Markets, Firms and Institutions
Why do markets work when they do, why do firms exist at all, and what rules let people cooperate at scale?
Every essay on this site describes a product inside a market and an organisation inside rules. This path is about those markets and rules.
It begins with Adam Smith and Karl Polanyi, who disagreed about whether markets arise naturally or are made. It then asks the question at the heart of business, why firms exist, with Coase, and how organisations hear their customers, with Hirschman. The middle of the path deals with cooperation: why groups fail to act together and how some communities manage shared resources for centuries. It ends with institutions and with Schumpeter’s creative destruction, the process by which economies renew themselves.
The ideas of Why Firms Exist and Exit, Voice and Loyalty are summaries of two of these books, and the essay on open source applies Ostrom’s work to software.
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The starting point. Smith’s account of the division of labour and the market as a coordinating system remains the basis of economic thinking, and is subtler than its reputation.
- Read it for
- The pin factory, the extent of the market and Smith’s warnings about merchants and monopolies.
- Carry forward
- Which part of our advantage comes from specialisation, and what limits its extent?
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Polanyi’s counter-argument holds that the self-regulating market was a political creation, and that treating land, labour and money as commodities provoked society to protect itself.
- Read it for
- Embeddedness and the double movement.
- Carry forward
- What would our customers or employees refuse to treat as a mere commodity?
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The Firm, the Market, and the Law
Coase asked why firms exist if markets are efficient, and answered with transaction costs. The idea explains where the boundary of a company falls.
- Read it for
- The Nature of the Firm and The Problem of Social Cost.
- Carry forward
- Which of our activities would be cheaper to buy than to do ourselves, and which the reverse?
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Hirschman’s short book explains how customers and members respond to decline, by leaving or speaking up, and why organisations need both signals.
- Read it for
- The interplay of exit and voice, and the role of loyalty.
- Carry forward
- When our customers are unhappy, can they tell us, or only leave?
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The Logic of Collective Action
Olson showed why large groups with shared interests often fail to act, because each member hopes others will bear the cost.
- Read it for
- The free-rider problem, selective incentives and why small groups organise more easily.
- Carry forward
- Which shared resource do we depend on but leave to others to maintain?
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Ostrom’s answer to the tragedy of the commons, drawn from fisheries, forests and irrigation systems, shows how communities create rules to manage shared resources without either privatisation or the state.
- Read it for
- The design principles of long-lasting commons institutions.
- Carry forward
- Which of Ostrom’s principles are missing from the shared systems we rely on?
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Institutions, Institutional Change and Economic Performance
North argued that institutions, the rules of the game, determine economic performance, and that they change slowly and along paths set by their history.
- Read it for
- Formal and informal institutions, transaction costs and path dependence.
- Carry forward
- Which unwritten rule in our organisation matters more than any written policy?
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Capitalism, Socialism and Democracy
Ends with dynamics. Schumpeter described capitalism as a process of creative destruction driven by entrepreneurs, and worried that its own success might undermine it.
- Read it for
- The chapter on creative destruction and the argument about the large firm and innovation.
- Carry forward
- What are we doing to destroy our own business before someone else does?
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