs associated with search, bargaining, monitoring, and enforcement. Hence, transformations in organizational arrangements must be largely driven by changes in information costs.
Elsewhere, Gil Reschenthaler and I (1994) have argued that changes in organizational arrangements produced four major shifts in the comparative advantage of alternative institutions in the late 19th century. These are:
1. The efficacy of centralized allocation and ex-ante control increased relative to decentralized allocation of resources and ex-post control, which had the effect of increasing the payoff to scale.
2. The efficacy of functional structures increased relative to process-oriented structures, which had the effect of increasing the payoff to scope.
3. The efficacy of hierarchically coordinated systems increased relative to self-organizing systems, which had the effect of increasing the payoff to vertically integrated systems of command and control.
4. The relative efficacy of government provision and control increased, which had the effect of decreasing the payoffs to free markets, secure property rights, and minimal government intervention.
Of course, if these shifts explain the rise of bureaucracy might not recent innovations in organizational design, operational engineering, accounting systems, and control technologies, by reversing these shifts, also suffice to explain its fall?
Prussians perfected the bureaucratic model: Heinrich von Stein, Gerhard von Scharnhorst, August von Gneisenau, and Helmuth von Moltke during the 19th century. Their administrative innovations included detailed centralized materials requirements and logistical planning, control by rules, standard operating procedures, and the merit principle, functional administrative design, decomposition of tasks to their simplest components and narrow job descriptions, and sequential processing.
The American contribution to this system lay primarily in activity and cost measurement, in process engineering: standardization of components, processes, and products, and in the use of electric motors to reconfigure workflow. These innovations made possible the moving, or continuous, assembly line, in which each assembler performed a single, repetitive task. The moving...
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