Thursday, 6 October 2011

An Austrian view of the firm

Per L. Bylund has an interesting article in the Quarterly Journal of Austrian Economics, Vol. 14, No. 2, pp.188–215, Summer 2011, on The Division of Labor and the Firm: An Austrian Attempt at Explaining the Firm in the Market. The abstract reads:
This paper reviews Austrian approaches to the firm and drafts a theory that emphasizes the firm as a market phenomenon. Here the firm is a vehicle for imaginative entrepreneurs to create artificially high factor density, thereby increasing its internal “extent of the market” to support specialization of factors beyond the general level of division of labor in the market. The firm therefore becomes a product of, and prospective catalyst for progressing the market’s overall division of labor, and the firm emerges as an entrepreneur-generated means toward increased efficiency and more roundabout production. It consequently may play a crucial role in the evolution of market structure and, by extension, the development of civilization.
Bylund opens his paper by noting
The theory of the firm has been a neglected area of study in mainstream economics. Despite Ronald Coase bringing the issue up for discussion in 1937, it was not on the research agenda until the 1970s. Even now, as both Coase and Oliver Williamson, the founder of and prominent scholar in the transaction cost-focusing analysis of firm organization, have received the Nobel Prize in economics, the area remains in the periphery of economic analysis.
This does raise the somewhat strange question of, If the theory of the firm is an area of study significant enough to warrant a couple of Nobel Prizes, why is it at the periphery of economics? Part of Bylund's answer is that,
Part of the reason the firm is not considered worthy of analysis in the economic mainstream is undoubtedly, to a degree, because it should not exist.
As Coase pointed out in a world of zero transactions costs firm have no rationale. He noted that firms would exist only in a world in which there were costs to using the price mechanism, that is, a world of positive transaction costs. The mainstream theory of the firm has grown out of this Coaseian insight. But
[...] even as mainstream economists began to realize Coase’s contribution, some thirty years after “The Nature of the Firm” (1937) was published, Austrians still had no such theory. About two decades after the rediscovery of Coase (1937) by Williamson (1967; 1973; 1979) and others (see e.g. Alchian and Kessel, 1962; Alchian, 1965; 1968; Alchian and Demsetz, 1972; Demsetz, 1967; Klein, Crawford and Alchian, 1978; McManus, 1975; Monsen Jr and Downs, 1965; Silver and Auster, 1969), O’Driscoll and Rizzo stated that “there is no […] Austrian theory of the firm” (1985, p. 123) and another decade later Foss (1994) made the same observation and could still, a few additional years later, safely theorize about “the Austrian lack of interest in the firm” (Foss, 1997, p. 176). More than seventy years after Coase’s seminal article, Foss and Klein identified that “a small Austrian literature on the firm has emerged” but that “[u]ntil recently the theory of the firm was an almost completely neglected area in Austrian economics” (2009, p. 2).
So while the mainstream has at least started to develop a theory of the firm, even if not with too much enthusiasm, the Austrians have lagged behind. Again the question is, Why?

As to why the firm was ignored in Austrian economics Witt (1999: 108) writes,
“[t]he neglect of the firm as the organizational form of an entrepreneurial venture has a tradition in Austrian economics. It may be traced back to a characteristic of the scientific community in the German language countries. There, economic theory (Volkswirtschaftslehre) and business economics (Betriebswirtschaftslehre) were institutionally segregated as early as at the turn of the century to a degree still unknown today in the Anglo Saxon world. As Lachmann once conjectured, Austrian writers therefore considered the organizational form of entrepreneurial activities to be a topic best left to their business economics fellows.”
As Bylund's paper shows this tradition is changing, which is all to the good.

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