When the 2018 World Cup kicks off in Russia, it’s once again with soccer balls produced exclusively in Pakistan. The city of Sialkot is the world’s leading supplier of the checkered spheres.
But from an economist’s perspective, Pakistan’s soccer ball-makers are doing something wrong. And for the bigger business world, the problem with Pakistan’s soccer balls – and the solution discovered by CBS Professor Amit K. Khandelwal with an international team of academic researchers – says something about the need for aligned incentives within firms, especially when adopting new technologies.
Because while it may sound obvious that workers, when given a choice between efficient and wasteful technologies, would choose a more cost-efficient method that could translate into large annual cost savings, Khandelwal found otherwise in the world’s soccer ball production capital.
Around 135 firms in Sialkot produce 30 million soccer balls annually, the majority from hand-cut pentagons and hexagons that are stitched together using needle and thread. The industry traces back to 1889, when a local saddle-maker was asked to repair a British colonel’s leather soccer ball. By accident, the city became known for its ball repair and production, with an economic cluster eventually forming that could source inputs, share labor, and meet export demand.
“When you step out of the car, you hear a lot of bangs,” says Khandelwal, the Jerome A. Chazen Professor of Global Business, who visited the dusty city located near Pakistan’s northeast border with India. All that banging turned out to be noisy machinery cutting pentagons and hexagons from an artificial leather called rexine. “You can hear the vibrant production that's happening.”
Khandelwal and his colleagues wanted to use Sialkot as a test lab to study how technology diffuses in a marketplace, so they started investigating potential cost-saving innovations that might be introduced to the sector. His research colleague Eric Verhoogen of Columbia’s School of International and Public Affairs stumbled upon a pattern for cutting pentagons that could reduce their total production costs by approximately 1 percent – nontrivial, given the industry’s average profit margin is 8 percent.
Together with researchers David Atkin of MIT and Azam Chaudhry and Shamyla Chaudry of the Lahore School of Economics, the professors randomly allocated this new pattern-cutting technology to 35 firms in Sialkot. To a second group of 18 firms, the researchers described the new technology and provided $300 cash to replicate it. A control group received nothing. The researchers waited 15 months to see how the knowledge would diffuse through the sector, in what is believed to be the first study to randomly allocate a new technology to manufacturing firms to examine the adoption process.
To their surprise, the technology didn’t diffuse. After more than a year, only five firms from the first group and one from the second group had adopted the technology – all others stuck with their less-efficient systems.
"This is a classic problem in economics."
Why? Because the workers weren’t incentivized to change, the researchers discovered through follow-up surveys and a second experiment. Paid by the hour, the workers saw no financial benefit in slowing down to learn a new technology so their bosses could save on production costs.
“This is a classic problem in economics known as the principal-agent problem,” says Khandelwal. “The principal, which is the owner of the factory, could really benefit from this new cutting pattern. But in the absence of compensating the workers by potentially increasing the amount they get paid per pentagon or changing them to a fixed wage, the agents, the workers at the factory, don't gain in those increasing profits.”
The researchers found a fix. In a second experiment, they returned to the first group that had initially received the new technology and divided it into two sub-groups. Group A was reminded of the benefits to the technology plus offered bonuses for every worker who adopted it. Group B was reminded of the benefits, but not offered the bonus. After six months, over one-third of Group A had adopted the new technology, but still none in Group B.
The results, published last year in The Quarterly Journal of Economics, highlight the necessity for businesses to align incentives – that is, to make sure workers have an interest in a firm’s overall success.
Several questions arise from the research: Why hadn’t Pakistan’s soccer firms already adopted this new pattern-cutting technology, especially if it was relatively easy for the researchers to discover it? And why didn’t Sialkot’s businesses incentivize their workers to adopt the technology, rather than wait for the researchers to offer a bonus?
On the spectrum of soccer producers, Sialkot sits within what economists call the production-possibility frontier, which refers to all the ways that a factory might be arranged in terms of labor and capital to produce a good. At the front of the frontier are companies that produce most efficiently with the latest technologies and best practices. While a handful of firms in Sialkot operate at the frontier (including the few that are making balls for the World Cup), the vast majority have production inefficiencies yet to be whittled away.
Khandelwal speculates that this divergence exists, in part, because Pakistan lacks the kind of robust consulting sector that is present in the U.S. and other developed nations to spread best practices and reduce inefficiencies. Sialkot is also dominated by family-run firms, which tend to be less well-managed and more reticent of outside services to improve operating efficiency.
But the takeaways from the study are not limited to emerging markets – nor to soccer balls – says Khandelwal.
“The general problem of workers not having full alignment with the owners of a company is common,” he says. “One of the messages that comes from this is that in order to get truthful revelations from your workers, in terms of what new technologies you should think about adopting, you may need to make sure that workers share in the benefits of those technologies.”
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About the researcher
Professor Khandelwal teaches an elective course on International Business. His research interests examine issues in international and development economics, including the strategic response of...Read more.