Tuesday, March 3, 2009

Albert O. Hirschman, Exit, Voice, and Loyalty: Chapter 2, Exit

How does exit lead firms to repair lapses in quality? When customers leave, the firm loses revenue. If this loss is large enough, the firm will try to correct the failure. If the loss is too large, however, it will be unable to act. So for exit to work optimally there must, paradoxically, be some inert customers -- ones who will not respond quickly to a deterioration in quality.

In a situation where all producers in an industry produce flawed goods, exit may actually create an equilibrium in which firms do not lose money from lapses in quality. Customers are effectively exchanged between the competing firms as they leave one and buy from another. Exit wastes effort (looking for competing goods) that would be directed more usefully through voice if there were no competition. Effectively conceals the systemic failure in quality.

This assessment (collusive competition obscures poor quality and frustrates improvement in conditions) can be applied to non-economic institutions. Examples: multiparty democracies, competing trade unions.