It is now widely accepted that rent-seeking (Anne Krueger, 1974) or directly unproductive profit seeking (Jagdish Bhagwati, 1982) may cause inefficiencies in the context of public sector decisions. The possibility that government decisions (for example, about taxes, quotas, franchises, or standards) may create or redistribute rents induces private parties to spend valuable resources to influence that distribution, even when such expenditures carry no social benefit. Moreover, the social cost of rent seeking can exceed the value of the resources spent trying to gain and protect rents, for example, because the fear of losing wealth through redistribution reduces the incentives for wealth creation. Treating rent-seeking activities as characteristic of public sector decision processes ignores the fact that similar phenomena are to be found in firms, unions, and other private sector organizations. Our recent work (Milgrom, 1988; our 1988, 1990 papers) attempts to identify the advantages of decision processes (private or public) that permit rent seeking, and to incorporate these into a cost-benefit analysis of optimal decision processes. Our work begins with an analysis of why rents and quasi rents arise in organizations and of the forms that the rent seeking they engender may take. Some measures to insulate the decision process from rent seeking, such as limits on the provision of by interested parties or restrictions on the range of options considered, may degrade the quality of decisions, especially by blocking the flow of valuable information. Optimal decision processes balance the costs of rent seeking against the value of obtained. Several aspects of the rules affect the opportunities that members have to spend resources trying to alter the distribution of rents. To ascertain the possibilities for rent seeking, the analyst must ask questions like: Can the parties propose new initiatives at any time? Can they give volumes of testimony in a form of their own choosing? Can they appeal adverse decisions? Are decision makers obliged to respond to the parties' initiatives? Is the range of actions that they can take in response relatively broad, rather than being tightly constrained by property rights or other formal rules? More affirmative answers to these questions lead to opportunities or greater incentives for costly rent seeking. As a kind of shorthand, we call decision processes that have of these elements more processes. The very elements that make a process open to rent seeking may also add flexibility and responsiveness, helping to ensure that important ideas and proposals are fully considered. From this perspective, the benefits of openness can (in principle) be measured by a value of information calculation, in the usual manner of statistical decision theory. Weighing the costs and benefits, it follows that a open process is desirable when the rents available for redistribution are low, and the value of the that might be acquired is high. Conversely, when the potential for redistribution is high and the value of is low, the optimal decision process is less open. This kind of reasoning helps to illuminate the variations in the decision processes that are found in many organizations. We have discussed a number of examples in our earlier work, including the characteristics of personnel departments, the contrasting patterns of decision making, employment and compensation in U.S. and Japanese firms, *Professor of Economics, Stanford University, and Jonathan B. Lovelace Professor of Economics, Graduate School of Business, Stanford University, Stanford, CA 94305, respectively. This work was supported by the National Science Foundation.

One of the most active and exciting areas of economic research over the last several years has been the use of noncooperative games of incomplete information to model industrial competition. This work has yielded not only a remarkable number of papers but also several new insights on and explanations of fundamentally important issues. The purpose of this paper is to attempt an appreciation and evaluation of this work. Because most of our individual and joint work since about 1979 has been in this mode, it will come as no surprise that we are proponents of this line of research. However, there are several questions and potential problems that we see as arising in connection with this methodology, and we will attempt to address these. First, a disclaimer. We are not attempting a survey of the applications of asymmetric information games (AIG) to industrial organization, although we will refer in a highly selective fashion to a number of prominent strands in this literature. (In particular, where any references are provided at all, they are typically only to the earliest contributions to a subject.) Even more, we do not deal with work in which informational asymmetries are important but the analysis is not game theoretic (for example, search and price dispersion, or the early work on the lemons problem and on moral hazard and adverse selection in insurance markets) or with game-theoretic treatments that assume complete information. I. AIG Methods and Applications

Where should decision rights be lodged in organizations? Michael C. Jensen and William H. Meckling (1992) argue that moving a decision away from the inherently best-informed party involves costs in communication and garbling but may lodge it with someone who has better incentives to make good decisions. Generally, however, we expect that incentives are part of the organizational design. Why not just provide incentives to those with the best information so that they make the right decisions? One reason is that the available incentive instruments must serve multiple purposes, and designing them to induce better decisions worsens performance against other organizational objectives. Our experience suggests that this is a common situation in actual organizations: the means available to affect one sort of behavior or decision inevitably affect the incentives governing other choices. Then, the design of incentive schemes and the allocation of decision rights become interlinked. This paper looks at this idea in the specific context of a principal’s problem of inducing agents to provide unobservable effort while also motivating the efficient selection of investments. Each of these problems has been extensively studied in isolation (on inducing effort, see e.g., Bengt Holmstrom [1979] and Holmstrom and Paul Milgrom [1991]; on decisions, see e.g., Eugene F. Fama and Jensen [1983], Milgrom and Roberts [1990a, b], Philippe Aghion and Jean Tirole [1997], Matthias Dewatripont and Tirole [1999]). We thus know that motivating effort is done best by rewarding agents on precise measures of their effort, not necessarily on the total value created in the firm. At the same time, it is clear that getting the right investment choices may require that the decision-makers’ rewards be tied to total value created. The difficulty is that the available measures do not allow doing both. The only available performance measures are aggregates whose component pieces cannot be disentangled, while contracts must be written in advance of learning about investment possibilities. Including many contingencies in the contracts ex ante is impossible, and ongoing renegotiation in every ex post eventuality is prohibitively costly. More formally, we assume that it is not possible to contract on investment projects, nor can the principal bargain with the agents over the adoption of these projects once they are identified. Instead, returns to projects are reflected in the performance measures available for use in the effort-incentive contracting. Then the incentives for effort and for decisions are inextricably tied together. In this framework, we explore the interactions among the design of jobs and assignment of individuals to tasks, the shape and intensity of effort incentives, and the allocation of authority over project selection. We argue that it may indeed be optimal to assign decisions rights to someone other than the best-informed party. An authority-based hierarchy then emerges endogenously, with some agents being given the right to make organizational decisions over projects that others discovered. Moreover, as in Herbert Simon (1951), those in authority will make the decisions in a self-interested way. Simon emphasized that this † Discussants: Michael Riordan, Columbia University; Bengt Holmstrom, Massachusetts Institute of Technology; W. Bentley MacLeod, University of Southern California.

Forthcoming in the American Economic Review The LeChatelier principle, in the form introduced into economics by Samuelson, asserts that at a point of long-run equilibrium, the derivative of long-run compensated demand with respect to own price is larger in magnitude than the derivative of short-run compensated demand. We introduce an extended LeChatelier principle that applies also to large price changes and to uncompensated demand as well as to a wide range of concave and nonconcave maximization problems outside the scope of demand theory. This extension also clarifies the intuitive basis of the principle.

Manufacturing is undergoing a revolution. The mass production model is being replaced by a vision of a flexible multiproduct firm that emphasizes quality and speedy response to market conditions while utilizing technologically advanced equipment and new forms of organization. The authors' optimizing model of the firm generates many of the observed patterns that mark modern manufacturing. Central to the authors' results is a method of handling optimization and comparative statics problems that requires neither differentiability nor convexity.

In the 19th century, the railroad and telegraph were at the center of a set of technological advances, physical investments and managerial innovations that transformed American industry (Alfred Chandler). Later, the automobile and telephone played a similar role in another transformation. Today, the high-tech industries include computers, telecommunications and electronics. Working on our remarkably powerful computers (even as they rapidly become obsolete), coauthoring papers by electronic mail and fax, and conversing on our portable cellular telephones, we are struck by what appears to be a self-supporting and reinforcing dynamic to the technological improvements across the electronics industries. An advance almost anywhere in the sector seems to call forth more advances across the sector. These advances are occurring contemporaneously with a broad pattern of other changes, not only in the electronics industries, but in manufacturing more generally, and not just in hardware, but in methods and organization as well. A new paradigm has begun to emerge. In contrast to traditional manufacturing firms, modern firms frequently (1) make greater use of flexible, programmable

Why Do Firms in Developing Countries Have Low Productivity? by Nicholas Bloom, Aprajit Mahajan, David McKenzie and John Roberts. Published in volume 100, issue 2, pages 619-23 of American Economic Review, May 2010