Home > Uncategorized > Once again on the theory of the firm

Once again on the theory of the firm

from David Ruccio

It is extraordinary that the hegemonic economic theory in the world today—neoclassical economics—still lacks an adequate theory of the firm.

It beggars belief both because neoclassical economics is the predominant theory that is taught to hundreds of thousands of students every year and used to make sense of the world and formulate policy in countless think thanks and government agencies and because the firm (or enterprise or corporation) is one of the central institutions of capitalism. It’s where many (but of course not all) goods and services are produced, value and surplus-value are created, and profits generated for capitalists.

And yet the neoclassical notion of the firm, even when developed by Nobel Prize-winning economists (such as Oliver Hart and Bengt Holmstrom), is not much more than an empty box—without any real history and, as it turns out, without any links to politics.

Daniel Carpenter, the Allie S. Freed Professor of Government in the Faculty of Arts and Sciences and Director of Social Sciences at the Radcliffe Institute for Advanced Study at Harvard University, certainly thinks that’s a problem in terms of making sense of how firms came to be constituted historically and what their effects are on contemporary society.  

Q: The neoclassical theory of the firm does not consider political engagement by corporations. How big an omission do you think this is?

 I think it’s an immense omission. For one, we can’t even talk about the historical origins of many firms without talking about corporate charters, limited liability arrangements, zoning, public contracts and grants, and so on. To view these processes as legal and not political is a significant mistake. I’m currently writing a lot on the history of petitioning in Europe and North America, and in areas ranging from railroads, to technology-heavy industries, to extractive industries, to banking, firms (or their investors) had to bring a case before the legislature, or an agency of government, or both. They usually used petitions to do so. 

 Beyond the past and into the present, there are a range of firm activities that we can’t understand without looking at politics. Industrial organization considers regulator-firm interactions, but does not theorize the fact that now most firms have regulatory affairs and compliance offices, or the fact that firms hire not just lobbyists but lawyers to do a lot of political work for them.

 And in the future, the profitability and survival prospects of many firms in the coming years will depend heavily, in a polarized environment, on the political skills of managers. The theory of the firm was developed in an era (1950s – 2000) when globalism was the rule. What might it look like if Trump and Brexit are the new norm?

Today, of course, many citizens are concerned about the corrupt links between the capitalist firms in which they work and the governments that are supposed to represent the people. In my view, that concern was one of the causes of the Brexit vote and Trump’s victory in the U.S. presidential election.

The problem is, neither the post-Brexit British government nor the Trump administration has given any indication they’re going to solve the problem of the firm. Quite the opposite. Both have tied themselves to the very same capitalist firms that have wreaked havoc on society for decades now.

Meanwhile, neoclassical economists continue to build their models based on a theory of the firm that bears no relationship to the way firms operate in the real world, manipulating market rules and political actors to their own ends.


  1. February 13, 2017 at 8:42 am

    Just as there is no theory of the firm, so there is no theory of the consumer. In fact, I have argued that modern microeconomic theory serves as a blinder, preventing economists from seeing regularities of human behavior which are obvious to untrained laymen. See my post on WEA Pedagogy Blog: “The Empirical Evidence Against  Neoclassical Utility Theory: A Review of the Literature” [with Mehmet Karacuka] International Journal for Pluralism and Economics Education Vol. 3 (4)  2012, p 366-414

    • February 16, 2017 at 1:04 am

      To have a ‘theory of the consumer’, we have, first of all to introduce human beings; second, we must look upon firms as consumers themselves, often competing with human beings for the uses of goods; third, we must re-introduce benefits as the use-values associated with different uses by different agents; fourth, we must recognize that values-in-use are or reflected by values-in-exchange; fifth, we must re-introduce budget formation rather than ‘endow’ consumers with budgets for sets of goods.

      That is where this reconstruction of economics must begin … And, YES, it throws out all of micro-economic theory (and the macro) because they have no foundations.

      I am hoping you will do this, Asad Zaman. That is the reply I would given Solow.

      • February 16, 2017 at 1:06 am

        Correction: ‘values-in-use are not reflected by values-in-exchange’

      • February 16, 2017 at 12:03 pm

        One addition to your list. It is also essential that we present a clear description of economics, economists, and the concerns of economics/economists based on broad discussions with other social scientists and the general public. This will hopefully help economists stay on course researching actual concerns that fit within this broad consensus on economics.

      • February 16, 2017 at 3:52 pm

        Yes! Thank you.

  2. February 13, 2017 at 10:04 am

    While the Spanish were the greatest imperialist nation early on in the opening of the new World, they lost that position to the English and Dutch by the 17th Century. This is crucial in the history of corporations. Exploration and exploitation by the Spanish had not involved private parties or interests. It was conducted solely by and through the Spanish monarchy. But the English and Dutch by 1600 has begun to displace the Spanish. The Dutch used the Dutch East India Company for this. While the English created the English East India Company and later the Hudson Bay Company. These were partnerships between government and private investors. Such partnerships had a long history in the UK and Holland. Bur no such history in Europe or the Americas. They came to be called Joint Stock companies. At the same time this was happening the democratic revolutions were happening in Europe and the Americas. Business people latched onto these, hoping to free themselves from the monarchy and church restrictions. By 1800 the business enterprises were free of all restrictions. They brought in more and more investment and created ever greater profits for their investors, They also invented industrialization. With the increasing production, sales, and revenues the political power of these joint stock companies also expanded, especially in the UK. With some refinements such as LLC, legal protections, government insurance, and personhood these are the corporations we see today. Their political influence has grown 100 fold since 1800. And they were copied by Europeans and in the Americas Aside from the obvious wealth they offered to investors and those who supported them the corporations also strategically used support for democracy, charity, and the church (so long as it did not interfere with profits) to entrench themselves within the UK. They also offered access to new products from new technologies (e.g., steam engine, mechanical loom, electricity) and from all parts of the world. They made themselves indispensable. And they remain so today. Today these companies literally define what both democracy and capitalism are and how they work.

    • robert locke
      February 13, 2017 at 12:12 pm

      This is one scenario, Ken, but the growth of the modern corporation in cooperation with the state, and under state tutelage is another. Just look at the industrialization of Germany and Japan over the past two hundred years for examples of this cooperation. The idea of the firm, moreover, as an expression of proprietary greed, has always been challenged, by, for example, the organic concept of the firm, which sees the firm as an amalgamation of stakeholders. Not in America, or in neo-classical economics. But I ran across extensive discussion of organic concepts of the firm in German business economic periodicals right after WWI, which expressed the idea of the firm embodied in Mitbestimmung (co-determination). The fact that the theory of the firm is only discussed in terms of proprietary conceptions is just a very sad manifestation of economics, sad because it prevents economists from entering into serious discussions about firm governance as a root cause of our problems.

      • February 13, 2017 at 1:19 pm

        Robert, I agree. Germany, Japan, China, and several others outside the “rich countries” club certainly experimented with corporate structure and objectives. Germany came late to the party. Was not considered a “rich” country. And had socialist (Volk) notions in its history. Which pushed corporate organization and relations with government away from the UK model. Even France pushed away from the brutal UK model. Japan was an outsider in many ways, from the very start. So modifying the corporate model to fit its history was not difficult, and perhaps unavoidable. And even members of the British Empire (e.g., Canada, Australia) after some period of time pushed away from the UK model. After the end of WW2 even the UK itself tried to restrict the freedom of corporations somewhat. The US was by far the most enthusiastic adopter of the UK corporation model. It soften that model after the Great Depression, but did not discard it. With the re-assertion of neoliberalism by Thatcher in the UK and Reagan in the US, the corporate model was again changed to one more closely resembling the 19th century UK model. And that model has been imposed on many countries, including Germany and France. By US insistence, by pursuit of highest returns for investors, and to control the over expansion of democracy. See for example, the recent events involving Germany and the Greek economic situation. Or, rules inserted into NAFTA and other international trade agreements that give corporations the upper hand over national governments in disputes that might reduce profits. I’m thinking that currently corporations as first set up in the UK are making a come back. Controlling more and more, extracting more and more revenues, even against the opposition of national governments such as Germany and Japan. And with the turmoil in the US I think the reborn “tough” corporate model will only grow stronger in the future. Can these corporations be brought under control and some sense of cooperation in economic affairs return? That’s one of the questions our children and their children will have to deal with.

      • robert locke
        February 14, 2017 at 9:49 pm

        I wouldn’t be quite so pessimistic about the future of alternatives to the Anglo-Saxon Corporate model. Tore Høie in Ethical Management – Creativity, Sustainability, and Governance, notes” that Nordic organisations are the main empirical basis for this book, not because they do everything correct, but because they belong to five economies, cooperating and partly competing, succeeding despite unfavorable conditions. They are burdened with high taxes, large governments, active trade unions, strikes, small salary differences, generous social benefits, long vacations, small markets and sometimes government ownership.

        Nearly identical ideas are popular in German Mittelstand, medium sized companies delivering quality products, often high-technology, and at the same time serving as contributing members in their local society. In the difficult year 2010 their sales increase was world class.

        The USA theoretically has all advantages: resources, money, markets, people, size and the ownership of business ideas. Still, the Nordics have consistently beaten the USA and the rest of Europe on several economic indicators (see later), and in addition enjoy happiness, peace and a good life. For this reason they are sometimes called “Bumble Bee” economies. The bumble bee appears unable to fly, but does.

        Indeed, some Nordic disadvantages have become advantages. High fuel costs mean that alternative energy is more attractive. People oriented management practices have led to smart use of technology. Small salary differences are good for organisation culture. High prices and harsh conditions have resulted in a competence strategy. Long vacations can help to reset competent brains. Small markets mean that companies must sell abroad, needing extra effort.

        The EU recommends the “Nordic model” to all its members (EU 2005).”

      • February 15, 2017 at 10:03 am

        Thanks, Robert. I have not seen the book from Hoie you mention. Thought I have read his other works and his class syllabi. I agree with most of his points. My major concern with his work is that he never asks whether the very notion of capitalism and industrialization is ethical. For me, this is an important question that must be considered. Do humans need these to live a productive, happy, effective, and meaningful life?

        Thinking holistically, the Nordics seem to have developed an approach not just to economics, but to living in general that is better for all involved. Better for humans, for the planet, and better for a livable and exciting future. But I wonder if it would not be better still if humans got rid of capitalism all together. I guess it’s this that makes my general outlook pessimistic. Can capitalism, a way of doing and thinking that has lead to so so much harm, shame, and fear really be reversed. I hope it can be, for we seem to be stuck with it for the foreseeable future.

    • February 16, 2017 at 1:16 am

      One thing that is often forgotten about corporate history is that, to obtain charters, private corporations had to show a public benefit to society. Making a private profit was not considered to be a public benefit. Nowadays, this has been lost. The public benefit requirement was a quid quo pro for decreased liability.

      It should be required.

      • February 16, 2017 at 12:37 pm

        The actual language of the Hudson Bay Company Charter, 1670. “Now KNOW YE, that We being desirous to promote all Endeavours tending to the publick Good of our People, and to encourage the said Undertaking, HAVE of Our especial Grace, certain Knowledge, and mere Motion, given, granted, ratified, and confirmed, and by these Presents for Us, Our Heirs and Successors, DO give, grant, ratify and confirm….” The Charter makes clear that Endeavours tending to the publick Good are those that create the maximum exploitation of the lands, waters, forests, minerals, etc. of the 1,000,000 acres covered by the Charter. Not certain how the Company was to prove it followed this part of the Charter. But that’s the problem with every corporation.

  3. February 15, 2017 at 5:25 pm

    Interesting discussion. Nice of Robert to quote me. My book on Ethical Management is not out yet, but I have written 7 others, congratulations to Ken for reading all, especially since three are in Norwegian :-) But he missed the point in my book Ethics from 2015 which is to base management on ethics.

    Ken is right in questioning if we need capitalism, but the definitions of capitalism varies, besides I have not found a well written, operative and successful definition. I turn you to The Economist December 17 2016 where management in general is questioned, has its teaching benefited the world? Economist is following up in 2017 with depressing statistics.

    Assad says there is no theory of the consumer, perhaps, but there is a strong service management, better argued than most management theories. It makes the customer a stakeholder, an assumption in my books. And I have helped clients make service level agreements, made by suppliers and customers in cooperation.

    Also I suggest UN Global Compact, ISO 26000 and OECD Guidelines for Multinationals for study, more important than many management texts.

    Since some people have tried to contact me, my email address is tore.hoie@vikenfiber.no.

    • February 16, 2017 at 12:54 pm

      Tore, don’t read Norwegian. But I do read/write German. So with that and Google translations I got through the material. Not sure I got every word right. But I think I got the general ideas okay.

      I often think that capitalism (generally defined as private ownership of economic production) continues in part because of the fear some have of the alternatives. I work with electric and farm cooperatives and credit unions. A credit union president told me once when he speaks at Chambers of Commerce and the like the one question he’s almost always asked is, “why are credit unions necessary?” I think many would like them to go away because their existence is a threat to privately owned (closely held or public stocks) businesses. They’re a challenge to the status quo. In cooperatives and credit unions the customer is an actual and full stakeholder, not a stakeholder behind investors (shareholders).

    • robert locke
      February 16, 2017 at 3:59 pm

      “Assad says there is no theory of the consumer, perhaps, but there is a strong service management, better argued than most management theories. It makes the customer a stakeholder.”

      Tore’s work and his comments here should provoke a broader discussion among economists about the nature of the enterprise, without which we cannot get out of the cul de sac into which economics is trapped. When I ran into the organic theory of the firm, reading German business economics literature, it seemed to be just common sense that a firm’s employees and it is customers should be considered, with the capitalist sponsors (proprietaire), to be integral to the existence of a firm and that, therefore, the purpose of a firm had to be more than just being a Geldfabrik that returns profits to investors. When employees and customers are included the propose of the firm takes on ethical and community service dimensions. .

      • February 17, 2017 at 5:53 am

        There’s an old debate that plagues US utility regulators. Who owns a utility? The investors? Or the customers who pay off both the investors and the utility’s employees, as well as provide all the utility’s dividends. A utility can therefore carry on without investors, but not without customers. I was generally working for the Commission staff so I had to argue their position on this question, which is that investors own the utility and must be paid for that ownership – both return of and on investment. Except, of course electric and gas cooperatives, where owners and customers are the same. Cooperatives always resisted state regulation, since they considered themselves self-regulated by the boards chosen by their owner-customers. Over the years, I decided I could not support the Commission position. Cooperatives are genuinely self-regulated, provide service in difficult conditions at lower prices, and provide financial and spiritual support for local communities. For-profit utilities come in a distant second in this race. But still regulatory commissions in the US will not cross utility investors. . Except for Nebraska where cooperatives provide all electricity. A center of the last US populist movement at the end of the 19th century, Nebraskans never made peace with for-profit utilities. That’s not the case with the other US states. Even once populist states like Iowa, Indiana, Oklahoma, and Texas now place investors top of the shelf. And these are states that the presumptive new populist king, Donald Trump won in the Presidential election. Problem being, Trump is not a populist. His friends don’t like cooperatives or populism.

      • robert locke
        February 17, 2017 at 12:59 pm

        The issue of firm governance is of paramount importance in international capitalism today and should, therefore, rank high in the discussions of economists. Huge firms, under director-primacy forms of management, are eager to acquire firms everywhere, although especially in Europe, but the stakeholder conception of management permits employee work councils to veto such mergers and acquisitions, which we see, for example, in the resistance at Opel works councils to GMs move to sell Opel to Peugeout-Citroen. The stakes could not be higher, because the existence of a European Union that serves the interests of its citizen, will not be possible if huge firms, under director primacy, can buy and sell assets in the market without regard to the communities in which these assets are embedded.

      • February 18, 2017 at 12:26 pm

        Excellent points, Robert. And one no longer debated much in US courts, regulatory agencies, or the Congress. Investor primacy through Boards of Directors and CEOs is enshrined in the US. Any opposition now has a long and difficult road to tread to even be heard, much less create change.

      • robert locke
        February 18, 2017 at 8:48 pm

        That is why the existence of the Europeajn Union is so important. I gave up a long time ago on America as a source of reform because Investor Primacy is enshrined in the US as you say. The Investor capitalist system pushes relentlessly to take over the world; its a tough battle to oppose view of investor capitalism that is being imposed on the world through Wall Street and the City. Right now we are at a crossroads because Investor capitalism’s insistence on austerity has almost destroyed enthusiasm in Europe for the union; insistence on a stakeholder view of the firm is one way to make the European Union serve general interests, and it is not impossible to achieve it, because stakeholder conceptions are part of continental European traditions.

      • robert locke
        February 19, 2017 at 10:52 am

        At the age of 85 (today), I feel for personal and historical reasons, a need to issue what the French call a profession de foi.
        I believe that the US and the UK cannot be relied upon as a political base to bring about the sort of reforms necessary to promote a free and prosperous society — for two reason.

        One is that the capitalist system enrooted in Anglo-saxonia, though director-primacy firm governance, cannot be relied upon to distribute the fruits of firm enterprise fairly. For that to happen groups that make up a firm must have a voice in how the firm is managed and to whom and how its emoluments are distributed. Self interest of all stakeholders in a firm requires that they do not permit a managerialist take over of a firm’s governance or for an intellectual system like economics to govern them, because as to the latter, since all thought systems can be subverted by owners and directors, all stakeholders whose interests are engaged in deliberations must have a voice at the table when decisions affecting their interests are made.
        The second reason is the management from hell that has been created through the financializatiion of the world through Investor capitalism. Britain’s entry into Europe in particular permitted the US-UK financialization of banks and financial institutions under director-primacy capitalism in the European Union that has promoted policies of austerity from Brussels bureaucrats , which undermine the European Project. It was a mistake to permit the UK to join the EU in 1972 and, considering the impact of US and UK Investor capitalism on Europe, a hard Brexit from the EU, might offer a way to correct the mistake by introducing stakeholder conceptions of the firm more thoroughly inside the European Union, once the Brits are out.
        I shall devote my efforts to promoting these ends and invite others on the blog to do the same.

      • February 19, 2017 at 12:17 pm

        Happy Birthday!

        And, I agree entirely with your appraisal of UK and U.S. capitalism management as seriously flawed in terms of how it defines stakeholders and makes decisions affecting the lives and interests of those it forgoes from even considering as stakeholders. I have also long felt that workers also have a sense of broader community as a stakeholder also. When I look at the investments made in providing roads, schools, housing, et cetera to communities dependent upon major employers in their areas, I often sense that workers have a far broader appreciation of social costs and benefits than UK/U.S style corporate management that excludes these workers. [And, in researching and writing the Report of the Commission of Inquiry into Lay-offs and Redundancies in Canada back in the late 1970s, I stressed just that.]

      • February 19, 2017 at 8:32 pm

        Amen to the Happy Birthday wishes, Robert.

        Looking at the state of our road, which has just been “mended” by “lowest tender” contractors rather than by the manageable lowest cost dedicated council staff of old (who had a stake in and were familiar with the town’s surfaces and services), I wonder whether there is any “community” left here for workers to sense. Our community representatives no longer represent and coordinate and assert our interests; they just dance to the tune of Austerity and the dismal rhythms of asset-stripping like puppets on a bankers’ string. So yes, I too agree with you on stakeholder management.

      • February 20, 2017 at 4:31 am

        Robert, I’m jumping on board with the others here. Your comments are absolutely on target. I’m not a soothsayer, but I knew this was happening. I worked on and off in the USSR in the 1980s. I was told over and over again by the corporate guys already moving in to make a killing off the fall of the USSR there was a new golden rule. Those who have the gold make the rules. And here we are in 2017 and that’s the golden rule.

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