Tuesday, 12 April 2016

What those who followed Smith also got wrong

The other day I argued that one thing Adam Smith could have done but didn't was develop a theory of the firm. He had building blocks that could have led to some version of such a theory but he didn't go - rightly or wrongly - in this direction.

Given that Smith left the issue of the firm under-theorised did other economists set in and fill the void? It looks like there is a $100 bill being left on the pavement. As noted in the previous post the other classical economists followed Smith in paying the firm little heed. But what of the schools of thought that came after the classical school?

It turns out that in the period following the classical economists, with the possible exception of Alfred Marshall, few economists wrote anything much on the firm. When reviewing the contribution of the old institutionalists to the theory of the firm Hodgson (2012: 55) writes, “[ ...] we search in vain for a well-defined ‘theory of the firm’ within the old institutional economics”. Carl M. Guelzo argues that one of the leading old institutionalists, John R. Commons, “[ ...] did not construct a rigorous theory of the firm since this was never his purpose” (Guelzo 1976: 45). With reference to the German historical school Le Texier (2013: 80) writes “[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”. When writing about the work of Joseph Schumpeter, Hanappi (2012: 62) 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” (Bylund 2011: 191) and “[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” (Bylund 2011: 191). Hutchison (1953: 308) comments “[t]he Austrian School, with the exception of Auspitz and Lieben, did not concern themselves much with the analysis of markets and firms, except in respect to their general principle of imputation”. Hutchison also summarised the early neoclassical contributions to the theory of the firm, and markets, as “Jevons has little on the firm. [ ...] Walras’s assumptions of perfect competition (maintained virtually throughout) and of fixed technical ‘coefficients’, limited his contribution to the analysis of firms and markets, [ ...]. Pareto’s contribution to the theory of firms and markets were not rounded off, and of very varying value, [...]” (Hutchison 1953: 307). Post-1920 the latter neoclassical economists started to develop a theory of firm level production - see any introductory or intermediate microeconomics text book for a discussion of the theory - but it is a model production without firms. Given the model assumes zero transaction costs there is no need for the services of the intermediaries known as firms.

In fact it took till around 1970 before anyone decided to take the firm seriously. It was only then the economists such as Oliver Williamson, Armen Alchian, Harold Demsetz, Michael Jensen, William Meckling, Benjamin Klein, Oliver Hart and many others started to consider the firm as an important economic entity is its own right.

This lack of interest in the firm is baffling given the importance of the firm to economic activity, employment, innovation, growth, income generation and general well-being.

  • Bylund, Per L. (2011). ‘Division of Labor and the Firm: An Austrian Attempt at Explaining the Firm in the Market’, Quarterly Journal of Austrian Economics, 14(2): 188-215.
  • Guelzo, Carl M. (1976). ‘John R. Commons and the Theory of the Firm’, The American Economist, 20(2) Fall: 40-6.
  • Hanappi, Gerhard (2012). ‘Schumpeter’. In Michael Dietrich and Jackie Kraff (eds.), Handbook on the Economics and Theory of the Firm (pp. 62-69), Cheltenham: Edward Elgar Publishing Ltd.
  • Hodgson, Geoffrey M. (2012). ‘Veblen, Commons and the theory of the firm’. In Michael Dietrich and Jackie Kraff (eds.), Handbook on the Economics and Theory of the Firm (pp. 55-61), Cheltenham U.K.: Edward Elgar Publishing Ltd.
  • Hutchison, T. W. (1953). A Review of Economic Doctrines 1870-1929, Oxford: Oxford University Press.
  • Le Texier, Thibault (2013). ‘Veblen, Commons, and the Modern Corporation: Why Management Does Not Fit Economics’, Homo Oeconomicus, 30(1) March: 79-98.


Riko Stevens said...

'In fact it took till around 1970 before anyone decided to take the firm seriously.'

What about that seminal paper 'Nature of the Firm' (1937) written by that Nobel laureate Ronald Coase? I take it that by "anyone", thus, you must mean rather "many people"?

Riko Stevens

RS said...

Correction: 'The Nature of the Firm' (1937).