Type E and Type B errors

 I like this model.  From Who needs Bureaucracy? by Arnold Kling.  The subheading is All of us.  

The opposite of bureaucracy is an organization in which individuals are empowered to make decisions without asking for permission or consulting a rule book. They can use their skills and know-how to solve the customer’s problem or embark on a new project.

Empowerment sounds so much better than bureaucracy. And yet bureaucracy survives. In a competitive environment, particularly in business, we should stop and ask ourselves whether bureaucracy serves a useful function.

When an organization suffers from an error, it will often adopt a rule that is intended to prevent the recurrence of such an error. I like to say that such rules are the pearls that grow in response to the irritation caused by errors.

I think that bureaucracy survives because it prevents certain types of errors. Call these Type E errors, meaning the type of errors that might be made by empowered individuals. The errors that bureaucracy itself makes can be called Type B errors. The utility of bureaucracy depends on the relative cost of Type E errors and Type B errors.

If anyone working in a hospital were empowered to administer medication, then a patient might be killed by someone who is not qualified to administer medication. That would be a Type E error. On the other hand, perhaps a patient could die because a qualified doctor or nurse is not around to administer life-saving medication that a less-qualified hospital worker might have provided. That would be a Type B error. I imagine that Type E errors are more of a problem than type B errors, so that a hospital is better run with bureaucratic rules than as a free-for-all where anyone can administer medication.

In economics, it is a truism that 

If marginal cost of production and the marginal revenue of production are equal, your business has reached its optimal production level. When marginal cost is equal to marginal revenue, efficiency has reached its peak, and you've maximized profits.

This is of course, a dynamic system driven by shifting production costs and market demand, all coordinated via price signals.  Production costs are dynamic and shifting as is customer demand.  Often, in non-transparent fashion.  Management and leadership have to make frequent consequential decisions arising from indigenous and exogenous changes which are always tipping marginal cost and marginal revenue out of alignment with one another.  

Kling's model has an implied similar rule.  

If the marginal net profit of Type E errors is equal to the marginal net profit of Type B errors, strategic effectiveness has been achieved and profits maximized.

As with marginal costs and marginal revenues, there is a tension in the balance between the marginal net profit arising from Type E errors and Type B errors.  Exogenous and indigenous shocks are always kicking them out of alignment.  

The challenge is different though.  Adjusting commercial decisions and fashions of production is hard enough.

Type E and Type B errors though are not about shifting the volume of inputs or modifying the means of production.  Type E and Type B errors are the product of Social Norms, Institutions, Corporate Cultural Norms, and embedded incentive structures.  All can be changed but not easily and not quickly.  Managing the balance between Type E errors and Type B errors is much harder work and not frequently recognized as a distinct model.