Exchange, Markets and Firms

1. Exchange, Markets and Firms Geoff Hodgson 1. Exchange 2. Property 3. Markets 4. Firms / 26

2. A B Exchange, Markets and Firms 1. Exchange Exchange is not simply a two-way exchange of goods or money but a corresponding transfer of property rights - Karl H. Rau (1835) and John R. Commons (1924) Property Rights Money or Goods Persons The situation with services is more complicated. / 26

3. Exchange, Markets and Firms 1. Exchange This view of exchange is not universally accepted - Ludwig von Mises (1949) defined exchange as “an attempt to substitute a more satisfactory state of affairs for a less satisfactory one”. - The repeated idea of production as “an exchange with nature”. - “Exchange theory” in sociology (Peter Blau, 1964). All the above conceptions all try to make exchange a universal and ahistorical phenomenon. / 26

4. Exchange, Markets and Firms 1. Exchange Exchange may require the state or other institutions: - institutions to support property rights - institutions establishing and enforcing contract law Legal property rights and contract are sustained by both custom and the state / 26

5. Exchange, Markets and Firms 1. Exchange Contracts depend on legal tests of mutual consent - there are dangers in the idea of ‘implicit contracts’ - Reverend Samuel Seabury (1861) on slavery. / 26

6. Exchange, Markets and Firms 2. Property Is ‘property rights economics’ really about property rights? - it involves establishing ‘well defined property rights’: often to replace taxes or subsidies - but this is essentially about establishing incentives and disincentives for individual actions - the policies proposed by ‘property rights economics’ would still involve the state - in dealing with increased property enforcement and grievance litigation / 26

7. Exchange, Markets and Firms 2. Property Armen Alchian (1977) defined the property rights of a person in terms of “the probability that his decision about demarcated uses of the resource will determine the use” But this universal and ahistorical definition is about control, not ownership, of a resource. / 26

8. Exchange, Markets and Firms 2. Property The emergence of law, including property rights, is never simply a matter of spontaneous development from individual interactions - Itai Sened (1997) argues, in his critique of the notion of property without law, that individual rights are established only when a territorial institution establishes its monopoly over the use of force - Individualist writers from Adam Smith to Friedrich Hayek over-emphasised the spontaneity of law, as essentially an outcome of individual interactions / 26

9. Exchange, Markets and Firms 2. Property Individual property is not mere possession; it involves socially acknowledged and enforced rights - Individual property is not a purely individual matter - It is not simply a relation between an individual and an object - It requires some kind of customary and legal apparatus of recognition, adjudication and enforcement - Such legal systems made their first full appearance within the state apparatuses of ancient civilisation / 26

10. Exchange, Markets and Firms 2. Property Law and property rights are the outcome of a power struggle between citizens and the state The state benefits by maintaining its power … … while citizens benefit from a regime of law and order in which they can produce, trade, enjoy leisure etc. / 26

11. Exchange, Markets and Firms 2. Property - The state has the capacity to appropriate, as well as to protect, private property - For private property to be relatively secure, a particular form of state had to emerge, countered by powerful and multiple interest groups in civil society - This meant that a pluralistic state with some separation of powers, backed up by a plurality of group interests in the community at large / 26

12. Exchange, Markets and Firms 2. Property There has always been a spontaneous and informal element in the evolution of property and contract However, all plausible arrangements involve some kind of legal or quasi-legal apparatus. Explanations of the emergence of rule-enforcing institutions purely from optimising individual behaviours are typically unconvincing (Sened, 1997; Mantzavinos, 2001). / 26

13. Exchange, Markets and Firms 3. Markets Although market behaviour is a major theme of economics, adequate definitions of the market are extraordinarily rare Douglass North (1977) has remarked: “It is a peculiar fact that the literature on economics and economic history contains so little discussion of the central institution that underlies neo-classical economics – the market. … I am not aware of any existing systematic analysis of the pre-conditions for price-making markets.” / 26

14. Exchange, Markets and Firms 3. Markets Furthermore, the market is often treated as an ahistorical and non-institutional entity Gary Becker (1976) wrote of ‘a market for marriages’ When advising former Eastern Bloc countries, Jeffrey Sachs (1993) wrote: ‘markets spring up as soon as central planning bureaucrats vacate the field’ / 26

15. Exchange, Markets and Firms 3. Markets In contrast, Ronald Coase (1992) observed: ‘The ex-communist countries are advised to move to a market economy ... but without the appropriate institutions, no market of any significance is possible’ Alan Greenspan (1999) has admitted that he originally assumed that the collapse of the Soviet regimes ‘would automatically establish a free-market entrepreneurial system’ believing that capitalism was simply ‘human nature’ … … but it turned out, Greenspan said, to be ‘not nature at all, but culture’ / 26

16. Exchange, Markets and Firms 3. Markets The institutional character of markets was emphasised by German historical economists in the nineteenth century, and by ‘old’ institutional economists such as John Commons, John Hobson and John Maurice Clark Hobson (1902) wrote: ‘A market, however crudely formed, is a social institution.’ J. M. Clark (1957): ‘the mechanism of the market, which dominates the values that purport to be economic, is not a mere mechanism for neutral recording of people’s preferences, but a social institution with biases of its own’ / 26

17. Exchange, Markets and Firms 3. Markets Markets, where they exist, help to structure, organise and legitimate numerous exchange transactions Definition: A market is an institution through which multiple buyers and multiple sellers exchange a substantial number of commodities of a particular type. Markets involve pricing and trading procedures that help to establish a consensus over prices, and often help by communicating information regarding products, prices, quantities, potential buyers or possible sellers / 26

18. Exchange, Markets and Firms 3. Markets Markets help to structure, organise and legitimate numerous exchange transactions Markets, in short, are organised and institutionalised exchange Markets differ substantially, especially when we consider markets in different cultures. Market routines differ. Compare USA/Japan/North Africa Not all exchanges take place in markets. / 26

19. Market ExchangeTransitory, non-relational contracting Non-Market ExchangeEnduring, relational contracting Firm Firm Firm Firm Firm Firm Firm Firm Firm / 26 Exchange, Markets and Firms 3. Markets

20. Exchange, Markets and Firms 3. Markets • Three key points: • The market is an institution - organised exchange • Different types of market institutions may exist • Not all exchanges take place in markets / 26

21. Exchange, Markets and Firms 4. Firms Lack of Consensus Over the Definition of the Firm: Sanford Grossman and Oliver Hart (1986) define the firm ‘in terms of the assets it owns’ - focusing exclusively on the relationship between persons and things, to the neglect of structured relations between persons. Eirik Furubotn and Rudolf Richter (1997) wrote: ‘A firm is understood … as a network of relational contracts between individuals ... with the purpose of efficiently organizing production’ - confuses a firm with a network. There is widespread confusion in the management literature of the term ‘organisation’ with ‘firm’. / 26

22. Exchange, Markets and Firms 4. Firms Conflating the firm and the market: Armen Alchian and Harold Demsetz (1972, p. 777) wrote: “Telling an employee to type this letter rather than to file that document is like my telling a grocer to sell me this brand of tuna rather than that brand of bread.” The contractual relationship between shopper and grocer was seen as virtually equivalent to the generally more enduring and complex employment relationship within the organisation of the firm / 26

23. Exchange, Markets and Firms 4. Firms The firm as an historical institution: Again, a principal defect in the literature is to attempt to conceive real institutions such as the firm in ahistorical and non-institutional terms / 26

24. Exchange, Markets and Firms 4. Firms The firm is a type of organisation. All firms are organisations but not all organisations are firms. We may define an organisation as a special type of institution involving a) criteria to establish its boundaries and to distinguish its members from its non-members, b) a principle of sovereignty concerning who is in charge, and c) a chain of command delineating responsibilities within the organisation. / 26

25. Exchange, Markets and Firms 4. Firms A firm is defined as an integrated and durable organisation involving two or more people, acting openly or tacitly as a ‘legal person’, capable of owning assets, set up for the purpose of producing goods or services, with the capacity to sell or hire these goods or services to customers. / 26

26. Exchange, Markets and Firms 4. Firms / 26