The Limits of Bureaucratic Efficiency
The Limits Of Bureaucratic Efficiency
Canice Prendergast∗ University of Chicago & NBER Third Draft: May 9, 2001
Abstract Bureaucrats typically intermediate between a principal and a consumer, by diagnosing benefits for the consumer. This paper argues that bureaucratic efficiency is limited by the fact that the decisions made by bureaucrats involve rents to consumers. This means that a primary means of oversight, namely, using consumers to complain about incorrect decisions, can become ineffective. This has two implications for a bureaucracy. First, oversight becomes more difficult as customers cannot be relied upon to point out bureaucratic error. Second, it gives bureaucrats an incentive to accede to consumer demands simply to avoid a complaint. I show that when this second effect is important, bureaucracies (efficiently) respond in the following ways: (i) they ignore legitimate consumer complaints, especially those aimed at incompetent bureaucrats, (ii) they monitor more in situations where it is not needed, (iii) they correct fewer errors than in non-bureaucratic situations, (iv) they delay decision-making “too long”, and (v) oversight is biased against consumers. This paper also shows how the need for bureaucrats depends on how their allocations are priced to consumers. The primary implication of this section is that observed bureaucracies are always inefficient: the features that make bureaucrats more efficient also make them unnecessary. To phrase this another way, when bureaucracies work well, consumer choice works even better. By contrast, when bureaucratic choice works inefficiently, consumer choice works even worse. Thus bureaucratic organizations appear to work less well than those where consumers have more choice, yet here this is no fault of the bureaucracy.
I am grateful to Kent Daniel, Lars Stole, and seminar participants at Harvard University, University of Michigan, Bristol University, and the Royal Economic Society, Durham, for helpful comments. I would
Canice Prendergast∗ University of Chicago & NBER Third Draft: May 9, 2001
Abstract Bureaucrats typically intermediate between a principal and a consumer, by diagnosing benefits for the consumer. This paper argues that bureaucratic efficiency is limited by the fact that the decisions made by bureaucrats involve rents to consumers. This means that a primary means of oversight, namely, using consumers to complain about incorrect decisions, can become ineffective. This has two implications for a bureaucracy. First, oversight becomes more difficult as customers cannot be relied upon to point out bureaucratic error. Second, it gives bureaucrats an incentive to accede to consumer demands simply to avoid a complaint. I show that when this second effect is important, bureaucracies (efficiently) respond in the following ways: (i) they ignore legitimate consumer complaints, especially those aimed at incompetent bureaucrats, (ii) they monitor more in situations where it is not needed, (iii) they correct fewer errors than in non-bureaucratic situations, (iv) they delay decision-making “too long”, and (v) oversight is biased against consumers. This paper also shows how the need for bureaucrats depends on how their allocations are priced to consumers. The primary implication of this section is that observed bureaucracies are always inefficient: the features that make bureaucrats more efficient also make them unnecessary. To phrase this another way, when bureaucracies work well, consumer choice works even better. By contrast, when bureaucratic choice works inefficiently, consumer choice works even worse. Thus bureaucratic organizations appear to work less well than those where consumers have more choice, yet here this is no fault of the bureaucracy.
I am grateful to Kent Daniel, Lars Stole, and seminar participants at Harvard University, University of Michigan, Bristol University, and the Royal Economic Society, Durham, for helpful comments. I would
References: Becker, G., “Crime and Punishment: An Economic Approach.” Journal of Political Economy, 1968, Vol. 76, pp. 169-217. Cannon, Lou, “One Bad Cop”, New York Times, October 2, 2000, New York. Christian Science Monitor, “Frisking the Feds”, August 30, 2000. Dewatripont, M., I Jewitt, and J. Tirole, “Missions and the Accountability of Government Agencies”, mimeo, 1997. Dixit, Avinash, “Power of Incentives in Private Versus Public Organizations?”, American Economic Review Papers and Proceedings, 1997, May, 378-83. Friebel, Guido and Michael Raith, “Abuse of Authority and Hierarchical Communication,” mimeo, Chicago GSB, May 2001. Milbourn, Todd, Richard Shockley, and Anjan Thakor (2001) “Managerial Career Concerns and Investments in Information,” forthcoming, RAND Journal of Economics. Holmstrom, Bengt and Joan Ricart I Costa (1986), “Managerial Incentives and Capital Management”, Quarterly Journal of Economics, 101, 835-60. Holmstrom, Bengt and Paul Milgrom (1992), “Multi-Task Principal Agent Analyses: Linear Contracts, Asset Ownership and Job Design”, Journal of Law, Economics, and Organization, 7, 24-52. New York Times, “Besmirched Deportland Wrestles With the INS” August 31, 2000a, New York. Prendergast, Canice, “The Provision of Incentives in Firms”, Journal of Economic Literature, 1999, 37, 7-63. Prendergast, Canice, “The Role of Consumers in Agency Problems”, forthcoming, Economic Journal. Star Tribune, “Congressional Cures for the IRS Worse than Agency’s Ills”, August 30, 2000. Tirole, Jean, “Hierarchies and Bureaucracies: On the Role of Collusion in Organizations”, Journal of Law, Economics and Organizations, 1986, 2:2, 181-214. Tirole, Jean, “Collusion and the Theory of Organizations”, in Advances in Economic Theory: Sixth World Congress, Vol. 2. J. Laffont, ed. Cambridge: Cambridge University Press, 1992. Wilson, James, Bureaucracy, Basic Books, New York, 1989. 31