Organizations and Markets

3 Comments Add your own

• 1. Kevin Carson  |  15 February 2007 at 4:29 pm

  We should also consider another factor–that firm size is currently promoted by state intervention: subsidized transportation that promotes economic centralization; subsidies to R&D, depreciation, etc., that promote capital-intensive forms of production (and hence higher entry barriers); and subsidies to the concentration of capital, like the interest deduction for corporate debt, and treating securities transactions differently under the capital gains tax when they’re involved in mergers. And of course, the corporate framework is good for exercising power over things like “intellectual property” rights [sic], and corporate finance in the context of a statist credit system. My guess is that vertical integration currently replaces the market to the extent that it does only because the corporation is such an excellent vehicle for exercising privilege.

  Generally speaking, I think Williamson was right in considering the transaction costs of internal administration (leaving aside asset specificity issues*) to be greater than those of market contracting. Outside contracting with a self-employed individual or a small peer-production group makes a lot more sense than putting the same number of added personnel on the payroll. The MBA types in management generally see the actual production process as a black box anyway, whether it takes place inside or outside the firm. The good thing about outside contracting is that it makes a virtue of the black box thing. Because the “black box” is outsourced to a self-managed individual or group, you eliminate most of the agency problems of substituting administrative incentives for market incentives. A self-managed production unit requires far fewer personnel for monitoring and quality control, as a percentage of the entire workforce, than an absentee-owned enterprise. The larger firm, meanwhile, no longer has to worry about what takes place inside the box; it only has to establish the “clear ins” and “clear outs” by contract.

  * Williamson neglects the extent to which the current degree of asset specificity is itself the product of state intervention. The state, by promoting artificially large market areas and more capital intensive forms of production, also promotes artificially high levels of specialization of machinery and of technical skills. In a free market society of smaller market areas, production would likely tend more toward frequent shifts between shorter production runs on general purpose production machinery.

• 2. Peter Klein  |  15 February 2007 at 6:13 pm

  Kevin, I certainly agree that defining the optimal firm size under state intervention is a different problem from defining it under laissez-faire, and that much of the literature glosses over this point. But I’m less sure than you what the free-market optimum would be.

  You list in your first paragraph many policies that promote larger, more vertically integrated firms. But there are also policies that have the opposite effect. Large firms are under stricter regulatory scrutiny than small firms; large firms are more likely to be the victims of political rent extraction (in Fred McChesney’s sense); corporations are subject to stricter disclosure requirements (SOX being only the most visible, recent example); small and young firms benefit from incubators, SBIR awards, regional development grants, and a host of other interventions designed to foster “entrepreneurship.” It is hard to know, ex ante, which set of effects outweighs the other.

  Similarly, regarding asset specificity, market size, capital intensity, and specialization, we should keep in mind that trade barriers, war, state control of education, and a host of other interventions retard the international division of labor, reduce stocks of human capital, lower the marginal product of labor, and so on. Under laissez-faire the optimal degree of capital intensity and task specialization could easily be higher, not lower, than it is under interventionism.

• 3. Kevin Carson  |  15 February 2007 at 11:03 pm

  I suppose it’s conceivable, but unlikely IMO. My own belief is that present levels of international trade and division of labor reflect government intervention–including, among other things, long-distance transportation subsidies, the international IP law regime, and foreign aid (including World Bank) subsidies to build the transportation and utility infrastructure to support specific investment projects. Not to mention, also, political risk mitigation for investors by the U.S. government, and U.S. government guarantees of open sea lanes and the like at taxpayer expense.

  I tend to side with Gabriel Kolko and the left-Rothbardians on the “qui bono” issue of regulations. The exemption of firms below a certain size threshold is a moot point, because the main effect of state policy has been to create an oligopoly market dominated by a few giant firms. And from the perspective of those firms, a major effect of quality and safety regulations is the same as if an industry trade association had adopted similar standards through the mechanism of a private cartel: it limits competition in terms of quality and safety to that extent. The main advantage of state regulation, as opposed to voluntary cartels, is that it’s non-defectable and stable.

  BTW, I stumbled onto this blog doing a web search after reading your excellent RAE article on Rothbard’s application of the calculation problem to the corporation. Great find!

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