Market, Hierarchy, and Trust: The Knowledge Economy and the Future of Capitalism

Recent conceptualizations of trends in the structure of U.S. industry have focused on the relative importance of markets, hierarchies, and hybrid intermediate forms. This paper advances the discussion by distinguishing three ideal–typical forms of organization and their corresponding coordination mechanisms: market/price, hierarchy/authority, and community/trust. Different institutions combine the three forms/mechanisms in different proportions. Economic and organizational theory have shown that, compared to trust, price and authority are relatively ineffective means of dealing with knowledge-based assets. Therefore, as knowledge becomes increasingly important in our economy, we should expect high-trust institutional forms to proliferate. A review of trends in employment relations, interdivisional relations, and interfirm relations finds evidence suggesting that the effect of growing knowledge-intensity may indeed be a trend toward greater reliance on trust. There is also reason to believe that the form of trust most effective in this context is a distinctively modern kind—‘‘reflective trust’’—as opposed to traditionalistic, ‘‘blind’’ trust. Such a trend to reflective trust appears to threaten the privileges of currently dominant social actors, and these actors’ resistance, in combination with the complex interdependencies between price, authority, and trust mechanisms, imparts a halting character to the trend. But the momentum of this trend nevertheless appears to be selfreinforcing, which suggests that it may ultimately challenge the foundations of our capitalist form of society while simultaneously creating the foundations of a new, postcapitalist form. (Knowledge; Trust; Market; Hierarchy; Capitalism) Introduction Considerable attention has been focused recently on data suggesting that the secular trend toward larger firms and establishments has stalled and may be reversing (Brynjolfsson et al. 1994). Some observers argue that the underlying new trend is toward the disintegration of large hierarchical firms and their replacement by small entrepreneurial firms coordinated by markets (Birch 1987). This argument, however, understates the persistence of large firms, ignores transformations underway within these firms, and masks the growth of network relations among firms. How, then, should one interpret the current wave of changes in organizational forms? Zenger and Hesterly (1997) propose that the underlying trend is a progressive swelling of the zone between hierarchy and market. They point to a proliferation of hybrid organizational forms that introduce high-powered marketlike incentives into firms and hierarchical controls into markets (Holland and Lockett 1997, make a similar argument). This proposition is more valid empirically than a one-sided characterization of current trends as a shift from hierarchy to market. The ‘‘swelling-middle’’ thesis is also a step beyond Williamson’s (1991) unjustified assertion that such hybrid forms are infeasible or inefficient. However, this paper argues that Zenger and Hesterlys’ thesis, too, is fundamentally flawed in that it ignores a third increasingly significant coordination mechanism: trust. In highlighting the importance of trust, this essay adds to a burgeoning literature (e.g. Academy of Management Review 1998; further references below); my goal is to pull together several strands of this literature to advance a line of reflection that positions trust as a central construct in a broader argument. In outline, the argument is, first, that alongside the market ideal-typical form of organization which relies on the price mechanism, and the hierarchy form which relies on authority, there is a third form, the community form which relies on trust. Empirically observed arrangements typically embody a mix of the three ideal-typical organization forms and rely on a corresponding mix of price, hierarchy, and trust mechanisms. Second, based on a well-established body of economic and sociological theory, I argue that trust has uniquely PAUL S. ADLER Market, Hierarchy, and Trust 216 ORGANIZATION SCIENCE/Vol. 12, No. 2, March–April 2001 effective properties for the coordination of knowledgeintensive activities within and between organizations. Third, given a broad consensus that modern economies are becoming increasingly knowledge intensive, the first two premises imply that trust is likely to become increasingly important in the mechanism mix. I present indices of such a knowledge-driven trend to trust within and between firms, specifically in the employment relationship, in interdivisional relations, and in interfirm relations. Fourth, I discuss the difficulties encountered by the trust mechanism in a capitalist society and the resulting mutation of trust itself. Finally, the concluding section discusses the broader effects of this intraand interfirm trend to trust, and argues that this trend progressively undermines the legitimacy of the capitalist form of society, and simultaneously lays the foundations for a new form. Both the theory and the data underlying these conclusions are subject to debate: I will summarize the key points of contention, and it will become obvious that we are far from theoretical or empirical consensus. In the form of an essay rather than a scientific paper, my argument will be speculative and buttressed by only suggestive rather than compelling evidence. My goal, however, is to enrich organizational research by enhancing its engagement with debates in the broader field of social theory. The Limits of Market and Hierarchy Knowledge is a remarkable substance. Unlike other resources, most forms of knowledge grow rather than diminish with use. Knowledge tends, therefore, to play an increasingly central role in economic development over time. Increasing knowledge-intensity takes two forms: the rising education level of the workforce (living or subjective knowledge) and the growing scientific and technical knowledge materialized in new equipment and new products (embodied or objectified knowledge). Recapitulating a long tradition of scholarship in economics and organization theory, this section argues that neither market nor hierarchy, nor any combination of the two, is particularly well suited to the challenges of the knowledge economy. To draw out the implications of this argument, I will assume that real institutions, notably empirically observed markets and firms, embody varying mixes of three ideal-typical organizational forms and their corresponding coordination mechanisms: (a) the hierarchy form relies on the authority mechanism, (b) the market form relies on price, and (c) the community form relies on trust. For brevity’s sake, an organizational form and its corresponding mechanism will be referred to as an organizing ‘‘mode.’’ Modes typically appear in varying proportions in different institutions. For example, interfirm relations in real markets embody and rely on varying degrees of trust and hierarchical authority, even if their primary mechanism is price. Similarly, real firms’ internal operations typically rely to some extent on both trust and price signals, even if their primary coordination mechanism is authority. Hierarchy uses authority (legitimate power) to create and coordinate a horizontal and vertical division of labor. Under hierarchy, knowledge is treated as a scarce resource and is therefore concentrated, along with the corresponding decision rights, in specialized functional units and at higher levels of the organization. A large body of organizational research has shown that an institution structured by this mechanism may be efficient in the performance of routine partitioned tasks but encounters enormous difficulty in the performance of innovation tasks requiring the generation of new knowledge (e.g., Burns and Stalker 1961, Bennis and Slater 1964, Mintzberg 1979, Scott 1992, Daft 1998). When specialized units are told to cooperate in tasks that typically encounter unanticipated problems requiring novel solutions, tasks such as the development of a new product, the hierarchical form gives higher-level managers few levers with which to ensure that the participating units will collaborate. By their nonroutine nature, such tasks cannot be preprogrammed, and the creative collaboration they require cannot be simply commanded. Similarly, the vertical differentiation of hierarchy is effective for routine tasks, facilitating downward communication of explicit knowledge and commands, but less effective when tasks are nonroutine, because lower levels lack both the knowledge needed to create new knowledge and the incentives to transmit new ideas upward. Firms thus invariably supplement their primary organizational mode, hierarchy/authority, with other modes that can mitigate the hierarchy/ authority mode’s weaknesses. The market form, as distinct from the actual functioning of most real markets, relies on the price mechanism to coordinate competing suppliers and anonymous buyers. With standard goods and strong property rights, marginal pricing promises to optimize production and allocation jointly. The dynamics of competition, supply, and demand lead to a price at which social welfare is Pareto optimal (that is, no one’s welfare can be increased without reducing someone else’s). A substantial body of modern economic theory has shown, however, that the price mechanism fails to optimize the production and allocation of knowledge (Arrow 1962, Stiglitz 1994). Knowledge is a ‘‘public good’’; that is, like radio transmission, its availability to one consumer is not diminished by its use by PAUL S. ADLER Market, Hierarchy, and Trust ORGANIZATION SCIENCE/Vol. 12, No. 2, March–April 2001 217 another. With knowledge, as with other public goods, reliance on the market/price mode forces a trade-off between production and allocation. On the one hand, production of new knowledge would be optimized by establishing strong intellectual property rights that create incentives to generate knowledge. On the other hand, not only are such rights difficult to enforce, but more fundamentally, they block socially optimal allocation. Allocation of knowledge would be optimized by allowing free access because the marginal cost of supplying another consumer with the same knowledge is close to zero. Over several decades, discussion of this trade-off between production and allocation was framed as a debate at a macroeconomic level over the relative merits of market, hierarchy in the form of central planning, and intermediate forms such as regulated markets and market socialism (Arrow and Hurwicz 1977, Stiglitz 1994). This ‘‘mechanism design’’ literature has more recently been applied to the analysis of individual firms (Miller 1992)— with the same results. On the one hand, hierarchy could simply mandate the free availability of knowledge and thus outperform market as far as allocation is concerned. On the other hand, hierarchy would have far greater difficulty than market in creating the incentives needed to optimize the production of new knowledge. Formal modeling has shown that neither market nor hierarchy nor any intermediate form can resolve the dilemma, leaving us stuck in a ‘‘second-best’’ equilibrium (Miller 1992). Recent research on knowledge and coordination mechanisms has highlighted the importance of tacit knowledge. The recognition of the importance of tacit knowledge does little, however, to restore confidence in the ability of the market form to assure optimal outcomes. First, tacit knowledge brings with it all the challenges of hidden knowledge in principal/agent relations. Second, notwithstanding the current scholarly interest in tacit knowledge, codified forms of knowledge continue to be an important factor in economic growth. The reasons are straightforward: The transfer of knowledge is much more costly when the knowledge is of a tacit kind, and the generation of new knowledge is usually much faster when it builds on a base of explicit rather than tacit knowledge. As knowledge becomes increasingly important in the economic development of firms and nations, the question of whether we can improve on the second-best allowed by market and hierarchy is posed with increasing urgency. Much recent economic scholarship has, however, argued for resignation: The second-best achievable in pure or mixed markets and hierarchies is redefined as the best feasible and ‘‘relatively efficient’’ (Alchian and Demsetz 1972, Williamson 1975). This resignation is not warranted. Hierarchy and market are not the only possible organizational forms. Community is an alternative (Ouchi 1980, Dore 1983, Bradach and Eccles 1989, Powell 1990). The Power of Community and Trust