Too Big to Succeed

On the ThinkMarkets blog, Jerry O’Driscoll argues that JP Morgan’s recent loss of $2 billion shows a structural limitation of large banks.

Reports indicate that senior management and the board of directors were aware of the trades and exercising oversight. The fact the losses were incurred anyway confirms what many of us have been arguing. Major financial institutions are at once very large and very complex. They are too large and too complex to manage. That is in part what beset Citigroup in the 2000s and now Morgan, which has been recognized as a well-managed institution.

In other words, they are too large to succeed.

This argument reminded me of a similar argument reviewed recently on the Mises blog, suggesting that the United States are too large to be a functioning republic.

We have abundant evidence that a state as large as 305 million people is ungovernable. Did not Katrina and the BP oil disaster prove that, or runaway health care costs and broken borders, or the failure of education…?

Any government will have regular failures, which do not by themselves show anything wrong with either the system of government or the people in power. Specifically, I do not see how the failures of Katrina and BP show an overall failure of government. The remaining three examples do show an ongoing problem, suggesting that the large size of the American republic challenges the capacity of the government.

While both posts point out challenges of size, they come from completely different directions. America is not too big for a autocrat to run it (well, maybe it is, but that is not the argument in the above post.) The argument on America’s size is that a large populace loses its free spirit. At JPM and other large banks, the challenge is that the people at the top cannot deal with the complexity of the organization they lead.

Size challenges institutions from the top and from the bottom. The people at the top cannot manage what they lead, and the people at the bottom cannot unite around their distant leadership and disparate interests.

JPM, for all its impressive size, is hardly so big that it can’t be managed. I am not convinced that JPM is too big to succeed. It seems more that the investments were too complicated to understand. We cannot prohibit investing in overly complicated schemes, unless we are willing to force all casual investors out of the stock market. Most people understand little of their investments, and often lose their money because of it, but there is no cry to stop them from investing. (come to think of it, it might not be such a bad idea, though I don’t think legal restrictions are ever the right solution for this sort of problem.)

Maybe JPM is too big too succeed in managing investments which are too complicated to understand. The complexity of the investments requires more direct oversight at the highest levels, but the top management is ill suited to such direct oversight on multiple large complex investments. The complexity breaks down the hierarchy. Too complicated to understand leads directly to too large to succeed.

Returning to the complementary argument that America is too big to succeed, that argument also fails in its basic presentation. If size challenged the social cohesion of the republic then it would rather decrease statist feelings as the leader grew distant and the citizenship grew apart. The large size of the American population should rather increase the demand for local involvement, and not lead to socialism.

Here again the problem seems to be rooted in the proper division of responsibility. As long as the federal government is restricted to national issues and states handle mid-level issues, with each state delegating responsibility for local issues to proper local governments, size would never inhibit the healthy functioning of the government. From the Mises post:

If the Constitution established the United States as a decentralized federation, unfortunately federal aggrandizement of power in the long run prevailed.

The breakdown begins when the federal government extends its involvement to the state level. Local politics is too varied and complex to allow a healthy interaction between government and governed. The federal government, in order to streamline its involvement, must encourage loyalty and deference to the central government, in place of civic involvement. In this sense it is correct to say that America is too big to be a republic. It is definitely too big to be a centrally governed republic.

Size requires an organization to implement a structured hierarchy of responsibility and involvement, and to restrict each level of management to its proper domain. If this hierarchy breaks down due to the top management extending its reach to the domain of the lower levels, the organization becomes too big to be a republic. If the domain assigned to lower levels becomes too complex for them, forcing more direct involvement of the higher levels, the organization’s challenges are to complicated to manage. Either way, until a healthier hierarchy can be found, the organization will be too big to succeed.


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