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Economic calculation and the organization of markets

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Abstract

Austrian economists have had mostly mixed feelings about transaction costs-based theories of the organization of economic activities. We argue that the two approaches, the Austrian and the Transaction costs, would gain from integrating their most important insights. In particular, we argue that both transaction costs and economic calculation are necessary analytical tools for a complete theory of the organization of markets. In a world without transaction cost, there would be no calculation problem because there would be no problem of the organization of markets. Only when transaction costs are positive will the scope of economic calculation be limited. At the same time, the optimal response to given transaction costs is itself the result of what we refer to as “secondary calculation.”

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Notes

  1. In this, we follow the same approach as the one in Leeson (2012) who suggests that Austrian law and economics should embrace “posnerian” rather than “coasean” foundations.

  2. While in a world of positive transaction costs the latter problem is merely a subset of the former, this distinction is still analytically important. First, the problem of allocating resources to their highest-valued employment still exists in a world of zero transaction costs, while that of organizing production does not. Second, the two operate on different levels, as discussed in Leeson and Boettke (2009). For example, as we argue below, the former can generally rely on market-generated prices while the latter does not.

  3. Our approach implies that a sharp distinction between market and non-market decision making is invalid. In this way, we side with Leeson and Boettke (2009) and disagree with Kirzner (1973).

  4. While Rothbard’s (2011) theory of property rights is explicitly normative, Mises (1949) defines ownership as control. For our positive analysis, we use Mises’ definition of ownership which is equivalent to Barzel’s (1997). See our discussion below.

  5. As we discuss in the next session, however, this is only true if one endorses a very specific definition of transaction costs. If one were to adopt our preferred understanding of the concept, sheer ignorance would indeed imply that contracts cannot be fully specified, i.e. that transaction costs are positive.

  6. Coase (1960), but also others working in his tradition (Demsetz 1964; Milgrom and Roberts 1992), usually add the provision that this result will only hold in the absence of wealth effects. For an Austrian perspective on the issue, see Rothbard (1982). See Allen (2015) for a critique of this provision.

  7. For an account of Coase’s argument for economic planning, see Bylund (2014).

  8. See, for example, the treatment by Hirshleifer et al. (2005).

  9. Thus, transaction costs are ultimately a subset of information costs. If information were perfect and complete across all agents, there would be no conflict over resources and transaction costs will be zero.

  10. Scholars in the transaction costs tradition abstract from risk-preference considerations in order to focus entirely on the former as determinants of equilibrium institutions. This choice is also justified on methodological and empirical grounds. Arguments about risk-preferences are by definition taste-based and therefore untestable. Furthermore, risk-preference is at odds with many empirical results (Allen and Lueck 1995; Prendergast 2002). In our discussion, we adopt the same approach. We do so with one more justification. In developing a praxeological argument of market organization, one must rely exclusively on praxeological notions. Risk-preference is not one.

  11. Demsetz (1967) discusses the case of the increased demand for North American fur that resulted from the rise of trade with Western Europe. This led to a move to private ownership over land by Native American tribes in the North East.

  12. On purely theoretical grounds, this is but a specific case of the influence of transaction costs on contractual solutions and ownership structure we mention in the paragraph above. Still, given the significance of this case in the literature, we discuss it separately.

  13. This is not the only theory of vertical integration that relies on the “property rights” understanding of transaction costs. Other, often compatible, approaches emphasize such issues as asset specificity and quasi-rents (Williamson 1975; Klein et al. 1978; Grossman and Hart 1986).

  14. See the discussion of capital-multispecificity in Boettke and Piano (2017).

  15. For example, Mises define private property as “full control of the services that can be derived from a good” and explicitly distinguish this from the “legal definition.” (Mises 1949, 678). Compare this with Barzel’s definition as “the individual’s ability, in expected terms, to consume the good (or the services of the asset) directly or to consume it indirectly through exchange” (Barzel 1997, 3). Barzel also supports a separation of economic and legal understandings of property (Barzel 2015).

  16. Menger’s and Mises’ theory of the emergence of money implicitly rely on transaction costs considerations (Chavas and Bromley 2008).

  17. We owe this point to Tate Fegley.

  18. We only refer here to the productive activities undertaken within the household and not to redistributive or consumptive ones.

  19. See for example Coase (1937) and Demsetz (2002). Stiglitz (1996, 12) argues that the fact that “most large firms are not run by owners but by hired managers” is a piece of evidence against the presumption that “the absence of well-defined property rights is the central problem” for the organization of economic activities.

  20. This notion applies to non-market decision making as well, even though these are not the main focus of our paper. Hence, it encompasses Becker’s own notion of “shadow prices” in the analysis of social interactions (Becker 1974). A difference (although arguably a semantic one) between Becker’s notion and ours is that we prefer to reserve the word “price” to the outcome of the market process in a money economy and believe that the traditional phrase “opportunity cost” is preferable.

  21. This point is integral to Mises’ theory of economic calculation. It is not surprising that Mises always emphasized on the primordial role of the stock market. Rothbard (1991) reports that Mises thought that the key to distinguish a socialist from a capitalist economy “is whether the economy has a stock market.”

  22. Assume all other agents also face the same benefits and costs of property rights enforcement.

  23. See Leeson and Harris (2017) for a study of the potential “wealth-destroying” effect of forcing the establishment of private property rights over land onto a society characterized by high transaction costs.

  24. This problem was recognized by socialist economist Oskar Lange who admitted that “socialism does not need to abolish private ownership of the means of production” in those industries where it ensures a superior result than communal ownership (Lange 1937, 126).

  25. This is emphatically not how real life socialist economies actually organize. See Anderson and Boettke (1997) for a study of the economic organization of the Soviet Union.

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Acknowledgements

We wish to thank Peter Boettke, Christopher Coyne, Bryan Cutsinger, David Lucas, Tate Fegley, Patrick Newman, and Rosolino Candela for their thoughtful comments and suggestions. We are also grateful to two anonymous referees for their incisive criticisms. All remaining errors are our own. Piano thanks the Institute for Humane Studies for financial assistance.

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  1. F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics and Department of Economics, George Mason University, Fairfax, VA, USA

    Ennio E. Piano & Louis Rouanet

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  1. Ennio E. Piano
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Correspondence to Ennio E. Piano.

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Piano, E.E., Rouanet, L. Economic calculation and the organization of markets. Rev Austrian Econ 33, 331–348 (2020). https://doi.org/10.1007/s11138-018-0425-4

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