Debunking the Theory of the Firm

Until recently, US tech companies were pretty good about taking care of employees from new hire to retirement. Many Fortune 500 companies had explicit no-layoff policies: Hewlett Packard, Motorola, General Motors, McDonnell Douglas, Lincoln Electric, American Airlines, Delta. IBM never laid off a single worker until 1993.

This tie clip is a tiny slide rule that IBM gave to retiring employees. Do they still give these out? Do employees even make it to retirement age anymore?

At some point, the employer-employee relationship fell off a cliff. Corporations used to value the loyalty they gained by promising lifelong job security. Now they don’t even want real employees: Nearly all of the 10 million jobs created since 2005 are temp positions.

Does this disprove the Theory of the Firm? According to Ronald Coase, organizations form long-term relationships with employees to eliminate the transaction costs of constant market exchange. Sourcing candidates, negotiation, hiring with incomplete information, making sure contractors don’t run off with a USB stick full of trade secrets – that’s all really expensive!

The Sovereign Individual predicted that technology would eventually automate the firm away. Information systems and AI could seamlessly coordinate a two-sided marketplace. Offices equipped with surveillance devices would measure workers’ output, obviating the need for employee trust. Isn’t that basically Uber? With the help of services like LinkedIn and Gigster and Foundry and Fiverr, we can already reduce transaction and coordination costs to the point where full-time employment makes no sense at all.

Why stop at ruining jobs? Marriage commitments are similarly passé. Humans used to mate monogamously because fathers had to be reasonably sure of paternity before investing in child-rearing chores. It took years to build up that kind of trust. With DNA tests, guys can quickly determine which kids to care about. Better yet, forget about turning parenting into a joint effort — just outsource it to an on-demand app.

Uber for Airdropped British Nannies.

Just as technology has lowered the marginal benefits of retaining a dedicated mate, it has also reduced the costs of sourcing such mate. We used to waste so much time on courtship and gentlemen callers and other nonsense, but now we can just swipe on Tinder and Grindr and OkCupid and Backpages.

Firms and family units are dead. That numbness you feel is full-blooded individual empowerment.

See Also:
Contracts and Trust

6 thoughts on “Debunking the Theory of the Firm

  1. Not to mention that hiring and firing become more and more expensive and prohibitive. On one side we get frictionless on demand / freelance service economy and on the other — it becomes more expensive to guarantee long lasting stable job. There should be middle ground somewhere there.

  2. 1. The firm does not merely exist to optimize on transaction costs; it also exists to act as a storehouse of knowledge and capabilities. Furthermore, even if employees leave, capabilities can still remain in the firm to the extent that they are encoded in tacit routines or explicit standard operating procedures. While it is nice to see markets and firms as two ends of the same continuum, no entrepreneur wants to run (or even participate in) a perfectly efficient market. This is even truer for information goods (refer to Arrow’s information paradox).
    2. Rumors about the death of the firm are greatly exaggerated. Consider that while Lyft and Uber have all but killed taxicab firms, you still need an Uber/ Lyft to act as an intermediary. How likely are you to take a ride with someone you have found over Craigslist? Even if you do, it is because of institutional safeguards that US law enforcement provides; you would certainly not do that in some west African country. The smooth functioning of markets still needs trust, and no amount of technological progress would completely do away with that need.
    3. In 2050, when rented driverless cars are the only vehicles on the roads, would Uber cease to exist? Technically, you don’t need a firm- anyone can buy a driverless car and put it on the road. But given that, why would anyone rent a random, unaffiliated car on the road? This means Uber (or some firm running cars for rent) could still exist, but it would look very different in terms of the number of employees.

  3. Hi Elaine,

    I thoroughly enjoy your idle mind. This one was particularly interesting because of your conclusion regarding individual empowerment. I’ve been ruminating on this for awhile and I’m curious what you think – is this a good development for society or not?

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