March 11, 2008

Diseconomies of scale

One of the scary myths of the anti-capitalist movement is that companies grow ad infinitum, and in the end you end up with one single giant corporation that runs everything in much the same way as a soviet command economy. This is not the case in reality, and for many of the same reasons that the soviet command economy failed (but with a lot fewer dead people along the way).

As a company gets bigger the bureaucracy needed to run it also gets bigger, and as the bureaucracy gets bigger the entity as a whole becomes less efficient. To begin with these bureaucratic inefficiencies are overwhelmed by the new efficiencies of scale but eventually you reach a point where there are no more efficiencies of scale to be had and the inefficiencies of bureaucracy dominate.

Companies are not motivated by becoming as big as possible, but by becoming as profitable as possible and there comes a point where by becoming any bigger they become less profitable. Cadbury/Schweppes has gone beyond that point and so is not splitting itself up to try and become more profitable in total as two smaller companies than as one massive one.

Anything run as a function of the state however does not have this luxury of trying to find the point where it operates most efficiently by growing or shrinking its total output. It has to generate enough output for everybody that it serves, and have the level of bureaucracy needed for this level of output no matter how inefficient that this makes it.

The NHS, for example, is enormous and controlled by dikat from the centre. It is the third largest employer on the planet behind the Indian railways and the Chinese army (both of which are also state controlled). In it money is spent where the central controllers think the money should be going. Where the people on the front line think this money should be going is rarely the same, and it is the people on the front line know what is needed. Thanks to the layers of bureaucracy and simple numbers involved it is very hard for these signals to get back from the front lines to the people controlling the budgets in any meaningful way.

You can hose the NHS down with money, just as Labour have been doing, and have it disappear without any gain in productivity at all because it is not going to where the people on the front line know it needs to go for that goal. It is hugely unlikely, for example,that when confronted with the need to be more efficient the first thing that GPs would think of would be to pay themselves far more money for doing exactly the same things, and then start a media witch hunt about it. However that is exactly what the government forced upon them.

Only by reducing the amount of bureaucracy between the desires people that pay for and consume its services and those at the front line will it ever even begin to satisfy them, and that cannot happen when it is still this bureaucratic colossus.


Blogger Thatcher's Child said...

What a great post.

Your points are very true, and I still dont understand why the public cant see this.

Looking at this the other way, it shows that smaller businesses can be some of the most efficient businesses going - but again reality is so much more complex than this!

I will keep reading your blog, to find out some of your other thought!

9:06 am  
Blogger chris said...

smaller business can be most efficient. It just depends on where the output level with maximum efficiency happens to be, the point where the efficiencies of scale get overwhelmed by the inefficiencies of bureaucracy. This point will be different for every business, so the really difficult bit is trying to find it.

10:53 am  
Blogger John B said...

The money into the NHS hasn't disappeared - it's improved outcomes. Falling productivity means that a (e.g.) 10% rise in spending has delivered an actual, but sub-10%, rise in outcomes - as you'd expect to see when putting more money into a previously-very-cheap system.

2:44 pm  
Blogger chris said...

Perhaps you would like to consult Dr. Crippen about how the latest top down commands are going to lead to many getting more money for doing less work (the witch hunt will come when the government realises what it has done). Or explain why both infant mortality and median average waiting times have been rising.

7:12 pm  
Anonymous Anonymous said...

The bureaucratic burden in an organisation as a function of scale is analogous to a mass of uranium. A small mass allows more neutrons to escape from the surface than are absorbed. As the mass gets larger, more and more neutrons are captured internally. Finally, when the mass is critical, the same number are captured as escape. Just a bit bigger than this, and boom!

Large organisations, especially in the public sector, generate an astounding volume of correspondence. As they get bigger, more and more of it is internal correspondence. Just like with the uranium, at the point where the volume of internal mail exceeds the volume of mail escaping the system, you get a bureaucratic explosion. Every message generates three more until virtually the entire output of the organisation is expended in running itself. This is most apparent in organisations like universities, where in most cases the tipping point was reached some time ago. It is not uncommon for the admin section of a university to consume the preponderance of funding. This is a result of the management being so unwieldy that it requires layer upon layer of meta-management. There's no real cure, unfortunately, since the only people capable of undertaking reform are the very administrators whose jobs would have to go. Turkeys, Christmas, etc.

9:35 pm  

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