Believe it or not, but there is no good explanation in economic theory for why there are firms. This may seem like a rather fundamental oversight, but it actually has good reason. Economic theory, whether Austrian or mainstream, shows beyond reasonable doubt that the market is the least inefficient and therefore “best” means to allocate resources. While the market is terribly imperfect and subject to constantly changing conditions (consumer preferences, changing policy, etc.), it still beats the impossibility of “rational” top-down planning. There are several reasons for this, which we can discuss in a future post. But what is interesting to note here is that if the market is in fact as good as theory says, then why are there firms? Obviously, following theory, it should be better to use the market and rely on the price mechanism than to sort of avoid the market through establishing colossal hierarchical structures that are only indirectly dependent on the price mechanism.

Even though classical economists studied the firm (see Adam Smith’s discussion of the pin factory in Wealth of Nations, and e.g. Marx’s Capital), they didn’t really get anywhere. Perhaps they weren’t interested. Then there was a huge literature on the organization of industry in the 1920s and 1930s, which culminated with Ronald Coase’s theory of the firm in 1937. This was followed by 30 years of silence before Coase’s work was rediscovered in the late 1960s and early 1970s, and after that mainstreamers have addressed the issue and developed several interesting theories. What about the Austrians? There are several approaches, but as late as 1985 there was pretty much nothing addressing this very important topic.

Today we can enjoy books like Frederic Sautet’s An Entrepreneurial Theory of the Firm, Peter Lewin’s Capital in Disequilibrium and Nicolai Foss and Peter Klein’s Organizing Entrepreneurial Judgment. But, in my view, while these books have important points and point to potential solutions to the “problem” of the firm, they ultimately fail to connect the issue of economic organization to the Austrian understanding of the market process. Rather than using and relying on a “thick” conception of the market, they rely on individual or limited combinations of aspects of market theory in which they find a function for organizing. For this (and other) reason(s), I am in the process of producing a book that delineates my view of where the firm fits in Austrian economic theory. The book is not scheduled to be published until December 2015, but I’m posting drafts of the chapters as I finish them. The first two chapters are already available, and of course free to read.

Please do read them and, if you don’t mind, shoot me a message on where I get things wrong (and why). The book with chapters is posted here, and the chapters posted so far are:

1. Austrian Economics and Organisation

2. The Extent of the Market Process

Please enjoy! (And if you don’t, send me a note explaining why.)