Unit 6 The firm and its employees

6.1 Exploding tyres: The mystery unravelled

In March 2000, Teri Lawrence was driving her 1996 Ford Explorer SUV near Fort Lauderdale, Florida. ‘All of a sudden,’ she said, ‘there was this explosion.’ One of her tyres had blown out. The Ford Explorer flipped over, and she was badly injured. By summer, with similar reports of blowouts and overturned Explorers accumulating, Ford convened a ‘war room’ to deal with the public relations catastrophe. They quickly determined that the Firestone tyres used on most Explorers were at fault. There were no unusual reports of blowouts on Explorers with Goodyear tyres.

In August 2000, in partnership with Ford, Firestone recalled 6.5 million tyres. According to the US National Highway Traffic and Safety Administration, blowouts of the Firestone tyres in question had resulted in crashes that took 271 lives. In the next four months, the market value of Firestone shares on the stock exchange dropped by $9.2 billion, to less than half of their value before the crisis. But the cause of the spate of fatal blowouts remained a mystery.

In 2003, economists Alan Krueger and Alexandre Mas set out to solve the mystery of the exploding tyres.¹ High-speed stress tests confirmed that there was nothing wrong with the design of the tyres. An inconspicuous clue, however, pointed to ‘the scene of the crime’, if not its motive. On the sidewall of each of the blown-out tyres was a ten-digit tyre code, indicating the particular plant that had produced the tyre and the week of its production. Most of the faulty tyres had been produced at just one of Firestone’s six plants, located in Decatur, Illinois.

For years, the Firestone Decatur plant had been in the news for other reasons. In 1994, the company had imposed a 12-hour shift that rotated between night and day for each worker, replacing the historic 8-hour shift. New hires’ wages were reduced by 30%; vacations for more senior workers were cut by two weeks. On 12 July 1994, the United Rubber Workers union that represented the employees called a strike. The firm immediately hired 2,300 replacement workers, paying them 30% less than wages previously paid. Ten months later, the union called off the strike; returning workers accepted substantial pay cuts, a freeze in their pension benefits, and the 12-hour shifts. Protests and bitterness towards the company continued.

Building tyres at the time was a labour-intensive and skilled occupation. A number of the union workers blamed lack of training and experience among the replacement workers for the tyre blowouts. William Newton, a senior tyre builder in Decatur, reported that he ‘saw a lot of people working as replacements who did not know how to build tyres’. But investigators looking at the detailed records of exactly when the faulty tyres were produced were in for a shock—virtually none of them had been produced during the strike, when Firestone was employing the replacement workers. Most of the faulty tyres had been produced by experienced union workers, both before the strike—when Firestone’s pay cuts, 12-hour shift, and other new demands had been announced—and after the defeat of the strike, when the union workers returned.

To Krueger and Mas the evidence suggested that the tyre defects were due to labour strife, the result of deliberate worker retaliation against Firestone’s anti-union policies. The owners of Firestone discovered that they could indeed impose a 12-hour shift and a 30% pay cut, but they could not ensure that safe tyres would be produced if their employees were angry as a result.

Firms and the coordination of work

Firms are major actors in the economy, and we often refer to a firm as if it were a person—we might talk about ‘the price Firestone charges’. But the story of Firestone Decatur illustrates that what happens within the firm matters too: firms are also stages, on which the owners, managers, and workers act out their sometimes common, but sometimes competing, interests. In this unit we study firms, and how they coordinate and manage the work done by individuals.

The economy is made up of people doing many different types of work: driving trucks or operating checkouts; producing Apple display modules, or tyres, or clothing. Producing display modules also involves many distinct tasks, done by different employees within Samsung or LG, the companies that make them for Apple. While some people work for governments and not-for-profit organizations, the majority of people in rich nations make their living by working in a firm.

The division of labour (specialization in different tasks) brings productivity gains both within firms, and across the economy when firms specialize and trade with each other.

• The components of goods are produced by different people in different departments of the firm, and assembled to produce a finished shirt or Apple iPhone.
• Alternatively, components produced in different firms may be brought together through market interactions between firms.
• Through a process of buying and selling goods on markets, the finished iPhone gets from the producer into the pocket of the consumer, and the American Apparel shirt ends up on somebody’s back.

Herbert Simon, an economist, has used the imaginary example of a view from Mars to explain why it is important to study firms as well as markets.

Great economists Herbert Simon

Imagine a visitor approaching Earth from Mars, Herbert ‘Herb’ Simon (1916–2001) urged his readers. Looking at Earth through a telescope that revealed social structure, what would our visitor see? Companies might appear as areas of green, he suggested, divisions and departments as faint contours within. Connecting the green areas, red lines of buying and selling. And within the areas, blue lines of authority, connecting bosses and workers.

Traditionally, economists had focused on the market and the competitive setting of prices. But to a visitor from Mars, Simon suggested:

Organizations would be the dominant feature of the landscape. A message sent back home, describing the scene, would speak of ‘large green areas interconnected by red lines.’ It would not likely speak of ‘a network of red lines connecting green spots’. (‘Organizations and Markets’, 1991)³

Trained as a political scientist, Simon made important contributions to economics. His desire to understand society led him to study both institutions and the human mind—to open the ‘black box’ of motivations that economists had come to take for granted. His work was celebrated in computer science, psychology, and economics, for which he won the Nobel Prize in 1978.

A firm, he pointed out, is not simply an agent, shifting to match supply and demand. It is composed of individuals, whose needs and desires might conflict. Simon asked: when would individuals work under contract to perform particular, predefined tasks, and when would firms and workers enter into an employment contract, allowing a boss to manage the worker’s time?

When the desired task is easy to specify in a contract, Simon explained, we could view this as simply work-for-hire. But high uncertainty (the employer not knowing in advance what needs to be done) would make it impossible to specify in a contract what the worker was to do. The result would be an employer–employee relationship that is characteristic of the firm.⁴

This early work showcased two of Simon’s lasting interests: economic interactions that are too complex to be described contractually, and the role of uncertainty in changing the nature of decision-making.

Understanding the need for employment contracts explains one feature of firms (the lines of authority that connect bosses and workers). But what makes a good organization? This is a question for psychologists as much as economists, because we know that incentives that tie individual rewards to the success of the organization appear to have little effect.

Simon’s intellectual career can be contrasted with another great economist, Friedrich Hayek, whose ideas we examine in Unit 8. Both were interested in how societies could thrive in the face of uncertainty. For Hayek, the price mechanism was all: a device to collect and process vast quantities of information, and so synchronize systems of arbitrary size.

But for Simon, the price mechanism needed to be supplemented—or supplanted—by institutions and governments better equipped to handle uncertainty and rapid change. These alternative ‘authority mechanisms’ draw on partially understood aspects of the human psyche: loyalty, group identification, and creative satisfaction.

By the time of his death in 2001, many of Simon’s ideas had reached the mainstream. Behavioural economics has roots in his attempts to build economic theories that reflect empirical data. Simon’s work showed that economics could not be a self-contained science: an economist needs to be both a mathematician, working with decision sets and utilities, and a social psychologist, reasoning about the motivations of human relationships.