Special Purpose Entities

Too many shadows, whispering voices
Faces on posters, too many choices
If, when, why, what?
How much have you got?
--Pet Shop Boys

Conventional wisdom holds that specialization encourages progress via the magic of comparative advantage. Viewed through this lens, we're collectively better off when producers focus on a narrow set of tasks and output. The specialization notion influences prominent socio-economic concepts such as work organization (Taylor, 1911), trade theory (Smith, 1776), and strategic competence development (Prahalad & Hamel, 1990).

Increasingly, I find myself questioning the merits of specialization in the context of free market systems. Free markets rely on the decisions of individuals who assess risk and reward in their own best interest.

In economies where specialization dominates, individuals necessarily outsource capacity for production and decision-making to others. Problematically, agents who make decisions on behalf of their principals may possess motivations and objectives that stray from the individuals they represent (Jensen & Meckling, 1976).

Essentially, specialists are more dependent on others. Agency problems that arise may distort the independent, individiualistic decision-making process necessary for effective free market functioning.

Problems related to specialization may be exacerbated in dynamic environments. For example, innovation may obsolete some individuals' specialized crafts. Unwinding the specialized commitment may require considerable resources, such as time and money for retraining. As such, specialized individuals are more rigid and less adaptable than their generalist counterparts.
Service economies may also be more susceptable to problems of specialization. Agency problems can be reduced by monitoring agent behavior (Jensen & Meckling, 1976). However, service processes that rely heavily on tacit decision-making processes may be difficult to monitor. As such, when a specialist outsources, say, investment decisions to an advisor at Merrill Lynch (MER) or tax decisions to an accountant at H&R Block (HRB), a mismatch between principal and agent goals may lead to decisions that differ from those that would be made by the individual alone.

Plausibly, to the extent that it increases dependence on others, specialization impairs the individualistic decision-making mechanism that drives free markets.

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References

Jensen, M.C. & Meckling, W. 1976. Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3: 304-360.

Prahalad, C.K. & Hamel, G. 1990. The core competence of the corporation. Harvard Business Review, 68(3): 79-87.

Smith, A. 1776. An inquiry into the nature and causes of the wealth of nations. London: Strahan & Cadell.

Taylor, F.W. 1911. The principles of scientific management. New York: Harper & Brothers Publishers.