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« Wal-Mart Follow Up, Wherein my 12 year-old Daughter Demonstrates the Economic Way of Thinking | Main | Reflections on the Seminar at FEE »


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Doesn't Surowiecki use an inappropriate example with the oil fields? That is a tragedy of the commons, not of the anti-commons.

"Privatize, privatize, privatize!" - Walter Block

This is an interesting argument, but it has been made before. Coase's work on the firm addresses just this problem, and he attempted to resolve it through "marginal substitution" -- replacing the firm with the market on the margin.

This article slightly restates the problem with no proposed solution or alternative. I hope Herllers' book acknowledges the contributions of Coase and his followers.


As I told you at FEE, I think your reading of Coase is a particularly Williamsonian one --- circa 1975 and his book Markets and Hierarchies.

It derives ultimately from Arnold Plant's description of firms as islands of socialism inside a sea of capitalism. Coase is very much influenced by Plant, but I think his thinking on this moved far from this position, and is more consistent with the work of scholars such as Langlois and Foss. Firms are not substitutes to markets, but in fact the enterprises that make markets go. This is how Coase came to see the relationship between institutions, organizations and the market process I would argue --- and I would point to both his discussions in The Firm, The Market, and the Law, and his Nobel Prize address. And as I told you, I think the best secondarly literature on Coase surrounds Steve Medema's book.

Do you follow the blog discussions at Organizations and Markets? Given your interests it might make a lot of sense to be a regular reader there.

Also, I highly recommend Frederic Sautet's An Entrepreneurial Theory of the Firm, and in particular his discussion of the "market theory problem" --- which I think (though I must admit that I might be alone in this assessment) is one of the really important and innovative ideas to come out of dissertation in Austrian economics. I don't think Fred exploited his idea to the max, but the idea is there and it is a blockbuster. One of my fondest memories of my 8+ years at NYU, was a long lunch conversation with Fred and Mario at a Sardinian resturaunt on Mercer Street discussing Fred's dissertation ideas --- critically debating his understanding of uncertainty and its role in his analysis, and being blown away by the implications of his idea of the 'market theory problem'.

So I guess my recommendation to you -- if you haven't done so already --- is to read Medema's book, but also to read all the post-Marshallian contributions of Loasby, etc. and the capabilities folks such as Langlois, Foss, etc.

All very cool stuff, and as far as I know, Heller is completely blind to this stuff, and instead buys the caricature version of Coase -- privative, privatize, privatize --- which actually was a statement Milton Friedman made when he first traveled to China (and only modified later as privatize, privatize, privatize, provided you have a rule of law). And while I understand where Matt and Heller are coming from to some extent, I actually would argue that Friedman's message to the Chinese and its modified form might be the most important message for the world's poor.

Dr. Boettke,

There are indeed many ways to read Coase's central message, and I think it is important that students be familiar with them all. Steven Medema, while an important researcher on Coase, is not regarded as one of the leading experts on transaction cost economics. Medema is important because he is one of the few economists to tie Coase's work to the heterodox literature that is seldom mentioned in mainstream expositions of Coase's framework. Medema has persuasively shown that there are many commonalities to be found between Coase, Gardiner Means and John Commons. Also, according to Medema, the most important work following Coase comes from people like Geoffrey Hodgson, William Lazonick, and Dugger, names that you never hear reading people like Jensen, Demsetz and Williamson.

I still think my interpretation is the correct one: firms are indeed substitutes (alternatives) to markets, and you said it best by writing: "firms as islands of socialism inside a sea of capitalism." I think this is right on. I posed this question to Dr. Lewin by asking him that why are we, as Austrians, so averse to central planning? It is because, I would argue, central planning is just one big firm. Coase poses the same question subtly in his own work by rebuking Hayek for arguing against central planning when it was clear to Hayek that even Western countries have firms.

Now the literature following Coase has lost this insight. Alchian and Demsetz began by disposing of the idea that firms are characterized by authority relations, and then Jensen and Meckling came along by arguing that the firm is just a nexus of contracts, similar in many respects to the way markets operate. This literature has developed Coase's powerful message into a theory of agency (principal-agent problems).

Coase was very clear. Firms are islands of conscious power, separate from the operations of the market. I do not see how one can argue that they complement markets, or, as you argue, "make markets go." Everything about them is different from markets. Direct control, fixed prices, authority relations, etc. etc.

And thanks for the recommendations. I will look into Sautet's book. And what specific articles should I look into by Loasby, Foss, and Langlois? Do you recall the titles?


First of all Matt, you misunderstand the nature of the firm if you think firms are all about "direct control", etc.. I suggest you read the literature Pete has pointed to you, which in the 30 years or so since Williamson has provided a much more sophisticated understanding of the firm that sees it as much more than an "island of socialism." In fact, the firm has more spontaneous order elements in it, according to this literature, than one might think. Firms are also attempts to make use of the tacit and contextual knowledge of their actors. Sometimes they use "direct control" but sometimes they use other processes as well.

My own work on Wal-Mart supports this view, I should add. So does Lewin's work on the firm.

Second, viewing "the market" as something that doesn't include the firm is, to use a phrase Pete used last week, an "institutionally antiseptic" view of the market. Markets are networks of institutions, including the firm. Markets are NOT just prices and maximization. This, I would argue, is the real lesson from Coase. It's ironic that you would implicit argue for a view that sees markets as "institution-free." Firms are not alternatives to markets, they are part and parcel of them.

I also strongly recommend Fred's book. It was very useful in my work on Wal-Mart.


Hayek wasn't against central planning, or planning in general. Read "who, whom" in The Road to Serfdom. As he says explicitly, planning takes place all the time, the question is who is going to do the planning.

Not sure I understand your dismissive of Medema's book --- which from what I understand was in fact endorsed by Coase himself.

Your understanding of the market/firm dichotomy is very neoclassical -- in fact a particular reading of neoclassical economics based on the perfect competition model and general competitive equilibrium. But it is not a new institutional let alone Austrian understanding of how markets work.

Here is a point again where we might actually run into a subject that is beyond this medium.

On Loasby, Foss and Langlois --- start with Organization and Markets blog spot, and then look up their webpages. Foss is very active as is Langlois --- Loasby is more old-school and writes books.


As I recall, Coase argues that there is a trade-off between organization costs and transactions costs.

Hence a firm within a market can save on transactions costs by arranging production to bypass the market, along its production chain: e.g. Wal-Mart can do a lot for itself more cheaply than it could by using market transactions at every step in its distribution chain.

However, the larger this organization becomes, and the more that it takes various roles on in place of the market, the more the organization costs increase, while the savings from transactions cost diminish.

Organization costs are not just the cost of management and bureaucracy, they include the lack of the benefits that markets provide: emergent knowledge, innovation, prices and price signals, division of labor and comparative advantage, etc.

In the Soviet Union, these latter benefits did not exist (no prices, knowledge innovation existed outside of the firm for it to benefit from) and transactions costs were very high (it was unknown whether the supply would ever come), so firms took on more and more of the supply chain, until one firm would do everything from forging a nail to building a rocket; in addition to supplying the food and housing for the workers.

When the whole economy is one firm, it might as well be one hundred thousand smaller firms doing the entire business. When there is a market to rely on, it makes more sense for firms to specialize and take advantage of the outside market.
So, I would say that they are complementary, but distinct kinds of organization; one is indeed socialism and the other markets, in many ways (although modern firms sometimes do introduce aspects of the market into their mechanism).

But efficient firms do not prove the viability of planning either: they are within a market and hence can rely on market prices for nearly every calculation, with the exception of just those transactions within the firm; and they are specialists with a known goal, even as they innovate they are responding to outside knowledge and signals.

This brings up the other trade-off -- hierarchical efficiency versus emergent knowledge. When a known goal is targeted, planning can work well. (Of course the more complex the goal, the less well even a known goal can be achieved by planning).

When the goal is elusive and always changing - as in a total economic system - individual unplanned transactions and actions are required to discover information, respond to change, and grow.

Firms are specialists and the owner or CEO lays out a plan as a response to conditions outside the firm, in the free market.

Heller's book is extremely weak. It makes no reference to Coase, although it owes an enormous debt to him (and although Coase and followers make important contributions to the precise point Heller is making). Most important, for nearly every instance of the "market dynamic" (Heller's words) identified in the book, the actual culprit is either actually a commons problem or else a clear failure of government planning (and usually both). So, for example, the singular realization which, Heller claims, motivated his work in this area has to do with too much "ownership" (Heller's word) in Moscow's stores during the Glasnost days. But what one finds out later in the book is that these "ownership" rights are actually what most of us would call "regulations." And absurd ones at that. So, it turns out that the problem of empty stores in Moscow is not due to too much ownership, as Heller claims, but rather to bad regulations which left decision-making over important aspects of the occupation and operation of these stores in a) government regulators' hands and b) several different ones, at that. This is a "market dynamic" of too much "ownership?"

Thanks to Pete for plugging the O&M blog. One small point of clarification: Williamson never characterized the firm as some kind of pure hierarchy. Transaction cost economists have always recognized that firms use "market-like" incentives such as delegated decision-making, performance-based incentives, negotiated and market-based transfer prices, internal capital markets, and the like -- what might be viewed as de facto property rights inside the firm. (At least two chapters of _Markets and Hierarchies_, chapters 8 and 9, deal with decentralization.) On the other hand, Williamson, like Coase, recognizes a fundamental ontological distinction between firm and market. The firm does, inherently, involve the exercise of fiat because the owner, not the employee, owns the assets. The way Foss and I describe it, asset owners possess "ultimate" decision rights -- residual rights of control, in the language of incomplete-contracting theory -- that non-owners do not possess. An independent contractor who owns his tools can use them as he sees fit and can sell or give them away. An employee who works with the owner's tools may be granted the right to use them according to his discretion, but cannot sell the tools. His decsion rights are circumscribed by the owner's authority. In this sense Alchian and Demsetz (1972) are wrong that firms exercise "no power of fiat" over their employees.

Of course, this fundamental difference between firms and markets doesn't imply some kind of tension between them. Firms operate _within_ markets, and depend on the intellectual division of labor that generates market prices. (See Rothbard on the One Big Firm problem.) Firms are part of the market order. At the same time, a vertically integrated transaction is different, in important ways, from an arms-length market transaction.

BTW the "islands of socialism" metaphor comes from D. H. Robetson, not Plant.

Whoops, make that "Robertson."


Just a quick endorsement of your point about ultimate decision rights ... markets do not have an ultimate decision maker, firms do. This is an important point that often gets underemphasized in the "market based management" discussions, but not I would argue in Charles Koch's presentations. In fact, decision rights is an extremely important part of his presentation of the theory.

On a history of thought point --- didn't Plant "teach" the Robertson point to Coase?


Hmmmm, I don't think so. In the 1937 paper Coase quotes Robertson's _Control of Industry_ on the presence of "islands of conscious power in this ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk." (Love that homey agricultural metaphor!) In "The Nature of the Firm: Origins" (JLEO, 1985), Coase describes Plant as teaching him basic price theory and the view that the market "works itself," a view against which Coase reacted in formulating his thesis on the firm.

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