There is a marvel at the center of economics, and it is easy to grow so used to it that one forgets to be amazed. No one is in charge of feeding a great city, and yet it is fed; no commissar assigns the bakers their flour or the grocers their fruit, and yet the bread is on the shelf and the apples in the bin, in roughly the right amounts, day after day. The price system does this, coordinating the labor of millions who never meet and have no common plan. But if the market is so good at coordinating without a coordinator, a strange question arises, and for a long time almost no one thought to ask it: why, then, is there any planning at all?
For there is planning everywhere, and we pass our working lives inside it. The marvel of the market is real, and the great liberal economists were right to be moved by it; but a moment's looking shows that vast tracts of economic life are not conducted in the market at all. They are conducted inside firms — the factory, the bank, the agency, the shop — and a firm is precisely a place where the price system has been switched off. The worker on the line does not sell each motion to the next station for a negotiated fee; the clerk does not bid for the file on the next desk. They are told what to do, and they do it. Within the firm, in other words, resources are moved not by prices but by orders, by the conscious direction of someone in charge — by exactly the kind of planning that, spread across a whole economy, the market is forever praised for rendering needless. The reigning theory could explain the bread arriving in the city. It could not explain why so much of the bread's making happened inside a bakery rather than across a market, and for the longest time it did not think to ask.
It was a young Englishman, Ronald Coase, who in 1937 at last asked the question and gave it an answer that has shaped the subject ever since. If the market is so efficient, he reasoned, then in a world of pure markets there would be no firms: every person would be a business of one, buying each input and selling each output at a price, the whole economy a seamless tissue of exchange with no islands of command in it anywhere. That such islands exist, and are vast, must mean the market is not, after all, costless to use. And it is not. To buy a thing rather than to command it, one must find out what it should cost and who will supply it, strike and write a bargain over it, and then watch to see the bargain kept — and these costs of transacting, trifling for a single purchase, mount ruinously when every step of a long production must be haggled afresh, again and again, with everyone involved. The firm is the escape. In place of a thousand separate market contracts it puts a single, deliberately open-ended one — the contract of employment — under which a person agrees, for a wage, to do as she is later told. The endless renegotiation falls away, and direction takes its place.
What the firm does, then, is to supersede the price mechanism with something older and simpler: authority. Where the market moves a resource by posting a price that draws it, the firm moves it by an instruction that sends it; and inside the firm's walls the whole apparatus of bidding and pricing simply goes quiet, replaced by the manager's word. This is a stranger fact than familiarity allows. It means that the market economy, far from being market all the way down, is honeycombed with small command economies — islands of conscious planning set in the unconscious order of prices — and that we spend the better part of our lives not in the market but in one or another of these islands, taking direction. The thing the market was supposed to make needless, planning, turns out to be everywhere within the market, hidden inside its firms; and it is there not in spite of the market's efficiency but because of the market's cost. Where using prices is dear, planning is cheap, and the island rises out of the sea.
The mark of the firm, on this account, is the substitution of obedience for exchange, and its instrument is the strange contract by which a person is hired. When you engage a plumber you buy a defined job; when a firm engages an employee it buys something far less defined — the right to direct her, within limits, at tasks not yet named. The wage is the price not of a particular piece of work but of submitting to be directed, and it is here that this volume and the volume on the wage prove to be regarding one thing from two sides. Coase's deeper accomplishment was to have brought the firm inside economics at last. Before him it sat outside the theory, a brute given; after him it was itself a result, an institution that arises, like everything else in the subject, wherever it is the cheaper way of getting something done. And the tool he forged to do it — the recognition that using the market has costs of its own — proved one of the most fertile in the century, the same idea he would turn, decades afterward, upon the factory's smoke and the neighbor's complaint, in the volume on the externality.
The theory has not gone unchallenged, and honesty requires its troubles be set down beside its triumph. For all its power, Coase's answer was for many years more a name than a measure: to say that firms arise to save transaction costs is to label the gap, not to fill it, until one can say which costs, how large, and when — and the work of giving the idea teeth fell to a later generation, and belongs to the plate on the boundary. A graver doubt strikes at the notion of authority itself. Is the employer's command truly different in kind from a customer's custom? He can tell the worker what to do, certainly; but if she refuses, all he can finally do is dismiss her — just as a displeased customer can do no more than take his trade elsewhere. On this view, pressed hard by Alchian and Demsetz, the firm is no realm of power at all but a particularly dense cluster of ordinary market contracts, and the bright boundary Coase drew between commanding and buying dissolves into a mere difference of degree. The quarrel is unsettled, and the plate on the nexus takes it up.
There is a last puzzle, and it is the deepest the firm has to offer. If planning inside a firm works — and it plainly does, for firms exist, endure, and grow enormous — then why does planning across a whole economy fail, as in the twentieth century it so catastrophically did? The corporation and the command state do the same thing: allocate resources by direction, not by price. Yet the one coordinates the labor of hundreds of thousands, while the other, attempting as much for a nation, collapsed into shortage and waste. The difference, the liberal critics of planning saw, lies partly in what surrounds the planner. The firm plans on a small patch within a vast market it did not make: it can look up the price of all it chooses not to produce, reckon against those prices, and feel at once, in profit or loss, the verdict of a competition it cannot suspend. The central planner has no such ocean to read; having abolished the market, he is blind to the very prices that would have told him whether his plan was wise. The island can plan only because the ocean prices everything around it — a thought the volume on the rules must finish.
Step back from the particulars and the firm rebukes a habit of thought this work has been at pains to expose. We are inclined to treat the market as a kind of natural medium, an economic atmosphere present everywhere and for free, against which any planning shows up as an intrusion. The firm teaches otherwise. The price system is not free; it is a contrivance with running costs, and like any contrivance it is used only where it pays. Where the cost of pricing a thing — of finding its price, bargaining it, policing it — comes to more than the thing saved, the price system is quietly set aside, and direction by authority takes its place. The market, then, has a boundary, and beyond that boundary it simply does not operate; the economy is not one great market but a patchwork of market and organization, priced here and planned there, by whichever is cheaper at each seam. A price is not the universal solvent of economic life. It is a tool with a reach, and the firm is what occupies the territory the tool cannot afford to enter.
And this recasts how we should read the prices we do see. Take the plainest example, a finished good with a number on it — a car in a showroom, say, marked at its price. We are tempted to read that number as a pure fact of the market, the clean resultant of supply meeting demand. But the car was built inside a firm, from components built inside other firms, by a long chain of orders and schedules and standing arrangements in which, for step after step, no price was struck at all. The showroom number is only the final, priced surface of an immense submerged organization — the visible peak of an iceberg most of which is planning. To take it for the whole story of how the car came to be is to mistake the market for the economy entire, and the seen for the unseen beneath it. The price is real; but it is the last word of a process most of which spoke no prices, and the contest it appears to settle was, for most of its length, settled not by price but by command.
The market is not the air, present everywhere by nature; it is a built thing, with a price of admission, and the firm is what rises where that price climbs too high.
So the first plate of this volume leaves us with a chastened picture of the very thing the whole table anatomizes. A price is a verdict on a hidden contest, mistaken for a fact of nature — and the firm shows that the machinery for rendering such verdicts is itself costly, partial, and bounded, switched off across great stretches of economic life in favor of the older expedient of command. We had thought the market the natural and total form of economic order, prices the medium in which all of it swims. It is not so. The market is one institution among others for getting the world's work coordinated, taken up where it is cheap and forsaken where it is dear; and the line between where it rules and where authority rules — the boundary of the firm — is no fact of nature but a contested, shifting choice, redrawn with every decision to make a thing rather than buy it. That boundary, and the forces that fix it, are the subject of the plate that follows. Where this one asked why the islands of planning exist at all, the next asks how far they spread. The argument remains open.