The Economist on Coase at 100

27 December 2010 at 12:19 am Peter G. Klein 11 comments

| Peter Klein |

The new Economist celebrates Ronald Coase’s 100th birthday (this coming Wednesday) with a short piece on “The Nature of the Firm” (1937), the founding document of modern organizational economics (16,379 Google Scholar cites). (Thanks to Avi for the pointer.) It’s nice to see the theory of the firm get its props, and the first few paragraphs do a good job summarizing the paper. But the (anonymous) author has misread the modern literature, first in setting up an artificial conflict between Coase’s transaction-cost approach and the resource-based approach to the firm and, second, by missing the depth and nuance of Coase’s own research program.

On the first point: Much recent work tries to reconcile transaction cost economics (TCE) and the resource-based view (RBV) (e.g., Silverman, 1999; Foss and Langlois, 1999; Tsang, 2000; Madhok, 2002; Foss and Foss, 2005), pointing out that the two theories are, in important ways, complementary. Put simply: TCE and RBV start with different explananda. The RBV asks which resources will be combined in which ways to produce which outputs, while TCE asks how this activity will be organized (market, hierarchy, or hybrid). RBV offers a theory of competitive advantage, while TCE focuses on boundaries and governance. Second, the Economist writer confuses Coase with the (Coase-inspired) transaction cost approach of Williamson (1971, 1975, 1979) and Klein, Crawford, and Alchian (1978):

Mr Coase’s narrow focus on transaction costs nevertheless provides only a partial explanation of the power of firms. . . . Companies can organise production and create knowledge in unique ways. They can also make long-term bets on innovations that will redefine markets rather than merely satisfy demand. Mr Coase’s theory of “market failure” needs to be complemented by a theory of “organisational advantages.”

The irony is that Coase’s own, revisionist explanation of the GM-Fisher case (discussed here, here, and here) is based precisely on “organizational advantages,” not transaction costs. Coase argues that GM acquired Fisher to make more effective use of the Fisher brothers’ specific human capital, not to avoid market transaction costs (as in the canonical version of the story).

What, The Economist doesn’t read O&M? Shocking!

Entry filed under: - Klein -, History of Economic and Management Thought, New Institutional Economics, People, Strategic Management, Theory of the Firm.

Happy Holidays Coordination Problems in the Theory of the Firm

11 Comments Add your own

1. Scott Masten | 27 December 2010 at 8:39 am

Ah, Peter! I was preparing a post exactly on this point to put up on Ronald’s birthday. But you preempted me. And you even got the tip from my student! (Avi, you traitor!) Oh well. Let that be a lesson to me. In the Internet age, pride goes to the swift.

I was actually hoping to engage another O&M Grand Co-Poobah in a debate on the issue. Dick had an essay in a volume titled Coasean Economics (Stephen G. Medema, ed., 1998) in which, as I read it, he made much the same point as The Economist piece. I was asked to comment on Dick’s essay (and one by Geoff Hodgeson) for the volume and noted “What is ironic is that Langlois would choose a volume on Coasean economics to reassert the criticism” that Coase’s emphasis on transaction costs has caused economists to ignore the role firm capabilities in determining organization. Unfortunately, it was a one-sided debate because Dick did not get an opportunity to reply. I have wondered ever since what his response is.
2. Peter Klein | 27 December 2010 at 9:13 am

Drat. I hate that I preempted a potentially deep post with one of my typically shallow ones. Dick and Scott, have at it!
3. more links « nonmarket behavior | 27 December 2010 at 12:54 pm

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4. srp | 27 December 2010 at 8:03 pm

Peter’s anodyne view of the modern literature on RBV and TCE is rational but unfortunately not indicative of the state of play, even in some of the papers he cites. The capabilities folks have been unwilling to concede that absent transactions costs (and ultimately opportunism risks) firm boundaries don’t matter at all. Many of them want to retain the idea that having employees who are more capable than suppliers justifies backward integration, ignoring the independence between specifying which party should do a task and specifying a governance structure for that party.
5. Peter Klein | 27 December 2010 at 9:19 pm

@srp: I’m usually considered a bit of a provocateur, but I take your point!
6. Nicolai Foss | 28 December 2010 at 11:09 am

Peter: I believe we are moving beyond the division of labour between the RBV and org econ that you are here proposing. Until now most thinking has stressed that the RBV/capabilities etc. are the fundamental story about heterogeneity as well as the fundamental story about “… which resources will be combined in which ways to produce which outputs.” This makes capabilities thinking primary, at least in the context of strategy. However, this view neglects that transaction costs influence which investments will be undertaken, along which technological trajectories firms will search and so on, so that TC antecede capability formation. Dick Langlois and I hinted at this in our 1999 paper. See also Foss & Foss, 2008, SEJ. There is also a recent excellent paper by Nick Argyres and Todd Zenger that makes this point, but I believe it is still unpublished.
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8. David Hoopes | 29 December 2010 at 1:40 am

You can include Demsetz with SRP’s group that think with zero Williamson-type transaction costs (governance) there will still be firms.
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10. Scott Masten | 29 December 2010 at 7:24 pm

David, Harold gets firm existence with zero transaction costs by defining transaction costs very narrowly. Why do people continue to try to dispute a tautology?
11. David Hoopes | 31 December 2010 at 12:09 am

My take was that Harold believed Williamson’s theory was only governance. And that governance problems were not necessary for firms to exist. I believe Steve’s point is that without governance problems there should be no firms.

Coase and Demsetz think more in terms of other frictions besides opportunism. That’s my understanding.