Saturday, October 29, 2011

Project Selection

J. Stiglitz paper

[..] Pluralism and competition, often associated with openness, are vital to innovation and the growth of knowledge. The structure of economic and political institutions powerfully affect which ideas, innovations, or projects are selected to be financed and implemented [..]

Some years ago, I explored one aspect of this, in contrasting two opposing extremes in project selection: a hierarchical system, where a proposal must pass a series of hurdles to be accepted, or a decentralized system of alternative decision centers, where a proposal can be accepted by any one of them (and can get a second chance if turned down). The hierarchical system would tend to err on the side of rejecting many good projects while the decentralized system would err on the side of accepting many bad projects. The advisability of the two systems (and various mixtures) would depend on the relative cost of accepting a project that turns out to be bad versus the opportunity cost of rejecting a project that turned out to be good. The hierarchical system would be best for a decision where accepting a bad project might be fatal–as in the decision to go to war. But where accepted bad projects are not fatal and only expend resources, the clear verdict of history is in favor of a more decentralized system of pluralistic political or economic units.

In a decentralized system, decision-makers compete against one another to find good projects. With centralized or monopoly project selection, there is no fear that a rejected innovation will be adopted by a competitor and an accepted innovation might have an uncertain effect on the monopoly. Thus hierarchical centralization has been a recipe for uniform and essentially static societies from ancient Egypt to the Soviet Union. In contrast, Columbus was turned down by the King of Portugal and two Spanish dukes before submitting his proposal to Ferdinand and Isabella. After a four year wait, he was again turned down, but the decision was reversed two years later in 1492. In this manner, the pluralistic and competing channels of selection foster innovation.

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Free market essentially is about selection of succesful projects, and selecting people who are best at selecting, funding those projects. Such people eventually become the "rich men / women" in the society. Since they are good at selecting, allocating money, they are entrusted with more and more of it to continue what they do best. Essentially that is what someone like Bill Gates does; in technology, he used to fund, lead projects for PCs, with in philantrophy, he funds, leads, selects projects that have the best chance of helping people. The criteria for success might be somewhat different btw philantrophy and consumer technology, but the allocation, monitoring, motivating, providing ideas part is the same. In whatever kind of system, capitalist or otherwise, we need such selection prowess because resources (money, time, ppl) are limited, and efforts should be channeled towards goals that promise optimal results.

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