Theories of the firm tend to start with Ronald Coase, but might they also end there? An interesting passage from Coase's seminal article.pdf (which I think has been almost entirely overlooked):
... exchange transactions on a market and the same transactions organized within a firm are often treated differently by Governments ... If we consider the operation of a sales tax, it is clear that it is a tax on market transactions and not on the same transactions organized within the firm. ... such a regulation would bring into existence firms which otherwise would have no raison d'être.
When a builder pays his workers cash in hand at the end of each days work, presumeably this wouldn't constitute "a firm" despite how long the arrangement lasts. It's simply exchange transactions, in a routine. It strikes me that the main reason why such a builder would become "a firm" is to become tax compliant - effectively, to become a legal enterprise. I wonder how far we can take Coase's point - if it were not for sales taxes, and the fact that many governments tax through companies... would firms exist?
Anthony, clearly you are right that government intervention affects the optimal size of the firm in the mixed economy. But it is not obvious, ex ante, which direction this bias goes. The ability to avoid taxes and regulations on market transactions, to capture regulators and get them to enact favored policies, to meet state legal and accounting requirements at a lower percentage of operating costs, and the like are all reasons for firms to internalize transactions they would otherwise leave in the market. But other government policies -- e.g., small business tax credits and subsidies, exemption from reporting requirements, SBIR awards, avoiding attention from antitrust authorities, etc. -- put downward pressure on firm size. It is certainly possible that the net effect is to make firms smaller than they otherwise would be.
Posted by: Peter G. Klein | June 05, 2007 at 08:04 PM