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Firms: Who Knew?

from Peter Radford

One of the controversies buried by contemporary economists in their great cause of advocating market freedoms, is that of the role of central panning. There was a time when economics accomodated controversy. Nowadays it’s arguments are securely contained within the narrow bounds of saltwater versus freshwater type spats that are little more than professional name calling inspired over minor differences of detail.

Recall the capital controversy? No?

How about the socialist calculating controversy? No?

They were real differences. Time has allowed modern economics to ignore its larger conflicts in the name of ideological purity.

Yet central planning lives on.

Bigly, as our new president might say.

One of the greatest deficiencies of modern economics is its total blindspot to the middle layer of economic activity. Few, if any mainstream economists, refer to a “meso-economics”on a par with their hallowed micro and macro versions. Indeed the most ideologically pure insist that macroeconomics is simply a summation of their micro version. So they try to pummel everything into one flat layer.

And yet that meso level exists. We call it business, and if you want to understand what’s going on in most modern economies you have top grasp what’s going on in business.  

Businesses are massively influential in setting the trends that we see manifest in the aggregate numbers.

Take, for example, current trends in employment. For a few decades now business has been dominated by an offshoot of ideologically right wing economics, called shareholder value. This is an idea that is based on the sand of what the purists insist is the “free” action of individuals. That was transformed into a body of thought applicable to business and can be summed up as: the only goal of a business is the to further the interests of its shareholders. Nothing else matters.

Since in that ideologically pure microeconomics there is no space for social action — it is entirely premised on individuals after all — there is no tolerance for a focus on anything else. Naturally when such a theory was translated into the business world this lack of social awareness was elevated into a basic management principle. That shareholders are a group or a collective, is ignored. That they might accumulate power by virtue of being a group was sidelined. Their collective interest were said to dominate. Referring to it as a singular interest made it easier to overlook the power relationship inherent in it.

Within the context of business, shareholder value then was elaborately embellished and changed into a technology that the bureaucratic processes and central planning of executive management could apply. With gusto.

The consequences of the avid activity of the central planning in business are everywhere around us. The application of the shareholder value technology affects us all. Outsourcing and globalization are its most obvious outcomes. In the incessant pursuit of profit and its so-called maximization, business realized that they ought shed any activity not deemed “core” to its “value proposition”. This is an administrative response to the pressure for profit even in slow growth economies. So out went any employee not employed in those core activities. Some work was sent overseas to lower its cost. Some was eliminated entirely. Some was sub-contarcted, with former employees being brought back to perform the exact same activity as before, only now at a lower cost and within highly circumscribed timeframes.

The entire purpose was to reduce cost. Since wages are the highest cost borne by business it is nor surprise that, after a few years, wage trends were flattened out. Nor is it a surprise that employment is less secure. Or that the number of people covered by strong retirement or health care benefit packages has plummeted. Inequality skyrocketed, and the share of our national wealth going to wages shrank dramatically. Meanwhile profits boomed.

You could describe these trends as macroeconomic, but that would be misleading. They are only explained by looking at the middle layer of the economy. By getting inside the “black box”, as economists prefer to see business, we can start to explain the bigger shifts in the economy. These aren’t consequences of individual consumer choices. Nor are they outcomes explained in those impossible models of decentralized economies that economist love to think about.

No. The big trends in the economy are best theorized about in the context of what we call the business firm.

And the business firm is a local example of central planning.

Ronald Coase knew this in 1937, quite why modern economics turns a blind eye to business eighty years later is perplexing. Maybe it has something to do with its fixation on decentralized market forces? Surely not?

In any case: anyone seeking to understand the economy needs to begin with a theory of the firm. Everything else can be built from there.

  1. April 12, 2017 at 3:12 pm

    Undoubtedly, there is a need for a theory of the firm as a consumer in competition with other consumers for the use of goods to realize objective benefits –here money profits– needed for its survival and growth. This would allow one to address the broader issue of whether the well-being of a firm or firms more generally, like that of individual ‘consumers’ or their aggregate, can or should be conflated with that of society or the economy.

  2. robert locke
    April 12, 2017 at 3:40 pm

    When Alfred D Chandler Jr. wrote about the “visible hand” replacing the “invisible hand” of market forces in the running of modern firms, he placed the skills and values of a managerial caste at the center of economic reasoning, and accordingly made the investigation of that caste in its educational and sociological setting and policy formulations integral to economic study, only the economists missed the bus on that one.

  3. April 13, 2017 at 10:07 am

    Three things. First, before the insanity of maximizing shareholder value, the “rational” consumer, and micro, micro, micro, economics and business worked with one another. Per Peter Drucker, “The purpose of business is to create and keep a customer.” And according to oilman H.L. Hunt, “Money is just a way of keeping score.” Economists before 1960 knew this and knew their bread was buttered by business. Some, but not many still know this. Second, government and firms work together constantly, especially on long-range planning. Unfortunately, this fact seems to slip by most economists and most “what’s called conservative” politicians today. In my view this is why most economists provide such poor policy advice and many “conservative” politicians write such lousy economic laws. Both are largely ignorant of how or why business and regulation function and why the two are necessary for one another. That’s sad and dangerous. Third, economists have ignored business and instead devoted their time and efforts to “forcing” the economy and economic actions into the molds provided by the dominant economic theories. Part of the push back we see today among many ordinary Americans is the result of those efforts.

  4. April 13, 2017 at 11:11 am

    Once we see economies as graphs, firms emerge as these giant subgraphs that have very characteristic boundaries, internal structure, and flows.

    Within the firm, value flows out in a multi-level network. You do work for your immediate colleagues, not just your boss. Departments and functions do work for each other. These value edges emerge dynamically. At the top the value aggregates and flows out through sales. Money flows in. Money gets split in a strict tree, unlike the value. That colleague you provided figures for is not paying you. Money comes in on different edges than value flowed out, and the process of forming and updating money-edges is much more formal.

    You can understand most things a firm does, and its relationship with society, customers, employees, and unemployment by looking at what it does as a graph. How it forms edges and how value and money flows through them. And firm-subgraph is very distinctly recognisable as such. Where a village economy is an undifferentiated graph between individuals trading symmetrically with each other, firms are a region of the economy-graph that grows a hierarchical structure and splits money and value flows along asymmetric edges.

    So do families. With small family firms the distinction is blurred. But easy to model in graphs.

    Economies are graphs, study them as graphs. Is anyone starting an economics program based on graphs?

    • April 13, 2017 at 4:17 pm

      Pavlos P. (just as maybe we should study economics as graphs for simplicity, may names should be simplified—eg john doe1, john doe2, etc.).my name also some have trouble spelling.

      I think you are totally correct (though of course you just wrote a few paragraph ‘abstract’ or summary).

      Regarding your question about economics programs using this approach i dont know any–i’m not the one to ask, so i know just what a very econ programs do –and they dont do that (but there may be some, or it may be some individudal economists– there are some whom to me do interesting stuff but you dont usually hear about them; also many of them to me are on the right track but write more at a general or philosophical level.

      i think there are some (who i may have read) who do related stuff but often not in econ depts.

      To really use that approach in my view, you have to read the physics literature, where they really study graphs and energy flows though usually not in an economic context. (graph theorists in math often dont consider anything beyond the topological structure of graphs tho occassionaly they have something similar–eg ‘cost’ as in ‘traveling salesman problem’. )
      (I have a list in my mind of maybe 50 or more people all over the world who do related stuff.)

      I sort of study that field and while there are alot of physicists who study aspects of this i can only think really of a couple papers which are really relevant (by polish physicists). In some ways they are easy (or ‘trivial’ or ‘obvious’) but the (math) details are fairly difficult (or very) at least for me. (The hard part is figuring out exactly how you assign different ‘economic variables’ to their corresponding mathematical variables—often there are many ways to do this–sometimes it doesnt matter, but other times people make wrong choices (and they stick with them, even if it leads to nowhere except alot of equations and alot more confusion.)

      ( to me the classic example is whether you decide ‘utility’ is ‘energy’ or ‘entropy’ instead. My view (and others nowadays) is that the most famous attempts by early ‘econophysicists’ (associated with the santa fe institue) made the wrong choice. But because these are famous people , you can’t say you disagree with them. (now some people do, and those are better papers). Also those papers used the most complex technical mathematical arguments so it was hard to argue with them—if you asked a question they might just reply ‘we derive this from that –if you can’t do the derivation, then your question is meaningless’ . Problem was they started with the wrong assumptions so they are deriving useless nonsense–you can actually fix it but its not worth the effort. That would be like trying to use a bicycle tire to replace a flat car tire—possible, but why bother. )

      This view of the firm is actually sort of basic from an interdisciplinary view–the pretty much exact problem arises in studying ‘collective’ and selforganzing phenomena in particles, or biological organisms. (You never really have a strict ‘edge’ or ‘boundary’ of a firm or anything else–what you have are ‘clusters’ with internal structure, each weakly connected to other clusters–firms.

      Economics differs because you arent just exchange energy; rather one has flows such as products exchanged for money from buyers.

      The basic model is chemical reactions. This is studied with graph theory and physics (currently by one very high powered mathematician–i’m actuallly signed up as an online member of his group but i’m not really at the level i canm make a useful contribution–though on occassion they do use some of the stuff i post (without acknowledgement–
      though likely they could or did find same stuff elsewhere)).

      I havent had the energy or iq to go through the details and adapt it to economics any more than trying to spell your last name.

      i’d be interested in a possibly onine studfy gorup on this, but if i’m going to do it, i may just have to do it myself if i want.

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