№ XIV
The twelve plates
The market coordinates without a coordinator: no one commands the baker, yet the bread arrives. Economics has marveled at this for two centuries. Yet most of economic life takes place inside firms, where the market is switched off and command rules — where no price guides the worker, and resources move by plan. This volume examines the great exception to the price system: the firm, the island of planning in the market's sea, and the question of where the one gives way to the other.
if the market needs no planner, why is so much of it conducted inside firms, which plan and nothing else?
There is a marvel at the center of economics, so constant that one forgets to be astonished by it. No one is in charge of feeding a city. No official assigns the bakers their flour or the grocers their fruit, no plan decrees how many loaves shall be baked on a Tuesday in March; and yet the bread is on the shelf and the fruit in the bin, in roughly the right amounts, year upon year. The price system performs this miracle of coordination without a coordinator, harnessing the labor of millions who never meet and share no purpose. It is the deepest argument for the market, and a true one. But it carries a puzzle in its wake, and the puzzle is the subject of this volume. For if the price system coordinates so marvelously, with no one giving orders, why is so much of economic life conducted inside firms — great organizations where no price guides anyone, and orders are given all day long?
The puzzle was posed, with disarming simplicity, by a young economist named Ronald Coase in 1937. Look, he said, at what actually happens within a company. The worker does not sell each task to the highest bidder down the corridor; the clerk does not negotiate a fresh price with the next desk. They are told what to do, and they do it. Within the firm, the market is switched off and a kind of planning — the very planning the market was supposed to render needless — reigns instead. So why have firms at all? Why is not every transaction a market transaction, every worker a one-person business contracting for each job? Coase's answer was that using the market is not free. To buy a thing rather than to command it, one must discover the price, find a willing party, haggle, draw up the contract, and watch that it is kept; and these costs — the costs of transacting — can easily exceed the cost of simply hiring a person and directing her. Search and discovery, the haggling and the drafting, the watching for cheating and the quarreling when terms go stale — each is a toll the market levies, and the firm, by substituting a single open-ended order for a thousand little bargains, contrives to avoid it. The firm arises wherever it is cheaper to organize a task by authority than to carry it out through the market.
The firm, then, is an island of conscious power — the phrase is D. H. Robertson's, and Coase made it famous — in an ocean of unconscious co-operation: a patch of deliberate planning amid the spontaneous order of prices. And the image puts a question with some force. If planning by command saves the costs of the market, why not plan everything — gather the whole economy into one colossal firm and dispense with the market altogether? The twentieth century, under the name of central planning, tried very nearly that, and the attempt is a chapter for the volume on the rules. The answer is that command has costs of its own, and they swell as the organization grows: the manager's grasp falls short of his reach, incentives slacken, the paperwork multiplies. So the firm expands only to the margin where the cost of arranging one more transaction inside it equals the cost of buying that transaction outside — and there, at that fine balance, its boundary lies. Make or buy, integrate or contract out: the size and shape of every firm is this line, drawn and redrawn with each decision. And what pulls a transaction inside the line is often a particular hazard, the one Oliver Williamson made central: where a party must sink money into an asset useful only to its partner — a plant built beside a single buyer's mill, a tool good for no other job — it falls thereafter at that partner's mercy, and to bring the two under one owner is the surest escape from the holdup that would otherwise follow.
Cross the boundary inward and one finds not a market but a hierarchy, and a contract unlike any other. When you hire a plumber you buy a named task; when a firm hires an employee it buys the right, within limits, to direct her at tasks not yet named — and Herbert Simon saw in this exchange of obedience for a wage the very signature of the firm. Yet authority breeds troubles the market is spared. The directed worker has no price spurring her to exert herself, and must somehow be watched or motivated; the managers who run the great corporation may pursue their own comfort rather than the owners' gain, for ownership and control, fused in the old proprietor, were split asunder in the modern company, its owners a scattered crowd of shareholders and its controllers a professional few. From these frictions grew a whole literature of agency. And they provoked a deeper dispute about the firm's very nature: whether it is truly a realm of authority at all, or whether — as Alchian, Demsetz, and others argued — the boss can no more command the worker than a customer can command his grocer, so that the firm is but a nexus of contracts, the market in another dress. Against them, the theorists of ownership reply that when contracts are inevitably incomplete, the one who owns the assets holds the residual right to decide, and that this power is real.
The firm is, besides, a great deal more than its economics can easily hold. It is a social institution, run as much on loyalty, identity, and unwritten norm as on incentive and clause — for the contract is always incomplete, the monitor always partly blind, and what fills the gap is a culture no price can purchase. It has a history: the giant managerial corporation, in which a visible hand of administrative coordination supplanted the market's invisible one, is scarcely older than the railway, and may already be loosening, as cheap communication lets firms buy what they once had to make and dissolve toward supply chains, contractors, and platforms. And it wears forms other than the familiar one in which capital hires labor and shareholders own all — the partnership, the mutual, the worker cooperative — each raising the question of why that familiar form so nearly always wins. There is, besides, an older account of why firms exist at all, owed to Frank Knight: that someone must bear the uncertainty of an unknowable future, and the entrepreneur is the one who shoulders it — guaranteeing others their wage, and keeping for himself the residue, profit or ruin, that no contract could fix in advance. To all this the twelve plates attend, from command and the nexus of contracts through the agent, the asset, and the bearer of uncertainty, to the corporation's rise, its rivals, its culture, its shifting edge, and its purpose.
Beneath these inquiries runs the conviction that animates the whole table. A price, this work has held throughout, is a verdict on a hidden contest, mistaken for a fact of nature; and the firm presses a companion truth, more humbling than it first appears — that the price system is far smaller than it looks. We speak of a market economy as though all of economic life were prices the whole way down, an unbroken weave of buying and selling. But most of it, measured in hours and in value, takes place inside firms, where prices fall silent and plans and commands do the work. The price of a finished car seems the sum of the prices of its parts; yet the parts were largely made within firms, by administrative fiat, the assembly line answering to no market at all, and the prices we observe are only the visible peaks of a vast submerged planning. The market, then, is not the whole of the economy but an archipelago of price in a sea of organization — and the waterline between them, the boundary of the firm, is set by no law of nature but by the costs of transacting, and moves with every merger and every outsourcing. We take the price system for the natural and entire form of economic order; the firm reveals that order is wrought as much by authority as by exchange, and that the border between the two is itself a contested, shifting choice rather than a given. Where the volume on money examined the institution that makes prices possible, this one examines the institution that suspends them. The argument remains open.