Friday, August 31, 2007

Capabilities and Economic Modeling

In the AEA Annual Meeting this year, there was a session that I cared most, namely Understanding Performance Heterogeneity between Firms: The Role of Organizational Capabilities. Three papers were presented and discussed, including John Sutton's (LSE) Competing in Capabilities, Robert Gibbons and Rebecca Henderson's (MIT) Organizational Capabilities: Persistent Performance Differences among Seemingly Similar Enterprises and Luis Garicano's (University of Chicago) Organizational Capabilities: A Cognitive Perspective. However, only Sutton's paper (maybe another verison) could be downloaded from his webpage. He has also addressed this topic at many different places, including the World Bank.

Nicolai Foss, the blogger of organizations and markets also posted his thoughts yesterday:

"In a recent paper, “Competing in Capabilities: An Informal Overview,” the influence goes the other way, as Sutton takes seriously the notion of capabilities, a central, if not unproblematic (cf. this, this, and this) construct in strategic management research (but actually originating in economics in this paper).

Sutton's approach is to take relatively traditional ideas from standard production theory (akin to the approach in this paper) and add his ideas on sunk cost to make sense of differential capabilities in the context of competition, trade and development, globalization, and technology transfer (in contrast, he is not interested in explaining capabilities themselves). The paper does reach some interesting conclusions, e.g., relating to the dependence of market structure on capability investments, but doesn't seem terribly innovative compared to what has been going in formal evolutionary economics and some parts of the international business literature (I may be wrong, of course; make your own judgment), but it is certainly interesting to note this case of spillover from strategic management to industrial organization. "

My personal comment on Sutton's endeavor is that comparing to the current paradigm of the theory of the firm, he tends not to really formalize the idea of organizational capability within the boundary of the firm, but to obtain some rather macro insights by taking advantage of standard production function and IO theory. However, I'd prefer a breakthrough of the former kind.

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