«New Perspectives on Political Economy Volume 2, Number 1, 2006, pp. 13 – 35 The Coordination Problems, the Market and the Firm∗ Judit Kapás† ...»
New Perspectives on Political Economy
Volume 2, Number 1, 2006, pp. 13 – 35
The Coordination Problems, the Market and the Firm∗
JEL Classiﬁcation: B53, D20, P10
Abstract: The aim of this paper is to contribute to a better understanding of the market
and the ﬁrm through an analysis of the coordination problem. An important question
is to what extent the nature and process of the coordination differs in the market from
that within the ﬁrm. The paper deals only with those aspects of this issue which are related to a distinction between two types of coordination proposed by Klein (1997) and Sautet (2002). The author presents three dilemmas stemming from this framework and investigates the similarities and differences between the ﬁrm and the market by providing answers to these.
∗ This paper has beneﬁted from the support of the Hungarian Scientiﬁc Research Fund (contract no: T 49602).
† Associate Professor, Department of Economics, University of Debrecen, 26 Kassai street, H-4028 Debre- cen, Hungary; Tel: + 36-52-416-580, Fax: + 36-52-419-728; e-mail: firstname.lastname@example.org 14 New Perspectives on Political Economy 1 Introduction The issue of coordination, both from a theoretical and empirical point of view, has been of primary importance in economics since Adam Smith. The major question is how a multitude of individuals participating in a complex division of labor can successfully co- ordinate their actions and minimize disappointments, when each possesses different and changing knowledge and expectations about future possibilities? How do agents make the decisions necessary to fulﬁll their goals when the success of their own actions de- pends upon the decisions and actions of others (Ebeling 1987)? These questions suggest that coordination is one of the essential ingredients for the functioning of society and organizations. In a broad sense, all actions are always somehow coordinated; the impor- tant question however, is how this coordination is achieved (Hülsmann 1997), and this leads to the issue of what the arenas of coordination are and how coordination is achieved within them.
That markets provide important institutions of coordination is widely accepted in economics. Hayek (1945, 1946, 1978) contributed to a signiﬁcant extent to an understand- ing of how coordination is achieved through a price system, and in addition, to an expla- nation of how the institutions of the market evolve spontaneously (Hayek 1967). “The institutional setting and the allocation of resources matter in economics precisely because behavior in a changing world is not automatically coordinated” (O’Driscoll 1977:141).1 Besides the market, business institutions also arise as solutions to coordination games (Langlois and Robertson 1993). The issue of how coordination is achieved within ﬁrms is extensively discussed in the theory of the ﬁrm which developed from Coase’s (1937) seminal paper.2 Nevertheless, the perspective of the theory of the ﬁrm is restricted to a view of the ﬁrm from a transaction-cost-efﬁciency point of view, which hampers this theory’s conception of the very essence of coordination and the nature of the coordination process (Langlois 1997).
1 Note also that the problem of economic coordination is important not simply because the decisionmaking is decentralized, although this is an important aspect of the problem, but because of constant change. Decentralization in an unchanging environment will not cause serious problems.
2 I will not criticize here the Coasean-Williamsonian theory of the ﬁrm, it is beyond the scope of my present paper, but it is important to stress that for a better explanation of the ﬁrm “we have to show how ﬁrms are part of the market process” (Sautet 2000:69). That is, we need to explain how existence of ﬁrms is linked to the operation of the market process.
Kapás: The Coordination Problems, the Market and the Firm 15 An important question is to what extent the nature and the process of the coordination differs in the market from that within the ﬁrm. In this paper I am concerned with this issue. My aim is to contribute to a better understanding of the ﬁrm and the market through an analysis of the coordination problem. I will not strive to give an allembracing account of how coordination is achieved in the market and within ﬁrms; this is beyond the scope of this paper. Instead I will deal only with those aspects of the issue which are related to a distinction between different types of coordination proposed by Klein (1997) and Sautet (2002). That is, my starting point will be the distinction between two kinds of coordination (type I and type II), and two kinds of solutions to these (catallaxy and conventions respectively). My argument will be that this simple schema poses severe problems in several respects; the major issue amongst them concerns the role of the ﬁrm in solving the coordination problem. I will investigate the similarities and differences between the ﬁrm and the market in terms of what kind of coordination problem is solved in what way in the market and within the ﬁrm.3 The major conclusion will be that both the market and the ﬁrm could be seen as particular solutions to both kinds of coordination problems.
The paper is organized as follows. Section 2 shows the two kinds of coordination and, based on certain controversial issues stemming from Sautet’s (2002) and Klein’s (1997) framework, draws up three dilemmas, the answers to which may help to better understand both the market and the ﬁrm. Section 3 and 4 deal with the issue of coordination in the market and within the ﬁrm respectively, while also providing answers to the dilemmas. Section 5 concludes.
2 Two kinds of coordination According to Sautet (2002) and Klein (1997) there are two kinds of coordination4. Although there is a slight difference in their views, basically they take the same position.5 Type I coordination is a process through which mutual awareness of individuals becomes 3 The issue of whether ﬁrms and markets are essentially different or similar things is an important question, on which views differ largely. For an overview, see Cowen and Parker (1997).
4 The word coordination comes from the Latin words co (meaning together) and ordinare (to arrange).
5 I use Sautet’s labels, i.e. type I and type II coordination, while Klein calls these metacoordination and coordination, respectively.
16 New Perspectives on Political Economy gradually greater. Here coordination happens without individuals being aware of it and without their ever knowing each other. Type I coordination means that a concatenation of activities is arranged so as to produce good results. As opposed to this, type II coordination refers to situations where one coordinates one’s actions with those of others in a purposeful way. Here coordination is understood as something one hopes to achieve in one’s interaction with others, i.e., it is deﬁned as the achievement of concerted actions.
This kind of coordination problem, contrary to type I coordination, can be assessed by the human mind. In this case the coordination requires the use of certain common means to achieve a particular end. The difference between the two meanings can be explored in terms of whether the verb coordinate is transitive or intransitive (Klein 1997). As an intransitive verb it means: “to be or become coordinate esp. so as to act together in a smooth, concerted way” (Klein 1997:326). Here there is a direct object only of a reﬂexive kind. This is type II coordination. Coordination as a transitive verb means “to put in the same order or rank... to bring into common action, movement, or condition” (Klein 1997:326), which is type I coordination.
The two authors argue that these two kinds of coordination are solved in two different ways. Type I coordination is the result of the entrepreneurial competitive process as described by Hayek (1946) and Kirzner (1973). An entrepreneur, by discovering proﬁt opportunities, turns information into knowledge and tends to improve the degree of coordination of individuals’ plans: discoordinatedness is gradually replaced by a greater degree of coordination. Since past entrepreneurial acts create new proﬁt opportunities (Holcombe 2003), this process never comes to a state of rest.6 Out of this process emerges a spontaneous social order that exists without being planned, which is based on abstract rules and has no particular purpose. The social order is achieved by following certain rules and utilizes the knowledge of all its members without the knowledge being available to any particular mind.
Type II coordination is solved by rules or conventions such as “we all drive on the same side of the road”. To put it differently, while the resolution of type I coordination brings about “a pleasing arrangement” (Klein 1997), that of type II means an agreeable interaction for the actors. An important point is that rules or conventions that are soluTwo other factors that create proﬁt opportunities are as follows: (1) factors that disequilibrate the market, (2) factors that enhance production possibilities (Holcombe 2003).
Kapás: The Coordination Problems, the Market and the Firm 17 tions to type II coordination permit the functioning of type I coordination: these rules establish a framework that makes type I coordination possible (Sautet 2002)7. That is, type I coordination can be solved by institutions that are in their turn solutions to type II coordination problems. This means that the two kinds of coordination have a hierarchical relationship.8 To summarize Sautet’s and Klein’s views, type I coordination refers to a coordination where the invisible hand coordinates the acts of many purposeful individuals, while type II coordination means an intentional coordination of the acts of many purposeful individuals by themselves.
From the above rather simple schema of the two scholars three propositions arise.
The ﬁrst is that the two types of coordination differ essentially from one another in intentionality. The second is that while type I coordination admits only organic solutions, that is solutions that emerge from the process itself, type II coordination may admit organic and pragmatic solutions as well (Sautet 2002). The third proposition maintains that type I coordination can be solved exclusively by the spontaneous market process, or put differently, ﬁrms solve exclusively type II coordination problems. My argument is that all these three propositions are controversial and require further investigation. It is worth transforming these assertions into dilemmas or questions to be answered.
The ﬁrst dilemma concerns whether coordination in a market, i.e., type I coordination is unintentional and all conventions and rules, i.e., type II coordination is intentional. The second question is whether the solutions to type I coordination could have an exclusively non-designed (organic) character. The third dilemma refers to whether type I coordination can be solved exclusively by the spontaneous order, or put alternatively, do ﬁrms exist to solve exclusively type II coordination problem?
My argument is that answers to these questions may help to better understand both the market and the ﬁrm. In what follows, by analyzing the coordination both in the market and within the ﬁrm, I will provide answers to the above three dilemmas. The argumentation will be based upon two things. First, I will emphasize more explicitly the difference as regards the nature of coordination problems (whether type I or type II) and 7 “Social order emerges through the existence of meta-market institutions such as property rights and contract law, and market institutions such as ﬁrms” (Sautet 2002:35).
8 This view will be supported by what will be said in Section 3.3. and 4.2.
18 New Perspectives on Political Economy their solutions (whether the market process or conventions and rules9 ). This suggests, as I will discuss below at greater length, that there is no one-to-one correspondence between them, in contrast to what both scholars have argued. On the other hand, I will show that it is crucially important to differentiate between the coordinating institutions and the solutions to coordination. This framework will allow me to draw some new conclusions.
3 Coordination by spontaneous order
Adam Smith (1776) argued that the invisible hand of the market produces coordination in an economy, albeit the details of how coordination is achieved remained unexplained.
Hayek (1945, 1946) and Kirzner (1973) provided an explanation for this. In this section I will ﬁrst show the Hayekian-Kirznerian theory of coordination. Then I will turn to the ﬁrst two dilemmas I have raised above and will discuss the issue of intentionality in the market and the issue of the organic character of the market.
3.1 The Hayekian-Kirznerian theory
The coordination problem is of central concern in Austrian economics. Based on Hayek (1945), who speaks of coordination in terms of individuals’ plans which reﬂect individuals’ knowledge and expectations, coordination is needed because of dispersed knowledge10. Dispersed knowledge has to be coordinated in order to exploit it for the beneﬁts of humans. The problem that the market has to solve is in fact how individuals’ particular knowledge can be diffused and made general (Bianchi 1994). Hayek’s theory maintains that in an uncertain world the discovery procedure of market competition spontaneously coordinates decentralized knowledge. According to him, this coordination is achieved by the mechanism of prices.
Hayek’s (1945) major achievement has been to show that the advantage of decentralized decision-making in a market stems from the fact that this is an extremely efﬁcient way to coordinate dispersed knowledge. Efﬁciency is reﬂected, on the one hand, in the fact that the price system allows us to economize on knowledge: the only thing we must 9 What Klein (1997) means by conventions, can be regarded as institutions.
10 Knowledge exists only in “the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess” (Hayek 1945:77).