I hear that there is an apparent paradox which economists have studied: If free markets are so great, why is it that the most successful corporations/businesses/etc. are top-down hierarchical planned economies internally?
I wonder if this may be a partial explanation: Corporations grow bit by bit, by people hiring other people to do stuff for them. So the hierarchical structure is sorta natural. Kinda like how most animals later in life tend to look like bigger versions of their younger selves, even though some have major transformations like butterflies. Hierarchical structure is the natural consequence of having the people at time t decide who to hire at time t+1 & what responsibilities and privileges to grant.
It would be interesting to have a reference to some source that makes the claim of a paradox.
It is an interesting question but I don’t think economists are puzzles by the existance of corporation but rather by understanding where the margin is between when coordination becomes centralized and when it can be price mediated (i.e., market transaction). There is certainly a large literature on the theory of the firm. Coases “The Nature of the Firm” seems quite relevant. I suppose one could go back to Adam Smith and his insight about the division of labor and the extent of the market (which is also something of a tautology I think but still seems to capture something meaninful).
I’m not sure your explanation quite works but am perhaps not fully understanding your point. If people are hiring other people to do stuff for them that can be: hire an employee, hire some contractor to perform specific tasks for the business or hire some outside entity to produce something (which then seems a lot like a market transaction).
I hear that there is an apparent paradox which economists have studied: If free markets are so great, why is it that the most successful corporations/businesses/etc. are top-down hierarchical planned economies internally?
Yeah, economists study this under the name “theory of the firm”, dating back to a 1937 paper by Ronald Coase. (I see that jmh also mentioned this in his reply.) I remember liking Coase’s “transaction cost” solution to this puzzle or paradox when I learned it, and it (and related ideas like “asymmetric information”) has informed my views ever since (for example in AGI will drastically increase economies of scale).
Corporations grow bit by bit, by people hiring other people to do stuff for them.
I think this can’t be a large part of the solution, because if market exchanges were more efficient (on the margin), people would learn to outsource more, or would be out-competed by others who were willing to delegate more to markets instead of underlings. In the long run, Coase’s explanation that sizes of firms are driven by a tradeoff between internal and external transaction costs seemingly has to dominate.
I think it’s a confused model that calls it a paradox.
Almost zero parts of a “free market” are market-decided top-to-bottom. At some level, there’s a monopoly on violence that enforces a lot of ground rules, then a number of market-like interactions about WHICH corporation(s) you’re going to buy from, work for, invest in, then within that some bundled authority about what that service, employment, investment mechanism entails.
Free markets are so great at the layers of individual, decisions of relative value. They are not great for some other kinds of coordination.
Conglomerates like Unilever use shadow prices to allocate resources internally between their separate businesses. And sales teams are often compensated via commission, which is kind of market-ish.
I think it’s because a corporation has a reputation and a history, and this grows with time and actions seen as positive by market participants. This positive image can be manipulated by ads but the company requires scale to be noticed by consumers who have finite memory.
Xerox : copy machines that were apparently good in their era
IBM : financial calculation mainframes that are still in use
Intel : fast and high quality x86 cpus and chipsets
Coke : a century of ads creating a positive image of sugar water with a popular taste
Microsoft: mediocre software and OS but they recently have built a reputation by being responsive to business clients and not stealing their data.
Boeing : reliable and high quality made in America aircraft. Until they degraded it recently to maximize short term profit. The warning light for the MACS system failure was an option Boeing demanded more money for! (Imagine if your cars brake failure warning light wasn’t in the base model)
This reputation has market value in itself and it requires scale and time to build. Individuals do not live long enough or interact with enough people to build such a reputation.
The top down hierarchy and the structure of how a company gets entrenched in doing things a certain way happens to preserve the positive actions that built a companies reputation.
This is also why companies rarely succeed in moving into truly new markets, even when they have all the money needed and internal r&d teams that have the best version of a technology.
A famous example is how Xerox had the flat out best desktop PCs developed internally, and they blew it. Kodak had good digital cameras, and they blew it. Blockbuster had the chance to buy netflix, and they blew it. Sears existed for many decades before Amazon and had all the market share and...
In each case the corporate structure somehow (I don’t know all the interactions just see signs of it at corporate jobs) causes a behavior trend where the company fails to adapt, and continues doing a variant of the thing they already do well. They continue until the ship sinks.
If the trend continues Google will fail at general AI like all the prior dead companies, and Microsoft will probably blow it as well.
lots of people aren’t skilled enough to defend themselves in a market, and so they accept the trade of participating in a command hierarchy without a clear picture of what the alternatives would be that would be similarly acceptable risk but a better tradeoff for them, and thus most of the value they create gets captured by the other side of that trade. worse, individual market participant workers don’t typically have access to the synchronized action of taking the same command all at once—even though the overwhelming majority of payout from synchronized action go to the employer side of the trade. unions help some, but ultimately kind of suck for a few reasons compared to some theoretical ideal we don’t know how to instantiate, which would allow boundedly rational agents to participate in markets and not get screwed over by superagents with massively more compute.
my hunch is that a web of microeconomies within organizations, where everyone in the microeconomy trusts each other to not be malicious, might produce more globally rational behavior. but I suspect a lot of it is that it’s hard to make a contract that guarantees transparency without this being used by an adversarial agent to screw you over, and transparency is needed for the best outcomes. how do you trust a firm you can’t audit?
and I don’t think internal economies work unless you have a co-op with an internal economy, that can defend itself against adversarial firms’ underhanded tactics. without the firm being designed to be leak-free in the sense of not having massive debts to shareholders which not only are interest bearing but can’t even be paid off, nobody who has authority to change the structure has a local incentive to do so. combined with underhanded tactics from the majority of wealthy firms that make it hard to construct a more internally incentive-aligned, leak-free firm, we get the situation we see.
Free markets aren’t ‘great’ in some absolute sense, they’re just more or less efficient? They’re the best way we know of of making sure that bad ideas fail and good ones thrive. But when you’re managing a business, I don’t think your chief concern is that the ideas less beneficial to society as a whole should fail, even if they’re the ideas your livelihood relies on? Of course, market-like mechanisms could have their place inside a company—say, if you have two R&D teams coming up with competing products to see which one the market likes more. But even that would generally be a terrible idea for an individual actor inside the market: more often than not, it splits the revenue between two product lines, neither of which manages to make enough money to turn a profit. In fact, I can hardly see how it would be possible to have one single business be organised as a market: even though your goal is to increase efficiency, you would need many departments doing the same job, and an even greater number of ‘consumer’ (company executives) hiring whichever one of those competing department offers them the best deal for a given task… Again, the whole point of the idea that markets are good is that they’re more efficient than the individual agents inside it.
I think that is part of it, but a lot of the problem is just humans being bad at coordination. Like the government doing regulations. If we had an idealized free market society, then the way to get your views across would ‘just’ be to sign up for a filter (etc.) that down-weights buying from said company based on your views. Then they have more of an incentive to alter their behavior.
But it is hard to manage that. There’s a lot of friction to doing anything like that, much of it natural. Thus government serves as our essential way to coordinate on important enough issues, but of course government has a lot of problems in accurately throwing its weight around.
Companies that are top down are a lot easier to coordinate behavior. As well, you have a smaller problem than an entire government would have in trying to plan your internal economy.
I hear that there is an apparent paradox which economists have studied: If free markets are so great, why is it that the most successful corporations/businesses/etc. are top-down hierarchical planned economies internally?
I wonder if this may be a partial explanation: Corporations grow bit by bit, by people hiring other people to do stuff for them. So the hierarchical structure is sorta natural. Kinda like how most animals later in life tend to look like bigger versions of their younger selves, even though some have major transformations like butterflies. Hierarchical structure is the natural consequence of having the people at time t decide who to hire at time t+1 & what responsibilities and privileges to grant.
It would be interesting to have a reference to some source that makes the claim of a paradox.
It is an interesting question but I don’t think economists are puzzles by the existance of corporation but rather by understanding where the margin is between when coordination becomes centralized and when it can be price mediated (i.e., market transaction). There is certainly a large literature on the theory of the firm. Coases “The Nature of the Firm” seems quite relevant. I suppose one could go back to Adam Smith and his insight about the division of labor and the extent of the market (which is also something of a tautology I think but still seems to capture something meaninful).
I’m not sure your explanation quite works but am perhaps not fully understanding your point. If people are hiring other people to do stuff for them that can be: hire an employee, hire some contractor to perform specific tasks for the business or hire some outside entity to produce something (which then seems a lot like a market transaction).
i like coase’s work on transaction costs as an explanation here
coase is an unusually clear thinker and writer, and i recommend reading through some of his papers
Yeah, economists study this under the name “theory of the firm”, dating back to a 1937 paper by Ronald Coase. (I see that jmh also mentioned this in his reply.) I remember liking Coase’s “transaction cost” solution to this puzzle or paradox when I learned it, and it (and related ideas like “asymmetric information”) has informed my views ever since (for example in AGI will drastically increase economies of scale).
I think this can’t be a large part of the solution, because if market exchanges were more efficient (on the margin), people would learn to outsource more, or would be out-competed by others who were willing to delegate more to markets instead of underlings. In the long run, Coase’s explanation that sizes of firms are driven by a tradeoff between internal and external transaction costs seemingly has to dominate.
I think it’s a confused model that calls it a paradox.
Almost zero parts of a “free market” are market-decided top-to-bottom. At some level, there’s a monopoly on violence that enforces a lot of ground rules, then a number of market-like interactions about WHICH corporation(s) you’re going to buy from, work for, invest in, then within that some bundled authority about what that service, employment, investment mechanism entails.
Free markets are so great at the layers of individual, decisions of relative value. They are not great for some other kinds of coordination.
Conglomerates like Unilever use shadow prices to allocate resources internally between their separate businesses. And sales teams are often compensated via commission, which is kind of market-ish.
I think it’s because a corporation has a reputation and a history, and this grows with time and actions seen as positive by market participants. This positive image can be manipulated by ads but the company requires scale to be noticed by consumers who have finite memory.
Xerox : copy machines that were apparently good in their era
IBM : financial calculation mainframes that are still in use
Intel : fast and high quality x86 cpus and chipsets
Coke : a century of ads creating a positive image of sugar water with a popular taste
Microsoft: mediocre software and OS but they recently have built a reputation by being responsive to business clients and not stealing their data.
Boeing : reliable and high quality made in America aircraft. Until they degraded it recently to maximize short term profit. The warning light for the MACS system failure was an option Boeing demanded more money for! (Imagine if your cars brake failure warning light wasn’t in the base model)
This reputation has market value in itself and it requires scale and time to build. Individuals do not live long enough or interact with enough people to build such a reputation.
The top down hierarchy and the structure of how a company gets entrenched in doing things a certain way happens to preserve the positive actions that built a companies reputation.
This is also why companies rarely succeed in moving into truly new markets, even when they have all the money needed and internal r&d teams that have the best version of a technology.
A famous example is how Xerox had the flat out best desktop PCs developed internally, and they blew it. Kodak had good digital cameras, and they blew it. Blockbuster had the chance to buy netflix, and they blew it. Sears existed for many decades before Amazon and had all the market share and...
In each case the corporate structure somehow (I don’t know all the interactions just see signs of it at corporate jobs) causes a behavior trend where the company fails to adapt, and continues doing a variant of the thing they already do well. They continue until the ship sinks.
If the trend continues Google will fail at general AI like all the prior dead companies, and Microsoft will probably blow it as well.
lots of people aren’t skilled enough to defend themselves in a market, and so they accept the trade of participating in a command hierarchy without a clear picture of what the alternatives would be that would be similarly acceptable risk but a better tradeoff for them, and thus most of the value they create gets captured by the other side of that trade. worse, individual market participant workers don’t typically have access to the synchronized action of taking the same command all at once—even though the overwhelming majority of payout from synchronized action go to the employer side of the trade. unions help some, but ultimately kind of suck for a few reasons compared to some theoretical ideal we don’t know how to instantiate, which would allow boundedly rational agents to participate in markets and not get screwed over by superagents with massively more compute.
my hunch is that a web of microeconomies within organizations, where everyone in the microeconomy trusts each other to not be malicious, might produce more globally rational behavior. but I suspect a lot of it is that it’s hard to make a contract that guarantees transparency without this being used by an adversarial agent to screw you over, and transparency is needed for the best outcomes. how do you trust a firm you can’t audit?
and I don’t think internal economies work unless you have a co-op with an internal economy, that can defend itself against adversarial firms’ underhanded tactics. without the firm being designed to be leak-free in the sense of not having massive debts to shareholders which not only are interest bearing but can’t even be paid off, nobody who has authority to change the structure has a local incentive to do so. combined with underhanded tactics from the majority of wealthy firms that make it hard to construct a more internally incentive-aligned, leak-free firm, we get the situation we see.
Free markets aren’t ‘great’ in some absolute sense, they’re just more or less efficient? They’re the best way we know of of making sure that bad ideas fail and good ones thrive. But when you’re managing a business, I don’t think your chief concern is that the ideas less beneficial to society as a whole should fail, even if they’re the ideas your livelihood relies on? Of course, market-like mechanisms could have their place inside a company—say, if you have two R&D teams coming up with competing products to see which one the market likes more. But even that would generally be a terrible idea for an individual actor inside the market: more often than not, it splits the revenue between two product lines, neither of which manages to make enough money to turn a profit. In fact, I can hardly see how it would be possible to have one single business be organised as a market: even though your goal is to increase efficiency, you would need many departments doing the same job, and an even greater number of ‘consumer’ (company executives) hiring whichever one of those competing department offers them the best deal for a given task… Again, the whole point of the idea that markets are good is that they’re more efficient than the individual agents inside it.
Others have mentioned Coase (whose paper is a great read!). I would also recommend The Visible Hand: The Managerial Revolution in American Business. This is an economic history work detailing how large corporations emerged in the US in the 19th century.
I think that is part of it, but a lot of the problem is just humans being bad at coordination. Like the government doing regulations. If we had an idealized free market society, then the way to get your views across would ‘just’ be to sign up for a filter (etc.) that down-weights buying from said company based on your views. Then they have more of an incentive to alter their behavior. But it is hard to manage that. There’s a lot of friction to doing anything like that, much of it natural. Thus government serves as our essential way to coordinate on important enough issues, but of course government has a lot of problems in accurately throwing its weight around. Companies that are top down are a lot easier to coordinate behavior. As well, you have a smaller problem than an entire government would have in trying to plan your internal economy.