I just got around to posting this paper on SSRN, although it was written a couple of years ago. I need to cite it for other work I’m currently doing, so it has to be out there, somewhere. It is a more concise version of the theory than previous renditions and stays closer to the main point.
What it shows:
There is a simple explanation for why firms exist, why they have the boundaries they have, and why they are organized as they are, which is superior to the alternatives—and it has nothing to do with transaction costs or anyone whose name begins with the letter C.
This theory is implicit in much of the management literature, especially strategic management.
It’s based on the same math as fitness landscapes, but it doesn’t draw on evolutionary theory.
It exemplifies a more general methodological approach that de-emphasizes hill-climbing (optimization theory derived from concave programming) and emphasizes instead hill-finding. There are many potential applications in economic theory, but the theory of the firm stands out.
For the life of me, I don’t understand why this approach to the economics of the firm isn’t universally accepted. Hardly anyone even knows it exists. It strikes me as too obvious to take credit for or be proud of.
Here’s the abstract:
This paper proceeds from the assumption that economies are characterized by a high degree of interactive nonconvexity in most activities and at most scales. The consequence is nonconvex production and preference sets and the corresponding inefficiency of myopic algorithms. One application of this perspective is the theory of the firm. Conventional theories explain the existence, boundaries and internal organization of firms on the basis of contracting costs that impede the otherwise optimizing properties of market decentralization. I propose instead an approach in which the motive for organizing production within rather than between institutions is to internalize nonconvexities, thereby obtaining the benefit of explicitly coordinated plans. A useful device for representing this problem is the profit landscape, understood to be nonconvex in the sense that fitness landscapes are in evolutionary theory. Firms face three types of challenges, optimizing with respect to a particular profit hill (the problem analyzed in standard microeconomics), selecting a desirable hill, and achieving flexibility to transition between hills in the face of environmental change. These entail tradeoffs, which are reflected in the diversity of personnel, organizational, and innovation strategies observed in actual enterprises. While the use of the landscape metaphor in coordinated activity theory resembles a similar deployment in evolutionary economics, the two approaches differ in the questions they ask and the units of observation and analysis they employ. The applicability of the coordinated activity model is underscored by its congruence with the bulk of management literature, which can be understood more readily in terms of hill-selection than, or in addition to, the hill-climbing paradigm of conventional economics. In this sense, the existing management literature already provides a body of empirical and applied support for coordinated activity theory, although not generally for the socially-founded objectives of economics.
It’s good to see an economic theory consistent with management theory. Economics tends to accept theories that only make sense from an economics viewpoint, but are nonsensical otherwise. It’s as if the theory of gravity only worked on earth if it were orbiting Jupiter. That’s might be a great theory, but the earth is orbiting the Sun.