Foundations of Organisational Economics

Histories and Theories of the Firm and Production

Paul Walker

• Publisher: Routledge
• Year: 2021
• ISBN:
  9781000358865
• Edition: 1
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

Foundations of Organisational Economics: Histories and Theories of the Firm and Production delves into a range of key topics to do with the history of the mainstream approach to the theory of production and the theory of the firm. This includes the frameworks used to analyse production, the division of labour and its application to the firm and the development of the neoclassical model of production.

The first topic explored is the change from a normative approach to a largely positive approach to the analysis of the theory of production, which occurred around the seventeenth century. The next topic is an examination of the relationship (or the lack of a relationship) between the division of labour and the theory of the firm. In the fourth chapter, the focus is on the development of the proto-neoclassical approach to production. Here, the development of the theories of monopoly, oligopoly and perfect competition are discussed, as well as the theory of input utilisation. Chapter 5 looks at Marshall's idea of the representative firm, which was the main early neoclassical approach to the theory of industry-level production. The penultimate chapter considers the criticisms made of the neoclassical model between 1940 and 1970.

This work is an illuminating reference for students and researchers of the history of economic thought, industrial organisation, microeconomic theory and organisational studies.

1
Introduction

Preliminaries

According to Robert Ekelund and Robert Hébert, there are a number of benefits that accrue to the study of the history of economic thought:

[o]ne of the things that can be gained from a study of the past is a better understanding of the creative process. All the great intellectual pioneers held a skeptical, almost iconoclastic, attitude toward traditional ideas and maintained an open, almost naive, credulity toward new concepts. Out of this combination came the crucial capacity to see a familiar situation or problem in a new light. The creative process is always a wrenching away of a concept from its traditional context or meaning.

Another benefit from a study of the past is an appreciation for the kind of ideas that have staying power. What separates good ideas from bad ideas? Why do certain ideas survive in economic theory long after their emergence on the intellectual scene? Why do other ideas fizzle quickly? Traditional economics courses have little time for such issues, yet they are entirely appropriate within the context of intellectual history, and, it turns out, the answers have an enormous impact on the content of economics at any particular point of time.

Yet another benefit is a keener understanding of contemporary economic theory by exposure to the shortcomings of past theories and the obstacles overcome by the principles that survive. Some students will find the abstract theory of economics more palatable – indeed, more understandable – when it is presented in a historical context. But in the final analysis the only justification needed for studying the history of economic thought may be that the subject is interesting.

(Ekelund and Hébert 2013: 3)

However, not everyone today shares Ekelund and Hébert’s view. Many, if not most, economists do not. The history of thought is largely ignored in contemporary mainstream economics. Historian of economic thought Mark Blaug has lamented the state of the history of thought within modern economics:

[i]t is no secret that the study of the history of economic thought is held in low esteem by mainstream economists and sometimes openly disparaged as a type of antiquarianism. There is nothing new in this. Practically every commentator on the role of history of economic thought in modern economics in the last 30 years has lamented the steady decline of interest in the area since the end of World War II and its virtual disappearance from university curricula, not just at the graduate but sometimes even at the undergraduate level.

(Blaug 2001: 145)

David Laidler has commented on the declining importance of the history of economic thought [HET] within modern economics:

[b]ut my pleasure tonight is tempered by the apprehension that many of us feel about HET’s future. Though matters are not so far gone in Europe as in North America, its serious study as a branch of economics seems to be in decline everywhere.

(Laidler 2012: 2)

Dieter Bögenhold also sees HET in decline:

[d]uring the last decades, HET has mostly been abolished or has disappeared in many contemporary teaching curricula in economics. When latest methods in econometrics and mathematical procedures are put into the reading schedule in university education, reading of the history of the own discipline appears to be nearly forgotten.

(Bögenhold 2017: 2)

But the history of thought to do with the theory of production and the theory of the firm¹ receives even less attention than the subject in general. If you look at, for example, Backhouse (2002), a well-regarded introduction to the history of economic thought, it devotes, roughly, one page out of a total of 369 to the history of the theory of the firm. Another well-used introduction, Sandmo (2011), does even worse in that none of its almost 500 pages deals with the theory of the firm. Heilbroner (1999), one of the most famous introductions to the history of economic thought, has no discussion of the questions which we today think of as making up the theory of the firm.² In 1893, when Edwin Cannan published the first of three editions of his A History of the Theories of Production and Distributions from 1776 to 1848, he commented that “I have been able to obtain surprisingly little assistance from previous writers” (Cannan 1893: v). Since then, sadly, little appears to have changed. There is still little assistance from the literature for those who are interested in the history of thought to do with production or the firm. In fact, in the more than one hundred years since Cannan wrote there seems to have been only three additional books (in English at least) published that directly deal with the topic of the history of thought to do with either the theory of production or the theory of the firm: George Stigler published a revised version of his PhD thesis as Production and Distribution Theories: The Formative Period in 1941; in 1978, Philip L. Williams published his PhD thesis as The Emergence of the Theory of the Firm: From Adam Smith to Alfred Marshall; and Paul Walker published A Brief Prehistory of the Theory of the Firm in 2018.

Hopefully, the essays presented here will shed light on a few of the wide array of interesting topics that can be investigated under the rubric of the history of the theory of production and the theory of the firm. The emphasis is on the pre-1970 mainstream literature on production and the firm. 1970 is used as a convenient, if not entirely accurate, dividing line between what constitutes the ‘past’ and the ‘present’ of the theory of the firm, since it was around this time that the theory of production began to be supplemented by a genuine theory of the firm. Pre-1970, what went under the heading of the ‘theory of the firm’ was, in fact, a microeconomic theory of production.³ It was in the 1970s that the present mainstream – largely Coaseian inspired – approaches to the firm started to develop, with works such as Williamson (1971, 1973, 1975), Alchian and Demsetz (1972), Jensen and Meckling (1976) and Klein, Crawford and Alchian (1978). The major difference between the mainstream theories of the past (the neoclassical theory of production) and the mainstream theories of the present (the theory of the firm), at least as far as they are conceived of here, is that the focus – in terms of the questions the theory attempts to answer – of the post-1970 mainstream literature is markedly different from that of the earlier mainstream (neoclassical) theory. The theory of the firm for Ronald Coase, Oliver Williamson, Bengt Holmström or Oliver Hart is a very different thing from the theory of production associated with the likes of Arthur Pigou, Lionel Robbins, Jacob Viner, Joan Robinson and Edward Chamberlin.

The questions the theory seeks to answer have changed from being about how the firm acts in its various markets, how it prices its outputs or how it combines its inputs to questions about the firm’s existence, boundaries⁴ and internal organisation. That is, within the mainstream theory there has been a movement away from seeing the theory of the firm as simply developing one component (albeit an important component) of price theory, namely the element concerned with the factor and product market behaviour of producers, to the theory being concerned with the firm as an important economic institution in its own right.

The focus here is on the mainstream⁵ microeconomic theory of production and the firm, and both the ‘mainstream’ and ‘microeconomic’ terms matter. The concentration on the mainstream means that the heterodox⁶ approaches to the firm are not discussed, while the microeconomic focus means that the macroeconomic theory of production⁷ and its associated controversies are not examined. The chapters are written in the—perhaps forlorn—hope that they will stimulate interest in the history of the mainstream theory of production and the firm.

The essays have been written as introductions to the topics covered and are intended to be accessible to undergraduate students and general readers. With this in mind, any background needed is provided and any mathematics used is explained either in the text or chapter notes. Given this, each chapter can be read independently of all the others, and thus readers can sample as they see fit. A cost to this approach is that there is some repetition between chapters.

Outline of the rest of the book

The second chapter looks at the change from a largely normative approach to the theory of production to a largely positive approach. Today we take a positive approach to the firm for granted, but before the mercantilists in the period, roughly, from the sixteenth to the eighteenth centuries the standard approach to production, and economics more generally, was predominately normative.

Chapter 3 considers the relationship between the division of labour and the theory of the firm since, as Ronald Coase has put it, “[t]o understand production, we have to go back to Adam Smith’s division of labor” (Wang 2014: 118). However, the main conclusion to be drawn here is about just how little impact the division of labour has had on the development of the theory of production and the firm. Before the twentieth century, the division of labour played little part in the development of the theory of the firm. Starting in the twentieth century, the manufacturing division of labour did begin to play a role, but it is a limited role within the contemporary mainstream theory of the firm. This literature has taken a more contractually based approach.

In Chapter 4 we consider some aspects of the development of the neoclassical approach to production, in particular the proto-neoclassical formulation of the theory of production. The case is made that much of what we call the neoclassical theory of production was in fact created before the ‘neoclassical revolution’ of the 1870s. The theories of monopoly, oligopoly, input utilisation and even the theory of perfect competition were developed before the 1870s.

Chapter 5 looks at Alfred Marshall’s ‘representative firm’. This was a concept that first appeared in the 1890s⁸ as a way for Marshall to construct an industry supply curve without having to assume that all firms in an industry were identical. It allowed him to marry his dynamic view of firms with a static view of industry. But the idea did not last long; it fell victim to the ‘cost controversy’ of the 1920s and was driven out of the economics literature by 1930.

The criticisms of the neoclassical approach to production that originated in the period 1940 to 1970 are briefly covered in Chapter 6. This chapter includes discussions of the full cost controversy that took place in the UK and the related marginalist controversy which occurred in the US. This is followed by an examination of some of the first attempts to look inside the black box of the neoclassical ‘firm’, namely the behavioural, managerial and X-inefficiency theories of the firm. These models took issue with a number of aspects of the neoclassical model including the notion that there are no principal agent problems in the firm, the use of profit maximisation as the objective for the firm, or in one case the use of the maximising assumption at all, and the idea that a firm operates in a technically efficient manner.

The final chapter is the conclusion.

Notes

1 Spulber (2008: 5, footnote 8) gives the origin of the word ‘firm’ as “[t]he word ‘firm’ de...