Plant (1937) vs. Coase (1937) on the theory of the firm
Plant (1937) vs. Coase (1937) on the theory of the firm
Their mutual disregarding of the other's (complementary) work is mystifying
The Nature of the Firm, a 1937 paper which contributed to Ronald Coase’s 1991 Nobel Prize, offered an economic explanation of why individuals choose to form partnerships, companies and other business entities rather than trading through contracts on markets to undertake production. (In the then standard (now, textbook) view of production, which implicitly assumed zero transaction costs, it is cheaper to contract via markets than form organisations to produce.) Coase argued that firms emerge because they are better equipped to deal with the transaction costs inherent in production and exchange than market interactions are.
Coase’s paper seemingly appeared from nowhere
One of the more surprising things about The Nature of the Firm is that it appears to have come from nowhere.1 It had no obvious antecedents, and there were no obvious examples of economists working along similar lines at the same time.
Or were there?
Arnold Plant, one of Coase’s old teachers, published a paper, Centralise or Decentralise?, which in several ways was very similar to Coase’s paper.2
Centralise or Decentralise? was Plant’s main contribution to the theory of the firm. It was published in the same year as Coase’s The Nature of the Firm. The similarities do not end there. Plant also took a transaction-cost like approach to his theory of the firm. He argued that the tasks to be carried out by a firm, and by whom within the firm, will help determine the boundaries and internal structure of the firm. Or, in other words, determining the balance between centralisation and decentralisation will help determine the boundaries and structure of firms; and this trade-off depends on the relative costs of using the market or a firm.
To decentralise?
Plant opened his paper by asking us to consider a one-man firm which faces a growing volume of varied business. Success in such a business requires a combination of different aptitudes, training and experience. The business owner needs assistance and thus must decide which functions to allocate to subordinates. Plant saw two main reasons for the delegation of a function. The first is that the delegated task may be better performed. The second is that the delegation may result in non-delegated functions being better performed.
Plant dealt with the second of these reasons first. He made a comparative advantage argument to explain how delegation can result in better performance of the non-delegated functions. He gave, as an example, a
“sales manager, although possibly a better salesman than any of his own staff, may wisely delegate the interviewing of clients to teams of inferior salesmen, if it is still more profitable for his firm that he should concentrate his own energy upon the direction of policy at headquarters”.3
The first reason for delegation noted above is that the delegated tasks will be better carried out. Plant argued that in
“some instances this is a fortunate concomitant of delegation necessitated by other considerations : in others the position is simply that there is an opportunity for profitable specialization, the gains accruing being sufficient to outweigh any increased costs due to new problems of co-ordination”.4
He went on to add that the gains from specialisation, in this case, include the ability to study functional and regional differences and the fact that specialists are more knowledgeable and thus better able to understand and respond to any such differences. Specialists will be able to make more and better decisions than a single central authority.
Plant added that the opportunities for decentralization will be less when the personal qualities of the central authority are of importance to the success of the firm. If the market in which the firm operates is highly heterogeneous and thus transactions require separate attention then decentralisation becomes impracticable.
For Plant, the “dominating fact throughout is the limit to the working day of the head of the business”.5 The head needs to find out the relevant facts for each new decision and assess the possible effects of any policy changes. The second of these can be delegated while the first cannot.
In Plant’s view, as the complexity of the company grows, the need for ever more complicated management techniques to coordinate the firm also grows.
“But it is one thing to increase the speed and range of contacts within a firm, and quite another to evoke indefinitely a greater and greater volume of response from the (still only human) organism which endeavours to direct the business from the centre. The time and energy of the central authority is strictly limited”.6
As the amount of business undertaken grows, and problems grow with the amount of business,
“the time approaches when the capacity of the cooperating specialists in the firm to serve its clients will be greater if the attempt at maintaining a central ‘co-ordination’ of all of their activities is abandoned, and parts of the firm are disintegrated into more easily manageable units”.7
Or to centralise?
Having considered decentralisation, Plant then examined centralisation. Centralisation is how firms can secure the advantage of specialised labour services or equipment which would not otherwise be available to them — or only available at a higher cost. If there is a well-functioning market for the good or service in question then there is no need for centralisation. Or, stated in more modern terms, if transaction costs are low there is no need for centralisation. But if there is no such market, i.e. transaction costs are high, then centralisation may be justified.
To justify having specialised employees or equipment there must be a sufficient volume of work available for these workers or machines to do. Centralisation, or the pooling of the good or service provided, may help make this possible. A make decision becomes preferable to a buy decision.
Standardisation of inputs and/or outputs can help achieve the necessary volume of work. But Plant asked, will the necessary standardisation pay? With complete standardisation a buyer could, for example, buy for several shops as cheaply as for one. But department stores have found that aiming for standardisation can result in trading down, i.e. lowering the quality of products offered to the lowest common denominator. More generally, the degree of standardisation required for efficient centralisation may not be in the interests of all departments of a business.
Also if customers prefer variety, then a price differential will be necessary for them to accept standardisation.
Discretionary centralisation may work better…
Plant next introduced the idea of discretionary centralisation. This is a looser form of cooperation under which each department or each firm may act in unison with others, but can act alone when this would serve their interests better than centralization. It is voluntary centralization in that any minority is free to abstain from any collective action that it feels is not in its best interest.
Coase and Plant differed on uncertainty
The examination of Plant’s paper just given suggests that there are similarities between Plant’s work and that of Coase. When contemplating the similarities, and differences, between the Coase and Plant papers one significant point is that it could be argued that Plant’s work implicitly assumes Knightian uncertainty,8 whereas Coase is more ambivalent on Knight.
In his paper Coase did acknowledge uncertainty as playing a role in the existence of firms: it “seems improbable that a firm would emerge without the existence of uncertainty”.9 But when discussing Knight’s approach to organisation he said, “Professor Knight would appear to consider that it is impossible to treat scientifically the determinants of the size of the firm”.10 Coase later considered Knight’s views in more detail11 and criticised them on several grounds.12 Most importantly Coase concluded that Knight did not give any reasons as to why the price mechanism should be superseded, i.e. reasons for why there should be firms.
Coase did not acknowledge Knight as influencing his work, in fact, he went so far as to state that it “can, I think, be said with some confidence that Knight played no part in the development of my ideas on the firm”.13 The Nature of the Firm did not feature any Knightian ideas such as differential attitudes to risk or moral hazard.
For Plant things were different. The “limit to the working day of the head of the business” is driven by uncertainty. Finding out the relevant facts for each new decision, e.g. about what goods and services to produce, is problematic because of uncertainty. Intuitive judgement must be relied upon when making such decisions. As noted by Plant, when each transaction needs separate attention, and the greater the uncertainty the more attention each decision needs, decentralization becomes impractical. With uncertainty, “[c]centralisation of this deciding and controlling function is imperative, a process of ‘cephalization,’ [ … ] is inevitable [ … ]”.14
In situations, for example, in which the prices of outputs are unknown at the time input resources must be allocated or when the reaction of competitors is uncertain, the judgement of the head of the firm is all the more important. Here the personal attention of those at the centre of the business is vital to the firm’s prosperity and this, Plant argued, results in delegation becoming infeasible. Having to contend with uncertainty gives Plant’s businessman more of an entrepreneurial feel than the manager vibe of Coase.
Insofar as Plant utilizes Knightian uncertainty, his approach is implicitly an incomplete contracts approach. Given Knightian uncertainty, entrepreneurs must rely on judgement, which is non-contractible. Thus if one wished to write Whig history, Knight could be seen as a forerunner of the incomplete contracts approach to vertical integration. For Knight incompleteness of contract was ultimately a matter of uncertainty, and thus Plant’s use of Knightian uncertainty means he inherits contractual incompleteness.
Plant's argument that specialists have more and better information and thus will make better decisions has a Hayekian feel to it. Hayek argued that knowledge is necessarily decentralized since each of us has our own personal (often tacit) knowledge of time and place, and therefore planning and control over resources should be decentralized so that people can take advantage of their local knowledge.15 Plant’s contention was consistent with such a view.
Plant as a management scholar
If we think of Oliver Williamson’s work on transaction-cost economics as operationalizing transaction costs, can we interpret Plant’s paper in a similar fashion in that it operationalizes management costs? Plant gave more detail, precision and empirical content in his analysis of the management issues raised than did Coase. Could the more detailed consideration of management costs reflect Plant's wider work as a management scholar?
Plant’s paper was, interestingly, part of “a series of public lectures to audiences of business people [ … ] designed to examine some “present day business problems”.16 The internal organization of a firm is an important component of the efficient operation of a business. Coase on the other hand was thinking of the economic problem of why we have firms within the economic system. He wanted to show what determined the boundaries between firms and markets. The answers given by each author reflect the different general contexts within which they worked.
Plant’s notion of discretionary centralisation invites comparison with Williamson’s concept of selective intervention. Selective intervention has a top-down quality while discretionary centralisation is more of a bottom-up idea. In the case of selective intervention, those at the centre manage the firm and if they see an advantage to centralisation then is it enacted; while for discretionary centralisation, those in the different departments of the firm are the decision-makers and centralisation only occurs for those who agree to it. Under selective intervention
"the parent firm deals with each of its parts by exercising forebearance with respect to those activities where no net gains are in prospect (in which event the parent directs the operating part to replicate small firm behavior) and intervenes wherever coordination yields net gains".17
For discretionary centralisation, the parts of the firm have to see centralization as being advantageous to them to get them to join. This suggests that discretionary centralisation has a noncooperative feel to it, centralisation has to be a best response for each part of the firm for it to occur. Selective intervention on the other hand seems more like a cooperative game: as long as there is a net gain for the firm as a whole, the parts can be required to cooperate.
Left with a conundrum
If the arguments presented so far have any validity, we are left with a conundrum. Accepting that Plant’s analysis is similar to that of Coase, then this fact raises the question as to why the reception by Plant of Coase (1937) was apparently so muted. Plant must have seen the similarities and thus we would assume think well of Coase’s paper. But Coase (1988) tells us that on
"the day that the issue of Economica was published in which ‘The Nature of the Firm’ appeared, on the way to lunch I was congratulated by Sargent and Plant, the professors of commerce. Neither ever referred to the article again or discussed it with me, although I worked closely with Plant and he thought of me as a member of his ‘team’ ".18
On the other hand, Coase does not discuss Plant’s paper either. In a 1977 review of Plant’s 1974 Selected Economic Essays and Addresses,19 Coase mentions that Plant’s 1937 Centralise or Decentralise? is reprinted in that volume, but makes no further comment.20 Again, in his 1986 essay on Plant’s ideas and influence, Coase does not discuss Centralise or Decentralise?21 And, yet again, in his later biographical essay on Plant in The New Palgrave Dictionary of Economics, Coase does not mention the paper.22
Given what appear to have been good personal and professional relationships, the mutual disregarding of the other's (complementary) work is mystifying.
This post is based on “The Teacher Versus the Student: Plant and Coase on the Firm” forthcoming in the History of Economics Review. By Paul Walker
Coase, Ronald Harry (1937). ‘The Nature of the Firm’, Economica, n.s. 4 no. 16 November: 386-405.
Plant, Arnold (1937a). ‘Centralise or Decentralise?’. In Arnold Plant (ed.), Some Modern Business Problems: A Series of Studies (pp. 3-33), London: Longmans, Green and Co. Reprinted in Plant (1974: 174-98).
Plant (1937a), 6.
Plant (1937a), 8.
Plant (1937a), 12.
Plant (1937a), 15.
Plant (1937a), 15.
The “practical difference between the two categories, risk and uncertainty, is that in the former the distribution of the outcome in a group of instances is known (either through calculation a priori or from statistics of past experience), while in the case of uncertainty this is not true, the reason being in general that it is impossible to form a group of instances, because the situation dealt with is in a high degree unique”.
Knight, Frank H. (1921). Risk, Uncertainty and Profit, Boston: Houghton Mifflin Company. (p. 233).
Coase (1937), 392.
Coase (1937), 394.
Coase (1937), 398–400.
Coase (1937), 400–1.
Coase, Ronald Harry (1988). ‘The Nature of the Firm: Meaning’, Journal of Law, Economics, & Organization, 4(1) Spring: 19-32. (p. 20)
Knight (1921), 268–9.
Hayek, F. A. (1945). ‘The Use of Knowledge in Society’, American Economic Review, 35(4) September: 519-30.
Plant, Arnold (1937b). ‘Foreword’. In Arnold Plant (ed.), Some Modern Business Problems: A Series of Studies (p. v), London: Longmans, Green and Co.
Williamson, Oliver E. (1985). The Economic Institutions of Capitalism, New York: The Free Press. (p. 135)
Coase (1988), 23.
Plant, Arnold (1974). Selected Economic Essays and Addresses, London: Routledge & Kegan Paul.
Coase, Ronald Harry (1977). ’Review of `Selected Economic Essays and Addresses by Arnold Plant’, Journal of Economic Literature, 15(1) March: 86-8.
Coase, Ronald Harry (1986). ‘Professor Sir Arnold Plant: His Ideas and Influence’. In Martin J. Anderson (ed.), The Unfinished Agenda: Essays on the Political Economy of Government Policy in Honour of Arthur Seldon, (pp. 79-90), London: The Institute of Economic Affairs.
Coase, Ronald Harry (1987). ‘Plant, Arnold (1898-1978)’. In John Eatwell, Murray Milgate and Peter Newman (eds.), The New Palgrave: A Dictionary of Economics, Volume 3 (pp. 891-2), London: Palgrave Macmillan.
Many thanks. This is useful as we think about the structure of local and central governments too in urban growth policy, and whether they be general or special purpose. After all, Coase said govts are just ‘super firms’