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«Coase’s Penguin, or, Linux and the Nature of the Firm Yochai Benkler∗ Abstract The emergence of GNU/Linux as a viable alternative to the Windows ...»

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This is because modularity and granularity determine the minimum individual investment necessary to contribute a component. If this investment is sufficiently low, then incentives for producing a modular component can be of trivial magnitude—like the pure hedonic pleasure of creation. Various actors, with varying levels of motivation, perhaps based on different taste for creation, or on different opportunities for indirect appropriation (like IBM or Red Hat), can collaborate in very different chunks of contributions. The very real question that then remains as an obstacle is the problem of integration of the modules into a finished product.

Integration can be solved in some combination of four mechanisms: iterative peer production of the integration function itself, technical solutions embedded in the collaboration platform, norm-based social organization, and limited reintroduction of hierarchy or market to provide the integration function alone.

This general statement leaves us with two questions for the next two sections.

The first concerns the relative advantage of peer production over firm-based or market-based production. Even if we were to accept the sustainability of peer production as a matter of “incentives,” we would ask whether it is in any dimension “better,” so that we can coherently speak of there being cases where using market or hierarchy is more costly—from a general welfare perspective, not from the private perspective of a firm that has outsourced some of its production costs to a bunch of volunteers—than peer production. The second question is how the coordination problems can be solved.

3. Markets, hierarchies, and peer production as information processing systems Peer production has a relative advantage over firm or market-based production along two dimensions, both a function of the highly variable nature of human capital. The first, to which I will devote most of this part, emerges when one treats all approaches to organizing production as mechanisms by which individual agents reduce uncertainty as to the likely value of various courses of action. 36 Differences among these modes in terms of their information processing characteristics could then account for differences in their relative value as mechanisms for organizing production. The second is to see that the particular strategy of reducing uncertainty by attaining secure access to agents and resources through contract and What follows is in some measure a sketchy application of the Herbert Simon’s statement, “It is only because individual human beings are limited in knowledge, foresight, skill, and time that organizations are useful instruments for the achievement of human purpose.” Simon, Models Of Man 199 (1957).

COASE’S PENGUIN Oct. 2001 property—a strategy that firms use extensively and markets to some extent—entails a systematic loss of productivity relative to peer production.

We could reduce the decisions that must be made by productive human beings as follows. Imagine a human agent, A, who is a member of a set of human agents {A1, A2, A3,... An }, having to decide to act, where act a is part of the set {a1, a 2, a 3,... a n }.

Act a is a combination of two elements: the effort to be exercised, where effort e is part of the set { 1, e2, e3,... en }, representing different levels and focuses of effort e possible for A, and the resources as to which the effort is exerted, where resource r is part of the set {r1, r2, r3,... rn } available for A to use. Both e and r are sensitive to the costs of collecting information. The components of either set are a function of the set of opportunities to exert effort and the set of resources available to work with that the agent perceives to be open to him. Both sets increase as information collection costs decline, because agents see more of the universe of opportunities actually available to them.

Imagine that A is a rational actor, where the value VA to A of doing a is the expected value of outcome O, where O is part of {O1, O2, O3,... On }, which is the value to A of O obtaining, discounted by the probability that O will obtain if A does a.

This means that the value to A of doing a increases as the probability that doing a will result in O obtaining increases.

An will a n, (en, rn ), if the value VAn is higher than the value VAm (the value of any other Om similarly discounted by the probability that any other a m, combining any (em, rm ), will lead to Om obtaining). The value of O and the probability of its obtaining given that any agent A will take any given action a is in some measure dependent on the actions of other agents in A’s set. Any such action of another agent is relevant to An ’s decision if it will either interfere with a n (reduce VAn if taken) or complement it (increase VAn if taken). The greater the interdependence of the value of an action on the decisions of others regarding their actions—the higher the uncertainty of the value to An of any given possible action a n, so long as An cannot control the actions of other agents.

Markets and firm-based hierarchies are information processes in the sense that they are means of reducing the uncertainty of agents as to the value of performing one or another productive action—exertion of effort on a set of resources—to a level acceptable to the agent as a level of uncertainty warranting action. Markets will price different levels of effort and resources, so as to signal the relative values of actions in a way that allows individuals to compare actions and calculate the actions of other individuals—whose actions affect the value of the agent’s action—faced with similar pricing of alternative courses of action. Firms will reduce uncertainty by specifying to some individuals what actions to take, reducing uncertainty of interdependent action COASE’S PENGUIN Oct. 2001 by controlling enough resources and people (by contract and property) to reduce the uncertainty of the outcomes of specified actions to a level acceptable to the managers.

To compare modes of organizing production as information processing systems one might use the term “information opportunity cost.” The idea is that different modes of organizing human activity entail different losses of information relative to an ideal state of perfect information. Perfect information is impossible to come by, and different organizational modes have different strategies for overcoming uncertainty, or an absence of perfect information. I use the term “information” here in the technical sense of a reduction in uncertainty, where “perfect information” is the condition where uncertainty regarding an action could not in principle be further reduced.

The different strategies differ from each other in terms of their “lossiness”, to use a term from communications. Each loses different amounts or kinds of information in the process of resolving the uncertainty that the lack of perfect information introduces for rational agents deciding what course of action they should follow under given circumstances. This difference among modes of organizing production in terms of the pattern of lossiness is that mode’s information opportunity cost.

Markets reduce uncertainty regarding allocation decisions by producing a signal that is clear, univocal (i.e., comparable across different uses) as to which use of the relevant factors would be most efficient. To do so, they require a codification of the attributes of different levels of effort, different kinds of resources, and different attributes of outcomes, so that these can all be specified as contract terms to which a price is affixed. An example of this was the introduction of codified standards for commodities as an indispensable element of the emergence of commodities markets.37 Since we are concerned with individual agents’ decisions, and levels and focuses of effort are a major component of individual action, it is intuitive that specification and pricing of all aspects of individual effort—talent, workload, and focus as they change in small increments over the span of an individual’s full day, let alone months—is impossible.38 What we get instead is codification of effort types—a garbage collector, a law professor—that are priced more-or-less finely. But one need only look at the relative homogeneity of law firm starting salaries as compared to the high variability of individual ability and motivation levels of graduating law students James W. Carey, Communication As Culture (1989).

In the context of the market for labor, this has sometimes been called the multi-task problem (the problem of inability contractually to specify completely all the tasks required and attributes of an employee who will likely need to perform multiple tasks.) See Bengt Holmstrom, The Firm as a SubEconomy (1999) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=162270.

COASE’S PENGUIN Oct. 2001 to realize that pricing of individual effort can be quite crude. Moreover, as aspects of performance that are harder fully to specify in advance—like creativity over time given the occurrence over time of opportunities to be creative—become more important, market mechanisms become more lossy.

Markets solve the problem of interdependence in two ways. First, agents can evaluate the risk that others will act in a way that is detrimental, or fail to act in a way that is complementary to, the agent’s action, given the relative pricing of the courses of complementary or detrimental action. This risk assessment can then be built into the perceived price of a possible action. Second, agents can maintain property rights in resources and projects,39 so as to prevent opportunities for negatively correlated action and to provide relatively secure access to resources for complementary action.

Firms or hierarchical organizations resolve uncertainty by instituting an algorithm or process by which information about which actions to follow is ordered, so that some pieces of information lead to a sufficient reduction in uncertainty about the correct course of action to lead to action by factors of production. The mythical entrepreneur (or the historical manager)40 becomes the sole source of information that is relevant to reducing the uncertainty of the workers in a purely managed firm. In the ideal-type firm, the question of incentives—reducing uncertainty as to which of a set of actions will increase an actor’s welfare—is reduced not by reference directly to market signals, but by fixing a salary for a stated behavior (following a manager’s orders) and shifting some of the risk of that course of action from employees to employers. Production processes (if I stand here and twist this lever all day, cars will emerge from the other side and I will get a paycheck) are codified as instruction sets.

The uncertainty of why to act and what to do (for the human factors of production), or what is to be done with this material factor is reduced by reducing the universe of information relevant to agents’ decisions to act. Information that arrives in a particular channel, with a particular level of authorization counts as signal, and all the rest as noise. It remains to the entrepreneur (in the pure model of the firm) to be the interface between the firm and the market, and to translate one set of uncertainty reducing signals—prices—to another set of signals with similar effect— organizational commands.

By controlling a set of resources and commanding a set of agents through property and contract the firm reduces the elements of uncertainty related to the Maintaining rights in what I call “projects” is, on Kitch’s now-classic reading, the primary function of the patent system. See Edmund Kitch, The Nature and Function of the Patent System, 20 J.L. & Econ.

265 (1977). Even if one is critical of Kitch’s almost-exclusive focus on this characteristic as the reason for the patent system, recognizing that in some measure patents provide control over projects is all that is necessary here. The derivative use right in copyright plays a similar function to a more limited extent.

Alfred Chandler, The Visible Hand (1977).

COASE’S PENGUIN Oct. 2001 interdependence of the actions of agents. But by doing so it creates a boundary around the set of available agents and set of available resources, and limits the information available about what other agents could have done with these same resources, or what else these agents could have done with these or other resources.

This boundary then limits the efficacy of information collection mechanisms—like incentive-based contracts—that firms use to overcome the difficulty of collecting information to which their employees have special access. These mechanisms mean that the employees and resources within the boundary are likely to be better allocated than in firms with no similar mechanism. But firms still lose information about what human agents outside the firm could have done with these resources, or what agents within the firm could have done with resources outside the firm.

The point to see is that like the price system, hierarchical organization is a lossy medium. All the information that could have been relevant to the decision regarding each factor of production, but that was not introduced in a form or at a location that entitled it to “count” towards an agent’s decision, given the algorithm used by the organizational structure, is lost. Again, there is an information opportunity cost of using the hierarchical system not only, or even primarily, as compared to the price system. There is an opportunity cost as compared to having perfect information available as to each allocation/action decision of each factor.

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