In his masterwork, Adam Smith (1776) provides two particularly deep insights about economic activity: the spontaneous organization of self-interested market exchange (the “invisible hand”) and the nature and implications of production specialization (the “pin factory”). John Stuart Mill notably generalized Smith’s division of labor to the “more fundamental” principle of worker cooperation.
The Wealth of Nations sought to explain decentralized market cooperation by large numbers of persons who efficiently price and distribute specialized output. Much later, Arthur Okun (1981) fundamentally enriched Smith’s insights with his “invisible handshake”. Okun’s invisible handshake helped introduce economists to fair treatment as a critical determinant of employer-employee relations. Adam Smith anticipated that contribution. In The Theory of Moral Sentiments, Smith identifies critical motivators of behavior to be the interrelated factors of status, respect, and justice, with the latter generally equivalent to equitable treatment: “… we find ourselves to be under a stricter obligation to act according to justice than agreeably to friendship, charity or generosity; that the practice of these last-mentioned virtues seems to be left to some measure to our own choice, but that, somehow or other, we feel ourselves to be in a peculiar manner tied, bound, and obliged to the observation of justice.”
Okun’s handshake became the organizing metaphor for his (incomplete) analysis of optimizing exchange inside large, specialized establishments, featuring a class of wage rigidity through which nominal-demand disturbances induce same-direction movement in production, employment, income, and profits.
Okun, like Smith, was onto something important. Nonmarket rational price-mediated exchange is necessary if formal economic theory is to accommodate the mutation of pin factories into the large, specialized firms ubiquitously organized in the aftermath of the Second Industrial Revolution. Bureaucratic workplaces, producing goods or services, are needed to motivate employee cooperation in circumstances of costly, asymmetric intra-firm information and routinized jobs. It is not surprising that Alfred Chandler’s “new corporate forms”, distilling over time best-practices management of workplace behavior, became globally characteristic.
It is surprising, and increasingly problematic, that macro theorists did not adapt. Deep thinking about integrating production and price-mediated exchange in the tradition of Smith. Chandler, and Okun is little rewarded in modern macroeconomics. Mainstream theorists are expected to think incrementally, pushing aside the massively altered production landscape that transformed workplace exchange into a critical economic activity. Coherent macro thinking has, for many generations, remained fixed in the profession’s comfort zone of market transactions. Meanwhile, the intra-firm class of optimizing decision rules, technical constraints, and exchange mechanisms has been studied elsewhere, finding homes in business schools and the burgeoning best-practices management literature. The cavalier dismissal of workplace modeling as insufficiently incremental is an exercise in hubris that has greatly damaged the stabilization-relevance of mainstream macro theory.
The crowding out of the powerful implications of specialized production was inspired by Walras, Jevons, Menger, and other authors of the marginalist revolution, who conceptualized economies as market systems in search of general equilibrium. It is interesting that Continental-tradition economists worked during, but were able to contain their interest in, the onset of the global transformation to large-scale, specialized production. Today, rigorous analysis that occupies the macro academy remains proudly coterminous with the study of market exchange, as illustrated by the otherwise admirable textbook by Mas-Colell, Whinston, and Green (1995, p.127): “Many aspects enter a full description of a firm: Who owns it? Who manages it? How is it managed? How is it organized? What can it do? Of all these questions, we concentrate on the last one. Our justification is not that the other questions are not interesting (indeed, they are), but that we want to arrive as quickly as possible at a minimal conceptual apparatus that allows us to analyze market behavior. Thus, our model of production possibilities is going to be very parsimonious: The firm is viewed merely as a ‘black box’, able to transform inputs into outputs.”
The GEM Project has demonstrated that, in clearly defined workplace circumstances, optimizing employees and employers generate meaningful wage rigidity that especially informs the aggregation and analysis of labor supply in axiomatic modeling. Most fundamentally, the exhaustion of mutually beneficial trades is now understood to be sufficient to produce full employment only if exchange is arbitrarily restricted to the marketplace. Recognizing the readily apparent workplace venue enriches dynamic general equilibrium, making it consistent with broad continuous-equilibrium market failure that microfounds activist management of nominal demand.
Blog type: Workplace venue of rational exchange
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