I have tried too hard to defer to this distinguished Sveriges Riksbank Prize Winner, but this is truly the most over-the-top outrageous comment I have heard from a technocratic public intellectual.
You know, what I don’t like? Being a 19 year old average Joe, who is shocked by what older and more learned experts say. From basic intuition, you hear some things and think, “That doesn’t make any sense.” No matter how well qualified the guy is, when he says something that doesn’t make sense, it doesn’t make sense.
Perhaps it’s simply because Krugman is an international trade specializing economist and not a business economist?
There’s plenty of criticism to be levelled against the idea.
A large automobile corporation like Toyota does not set prices of steel, control distribution of steel, and decide how much steel is to be allocated across various plants straight from the steel mill. It can only accept prices at which steel transactions are done, and not control them with a government bureaucracy style price control.
A large capital goods producing company like General Electric can only use as much fuel and electricity as is sold by other firms at the prices those firms ask, and can not have control over how fuel and electricity are produced, transported, and supplied.
Goldman Sachs does not have singular control over the education system and does not decide how many finance majors are to be produced, how many are to be allocated across their various departments, and where they are to be placed after they leave the organization. They can only accept the prices at which financial analysts are available and they have little scope for changing salary and pay of finance sector employees.
The whole idea is total garbage. It reminds me of the Lerner’s Index I learnt at college which says that price should be equal to marginal cost and that justifies price controls. Ha! According to the Lerner’s Index, we should believe that the poor Sudanese farmer is a monopolist because he sells his crops at a price above marginal cost. Double Ha!
There is a presumption among some people that small and decentralized is automatically superior. That might be politically true, but that’s just because more efficient political orders are bad. In the market the degree of vertical integration and centralization that is best is whatever makes the highest profits, and there is no a priori way to know how big that will be.
Here in India, the government set an arbitrary limit of paid-up capital at one hundred thousand rupees to distinguish a “small” firm from a “big” one, and then had punishments for companies with capital above that limit and incentives for capital below that. Licensing requirements were hefty above the limit. Keep in mind this was all Frank Knight’s idea, and the man thought firms needed to be small to keep “perfect competition”.
I wish someday I could find Amartya Sen, the man responsible for implementing these crack-brained measures, and do to him what Michael Corleone did to his older brother in Cuba in Godfather Part II. “You made us all poorer, Professor Sen! kiss You broke our hearts! You broke our hearts!”
I don’t think the theory is new, but it has recently been re-introduced by Peter Klein. There is a point in which a large firm may begin to suffer from the calculation problem. It’s Klein’s theory of limitation of firm size, in which at a certain point (after a number of vertical integrations, and firm expansions over industries which supply the firm with factors of production — this done as a means of limiting the firm’s costs of production) a firm may lose efficiency compared to another one, due to a circumvention of the pricing process.
Apart from the above, you can argue that Krugman misidentifies the source of “socialization”. Many large firms, today, enjoy government protection through interventions. It’s true that some firms today are larger than they otherwise would be. But, the source of socialization is not the firm, but the government who provides the firm certain benefits the firm would otherwise not have.
I don’t think the theory is new, but it has recently been re-introduced by Peter Klein. There is a point in which a large firm may begin to suffer from the calculation problem. It’s Klein’s theory of limitation of firm size, in which at a certain point (after a number of vertical integrations, and firm expansions over industries which supply the firm with factors of production — this done as a means of limiting the firm’s costs of production) a firm may lose efficiency compared to another one, due to a circumvention of the pricing process.
Yes, a firm can’t price its internal products for internal use except by reference to world prices, as the Soviet Union does; however there are other options open to firms such as internal capital markets and advantages derived from various partnership and incorporation methods that offset the internal calculational problem. However, the firm will start losing money once it exceeds optimal centralization and verticalization; which is one reason many megacorps have a lot of sub-units and wholly-owned subsidiaries with independent finances.
Many large firms, today, enjoy government protection through interventions. It’s true that some firms today are larger than they otherwise would be. But, the source of socialization is not the firm, but the government who provides the firm certain benefits the firm would otherwise not have.
Right, though I would argue that for firms in general the damages caused by regulation, triple taxation and the decline in labor quality actually impede growth more than the handful of direct supports to politically connected firms provide; likewise there is a ton of artificially decentralizing effects that come from the redistribution of Federal funds through the municipal governments as well as the regulatory powers of local governments which are deeply wedded to local businesses and their political patrons.
Like how you could kick General Motors from one end and it will take two years before it says ouch?
Sure, diseconomies of scale make firms less efficient and fall apart. But that merely verifies what we already know about creative destruction - every business is a business that has either failed or not failed. Failure is more important than success in the best allocation of scarce resources.
The fact that a business may fall apart could be due to any reason, whether it’s big or small. All businesses are one breath away from doom at any point, be it Lehman Brothers or A&P Grocery Chain.
Krugman is saying absolutely nothing new here. It is nothing but the Coase’s Theory of the Firm. So there really should be nothing at all that should shock most libertarians or especially most readers of Coase.
You can either read Coase’s major paper Theory of the Firm
There is really nothing obscure about this. Coase won the Nobel Prize in part for this work. It helped launch the work of Williamson and other transaction costs theoriests. Munger wrote this friendly summary 3 years ago (long before Peter Klein’s book ever got published, who ever said Klein can be credited for this notion or even re-popularizing it).
Did not read the article. But the sentence “A large corporation is a centrally commanded economy” is actually true. The key is that this central command economy operates within a non-central commanded larger economy.
This is a reason why companys need internal transfer pricing, which is actually a good example of the problems with central command economies.
Did not read the article. But the sentence “A large corporation is a centrally commanded economy” is actually true. The key is that this central command economy operates within a non-central commanded larger economy.
This is a reason why companys need internal transfer pricing, which is actually a good example of the problems with central command economies.
Actually, this is still wrong. Corporations only receive capital from investment or income from sales. This makes them utterly different from the Soviet Union.
Actually, this is still wrong. Corporations only receive capital from investment or income from sales. This makes them utterly different from the Soviet Union.
Hence why i said, corporations operate within a non-central commanded larger economy.
Don’t be so quick to trust your intuitions. For billions of people around the world, the idea that stealing money from richer people will actually make everyone poorer, not wealthier, is completely non-sensical and counter-intuitive. That we here happen to be guarded against this particular intuitional failure (and many others) does not mean we are guarded against all of them.
That said, I don’t think this article is worth taking seriously. I’ve no idea when the addendum was added, but Krugman essentially admitted to being a troll.
It’s not a comparison of corporations to governments in a moral or normative sense. It’s an economics things–hence “theory of the firm” rather than “morality of the firm.” Furthermore, it’s a limited comparison. Firms aren’t like governments in every sense.
A long time ago a bright young lad named Ronald Coase had a question: if central planning is so innefficient, and the price system is efficient, and businesses want to be efficient, why do they rely on central planning rather than prices? Why does a manager order his flunky to do something rather than design a contract that the flunky then agrees to?
Coase realized that the answer lies in the fact that using markets itself is costly–transaction costs. When transaction costs > benefits of price system, central planning is actually more efficient than the price system, hence the emergence of big businesses that employ a great deal of command-and-control rather than lots of small businesses that use contracts and prices for everything.
That businesses are centrally planned economies is self-evident btw. The theory of the firm merely explains this odd truth.
Krugman says nothing controversial to anyone familiar with the theory.
Transaction costs are part of it, but the Chicago boys are obsessed with it. There are a lot more reasons: internal capital markets, stability and monitoring of performance by employees, large scale capital accumulation and investment including both investment and loan collateral, internalizing externalities, making use of especially skilled managers or proprieters over people who are less capable of self-management (left-libertarians weep). And that’s just the tip of the iceberg. The firm in general, and incorporated firms especially, represent one of the most advanced form of capitalist contracting; they ‘democratize’ the market and enable small scale-savers to invest easily in the market without their having to become proprieters themselves or know how to run the business.