Comments on: Markets, Firms and Planning

By: Nicholas Gruen

Nicholas Gruen — Wed, 28 Jul 2004 13:58:52 +0000

It surprises me that after over sixty years of Hayek saying it and over 30 years of the Arrows and the Akerlofs of the world saying it, the idea of policy seeking to systematically improve information flows in markets has not really entered mainstream economics as a normative program. True we all hear that securing integrity of information flows in markets is a function of governments, and a rationale for regulation in the markets for consumer and investor information for instance. But is this all the state can do to improve information flows in markets and thus (providing the interventions are not too costly) improve economic efficiency? I would suggest there are lots of things it could do to do so. They are relatively light handed things also. I have had a go at sketching some ideas in http://www.lateraleconomics.com/outputs/AJPA%20Article.pdf “>this article.

By: kevin quinn

kevin quinn — Tue, 27 Jul 2004 12:20:36 +0000

Just a few comments on a very interesting thread. It has always seemed to me that the most important idea to come out of the transactions cost lit. is the idea that non-market institutions – firms, governments, eg have advantages over markets when it comes to creating environments that encourage “specific” investments. A world organized only by markets would be a much poorer world than the one we see because the level of investment in highly productive but specific assets would be abysmally low. On the other hand, I don’t share the confidence of the tc people that there is some metamarket that insures that the trade-off between markets and hierarchy is efficiently made. I have been thinking lately that there is a potential link here with the more narrow EMH discussion. The idea is Keynes’, that pathologies occur in the pricing of infinitely-lived assets due to the illusion of liquidity fostered by the secondary market.

By: khr

khr — Tue, 27 Jul 2004 10:04:55 +0000

Re: Fraud If the market is, in theory, a perfect information system, shouldn’t any type of fraud be, in theory, impossible ? If all the information is available to everybody, false information could easily be recognised and rejected.

By: burritoboy

burritoboy — Mon, 26 Jul 2004 18:08:12 +0000

Response to sebastian: In your response to the booksellers argument, I noted that your first argument failed if we held all else equal. You responded by arguing a number of factors which wouldn’t hold all else equal. The largest problem I see with your argument is that all of your proposed factors would have been true 35, 50 or even 100 years ago. Essentially, you reverted to a returns to scale argument with the addition of a replacing labor with capital argument. The only part I find plausibly increasing over the past century is the capital versus labor factor, since computers probably did replace some of the labor previously needed to organize a large bookstore. I don’t know if that’s a substantial enough reed to hang your entire argument off of. I don’t believe that the cheaper labor factor in the large bookstore chain is really that substantial, if it even exists at all. Remember that while the front-line labor might be marginally cheaper at a large bookstore chain, the managerial labor is vastly more expensive at the large chain than it is with a single store. The equation may work out positively but also may not. Without real data to support either side, that initially doesn’t seem to be a massively compelling competitive advantage. As to the shipping costs issue, it’s possible that what you’ve proposed is true. If you had any figures to prove it, I would admit that to be an actual factor. However, I would rebut by pointing out that shipping is not really that much of a expense. Plus, there’s no reason why it all has to be done through Home Depot as a vertically integrated firm, since a distributor could be handling the national shipping level, with the small retailer handling the actual retail activities. Distributors could be (and in fact are) very large indeed. That is the way the supply chain worked before the big-box expansion. The scale of shipping doesn’t seem to be a massively compelling advantage either.

By: chris borthwick

chris borthwick — Mon, 26 Jul 2004 04:19:55 +0000

Economics, political science and management theory seem to be slighting Ev biol. Let us imagine you are in a position of power. A proposal comes to your desk. One of the options is obviously sensible, is supported by the data, and comes with the recommendation of your experts. One is less satisfactory. One is plainly an almost total wipeout. What do you do? If you do the sensible thing, you are doing what anyone could do. You don’t need power for that. If you want to demonstrate to others that you have power, you have to take a decision that nobody in their right mind would take and push it through against unanimous opposition. This is in some ways in line with the present trend in evolutionary biology, which explains survival handicaps such as the peacock’s tail by hypothesizing that it is a way of demonstrating to potential mates or rivals that you have such potency that you can cope successfully with enormous self-imposed handicaps. At some point this comes up against the imperatives of simple survival, but if you are Stalin or a top manager in a large corporation you have a very wide range of action before you reach this boundary. If accepted, this theory explains quite a lot—perhaps too much, in fact; as in evolutionary biology, it means that any decision, good or bad, can be accounted for under one arm of the theory, making it virtually irrefutable and in Popperian terms trivial. But any good theory has to be able to explain Hitler as well as Bill Gates.

By: Phill

Phill — Sun, 25 Jul 2004 15:41:46 +0000

The Efficient Markets stuff looks to me like it is begging the question. Looks to me like these people want to conclude that government intervention is unnecessary so they code an axiom that essentially says that the market is all that is necessary. Sure there is some truth to the notion that over extended periods of time markets tend to converge on reasonable valuations but since the market is being used as the definition of true value this is hardly a profound insight. The problem with economics is that it is the only academic field where eminence is effectively judged by politicians. So for the past thirty or so years constructing useful models of the economy based on sound logic has been a less successful career promotion strategy than developing sophisticated arguments that support the policies that serve the interests of politicians favorite constituencies. Sure markets can be reasonably effective. They can also be utterly wrong. For the protection of the rest of society there should be a rule that requires all economics papers to carry a government wealth warning, “WARNING: This Paper Contains UNREALISTIC ASSUMPTIONS. Prolonged implementation of policy conclusions may lead to economic ill health”

By: travc

travc — Sun, 25 Jul 2004 10:05:58 +0000

A quick observation about the current “mega-corporation” trend… As I see it, huge firms generally don’t realize a significant benefit by internalizing transactions and minimizing their costs. Instead, the benefit of a huge size comes mostly from being able to coerce suppliers, regulators, customers, and everyone else a firm has to deal with. Wal-Mart is prime example #1 of this effect. A potentially significant, and less pathological from a free market perspective, effet is the standard gambling problem. Larger firms are more likely to survive a streak of bad luck (or bad decisions) since they have more financial resources. Selection (as in natural selection) plays a big role in what sorts of firms exist, since there is a very large “death” rate. Firms that are harder to kill, are more likely to be around. Back to transaction costs… internal transactions in large corporations are very frequently less efficent than transactions between firms. They lack the obvious pressures that increase transaction efficiency in a traditional market. Sure, it is in the best interest of the firm to minimize the costs, and it theorectially has the power to do so… but the immediate feedback of a buy-sell relationship is missing. Indirect costs within a firm are notoriously under weighted when it comes to cost containment for the simple reason that people are not rational and see ovbious costs first and foremost. Now, one does have to ask, is a more centrally planned system better? I think not. It is even more prone to pathologies. Just my perspective from a perspective more along the lines of dynamic systems than traditional economics. Hope it isn’t too trite or uneducated.

By: Sebastian Holsclaw

Sebastian Holsclaw — Sun, 25 Jul 2004 06:15:36 +0000

Kieran, ok. And does that change any of the analysis, or is it just a flip comeback? I’m trying to point out that these abstractions may obscure more than they reveal. If you think it applies equally to the term ‘market’ you are merely strengthening my point. I suspect the criticism does not apply equally to the term ‘market’, especially those markets that reduce information to ‘prices’. I can’t think of such an easily measurable commonality between ‘firms’, but then again I’m not an economist. It seems to me that while the idea of ‘market’ obscures some differences in different types of markets, it might not obscure nearly as many important differences as ‘firm’. And considering the increasing number of relatively small ‘firms’ in the U.S., I think it might be a set of distinctions worth looking at. Burritoboy, shipping costs as a whole are down. The difference in shipping costs between a single item and a large number of items has increased with shipping efficiency. That still favors large shipments to large locations—and it favors it more so now. For analysis effect say the 1970s shipping cost for one item by itself was $20 while the per item shipping cost of 100 items together was $10. If the 2004 costs in constant dollars is now $10 for the single item and $4.50 per item for 100 items, the cost of shipping has gone down, but that has favored the large shipments. RE booksellers, I’m not sure it is obvious that the need for a corporate headquarters and CEO salary outweighs the advantages of being a big bookstore. The big bookstore has a lot of advantages. It has larger floorspace, which typically means cheaper rent per square foot. It often has fewer empolyees per book. It has lower shipping costs. It can often pay lower wages because it has many new-to-marketplace trainee workers who don’t intend to stick around in the job. It can sell a good selection of music to try to offset the reduction in book sales, something that your small bookstore can’t add in any meaningful quantity with limited space. I’m not sure that these and other scale advantages are outweighed by the corporate offices. Also small booksellers aren’t necessarily dead, they just have to fill a niche that the general booksellers do not. There is a great store in San Diego called “Mysterious Galaxy”. It sells only certain genres of fiction—mystery, fantasy, sci-fi and horror. It has a number of book clubs and is very agressive about getting author signings. I have seen it go from a little store to a medium store to a fairly big store in the past 12 years. It does quite well, though it has a level of dedication from the owners that probably isn’t easy to reproduce.

By: Kieran Healy

Kieran Healy — Sat, 24 Jul 2004 21:38:46 +0000

“The word “firm” is a little deceptive here, since it can mean anything from a sole proprietor to Wal-Mart.” … Isn’t it possible that there is a problem with this abstraction that lumps together sole proprietors and Wal-Mart …? You might say the same about an abstraction that lumps together my local street bazaar and the global forex or derivatives exchange.

By: burritoboy

burritoboy — Sat, 24 Jul 2004 21:31:16 +0000

Sebastian, No, that wouldn’t explain book retailing’s transformation into an oligopoly. In fact, it would indicate the exact opposite: if margins declined (without any compensatory factor working for the large retail chain), there would be less money for corporate overhead, thus making the individual retailer more competitive than Borders/Barnes. Both those chains have very substantial headquarters that cost a great deal of money – costs that the individual store doesn’t have (few individual bookstore owners would demand the million-dollar salaries paid to Borders or Barnes executives, for instance). On your hardware argument, it’s essentially a returns to scale argument, which at least is a plausible argument theoretically. The problem is, however, that transportation costs have been going down, not up – while the industry concentration has been increasing rapidly. It was much more expensive to ship things in 1965 or 1975 (oil was more expensive, trucking was heavily regulated, etc.) than now. But the industry concentration occurred as shipping costs fell – in fact, the period of the most big-box store expansion was in the 1990s, when oil prices were exceedingly low.

By: Sebastian Holsclaw

Sebastian Holsclaw — Sat, 24 Jul 2004 17:49:28 +0000

RE book retailers at least, the margin of profit for small booksellers has been declining for decades as fewer people regularly read. My GUESS would be that the breaking point was finally reached where being a small bookseller couldn’t pay in many markets. I don’t know anything about the hardware market. But as a general concept I would bet that shipping costs have a lot to do with hardware profits. As a general rule shipping is less expensive (per unit) in bulk.

By: burritoboy

burritoboy — Sat, 24 Jul 2004 17:35:50 +0000

Kieran, This post is very good. I personally believe that Perrow and Roy do actually give the most plausible explanations (at least, the most plausible explanations we have right now). Also directly challenging transaction-cost economics are two articles by Ghoshal and Moran in the Academy of Management Review in 1996 that argue TCE theory as internally incoherent. Williamson tried to defend his version of TCE in a response, but Ghoshal and Moran effectively rebut his piece. Someone else was also recommending to me another article that tried to test the actual costs of transactions with the actual costs of having (large) firms. I can’t recall actually reading the article (the other person believed it was by Ghoshal, but I thought it wasn’t) or much else about it, but my informant claimed that the article showed transaction costs were generating nowhere near the expense level of managing a large firm. Both the Hayekian and Coasian theories are pretty dubious, in my view. Neither would explain why many markets have gone from being competitive to oligopolies in relatively short timeframes. Did transaction costs increase so rapidly between 1975 and 1995 that the book retail sector went from very competitive to two/three-player oligopoly? Did transaction costs increase so rapidly between 1975 and 1995 that the hardware retail sector went from very competitive to few-player oligopoly? It’s very hard to fit either model unto these events.

By: c8to

c8to — Sat, 24 Jul 2004 03:51:37 +0000

i think we are asking the wrong questions. of course a firm’s organisational structure can outperform a market. just like a dictator could outperform a democracy. markets arent a miracle cure for organisation is the answer to why firms exist. but this is the wrong question. the real problem with the government is not its organisational structure, its whats external to the structure, namely incentive. governments have no competition (aside from a few elections every now and then) and their customers, the tax-payers, cant decide to not pay tax. that is the problem with governments. you could have ten different firms, all with different organisational structures (one could make decisions based on tea leaves, it doesnt matter) and if they compete against each other, the bad ones will lose out, and the good ones will flourish (probably the tea leave readers wont do so well) theres no problem with having an orginisational structure where a bunch of people sit down and tell everyone else what to do, as long as the bad versions of this organisational structure die off, and the good ones suceed. the problem with government is not the structure, its that it doesnt have enough incentive to suceed.

By: Sebastian Holsclaw

Sebastian Holsclaw — Sat, 24 Jul 2004 01:55:28 +0000

“The word “firm” is a little deceptive here, since it can mean anything from a sole proprietor to Wal-Mart.” Which is exactly my point. Isn’t it possible that there is a problem with this abstraction that lumps together sole proprietors and Wal-Mart for the purposes of information gathering and processing? Maybe the difference in need of hierarchy between the two is irrelevant—I’d just be really surprised.

By: James Surowiecki

James Surowiecki — Sat, 24 Jul 2004 00:17:39 +0000

It doesn’t: the more transactions that are done via markets (rather than inside companies), the more firms you’re likely to have, but each firm will be smaller. The word “firm” is a little deceptive here, since it can mean anything from a sole proprietor to Wal-Mart. Regardless, the point is that as markets are used more, the number of separate players in the economy will rise.