Krugman Discovers Theory of the Firm!

Whoa.

Did I read that correctly?

Paul Krugman just blogged about the Microsoft introduction of it new tablet to compete with Apple’s iPad. He sees it through the prism of the theory of the firm. Unfortunately he cites Oliver Hart’s 1993 article about incomplete contracts and leaves aside comment on why that article became so important. For the interested: it has to do with unifying the explanation of vertical integration and transaction costs under one roof where previously there were two separate explanations with people like Alchain and Klien on the integration side and Coase and Williamson on the cost side.

Never mind.

It’s good to see such a determinedly macro guy get excited over a micro theoretical issue.

Now if only we could all just realize that the Hart article is a kluge. He tries to rescue traditional micro from itself. You see the reason firms exist is not due simply to arcane legal and contractual advantages or to the existence of transaction costs. Both those are symptoms of a deeper issue. Uncertainty. A firm is a way to posit an alternative future within which it makes sense to develop the complex production processes our economy relies upon. Since the future is inherently uncertain we need to offset it by pretending we know enough about it to have the confidence to build things. We act as if we know something that is unknowable. We call it having a plan. And we hope that our plan resembles the actual future as out unfolds sufficiently that our actions were not in vain.

The problem for traditional microeconomics is that once you admit the importance of uncertainty the whole foundation crumbles. So rather than go there everyone stops at the kind of kluge Hart is well known for.

This, incidentally, is why the fad for constructing macroeconomic theories only on micro foundations – in the manner of people likeLucas and his followers – is so silly. The foundation is rotten. So it’s not surprising that the subsequent macro theory is also so rotten.

Uncertainty matters. You can’t assume it away. It comes back to haunt you eventually.

Anyway.

It’s nice to see Krugman giving a nod to theories of the firm. Even if they’re half way houses to a good one.