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  • American Economic Association

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  • Norms and Networks in Economic and Organizational Performance

    By VICTOR NEE*

    Analyzing institutions and the part they play in governing economic action has comprised the central problem addressed by the new institu- tional economics. This paradigm has made im- pressive progress in explaining a wide array of economic activity by extending the tools of stan- dard economic theory to examine institutions. Thus far, new institutional economics has em- phasized understanding the part played by formal institutional arrangements: contracts, property rights, laws, regulations, and the state. In recent years, new institutionalists have also incorporated a focus on informal constraints, principally norms and networks. These studies examine how infor- mal constraints provide a framework for collec- tive action and furnish an alternative mechanism in enforcing the rules of the game and facilitating transactions between economic actors (e.g., Robert Ellickson, 1991). But they do not exam- ine the manner in which informal and formal con- straints combine to shape the performance of organizations and economies.

    The economics of organizations pio- neered by Ronald Coase (1937) and Oliver Williamson ( 1975) proffers predictive hy- potheses as to the forms of organization and governance structure likely to emerge. On a larger canvass, Douglass North (1981) ex- tended his theory of the state to explain the political conditions that give rise to efficient property rights favorable to economic growth. These theories emphasize the causal signifi- cance of formal constraints in making predic- tions about economic and organizational performance.

    However, explanations by reference to in- stitutional effects are problematic without a theory of the nature of the relationship be- tween formal and informal constraints. What is the nature of the relationship between infor-

    mal and formal constraints in explaining vari- ation in performance? Informal constraints embedded in norms and networks, operating in the shadows of formal organizational rules, can both limit and facilitate economic action. Informal constraints can give rise to inefficient allocation of resources when private entrepre- neurial networks collude to secure resources from government for their group, resulting in structural rigidities and economic stagnation (Mancur Olson, 1982). They can also facili- tate the growth of a new industry by providing a framework for trust and collective action, as documented in a case study of Thomas Edison and the rise of the electric utility industry (Patrick McGuire et al., 1993).

    Unless the nature of the relationship be- tween informal and formal constraints is better specified, the inclusion of informal constraints by new institutionalists contributes to a prob- lem of indeterminacy. Transaction-cost rea- soning based on analysis of formal constraints may identify the optimal institutional arrange- ment from the vantage point of the corporate actor, but this may be abraded by informal norms and networks operating to realize inter- ests and preferences of individuals in sub- groups. Uncertainty about whether informal constraints in a particular institutional environ- ment will function in opposition or in harmony with the formal rules accentuates a difficulty of prediction in the new institutional econom- ics. How is it possible to extend the same transaction-cost reasoning to the domain of ongoing social relationships, where economic theory runs into predictable trouble in account- ing for something as elusive as sentiment and identities?

    I. Informal Norms and Networks: Examples

    In transition economics, rulers implemented far-reaching transformation of formal rules of the game to institute market economies.

    * Department of Sociology, 312 Uris Hall, Cornell University, Ithaca, NY 14853.

    85

  • 86 AEA PAPERS AND PROCEEDINGS MAY 1998

    Economic analyses of transition economies tend to focus on the changes in the institutional framework resulting in (and from) the disman- tling of state control over economic activity- for good reason, as those changes shift incentives away from bargaining with bureau- crats in political markets toward seeking profit and gain in economic markets. But whether rul- ers followed blueprints of capitalist transition provided by Western economists or pursued a trial-and-error evolutionary approach, the behav- ior of economic actors frequently bears little resemblance to the legitimate courses of action stipulated by the formal rules. Instead, networks based on personal connections serve to organize market-oriented economic behavior according to informal norms reflecting the private expecta- tions of entrepreneurs and politicians. They act in the shadow of the state, often at odds with the goals formulated by rulers. In China, infor- mal privatization and local arrangements have contributed to a remarkable two decades of sus- tained economic growth. But in Russia, mafia- like business networks have operated to obstruct Boris Yeltsin's efforts at building a modern mar- ket economy. What accounts for the difference in results? One thing is certain: a one-sided focus on either formal or informal constraints would miss the boat in understanding economic behav- ior in transition economies.

    In advanced market economies, informal constraints influence productivity to a larger extent than has been readily acknowledged by economists. The workaday norms and net- work structure of workers have a decisive ef- fect on organizational performance, as Fritz Roethlisberger and William Dickson's study (1939) of a work group in the Western Elec- tric Company's Hawthorne Plant documents. This work group's productivity was not regu- lated by management, since the foreman as- signed to the group chose not to enforce formal organizational rules so as not to sacrifice his good relationships with the men in the work group. Instead, he chose to side with workers and to "wink" at activities in the workshop that violated formal rules. In practice, group performance was regulated by an informal out- put norm, which limited production to two pieces of equipment a day. This output was considered satisfactory by management; how- ever, it was not as great as it could have been

    if worker fatigue were the limiting factor. Workers enforced the "restriction of output" by submitting offenders to merciless ridicule. They called a fellow worker who exceeded the informal output norm a "rate-buster" or "speed king," while they labeled someone who fell below the norm a "chiseler," for cut- ting down the earnings of the group. "Bing- ing" (hitting as hard as possible on the upper arm) was meted out to fellow workers who worked either too fast or too slow. Workers who consistently conformed to the informal output norm enjoyed higher informal rank, re- flected in social approval from fellow workers and a position of centrality in the network structure, while those who regularly violated the output norm were ostracized.

    Although these examples (work group and transition economies) are drawn from very different institutional environments, there is a common thread. In both kinds of contexts, the formal constraints have established the param- eters of legitimate action, providing the insti- tutional mold within which emergent norms and networks operate. This is seen in transition economies where the state still controls re- sources needed by entrepreneurs who must manage their firms in quasi-markets. Not sur- prisingly partial reform and quasi-markets re- sult in "crony capitalism," characterized by strategic network ties between entrepreneurs and politicians. Similarly, in the Hawthorne Plant of the Western Electric Company, the informal norm emerged in response to the group piece-rate program designed by man-" agement to encourage workers to work up to the limit imposed by fatigue. Workers instead enforced the informal norm as a "satisficing" strategy in opposition to the formal rules. In both kinds of contexts, the informal over- whelmed the formal rules of the game in shap- ing economic action. Network ties provided the basis for trust and identity in close-knit groups, and informal norms enabled actors to engage in collective action to realize their preferences and interests.

    Il. The Relationship between Formal and Informal Constraints

    Herein lies the problem. Formal rules are produced and enforced by organizations such

  • VOL. 88 NO. 2 THE NEW INSTITUTIONAL ECONOMICS 87

    as the state and firm to solve problems of col- lective action through third-party sanctions, while informal norms arise out of networks and are reinforced by means of ongoing social relationships. To the extent that members of networks have interests and preferences inde- pendent of what rulers and entrepreneurs want, the respective contents of informal norms and formal organizational rules are likely to reflect opposing aims and values.

    Unlike formal rules, the monitoring of in- formal norms is intrinsic to the social relation- ship, and enforcement occurs informally as a by-product of social interaction. Norms are implicit or explicit rules of expected behavior that embody the interests and preferences of members of a close-knit group or a commu- nity. The norm of "publish or perish," for ex- ample, articulates the preference of senior faculty and administrators in research univer- sities where the ranking of a department and university is based on the research productiv- ity of its faculty. The formal procedures of promotion review, providing an institutional- ized mechanism to enforce a high standard of faculty quality, preceded the emergence of the "publish or perish" norm. The formal rules emphasize teaching and research. But accord- ing to the norm of "publish or perish," indi- vidual faculty members are expected to devote their best effort to research and writing. Al- though teaching and department citizenship are valued, the norm makes the priority clear. Faculties strive to maintain a high standard of research productivity because it is in their col- lective interest to secure a high national rank- ing for their departments. But the everyday interactions of faculty members enforce the in- formal norm of "publish or perish" to the ex- tent that those who are "active" enjoy social approval and higher social rank, and those who are unproductive are marginalized. Inso- far as norms help solve the problem of coor- dination and collective action, they enable actors to capture the gains from cooperation, which in the case of "publish or perish" is a higher national ranking, research funding, and the capacity to attract better students.

    The proposition that individuals jointly pro- duce and uphold norms to capture the gains of cooperation opens the way to specifying the relationship between informal and formal con-

    straints (Nee and Paul Ingram, 1998). It is consonant with Ellickson's (1991) welfare- maximizing hypothesis for workaday norms: "Members of a close-knit group develop and maintain norms whose content serves to max- imize the aggregate welfare that members obtain in their workaday affairs with one an- other." Both assume that norms are ideas that arise from the problem-solving activities of human beings in their strivings to improve their chances for success (the attainment of rewards) through cooperation. Informal norms arise through trial and error and are adopted by members of a group when they result in success. Whether members of a group are in- dividually rewarded governs the selection of a norm. The core assumption behind each prop- osition is that informal norms embody inter- ests and preferences that can only be realized by means of collective action.

    III. Congruent, Decoupled, and Opposition Norms

    When the formal rules of an organization are perceived to be congruent with the pref- erences and interests of actors in subgroups, the relationship between formal and informal norms will be closely coupled. The close cou- pling of informal norms and formal rules is what promotes high performance in organi- zations and economies. Wheni the informal and formal rules of the game are closely coupled, they are mutually reinforcing. This is illus- trated in the case of research universities in the close coupling between formal review proce- dures gauging and rewarding research produc- tivity and the informal norm of "publish or perish." It is also seen in the congruence be- tween informal norms of fair play and formal rules in competitive games. When informal and formal norms are closely coupled, it is of- ten difficult to demarcate the boundaries be- tween informal and formal social control. Close coupling of informal and formal con- straints results in lower transaction costs be- cause monitoring and enforcement can be accomplished informally. The cost of social rewards to achieve conformity to norms is low because it is produced spontaneously in the course of social interactions in networks of personal relations. By contrast, the greater the

  • 88 AEA PAPERS AND PROCEEDINGS MAY 1998

    reliance on formal sanctions, the higher the transaction costs involved in maintaining compliance.

    When the formal rules are at variance with the preferences and interests of subgroups in an organization, a decoupling of the informal norms and practical activities, on the one hand, and the formal rules, on the other hand, will occur. As John Meyer and Brian Rowan (1977) observe, decoupling "enables organizations to maintain standardized, legitimating, formal structures, while their activities vary in re- sponse to practical considerations." For certain types of organizations, particularly those (such as public schools and government agencies) for whose output there is not a competitive market, formal organizational rules will be largely ceremonial, designed to satisfy external con- stituents that provide the organization with le- gitimacy. Independent of this ceremonial formal structure, informal norms arise to guide the day-to-day business of the organization.

    Informal norms evolve into "opposition norms" if institutions and organizational sanc- tions are weak relative to contradicting group interests. Opposition norms encourage indi- viduals to directly resist formal rules. In state socialist societies where the state-managed economy was widely perceived to be at odds with the interests of economic actors, opposi- tion norms emerged to organize what came to be known as the illegal "second economy." Elsewhere too, when the organizational lead- ership and formal norms are perceived to be at odds with the interests and preferences of actors in subgroups, informal norms opposing formal rules will emerge to "bend the bars of the iron cage" of the formal organizational rules. Opposition norms have the most nega- tive implication for performance. They give rise to organizational conflict and factionalism and often result in low morale.

    IV. Concluding Remarks

    Institutional design requires a combination of poetry and science. The cold rationalist view based on the extension of standard economic theory to analyze the workings of institutions is effective so far as the formal organizational rules are concerned. However, in the domain of in- formal norms and networks of ongoing social

    relationships, a poet's insight into the human condition may prove to be as useful in institu- tional design as science. In a recent Gallup Or- ganization survey of 55,000 workers to match employee attitude to organizational perfor- mance, four attitudes were found to be strongly correlated with company results: that workers feel they are provided the opportunity to do their best work, that they feel their opinions matter, that they are confident that fellow workers are also committed to quality, and that they sense their effort contributes directly to the company's success (Linda Grant, 1998). All of these mat- ters involve sentiment and identity, which confer a sense of self-worth and purpose realized in the workplace. In other words, informal norms are not always utilitarian in content as they also embody more intangible states of sentiment and identity that arise from ongoing social relationships.

    Notwithstanding, to the extent that the for- mal rules are consonant with the preferences and interests of organizational actors, informal processes of social control largely subsume the cost of monitoring and enforcement. It is this circumstance that affords for lower transaction costs, often leading to high economic and or- ganizational performance. When rulers and entrepreneurs ignore or ride roughshod over this principle, they are likely to confront op- position norms and networks that organize re- sistance to their goals.

    REFERENCES

    Coase, Ronald H. "On the Nature of the Firm." Economica, November 1937,4, pp. 386-405.

    Ellickson, Robert. Order without law. Cam- bridge, MA: Harvard University Press, 1991.

    Grant, Linda. "Happy Workers, High Re- tums." Fortune, 12 January 1998, 137(1), pp. 81-92.

    McGuire, Patrick; Granovetter, Mark and Schwartz, Michael. "Thomas Edison and the Social Construction of the Early Electric- ity Industry in America," in Richard Swedberg, ed., Explorations in economic sociology. New York: Russell Sage Foun- dation, 1993, pp. 213-48.

    Meyer, John W. and Rowan, Brian. "Institution- alized Organizations: Formal Structure as

  • VOL. 88 NO. 2 THE NEW INSTITUTIONAL ECONOMICS 89

    Myth and Ceremony. American Journal of Sociology, September 1977, 83(2), pp. 340-63.

    Nee, Victor and Ingram, Paul. "Embeddedness and Beyond: Institutions, Exchange and So- cial Structure," in M. Brinton and V. Nee, eds., The new institutionalism in sociology. New York: Russell Sage Foundation, 1998, pp. 19-45.

    North, Douglass C. Structure and change in eco- nomic history. New York: Norton, 1981.

    Olson, Mancur. The rise and decline of nations: Economic growth, stagflation, and social ri- gidities. New Haven, CT: Yale University Press, 1982.

    Roethlisberger, Fritz J. and Dickson, William J. Management and the worker. Cam- bridge, MA: Harvard University Press, 1939.

    Williamson, Oliver E. Markets and hierarchies: Analysis and antitrust implications. New York: Free Press, 1975.

    Article Contentsp. 85p. 86p. 87p. 88p. 89

    Issue Table of ContentsThe American Economic Review, Vol. 88, No. 2, Papers and Proceedings of the Hundred and Tenth Annual Meeting of the American Economic Association (May, 1998), pp. i-viii+1-538+i-xxiiVolume Information [pp. i - vi]Front MatterEditors' Introduction [p. vii]Foreword [p. viii]Richard T. Ely LectureTurnpikes [pp. 1 - 14]

    Clio and the Economic Organization of ScienceCommon Agency Contracting and the Emergence of "Open Science" Institutions [pp. 15 - 21]Revolution from above: The Role of the State in Creating the German Research System, 1810-1910 [pp. 22 - 27]Academic Science and Technology in the Service of Industry: MIT Creates a "Permeable" Engineering School [pp. 28 - 33]Federal Government Initiatives and the Foundations of the Information Technology Revolution: Lessons from History [pp. 34 - 39]

    Historical Perspectives on Current Issues of Economic PerformanceMicro Rules and Macro Outcomes: The Impact of Micro Structure on the Efficiency of Security Exchanges, London, New York, and Paris, 1800-1914 [pp. 40 - 45]The Peace Dividend in Historical Perspective [pp. 46 - 50]Wages and Labor Markets before the Civil War [pp. 51 - 56]

    Useful Microeconomics from Business HistoryRepresentative Firm Analysis and the Character of Competition: Glimpses from the Great Depression [pp. 57 - 61]Survival and Size Mobility among the World's Largest 100 Industrial Corporations, 1912-1995 [pp. 62 - 65]Partnerships, Corporations, and the Theory of the Firm [pp. 66 - 71]

    The New Institutional EconomicsThe New Institutional Economics [pp. 72 - 74]The Institutions of Governance [pp. 75 - 79]Historical and Comparative Institutional Analysis [pp. 80 - 84]Norms and Networks in Economic and Organizational Performance [pp. 85 - 89]

    What We Get for Health-Care SpendingTechnological Change in Heart-Disease Treatment. Does High Tech Mean Low Value? [pp. 90 - 96]The Value of Health: 1970-1990 [pp. 97 - 100]Economic Effects of Reducing Disability [pp. 101 - 105]Measuring Prices and Quantities of Treatment for Depression [pp. 106 - 111]Public Funds, Private Funds, and Medical Innovation: How Managed Care Affects Public Funds for Clinical Research [pp. 112 - 116]

    The Changing Market for Health InsuranceThe Demand for Medical Care: What People Pay Does Matter [pp. 117 - 121]Adverse Selection and Adverse Retention [pp. 122 - 126]Payment Heterogeneity, Physician Practice, and Access to Care [pp. 127 - 131]What Has Increased Medical-Care Spending Bought? [pp. 132 - 136]

    Social Security and the Real Economy: Evidence and Policy ImplicationsSocial Security: Privatization and Progressivity [pp. 137 - 141]Perspectives on the Social Security Crisis and Proposed Solutions [pp. 142 - 150]Social Security and the Real Economy: An Inquiry into Some Neglected Issues [pp. 151 - 157]

    Social Security and Declining Labor-Force Participation: Here and AbroadSocial Security and Retirement: An International Comparison [pp. 158 - 163]Social Security and Labor-Force Participation in the Netherlands [pp. 164 - 167]Pensions and Labor-Market Participation in the United Kingdom [pp. 168 - 172]Social Security and Declining Labor-Force Participation in Germany [pp. 173 - 178]

    Informing Retirement-Security Reform401 (k) Plans and Future Patterns of Retirement Saving [pp. 179 - 184]The Cause of Wealth Dispersion at Retirement: Choice or Chance? [pp. 185 - 191]Socioeconomic Status and Health [pp. 192 - 196]Extending the Consumption-Tax Treatment of Personal Retirement Saving [pp. 197 - 201]

    Women and Retirement IssuesMarried Women's Retirement Expectations: Do Pensions and Social Security Matter? [pp. 202 - 206]Gender Differences in the Allocation of Assets in Retirement Savings Plans [pp. 207 - 211]How Are Participants Investing Their Accounts in Participant Directed Individual Account Pension Plans? [pp. 212 - 216]

    Life-Cycle and Cohort Studies of AgingAging in the Early 20th Century [pp. 217 - 221]The Rise of the Welfare State and Labor-Force Participation of Older Males: Evidence from the Pre-Social Security Era [pp. 222 - 226]Secular Trends in the Determinants of Disability Benefits [pp. 227 - 231]The Evolution of Retirement: Summary of a Research Project [pp. 232 - 236]

    Demographic Trends and Economic ConsequencesUncertain Demographic Futures and Social Security Finances [pp. 237 - 241]Demographic Analysis of Aging and Longevity [pp. 242 - 247]Aging and Inequality in Income and Health [pp. 248 - 253]

    Intergenerational RelationsGenerations and the Distribution of Economic Well-Being: A Cross-National View [pp. 254 - 258]Relative Cohort Size and Inequality in the United States [pp. 259 - 264]Intergenerational Transmission of Health [pp. 265 - 270]

    On the Economics of GivingTransfers, Empathy Formation, and Reverse Transfers [pp. 271 - 276]The Prestige Motive for Making Charitable Transfers [pp. 277 - 282]Tax Policy and Gifts [pp. 283 - 288]

    Tax and Human-Capital PolicyTaxes, Uncertainty, and Human Capital [pp. 289 - 292]Tax Policy and Human-Capital Formation [pp. 293 - 297]Does Government R&D Policy Mainly Benefit Scientists and Engineers? [pp. 298 - 302]

    Rethinking Public EducationThe Origins of State-Level Differences in the Public Provision of Higher Education: 1890-1940 [pp. 303 - 308]How Much Does School Spending Depend on Family Income? The Historical Origins of the Current School Finance Dilemma [pp. 309 - 314]Demographic Change, Intergenerational Linkages, and Public Education [pp. 315 - 320]

    Work or Leisure: A Changing Decision?When We Work [pp. 321 - 325]Assortative Mating by Schooling and the Work Behavior of Wives and Husbands [pp. 326 - 329]The Unequal Work Day: A Long-Term View [pp. 330 - 334]

    What Is Poverty and Who Are the Poor? Redefinition for the United States in the 1990'sAbsolute versus Relative Poverty [pp. 335 - 341]Self-Reliance as a Poverty Criterion: Trends in Earnings-Capacity Poverty, 1975-1992 [pp. 342 - 347]Alternative Historical Trends in Poverty [pp. 348 - 351]Poverty-Measurement Research Using the Consumer Expenditure Survey and the Survey of Income and Program Participation [pp. 352 - 356]

    African-American Economic Gains: A Long-Term AssessmentRace and Class in Postindustrial Employment [pp. 357 - 362]Quit Behavior as a Measure of Worker Opportunity: Black Workers in the Interwar Industrial North [pp. 363 - 367]Assessing 50 Years of African-American Economic Status, 1940-1990 [pp. 368 - 375]

    Theoretical and Empirical Developments in Cost-Benefit Analysis and Program EvaluationImagined Risks and Cost-Benefit Analysis [pp. 376 - 380]General-Equilibrium Treatment Effects: A Study of Tuition Policy [pp. 381 - 386]

    Government in TransitionRegulatory Discretion and the Unofficial Economy [pp. 387 - 392]Changing Incentives of the Chinese Bureaucracy [pp. 393 - 397]Private Enforcement of Public Laws: A Theory of Legal Reform [pp. 398 - 403]

    Forecasting Japan's Future: The Lessons of HistoryThe 1940 System: Japan under the Wartime Economy [pp. 404 - 407]Structural Change and Japanese Economic History Will the 21st Century Be Different? [pp. 408 - 411]Declining Population and Sustained Economic Growth: Can They Coexist? [pp. 412 - 416]The Incentive Structure of a "Managed Market Economy": Can It Survive the Millennium? [pp. 417 - 421]

    China's Economic Reforms: Some Unfinished BusinessCompetition, Policy Burdens, and State-Owned Enterprise Reform [pp. 422 - 427]China's State Enterprises: Public Goods, Externalities, and Coase [pp. 428 - 432]Village Leaders and Land-Rights Formation in China [pp. 433 - 438]

    Banking Crises, Currency Crises, and Macroeconomic UncertaintyThe Double Drain with a Cross-Border Twist: More on the Relationship between Banking and Currency Crises [pp. 439 - 443]Financial Crises in Asia and Latin America: Then and Now [pp. 444 - 448]On the Importance of the Precautionary Saving Motive [pp. 449 - 453]Risk, Entrepreneurship, and Human-Capital Accumulation [pp. 454 - 457]

    The Economics of Gun ControlWho Owns Guns? Criminals, Victims, and the Culture of Violence [pp. 458 - 462]Guns, Violence, and the Efficiency of Illegal Markets [pp. 463 - 467]Lives Saved or Lives Lost? The Effects of Concealed-Handgun Laws on Crime [pp. 468 - 474]Criminal Deterrence, Geographic Spillovers, and the Right to Carry Concealed Handguns [pp. 475 - 479]

    Teaching Statistics and Econometrics to UndergraduatesEngaging Students in Quantitative Analysis with Short Case Examples from the Academic and Popular Press [pp. 480 - 486]Teaching Undergraduate Econometrics: A Suggestion for Fundamental Change [pp. 487 - 492]

    Proceedings of the Hundred and Tenth Annual Meeting [pp. 493 - 538]Back Matter [pp. i - xxii]