6 - The contractual nature of the firm

Summary

Introduction

Adam Smith began his Wealth of Nations with an examination of the internal works of a pin factory, but he soon turned his attention to other things: the coordination of a market system and the economics of growth and development. For more than a century and a half following the publication of Smith's masterpiece, the nature and internal organization of the firm received little attention in mainstream economic theory. At the same time the firm grew in size and complexity. McNulty (1984) describes how preoccupation with certain themes – with the macroeconomic distribution of income among rent, wages, and interest, or the logic of the competitive model and decentralized allocation of resources – pushed aside issues related to the firm and its internal organization:

The marginalist revolution and the development of neoclassical price theory, while producing a theory of the firm which was lacking in the earlier classical analysis, nonetheless failed to provide a full rationale for the firm's role in the economic system. Indeed, in its single-minded emphasis on choice in factor substitution, it reduced the firm, conceptually and analytically, to a set or series of actual or potential exchange relationships not unlike those of the market itself. Its incorporation of the firm fully into the market nexus, thereby perhaps obscuring some of the fundamental differences between these two institutions, was undoubtedly one of the principal reasons why the neoclassical paradigm left unasked the fundamental questions not raised until Coase's pathbreaking analysis appeared several decades later.