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What Economists Know That Managers Don’t (and Vice Versa)

By Pankaj Ghemawat

Pankaj Ghemawat

Market failures expand the scope for management failures to matter a lot.

Why did Jean Tirole win the Nobel Prize in Economics? Not for the highly-regarded work on competition between small numbers of firms with which his career began more than thirty years ago but for more recent work on how carefully structured regulation can improve performance relative to unbridled market forces. This is a reminder that serious students of market performance take market failures seriously.

But what many economists generally gloss over is a notion that I will argue is highly complementary to market failures: management failures. For policy-making purposes economists assume that all businesses act rationally in the pursuit of profits. The possibility that that might not be the case is generally ignored, or even when mentioned, quickly finessed.

Even Tirole betrays this bias. The section on the profit maximization hypothesis at the end of the introductory chapter of his classic 1988 textbook on industrial organization concludes by saying that even if a firm doesn’t maximize profits, it can be treated, for the purposes of many of its interactions with the outside world, as if it does. Partly because profit maximization is a bedrock assumption and partly because maximization is a basic mathematical tool, economists have trouble dealing with firms that are not maximizing profits.

Read full article as published in Harvard Business Review

Pankaj Ghemawat is a Global Professor of Management and Strategy and Director of the Center for the Globalization of Education and Management.