Can What We Know About Firms Help Us to Understand the Organization of Congress?
Congress, like the firm, is designed to minimize the costs associated with ensuring contractual performance and opportunistic behavior
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When you take an introductory economics class, much of the discussion focuses on markets — and rightfully so. Economics is fundamentally about how people make decisions under the conditions of scarcity. There isn’t enough stuff for everyone to have everything they want all time. Given that recognition, how does society allocate those resources? Markets and prices are the primary (and correct) focus of those introductory classes. There is a great deal of value in understanding how prices adjust to coordinate economic behavior.
Nonetheless, there are a lot of implicit assumptions working in the background of the analysis.
For example, discussion of firm behavior focuses mostly on the profit and loss incentive. But once you understand markets, you can start to ask deeper questions about why firms do what they do. For example, think about the day-to-day operations of the firm. Some of the things that firms do involve markets. They might buy supplies or sell their goods in markets.
However, firms also establish durable relationships with their workers. Although the initial hiring decision occurs in a market, this isn’t true day-to-day. An employee’s pay is generally determined by the accepted offer of employment. They show up and get paid an agreed upon wage or salary and complete the work they are instructed to complete. Their wage or salary does not fluctuate from day-to-day based on the conditions of the market. Nor are they moving from firm-to-firm each day.
This isn’t just a story about employment. Sometimes firms purchase inputs in their production process from other firms in a market. Other times, firms produce their own inputs.
A more general way of describing this phenomenon is that for some allocation decisions, the firm decides how to allocate resources. For other allocation decisions, the market determines the allocation of resources. In other words, the firm tends to draw a line around certain activities in which it decides how to allocate resources. Outside of that line, the firm is interacting with markets. The relevant question is where the firm draws the line and why. Some answers to those questions are found in the literature on the theory of the firm.
That literature has taught us a great deal about the nature of economic organization. Thus, one might wonder whether there is broader applicability of these lessons to other forms of organization.
This would seem to be important once we consider the fact that the focus on markets and cooperation masks the fact that some resources are allocated through conflict. This can be literal conflict, such as theft or extortion. However, this could also refer to contract disputes and other issues handled through the legal system.
The political process is another means of (re)allocating resources through conflict. Politics often involves forcibly taking resources from some to give to others. Interest groups organize and emerge to encourage politicians to allocate resources in a particular way.
One question we might consider is whether we can apply the lessons from the literature on the firm to think about things like politics or, more specifically, legislation. Are there any lessons from the theory of the firm about legislatures? If we take the literature on organization within the firm seriously, this seems like a worthwhile line of inquiry to pursue. The trouble is that most people don’t see politics and legislatures this way. Politics is messy and many come to this subject with many biases about how well or how poorly the system works.
Today, we will explore this topic using lessons from a paper by Barry Weingast and William Marshall on the industrial organization of Congress.
Lessons from the Firm
The description that I gave about drawing a line around the things that are done inside the firm with the remaining things done in the market is a useful starting point. This was one of Coase’s key insights in his paper on the nature of the firm. Firms choose to allocate within the firm for certain activities but participate in markets for other activities. As Coase argued, this suggests that certain activities are less costly to do within the firm itself and other activities can be done at a lower cost through markets.
More specifically, we might think of the choice as between contractual agreements and markets. Nonetheless, even if markets are costly, contracts come with their own costs. Contracts are inherently incomplete. The cost of outlining every possible contingency will almost certainly be greater than the benefits. Even setting aside issues of completeness, there are costs associated with making sure that someone fulfills the obligations specified in the contract. For example, how does one enforce a contractual agreement when it is difficult to tell how much output is the result of worker effort and how much is due to randomness? Or when someone has private information about quality? Or when ex post incentives differ from ex ante incentives, such as when there are hold-up problems or other forms of opportunistic behavior? Issues of incomplete contracts and contractual performance therefore require that these contractual agreements are paired with an organization of the firm designed to enforce or otherwise minimize the costs of those contractual agreements.
If we think about the political process, there is a supply and demand for legislation. However, the allocation through the political process doesn’t occur in a market. Legislation is a contractual agreement. Yet, like most contractual agreements, legislation faces problems with performance and enforcement. In a system in which politicians are elected to office, how durable can such contracts truly be? After all, if the legislators are changing all the time, how can you trust the new legislators not to simply repeal prior legislation? Perhaps the legislature, like the firm, is an institution designed around enforcement and contractual performance.
Application to the Legislature
One way to think about the process of how legislation gets passed is to think about the nature of agreements between members of the legislature. Each legislator represents a particular geographic area. Within that geographic area, there are particular interest groups that advocate for policies and monitor the performance of the legislator. These legislators must be cognizant of the demands of these interest groups because they are accountable to their constituents. Although individual constituents might not pay particularly close attention to what their legislator is doing, the interest groups who do monitor the legislator also provide information to voters about performance. In short, legislators are accountable to their constituents and, in particular, the interest groups.
This external accountability is important. Nonetheless, one legislator cannot enact legislation on his or her own. Passing legislation requires support of a majority of the legislators. Of course, there is no guarantee that the interest groups are sufficiently geographically dispersed to produce a majority coalition. It therefore follows that legislators must work together to get legislation passed. This implies is that an interesting contractual problem is the one that takes place between the legislators.
One need not necessarily rely on contracts. Logrolling is a way of finding a market-like solution. One legislator agrees to vote for one piece of legislation that imposes minimal costs (or no costs) on his or her constituents in exchange for votes from other legislators on his or her preferred legislation. However, this really only resembles a market when votes are traded at the same point in time. Votes could also be made with the understanding that the vote will be repaid at some point in the future. In either case, there can be a multitude of problems.
One problem is that a legislator might vote for a road today in exchange for receiving a vote on his or her own legislation in the future. Yet the legislator who wants the road will find his or her ex post incentives differ from the ex ante incentives. In other words, once the legislation to build the road has passed, the sponsor of that legislation has a limited incentive to actually follow through by providing the necessary vote in the future.
It is also possible for circumstances to change. Perhaps the promised vote is harder to make because the legislator’s constituents have now turned against the bill and it’s no longer a small cost to vote for the bill. Or it is possible that the actual legislation differs from the promised legislation. That could be the result of being misled about the nature of the proposed legislation or it could also be that bill itself changed as a result of changing circumstances. Regardless, such changes alter the original agreement and thus the promised vote might never occur.
But even in the event that the votes for legislation are exchanged at the same point in time, it’s still possible to renege. Legislators who exchanged their vote could renege by taking part in measures to repeal the legislation that they only voted for as part of a voting trading agreement.
In theory, repeated interactions could potentially solve the problem. The literature on credit suggests that borrowers will have a greater incentive to repay the debt when they engage in repeated interactions with the lender and the lender has the means to punish default. The legislation example that I just described is no different than an IOU. One legislator is issuing an IOU to another legislator in exchange for a vote. In the event that legislators engage in repeated dealings and have the ability to punish those who renege on their promises, this could provide a mechanism to ensure cooperation and repayment.
Nevertheless, lessons from the firm are important here. Differences between ex ante and ex post incentives are a problem that repeated interactions cannot necessarily solve. Repeated interactions similarly fail to produce performance when one party has private information (e.g., lying about the nature of the future bill).
Weingast and Marshall argue that this is the role of the committee system within Congress. Committees are set up with each committee overseeing only a subset of possible legislative issues and there is a formal process for determining who sits on these committees and committee membership is durable for legislators who remain in office. Which committee that one serves on is likely to be determined by the interest groups that the legislator represents.
These characteristics are important for several reasons. First, there is competition for committee assignments. Legislators are accountable to their constituents. As such, they have a desire to sit on committees that oversee the type of legislation that is important to their constituents. Since one cannot serve on every possible committee, legislators should end up with committee assignments in line with the issues they (and their constituents) value most.
Second, committees allow for much more durable contractual-type agreements between legislators. One reason for this is that each committee has a say in what legislation gets brought to the floor for a vote. Since committees oversee particular issues, the population of the committee is made up of people who represent interest groups that care about the issues of the committee. Thus, those with a vested interest in making previous legislative agreements durable can prevent attempts to renege on previous agreements by refusing to let a bill out of committee.
Put differently, a committee’s control over the agenda automatically contributes to making previous legislative agreements durable. Because committees control the agenda, there is an inherent bias towards the status quo. This is important for the durability of legislation in the sense that it prioritizes the continuation of prior legislative agreements. Only through majority support of the committee can legislation makes its way to the floor for a vote. This is especially important because typically those who have a vested interest in protecting the status quo are members of the committee.
In short, like the firm, the committee organization in Congress is designed to ensure contractual performance, minimize costs associated with enforcement and opportunistic behavior, and maintain the durability of contractual agreements.
Concluding Thoughts
The lessons from the literature on the firm have much to offer for understanding all organizational forms. The reason for this is that the underlying issues that the firm faces are really just about contractual arrangements and the problems thereof. The structure of the firm is designed to deal with problems like incomplete contracts, contract enforcement, and opportunistic behavior. The lessons from this literature therefore offer lessons for any type of environment in which behavior can be understood as contractual (even if informally so) or where opportunistic behavior is possible. In these environments, people will seek to find the way to minimize the costs associated with enforcing agreements and opportunistic behavior.
As the work of Weingast and Marshall reveals, this type of analysis lends itself well to thinking about the organization of the legislature. In doing so, it provides us with a way of thinking about politics and the legislative process grounded in the sorts of issues that economists typically think about. This is especially important for this topic since many of us come to the issue of politics with biases about how well (or how poorly) the political process works.