Edited by John B. Davis and Wilfred Dolfsma
Chapter 20: The cement of the firm: command, separation or association?
Firms have always been a source of embarrassment to mainstream economics. In the past the problem was that an explanation for their existence was missing. In fact, Adam Smith had identified the division of labour as the key to the wealth of nations, and noted that it could be achieved either in the market or within the pin factory. But while he elaborated extensively on why the division of labour was dependent on markets, he did not feel the need to explain why specialization, rather than market mediation, was sometimes effected within the pin factory. Two centuries later Coase (1937) identified this blind spot in Smith’s legacy. He perceptively noted that, for a theoretical account that depicted the ‘normal economic system’ as one that ‘works itself’ in the absence of any type of central control, firms would remain abnormal facts unless an explanation were provided for their very existence. Coase did indeed advance such an explanation. In opening the firm’s black box, Coase found command as a means to reduce the costs of market transactions. However, for an economics that claimed to descend from a tradition according to which command was to be eradicated in a liberal market society, Coase’s finding was a further source of embarrassment. Consequently, neoclassical economists have since then focused on developing accounts of the firm that might dispense with Coase’s awkward illiberal residual.
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