Friday, 11 July 2014

Economists and firms

A few days back Donal Curtin posted a piece at the Economics New Zealand blog on raising productivity in the services sector. A one point he writes,
Maybe economists aren't the best people to investigate business management - with exceptions (eg Baumol, Varian), economists tend to see the business production function as a "black box" with inputs in and outputs out, and they don't typically take the lid off the box - but this looks to me like one of the more likely keys to fit the productivity paradox lock.
I have to say that, in the past at least, he has a point. Economists for many years simply didn't see the workings of the firm as an area they should be bothered with. Arthur Pigou (he of the tax) famously once wrote:
“[ ...] it is not the business of economists to teach woollen manufacturers to make and sell wool, or brewers how to make and sell beer, or any other business men how to do their job. If that was what we were out for, we should, I imagine, immediately quit our desks and get somebody - doubtless at a heavy premium, for we should be thoroughly inefficient - to take us into his woollen mill or his brewery”
While Lord Robbins thought that
“[t]he technical arts of production are simply to be grouped among the given factors influencing the relative scarcity of different economic goods. The technique of cotton manufacture [ ...] is no part of the subject-matter of Economics [ ...]”
As to why the firm was ignored in Austrian economics Witt 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”
And if one looks at the history of economic one finds little, if any, interest in the firm. When reviewing the contribution of the old institutionalists to the theory of the firm Hodgson writes,
“[ ...] we search in vain for a well-defined ‘theory of the firm’ within the old institutional economics”.
With reference to the German historical school Le Texier explains
“[m]embers of the German historical school such as Gustav von Schmoller analysed at length the birth and growth of the business enterprise, but they were more historians than economists. None of these thinkers proposed a theory of the business firm”
About the work of Joseph Schumpeter, Hanappi says
“[a] well-defined theory of the firm thus cannot be found in Schumpeter’s oeuvres”.
As to Austrian economics Per Bylund writes,
“[b]ut despite the focus in Austrian economics on [ ...] “mundane economics,” and the fact that “the Austrians [have] so many necessary ingredients for a theory of the firm” [ ...], there is no Austrian theory of the firm”
“[w]hereas the theory of the firm has been a neglected area of study in mainstream economics, it has been missing from the Austrian economics literature”.
In the mainstream of economics up until around 1970 the standard theory of the firm was the neoclassical theory which as Donal notes treated the firm as a "black box", a production function or production possibilities set, a means of transforming inputs into outputs with no one asking how the transformation took place.

Since the 1970s, however, things have started to improve. During the 1970s work by Oliver Williamson Alchian and Demsetz and Jensen and Meckling started an upswing in interest in the firm as an significant economic institution. Today one only has to consider works like the "Handbook of Organizational  Economics", edited by Robert Gibbons and John Roberts, Princeton: Princeton University Press, 2013, to see that the firms and their inner workings are taken much more seriously. There are 1200 pages of people at least trying to take the lid off the "black box".

So I would suggest that there are good reason for letting economists, among others, investigate business management.

Given the concern with productivity of firms an additional area of investigation would be the relationship between firms and entrepreneurs. It is, after all, entrepreneurs who innovate and force change in business practises as well as in production techniques of goods and services. One only has to think of the effects of 'just in time' manufacturing to see how organisational change can affect costs and productivity.

The relationship between the theory of the firm and the theory of entrepreneurship is not as yet well understood but process is being made even here as witnessed by the Foss and Klein book "Organizing Entrepreneurial Judgement: A New Approach to the Firm", Cambridge: Cambridge University Press, 2012 (see this previous post) or Daniel Spulber's book "The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Markets, and Organizations" , Cambridge: Cambridge university Press, 2009.

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