Wednesday, 16 December 2009

What have we learnt about the theory of the firm?

My question of the day. In a recent paper I used a 1989 quote from Oliver Hart about the state of our understanding of the theory of the firm,
“An outsider to the field of economics would probably take it for granted that economists have a highly developed theory of the firm. After all, firms are the engines of growth of modern capitalistic economies, and so economists must surely have fairly sophisticated views of how they behave. In fact, little could be further from the truth. Most formal models of the firm are extremely rudimentary, capable only of portraying hypothetical firms that bear little relation to the complex organizations we see in the world. Furthermore, theories that attempt to incorporate real world features of corporations, partnerships and the like often lack precision and rigor, and have therefore failed, by and large, to be accepted by the theoretical mainstream.” (Hart 1989: 1757).
In recent correspondence (from November 2008), Professor Hart said of the 1989 quote
“The language of 1989 is strong, and I’d probably tone it down a bit now. There’s been a lot of work in the last twenty years, and some progress. However, we are still not at the point where we have good models of the internal organization of large firms.”
So I’m left wondering, What have we really learnt over the last 20 years? Have we really made any process in understanding the organizations that we refer to as firms? I have trouble in trying to think of what we have learnt.

Take, as an example, the point that there doesn’t even seem to be agreement on a definition of a firm. Alchian and Demsetz (1972) started a literature which argues that there is no real difference between markets and firms and so it is not generally useful to talk about firms as distinctive entities. The Grossman/Hart/Moore approach on the other hand thinks of firms as a collection of non-human assets under common ownership. Others see the firm in terms of the employment relationship. This seems a very basic point for there to be no agreed upon answer.

So, are we really any further advanced than we were 20 years ago?
  • Alchian, Armen, and Harold Demsetz (1972). ‘Production, Information Costs, and Economic Organization’, American Economic Review, 62(5) December: 777-95.
  • Hart, Oliver D. (1989). ‘An Economist’s Perspective on the Theory of the Firm’, Columbia Law Review, 89(7) November: 1757-74.

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