Economic Calculation and the Limits of Organization

Economists have become increasingly frustrated with the textbook model of the firm. The "firm" of intermediate microeconomics is a production function, a mysterious "black box" whose insides are off-limits to respectable economic theory (relegated instead to the lesser disciplines of management, organization theory, industrial psychology, and the like). Though useful in certain contexts, the textbook model has proven unable to account for a variety of realworld business practices: vertical and lateral integration, geographic and product-line diversification, franchising, long-term commercial contracting, transfer pricing, research joint ventures, and many others. As an alternative to viewing the firm as a production function, economists are turning to a new body ofliterature that views the firm as anorganization, itself worthy of economic analysis. This emerging literature is the bestdeveloped part of what has come to be called the "new institutional economics."' The new perspective has deeply enhanced and enriched our understanding of firms and other organizations, such that we can no longer agree with Ronald Coase's 1988 statement that "[wlhy firms exist, what determines the number of firms, what determines what firms do . . . are not questions of interest to most economists" (Coase 1988a, p. 5).The new theory is not without its critics; Richard Nelson (1991), for example, objects that the new institutional economics tends to downplay discretionary differences among firms. Still, the new institutional economics-in particular, agency theory and transaction cost economics-has been