The New Economics of Organization

Over the last ten years or so, an important new approach to the study of organizations has emerged within economics. It is perhaps best characterized by three elements: a contractual perspective on organizational relationships, a theoretical focus on hierarchical control, and formal analysis via principal-agent models. This paper provides political scientists with an overview of the "new economics of organization" and explores its implications for the study of public bureaucracy. So far, positive political theory has not contributed much to our understanding of public bureaucracy. In part this is due to the unsympathetic treatment that rational modeling and most other modes of quantitative analysis have long received from students of public administration. The other side of the coin, however, is that positive theorists have not made much of an effort to develop theories of bureaucracy. Their concerns have centered around two basic mechanisms of social choice, voting and markets, and they have devoted little systematic attention to a third mechanism that is clearly important for understanding how societies and other aggregates make collective decisions. This third and relatively unexplored mechanism is hierarchy. Movement toward a positive theory of hierarchies would fill a serious gap in the social choice literature, while at the same time making a theoretical contribution that strikes to the essence of public bureaucracy, indeed of all organizations. In fact, significant steps toward a positive theory of hierarchies have very recently been taken-but by economists, not political scientists. In small numbers, of course, economists made contributions to the study of public bureaucracy some time ago with the pioneering works of Downs (1967), Tullock (1965), and Niskanen (1971). But this new wave of theoretical work is different. It is already a large, complex body of literature that is the focus of innovation and excitement among a growing number of economists, and it reflects an unusual degree of theoretical coherence and cumulative effort. Work in this tradition tends to receive orientation from a distinctive economic approach to the analysis of organizations, an approach perhaps best characterized by three elements: a contractual perspective on organizational relationships, a focus on hierarchical control, and formal analysis via principal-agent models. This approach has emerged from recent attempts to move beyond the neoclassical theory of the firm, which assumes away all organizational considerations, to a theory of economic organizations that can explain why firms, corporations, and other enterprises behave as they do. Propo