Coase’s “Nature of the Firm”: An Anthropological Critique

But is it a good one? Is it even made in good faith? I need help.

From American anthropologist John D Kelly’s The American Game…:

Ronald Coase’s theory of the nature of the firm rescued, for neo-classical economics, the existence of firms or corporations as rational entities […] Markets always come first, and the problem of the existence of firms is depicted as the problem of why a rational manager would rely on employees rather than markets. State planning and private firms are taking over what already exists, integrated by the price mechanism of markets, and are successful to the extent that they lower costs, since there are a variety of costs involved in market transactions. Thus marginalist analysis implies that an equilibrium will always be found between planning structures and integration by price mechanism, especially since, as Coase says in “The Nature of the Firm,” “businessmen will be constantly experimenting, controlling more or less” and “firms arise voluntarily because they represent a more efficient method of organizing production.” The rise of the firm, as Coase imagines it, is always a movement from many pre-existing contracts to a controlling structure, “For this series of contracts is substituted one.” (94)

The emphasis is mine. Kelly continues:

This imaginary fits poorly the situations that were precisely the actual origins of firms, as when banks gave mortgages to planters, or stock markets funded companies of young agents, prepared to cut plantations into captured wilderness for tropical commodities […] usually employing labor moved long distances and disciplined by direct violence. There is more in the universe than Coase’s imagination, more motives for controlling powers of firms than their cost efficiencies. (94-95)

Kelly goes on to give a brief account of 1) how corporations created commodity production out of thin air, 2) how these corporations were tied to European imperialism, and 3) how they used slaves and indentured servants even when it would have been cheaper to hire the locals.

I want to address Kelly’s summary of Coase’s paper (here is a pdf, by the way, in case you want to follow along), mostly because I’ve never read it although I know it’s important, but first I want to make a couple of digressions. Libertarians would more or less answer Kelly’s three charges listed above as follows: 1) yes, and this is a good thing, 2) state-sponsored corporations and private firms are two distinct entities with two very different incentive structures, and 3) see #2. There is also an issue of accuracy in regards to Kelly’s brief summary of world history since 1600. I don’t want to get into the details here, but I do want you to recognize that I am reading Kelly critically. My last digression is simply to point out that libertarians and Weberian Leftists like Kelly have more in common than we think.

To get back to Coase’s paper, and Kelly’s critique of it, I want to highlight one sentence from Kelly’s book in particular and then turn it over to the peanut gallery in the hopes of gaining some insight:

Markets always come first, and the problem of the existence of firms is depicted as the problem of why a rational manager would rely on employees rather than markets.

Is this the puzzle Coase was trying to grapple with in his paper? I ctrl+f’d Coase’s paper (“employe” – not a typo) and couldn’t find anything that actually confirms Kelly’s summary, but it would be an interesting project (if I am right in stating that Kelly’s summary of Coase’s paper is not accurate) to follow this line of thought and delve into Kelly’s insight about the reliance that entrepreneurs/firms have on employees (rather than markets)…

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9 thoughts on “Coase’s “Nature of the Firm”: An Anthropological Critique

  1. Kelly is right that Coase’s general goal with the paper is to explain why firms exist. See:

    “Sir Arthur Salter’s description, however, gives a very incomplete picture of our economic system. Within a
    firm, the description does not fit at all. For instance, in economic theory we find that the allocation of factors of production between different uses is determined by the price mechanism. The price of factor A becomes higher in X than in Y. As a result, A moves from Y to X until the difference between the prices in X and Y, except if so far as it compensates for other differential advantages, disappears.

    Yet in the real world, we find that there are many areas where this does not apply. If a workman moves from department Y to department X, he does not go because of a change in relative prices, but because he is ordered to do so.

    Those who object to economic planning on the grounds that the problem is solved by price movements can be answered by pointing out that there is planning within our economic system which is quite different from the individual planning mentioned above and which is akin to what is normally called economic planning. The example given above is typical of a large sphere in our modem economic system. 0f course, this fact has not been ignored by economists…”

    • Thanks for the clarification Michelangelo. My main question, though, is whether or not Coase was trying to figure out “the problem of why a rational manager would rely on employees rather than markets.” I could not find this anywhere in the paper, though again I could have simply missed it or not been able to comprehend it. (If it’s not there, then Kelly might have accidentally stumbled upon a very interesting question in and of itself.)

      By “employees” does Kelly mean that the creation of firms implies that managers don’t rely on markets? What does Kelly mean by a reliance on employees?

      I am tired and perhaps thinking about this too hard, but that’s why I’ve turned this over to the peanut gallery…

      • By “market” Kelly seems to be referring to why firms hire employees instead of just hiring contract workers for specific jobs that need doing. The answer, as Coase explains, is transaction costs. In a transaction cost free world traditional employees make little sense. This is why technologies like uber, which reduce transaction costs, have lead the shift towards contract employees.

        Kelly is not saying that firms/managers don’t rely on market prices to decide what the firm should produce.

        Is this what you’re referring to?

      • By “market” Kelly seems to be referring to why firms hire employees instead of just hiring contract workers for specific jobs that need doing.

        This. Thanks Michelangelo.

  2. As an aside, I think Oliver Williamson is much better on how/why relative transaction costs explain the existence of firms.

    “By “employees” does Kelly mean that the creation of firms implies that managers don’t rely on markets? What does Kelly mean by a reliance on employees?”

    By ‘reliance on employees’ the TC people mean that transactions internal to the firm are governed by administrative fiat coupled with incomplete employment contracts for governance.

Please keep it civil (unless it relates to Jacques)

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