We argue that social capital as proxied by regional trust and the Rule of Law can improve aggregate productivity through facilitating greater firm decentralization. We collect original data on the decentralization of investment, hiring, production and sales decisions from Corporate Head Quarters to local plant managers in almost 4,000 firms in the US, Europe and Asia. We find Anglo-Saxon and Northern European firms are much more decentralized than those from Southern Europe and Asia. Trust and the Rule of Law appear to facilitate delegation by improving co-operation, even when we examine "bilateral trust" between the country of origin and location for affiliates of multinational firms. We show that areas with higher trust and stronger rule of law specialize in industries that rely on decentralization and allow more efficient firms to grow in scale. Furthermore, even for firms of a given size and industry, trust and rule of law are associated with more decentralization which fosters higher returns from information technology (we find IT is complementary with decentralization). Finally, we find that non-hierarchical religions and product market competition are also associated with more decentralization. Together these cultural, legal and economic factors account for four fifths of the cross-country variation in the decentralization of power within firms.Interesting that the paper shows that countries with higher trust and stronger rule of law specialise in industries that rely on decentralisation and allow more efficient firms to grow in scale. Given that tacit and local knowledge can be important players in efficient decision making, it makes sense that decentralisation would improve the decisions made since it allows better utilisation of such knowledge. What Hayek argued was true for the economy as a whole also looks like its true at the level of the firm.
Sunday, 26 July 2009
The organization of firms across countries
Peter Klein from Organizations and Markets points us to a interesting NBER working paper on The organization of firms across countries by Nicholas Bloom, Raffaella Sadun and John Van Reenen. The abstract reads,