Friday, November 20, 2009

Albert O. Hirschman, Exit, Voice, and Loyalty: Chapter 7, "A Theory of Loyalty"

Question: under what conditions can exit and voice coexist? That is, when will voice still be used even when exit is available?

Answer: when individuals are (1) willing to trade off the certainty of exit for an uncertain prospect of recuperation of the product and (2) confident of their ability to influence the defective firm or institution.

Loyalty -- the attachment to the institution -- comes into play in the first case, but in fact both factors reinforce one another. People who care about an institution will tend to put themselves into a position where they can influence it, and people with influence will feel like they have more at stake.

Loyalty isn't an absolute barrier to exit. It is similar in its effect to a significant transaction cost.

Loyalty is most useful when (1) the use of voice is not straightforward but will require ingenuity and creativity (2) when the deteriorating product has close substitutes. The second case is paradoxical -- it seems irrational not exit when close substitutes are available -- but firms in this condition would have no chance to recuperate were it not for loyalty. Since products, institutions, and social groups are typically unevenly distributed on a scale of quality and prestige, with greater density on the lower end, the second case also means that loyalty is more useful at the lower end of the scale.

In using voice, the loyalist's most effective tool is the threat of exit. So we have the following seeming paradox: ease of exit makes voice less likely, but possibility of exit makes voice more effective. The conclusion which can be drawn from this is that voice will be most likely to be both used and effective when exit is possible but not too easy.

Notes on model of loyalist behavior:
  • voice increases with deterioration of quality, and curve bends up at points where there would be exit without loyalty and where there is threat of exit with loyalty
  • once loyal customers exit, they will not return until at least the quality associated with exit without loyalty is restored; the demand curve for exit is separate from the demand curve for return

Leaders of organizations and firms want to reduce both exit and voice. Will use high entry fees and high penalties for exit to make exit more difficult and to promote unconscious loyalist behavior. However, high entry cost induced loyalist behavior will ten to suppress the initial use of exit, but to make it more vigorous once it has started. If the cost of exit is high as well, however, the loss of threat of exit will make voice less effective. On the other hand, organizations where exit is difficult or impossible but entry cost is automatic (e.g., family, country) may actually sustain the most vigorous use of voice because members will see it as their due.

A special case of loyalty among influential members of organizations is brought into play under the conditions that (1) their departure would result in a further decline in quality and (2) they would continue to care about the quality even after exit. The first condition presumes that the departure of influential members has the opposite effect of the exit of market makers in monopoly or monopolistic competition; this is possible because the members play a part in the production of the good as well as its consumption. The second condition is rational under the assumption that full exit is impossible, which is the case for public goods. (Examples: Public schools, political parties, government administrations)

In such cases, members may be even less likely to depart as an organization gets worse, because they feel more strongly that is their responsibility to stick around to prevent things from getting yet worse. (With tongue only halfway in cheek, Hirschman uses the term spinelessness for this behavior). On the other hand, a member who does decide to exit under these conditions is more likely to use their exit as a tool of protest that will initiate continued use of voice from outside of the organization. Hirschman laments, however, that this use of exit by disgruntled public officials has fallen into disuse, replaced by officials treating their exit as a private matter -- one thinks of the stock "spending more time with my family" excuse.

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