Markets and Organization

In this chapter, we shall present the basic ideas and methodologies of a set of contemporary contributions which we shall group under the general heading of “evolutionary economics” (a more precise definition of what we mean will be given shortly). We shall illustrate some achievements — especially with regards to the analysis of technological change and economic dynamics —, discuss some unresolved issues, and flag a few promising topics of research.

Recent works on the theory of the firm have demonstrated how difficult it is to fully grasp and qualify this subject (L. Putterman, 1986; G.C. Archibald, 1987; B.R. Holsmtrom-J. Tirole, 1989). It is presented as a juxtaposition of different subjects since “obviously, no single model or theory will capture all elements of the puzzle” (B.R. Holmstrom — J. Tirole, 1989, p. 65). The suggested subjects are supposed to integrate the empirical aspects lacking in the abstract notion of the firm necessary to the coherence of the theory of value. Among the privileged subjects, emphasis is generally placed on the recent evolution of the theory of the firm towards the organizational nature of the phenomenon. The latter exhibits two main dimensions: the internal organization of the firm and the relationship of the firm with the market. The need to describe the nature and the boundaries of the firm is thus underlined by B.R. Holmstrom and J. Tirole (1989, pp. 65–66): “One needs to explain both why firms exist as well as why all transactions are not organized within a single firm”.

Whereas the standard micro-economic analysis of the theory of general equilibrium and the theories of partial equilibrium consider that all agents can be treated the same way and that firms are empty boxes, the theory of organization develops the idea that the participants to a productive organization are bound by hierarchy and control relations where information is not always symmetrical among agents.

The boundaries of the firm have two fundamental dimensions. A first one concerns the scope and limits of expansion of firms within the industry (or industries) where they operate. An explanation of the boundaries, in this sense, overlaps with the explanation of so-called ‘market structures’. Why is production in some industries highly concentrated and much less so in others? What makes the difference between, say, aerospace, pharmaceutical or mainframe computers, on the one hand, and garments or shoemaking, on the other? Leaving aside regulatory measures, such as antitrust legislations, what prevents industrial production from being monopolized within a single firm? Along this dimension the boundaries of the firm over time are set by the “forces generating and limiting concentration” in the evolution of each industry (Nelson and Winter (1982); see also Dosi et al. (1993)).

Profit seeking has been recognized for a long time now as one of the main engine of modern industrial economies. It is beyond the capitalist logic that shall partly explain both the sustained increase of aggregate output per head and the tremendous transformation of our societies, from an agricultural-based economy to a complex industrial economy.

The financial policy of corporate firms has been generally depicted in the economic literature in terms of “puzzles”: “capital structure puzzle”, “debt- existence puzzle”, “dividend puzzle”… These puzzles are the result of the old divorce or evident contradictions existing between economic theory and economic facts when considering corporate finance. The first, in its general equilibrium orthodox version, concludes to the irrelevance of the capital structure of the firms; the second shows the interest of the firms in finance when designing their strategy, and, the close influence of differences and shifts in financial structure on their performances. In fact, as stated by Stiglitz (1969), the decisions of the firm can be divided into four groups:

According to the “Oxford Concise Dictionary”, an auction market is a “public sale in which goods are sold to the highest bidder”. In this ordinary meaning, it is seen as a “public auction sale”. More generally, however, “auction markets” represent a specific method of exchange organization. An auction market is different from a market where the prices are posted and where a seller (buyer) enjoying some monopoly position faces buyers (sellers) placed in a more competitive situation. The posted price system simply offers an alternative: to accept or to turn down the exchange conditions, among them, the price. An auction market is also different from a market where prices are “negotiated”. On a negociated market, two partners discuss with each other and eventually agree on a price. The discussion and the price remain a private information between them. Each discussion is a unique event and can end up in its own result. However, on the basis of this definition, it is possible to point to a number of characteristic features of “auction markets”.

Market concepts and mechanisms are, systematically, supposed to apply equally to service activities, at least of course to market services (¹). Most economists consider that services are “products” the same way goods are, and that their prices are the result of the confrontation of demand and supply (or the simultaneous solution of demand and supply functions with specific characterics, e.g. in terms of income and price elasticities). Markets are determining prices (which equilibrate quantities demanded and supplied), and are, at the same time, producing information as concerns the state of the market, in terms of relative abundance or scarcity, i.e. as concerns the degree of adaptation of demand and supply. In order to be efficient, markets must be transparent, perfect or contestable,.. but even so, the cases in which market failures are likely to occur are well known.

If no one tries to deny the importance of financial institutions in the realization of investment projects, it has been hard to reach a consensus on the means to collect the funds necessary to create a productive activity. And, has it really been reached? In fact, isn’t it somewhat striking to notice that whereas financing by saving is unanimously qualified as good and beneficial to society, serious doubts are raised about the validity of loans granted by financial institutions.

Economists are fascinated by financial markets. The way they work creates numerous legends in economics theory. As a matter of fact, many writers have been inspired by the way they work to create theories on competition, to illustrate the question of information transmission, and to transform them into places where anticipations are expressed… This attraction is increased by periodical optimistic or pessimistic crises that are expressed by a remarkable volatility and instability when compared to other markets (White, 1990). Beyond the spectacular aspect of stock prices increases and decreases, the essential questions raised by economists are to determine:

The specification of any market must define the agents, their rules of behaviour and interaction, leading to the allocation of the particular commodity defining the market itself. The outcome of the process establishes the quantities exchanged of the commodity and the price at which this exchange takes place.

The economic analysis of international trade in most textbooks takes the functioning of international markets for granted. The questions that excite attention are about the patterns of trade produced by those markets, and about government restrictions on the operation of those markets.

For any citizen of an industrialized capitalist country product differentiation is simply a fact of life. We generally take for granted that there are several, sometimes many, different variants of the same product. This has not always been the case and, even now, the extent of it varies greatly across different societies, being in general lower in developing countries, or having been more limited in the previously socialist countries of Eastern Europe. However, in most countries and for most people, product differentiation started developing only after the industrial revolution and, more likely, towards the end of the XlXth century. The phenomenon of product differentiation refers essentially to the different brands/variants of the same product. We would consider as examples of product differentiation the different types of breakfast cereals, of car models, of detergents, etc. Also manufacturing firms tend in many cases to achieve some kind of “uniqueness” for their products. Thus Coca-Cola can claim to be somewhat different from any other comparable drink (e.g. Pepsi Cola). It is quite clear that the phenomenon itself has had quite a large diffusion starting at least from the beginning of this century.

To clear up the issue of regulation and deregulation is the same as unravelling a very intricate skein. For “regulation” the New Palgrave Dictionary of Economics produces two different entries, presented as substantially distinct. The first entry, written by Robert Boyer, who mostly contributed to the corresponding line of thought, defines regulation (or rather the French label “régulation”) as “Any dynamic process of adaptation of production and social demand resulting from a conjunction of economic adjustments linked to a given configuration of social relations, forms of organization and structures”, its study aiming at “.. describing, and.. explaining the transition from one mode of régulation to another in a long- term historical perspective”. The second entry, instead, more traditionally defines regulation as consisting “.. of governmental actions to control price, sale and production decisions of firms in an avowed effort to prevent private decisionmaking that would take inadequate account of the ‘public interest’”(Breyer-MacAvoy 1987).

Two positive effects are expected of competition in a free market economy: to promote an efficient allocation of productive resources and technical progress. What can then be the role of a superior authority in charge of enforcing the rules of competition when the economic activity relies on private initiative? Is the intervention of such authority even necessary if, as some people think, competition rivalry is not only natural but also unavoidable in society?

A firm is said to be vertically integrated if it includes two production processes in which either the total output of the upstream process is used as intermediate output (all or part of it) in the downstream process or the total input used in the downstream process is the result of all or part of the output of the upstream process (M.K. Perry, 1989).

The development of inter-firms cooperative agreements constitutes one of the most important characteristic of the resetting of the industrial landscape, and the evolution in the firms strategy since the beginning of the 80s.

The aim of this chapter is to pinpoint subjects of critical discussion on the notion of “local systems of production and innovation” (LSPI) by replacing it in the history of economic analysis in order to underline its evolution and understand its importance.

Multinational firms (M.F.) have existed for a long time: it is possible to trace them back to the middle of the 19^th century through direct investments made by European firms settling in the United States, through American firms investing in Europe or again through Belgian, French and American units of production transferred in Russia. But it is only in the 60’s that economic analysis really became interested in this particular form of international economic relations. The flow of direct american investments in Europe, and the formation of the European community is at the origin of this new interest. The recording of statistical data aimed at keeping track of foreign firms settling on national territories goes back to that period. It is the case for the French.

In the 80s, a consensus has been reached about the empirical analysis of industrial relations. At the beginning of the 90s, the authors have noticed that firms tended to keep more frequently a cooperative form in their strategy when they were facing a challenging environment in terms of technological changes, competitive conditions and market globalization. On another hand, this observation was in agreement with the evolution of the literature. In fact, in different analytical areas, a more important place has been given to what is known today as “the intermediate forms of coordination” between market relations and firms internal relations. This subject has finally been illustrated in a particular context, that of the European economy in which the Maastricht agreements have been the lastest evolutions. The question was to study the most performing tools to create a competitive technological pole (faced by the two other areas of the “triad”: Japan and the United States), and a less heterogeneous industrial organisation while respecting the rigid competitive conditions.