Economic Power and the Firm in New Institutional Economics: Two Conflicting Problems
Palermo, Giulio, Journal of Economic Issues
The problem of the nature of the firm is at the origin of the research program of New Institutional Economics (NIE). The problem was first addressed by R. H. Coase , who explored the reasons why authority and direction are economically superior to market relations. In my interpretation of NIE, starting with the contribution of Coase, research has developed along two distinct lines. In the former, Coase's intuition has been developed by denying the existence of real authority relations within the firm. The work of A. A. Alchian and H. Demsetz  and the developments of M. C. Jensen and W. H. Meckling  and S. N. S. Cheung  are the main contributions to this research line. In the second approach, costs and benefits of hierarchies have been analyzed systematically by specifying the theoretical categories that make hierarchical relations economically superior to markets. O. E. Williamson [1975, 1985] is the main contribution to this line.
The different views of the roles of authority in the institutions of capitalism lead to different theories of institutions. Two particular aspects of these theories are discussed in this paper: (1) the possibility of providing a straightforward characterization of the firm and (2) the internal coherence of the theories with respect to the problem of economic power.
The approach of Alchian and Demsetz, if developed to its extreme consequences, leads to the conclusion that it is impossible to characterize the firm as an institution qualitatively distinct from the market; in Williamson's framework, on the contrary, the analysis of the different kinds of contractual relations that take place within the firm and within the market provides a clear-cut distinction of the two institutions.
My position is that neither of the streams develops an analysis of economic power sufficiently. This, however, has different implications for the internal consistency of the two streams: the lack of an analysis of economic power in the approach of Alchian and Demsetz stems from the denial of its relevance in the investigation of reality; Williamson instead considers economic power as relevant but does not develop its implications, which makes his position vulnerable on the ground of theoretical consistency.
In the one case, reconciliation of economic power and the firm raises problems in the analysis of the firm and, in the other, in the analysis of economic power. In my view, these difficulties are not occasional. In order to characterize the firm and the market, it is necessary to investigate the social relations that take place in them. Here is the bifurcation: on the one hand, the attempt to build a theory of the firm with no reference to its particular power relations makes the firm hardly distinguishable from the market; on the other hand, the analysis of such power relations cannot be fully developed, since it collides with one of the fundamental assumptions of NIE, i.e., the hypothesis that institutional arrangements are Pareto-efficient outcomes of free voluntary interactions.
My conclusion is that in NIE the problem of economic power and the characterization of the firm are conflicting and that a step out of NIE is necessary in order to deal coherently with the two problems. A possible way out, I suggest, may be an explicit analysis of the role of economic power in the relations within and among the institutions of capitalism. This analysis of economic power, in light of the theoretical problems of NILE, should be founded on its social and dynamic dimensions. My proposal is to develop such an analysis by building on the existing bridges between institutionalism and Marxism. The resulting approach is clearly incompatible with NIB and casts doubts on the whole theory of efficiency of capitalist institutions.
The structure of the paper is as follows. I commence by discussing the general features of the approaches of Alchian-Demsetz and Williamson. …