Organizations and Markets

Ben Klein’s Reply to Coase

11 March 2007 at 11:20 pm Peter G. Klein 2 comments

| Peter Klein |

Ben Klein’s new paper, “The Economic Lessons of Fisher Body – General Motors,” appears in the February 2007 issue of the International Journal of the Economics of Business. He is not about to give Ronald Coase the last word. Indeed, Klein writes, the newest evidence on the history of the relationship between Fisher and GM confirms his earlier claim that GM’s acquisition of Fisher in 1926 was a response to opportunistic behavior by Fisher. This evidence

sheds new light on the conduct underlying these events, most importantly on how Fisher Body accomplished its holdup of General Motors in 1922. . . . The analysis presented in this paper reconciles [my] previous evidence of Fisher Body’s reluctance to locate its body plants adjacent to GM assembly facilities and Fisher Body’s reduction in its capital to sales ratio with [Coase’s] new evidence regarding contract restrictions on the use of inefficient production technology and the lack of mis-located plants. In the process we not only more fully explain what happened in the Fisher Body-General Motors relationship but also provide significant insights into the economics of holdup behaviour. The conclusion that Fisher Body held up General Motors not only stands, but is substantially strengthened by the analysis because Fisher’s conduct is shown to be consistent with what we would expect from economics.

What of Coase’s contention that there was no holdup, and that the entire case illustrates economists’ tendency to disregard the facts?

To further the understanding of the Fisher Body-General Motors holdup, I provided the Fisher Body-General Motors contract along with an early draft of this paper to Ronald Coase. Coase has used the contract to publish an article that is sweeping in its condemnation of my previous analysis, concluding that the events I previously described as the Fisher Body holdup of General Motors is a “tale” that “never happened” and merely “a product of the imagination” (2006: 255 and 269). Coase claims I essentially made up a story to fit a preconceived theory, and accuses the economics profession for uncritically accepting this story because of its similar excessive reliance on theory (2006: 274-77). The true facts with regard to Fisher Body and General Motors, Coase maintains, supports his conclusion that asset specificity and the associated risk of opportunistic behaviour is “not an important factor influencing the structure of industry” (2006: 259). The two primary reasons Coase is convinced that a Fisher Body holdup of General Motors “never happened” is because Fisher Body’s plants were co-located with General Motors’ assembly facilities and because Fisher Body did not have the ability to adopt an inefficient low capital-intensive production technology under its cost-plus contract with General Motors. These two facts are correct, however Coase makes no attempt to reconcile these facts with the testimonial evidence of Fisher Body’s initial refusal to co-locate body plants and Fisher Body’s actual substantial reduction in its measured capital to sales ratio.

In addition, Coase incorrectly maintains that Fisher Body did not have an incentive under the contract to reduce its capital to sales. This involves a misinterpretation of the Fisher Body-General Motors contract and its cost-plus pricing formula, which did not include (but instead was designed to cover) Fisher Body’s equity capital costs. The fact that the cost-plus pricing formula was not adjusted in the face of General Motors’ sharing of body plant investments and the resulting reduction in Fisher Body’s capital to sales is what led to a large wealth transfer over time from General Motors to Fisher Body.

More generally,

Rather than defining a holdup in terms of a transactor taking advantage of a trading partner that is locked-in to a long-term imperfect contract by appropriating relationship-specific quasi-rents in the way Fisher Body held up General Motors, Coase is convinced that a holdup did not occur because he focuses on deceptive and fraudulent behaviour as the defining characteristic of a holdup.

This sentence points to the problems many economists have with the concept of “opportunism” — is it simply self-interested behavior, and if so, then why does it need a special term? (See my discussion of opportunism here.) 

Klein concludes his introduction with a general methodological point:

It is ironic that Coase criticizes economists who accept Fisher Body-General Motors as an example of holdup behaviour for relying too heavily on theoretical analysis independent of the facts when his landmark article on “The Nature of the Firm” (1937) was essentially pure theory. Coase provided us with an important theoretical insight — that organizational arrangements are indeterminate in a world of zero transaction costs — but very little in the way of an empirical answer to the question posed by this insight, namely the type of transaction costs that determine vertical integration and the conditions under which we are likely to observe such transaction costs. I, along with many other economists, have used asset specificity considerations in an attempt to build upon Coase’s theoretical insight. The expanded analysis of the Fisher Body-General Motors case presented here continues in this tradition, placing empirical flesh on Coase’s theoretical skeleton by examining the costs transactors bear when using long-term contracts to solve potential holdup problems.

Entry filed under: - Klein -, Strategic Management, Theory of the Firm.