Abstract
Only a few goods are traded forward, because, as Hicks (1946, p. 139) explains, ‘[…] it is uncertainty of the future and the desire [of the consumer] to keep one’s hands free to meet that uncertainty, which limit the extent of forward trading under capitalism.’ Most forward markets for consumer goods fail. The cause is—from the perspective of New Institutional Economics (NIE)—the presence of positive transaction costs, imperfect individual foresight and bounded individual rationality. The unspoken assumption of classical economics is that private firms and their managers or entrepreneurs serve as surrogate futures traders of goods and services. They decide ‘today’ what, where and how much will be produced for ‘tomorrow’ and, in that context, what, etc., factor inputs should be bought ‘today’ for that purpose. The reason why the price mechanism is superseded by ‘the firm’, whose ‘entrepreneur-coordinator’ directs production, is transaction costs or the ‘cost of using the price mechanism’ (Coase 1937, p. 390) and, according to the reading of Williamson (1975, p. 4), ‘[Knightian] uncertainty and, implicitly, bounded rationality’. The latter two include the costs of adapting to unforeseen events and of repairing errors resulting from bounded rationality. Anyway, transaction costs, imperfect foresight and bounded rationality require suitable institutional arrangements and ‘[…] some authority (an “entrepreneur”) to direct the resources’ such that ‘certain marketing costs’ are saved. Coase continues:
An act of individual saving means—so to speak—a decision not to have dinner to day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specific thing at any specified date.
Keynes (1936, Ch. 16)
In slightly changed form reprinted from European Business Organization Law Review 11, 2010, pp. 459–475. (T.M.C. Asser Institute, The Hague, Netherlands).
Paper presented at the 14th Annual Meeting of the Society for New Institutional Economics at the University of Stirling, Scotland, 17–19 June 2010. I would like to express my thanks to Günther Hönn, Saarbrücken, for his helpful comments. I thank also Rainer Kulms (editor-in-chief of EBOR) for his suggested explanatory notes and Suzanne Habraken for her linguistic improvements of my original text.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
Such as on the London Metal Exchange, the New York Board of Trade and the New York Mercantile Exchange.
- 2.
Both futures and forward contracts are contracts to deliver an asset or good on a future date at a pre-arranged price but differ, inter alia, insofar as futures are exchange-traded while forwards are traded over the counter.
- 3.
Williamson referring to Coase (1937, p. 392), emphasis added.
- 4.
Coase (1937, p. 392).
- 5.
The cross formed by the demand and supply curves intersecting at the equilibrium price of a good, named after Alfred Marshall who was one of the first to argue that both demand and supply determine the market price of a good.
- 6.
For instance: I purchase x bushels of wheat to be delivered here, 1 year from now, payable today, on the condition that my next year’s crop is destroyed by hail (i.e., purchase of hail insurance). Individuals have full knowledge of all possible events (hail, drought, normal weather) and their probability distributions at each particular location, etc.
- 7.
Cooter and Ulen (1988, p. 235).
- 8.
More precisely, their Von Neumann-Morgenstern (expected) utility.
- 9.
Under this condition, since by assumption all firms are privately owned, their managers have to maximise the firms’ profit subject to the latter’s production functions. Managers are fully informed about their technically feasible production plans.
- 10.
Hirshleifer (1970, p. 231 ff.).
- 11.
One of the ‘three fundamental laws of nature’, see Hume (1739/40, Book III, Sect. VI).
- 12.
For reasons of economic progress.
- 13.
‘Futures contracts in commodities and in foreign exchange are well known to supply insurance against price movements among their other social functions.’ (Arrow 1970, p. 137).
- 14.
A core problem for German ‘Ordo Policy’ (Ecken 1975, pp 279–285).
- 15.
Note that the combination of spot and forward purchases, both payable today, may be separated (in the general equilibrium case) into three individual transactions when a money loan is inserted, viz., a spot transaction payable today, a money loan transaction, and a forward transaction payable tomorrow (cf. Richter 1987, p. 142).
- 16.
See the above reference to Williamson (1975, p. 4).
- 17.
North (1990, p. 80).
- 18.
An allocation of goods or outcomes among actors (such as in a market equilibrium) is defined as ‘Pareto efficient’ or ‘Pareto optimal’ when no other allocation exists in which at least one actor can improve himself without hurting someone else. The concept was named after Vilfredo Pareto.
- 19.
Furubotn and Richter (2005, p. 71); on the other hand, ‘efficiency’ is, in a general sense, an important purpose of economics, as is ‘general health’ in medicine. Given the assumptions of NIE—positive transaction costs, incomplete foresight and bounded rationality—one may speak of ‘NIE efficiency’.
- 20.
Arrow (1970, p. 142 ff.) expressly points to this problem.
- 21.
Knight (1921, p. 271) did not view entrepreneurs as one personality but as a ‘special social class, the business men, [who] direct economic activity’. On this point and related issues, see also Drucker (1962, pp. 26–36, 235n). The history of the figure of ‘the entrepreneur’ in economics is reviewed in Ricketts (2002, Ch. 3).
- 22.
Jensen and Meckling (1976, p. 310; emphasis in the original).
- 23.
In this context, Schumpeter (1942, p. 141) complains about the erosion of ownership interests (‘[…] the figure of the proprietor and with it the specific proprietary interest have vanished from the picture’.). It is tempting to illustrate the wealth-destroying consequences of employee-run capitalism by the fallout of the financial crisis of 2008 or events such as the Enron scandal (see The Economist, 9 February 2002, p. 9).
- 24.
Because without a (costly) organisation of stockholders, ‘any effort the typical stockholder makes to oust the management will probably be unsuccessful’ (Olson 1965, p. 55). The law seems unable to compensate for this phenomenon. At least according to Baums and Scott (2005) ‘[…] it cannot be said that either US or German law is designed to give primacy to shareholder interests’.
- 25.
In their survey article (1989) Holmström and Tirole distinguish between internal disciplining by design of executive compensation plans and external disciplining through managerial labour markets, product market discipline (competing away slack) and capital market discipline (under threat of takeovers).
- 26.
Hellwig (2000, p. 98).
- 27.
Bebchuk, et al. (2002, 2003, 2004), who stress that the problems of executive compensation arrangements are rooted in boards’ failure to bargain at arm’s length with executives.
- 28.
‘In the absence of central planning, the financial system becomes the center piece of the allocation of resources’ (Hinds 1990, p. 20), which sounds somewhat quixotic after the performance by financial firms and markets during the 2008 crisis.
- 29.
Bad products drive out good products (Akerlof 1970).
- 30.
- 31.
One such moral hazard was that banks, instead of holding loans on their balance sheets, changed to an ‘originate and distribute’ model. ‘They repacked loans and passed them on to various other financial investors, thereby offloading risk’ (Brunnermeier 2009, p. 78). In doing so, banks created ‘structured’ products—collateral debt obligations (CDOs) consisting of diversified portfolios of mortgages and other types of loans—sold in private placements with confidentially agreements. Banks then sliced these portfolios into different tranches, which they sold not only to investor groups with different attitudes toward risk but also to themselves. Furthermore, buyers could also protect themselves by purchasing credit default swaps (CDSs; see also nn. 38 and 39). As a consequence, originators of loans had less incentive to care about the quality of the contracts they wrote because they thought the risks were someone else’s problem (Keys et al. 2008).
- 32.
As Freixas and Rochet (2008, p. 15) say: they ‘[…] deal in financial contracts (loans and deposits), which cannot be easily resold, as opposed to financial securities (stocks and bonds), which are anonymous […] and thus easily marketable’.
- 33.
Example: the German house bank as described by Edwards and Fischer (1994, Ch. 7).
- 34.
G. Wagner, ‘Falsche Anreize’, Handelsblatt. Legal Success, 24 August 2009, p. 16, available at: <http://handelsblatt.com>.
- 35.
Scott (2009) describes the complexity of CDOs and adds: ‘About 80 % of the 2.5 trillion subprime mortgages made since 2000 went into securitization pools’. By way of illustration he adds an example of a CDO2 created by a large bank in 2005. ‘It had 173 investments in tranches issued by other pools […] It issued 975 million of four AAA tranches, and three subordinate tranches of $55 million. […] Two of the 173 investments […] were tranches from another billion-dollar CDO […], which was composed mainly of 155 MBS tranches and 40 CDOs. Two of these 155 MBS tranches were from a 1 billion RMBS pool created in 2004 […] composed of almost 9000 mortgage loans (90 % subprime) […]’, etc. Scott concludes: ‘With so much complexity, and uncertainty about future performance, it is not surprising that the securities are difficult to price and that trading dried up’.
- 36.
In Germany: in 1872 ca 45 %, since 1960 about 5 % and less (Welcker 1978, p. 67).
- 37.
‘The risk of a chain reaction of falling interconnected dominos’ (Kaufman 1995, p. 47) Systemic risk, seen from the perspective of a repeatedly played trust-abuse game, is the ‘risk’ that an existing reputation equilibrium might tip to its opposite: a no-trade equilibrium as result of an extreme lemons effect. Note: reputation equilibria rely heavily on buyers’ beliefs.
- 38.
That may be an unwelcome side effect of regulatory measures and belongs to the core problems of German ‘Ordo Policy’ (Ecken 1975, pp 279–285 and Richter, these Essays Ch. 7).
- 39.
Thus, Carl Menger, one of the prominent representatives of the theory of organic institutional evolution, argued rather cautiously: ‘[…] some social phenomena are the results of a common will directed toward their establishment (agreement, positive legislation, etc.), while others are the unintended result of human efforts aimed at attaining essentially individual goals (the unintended results of these)’ (Menger 1963, p. 133; emphases in the original).
References
Akerlof, G. A. (1970). The market for “Lemons”: Quality uncertainty and the market mechanism. Quarterly Journal of Economics, 84, 488–500.
Arrow, K. J. (1953). Le rôle des valeurs boursières pour la répartition la meilleure des risques, Econométrie (pp. 81–120). Paris: Centre National de la Recherche Scientifique.
Arrow, K. J. (1970). Essays in the theory of risk-bearing. Amsterdam: North-Holland.
Barzel, Y. (1982). Measurement cost and the organization of markets. Journal of Law and Economics, 25, 27–48.
Baums, T., & Scott, K. E. (2005). Taking shareholder protection seriously? Corporate Governance in the United States and Germany. American Journal of Corporate Law, 53, 31–75.
Bebchuk, L. A., Fried, J. M., & Walker, D. I. (2002). Managerial power and rent extraction in the design of executive compensation. University of Chicago Law Review, 69, 751–846.
Brunnermeier, M. K. (2009). Deciphering the liquidity and credit crunch 2007–2008. Journal of Economic Perspective, 23, 77–100.
Coase, R. H. (1937). The nature of the firm. Economica, 4, 386–405.
Cooter, R., & Ulen, T. (1988). Law and economics. Scott Foresman: Glenview, IL.
Debreu, G. (1959). Theory of value: An axiomatic analysis of economic equilibrium. New York: John Wiley.
Drucker, P. F. (1962). Concept of the corporation. Boston, MA: Beacon Press. second printing with new foreword.
Ecken, W. (1975). Grundsätze der Wirtschaftspolitik (5th ed.). J.C.B. Mohr (Paul Siebeck): Tübingen.
Edwards, J., & Fischer, K. (1994). Banks, finance and investment in Germany. Cambridge: Cambridge University Press.
Freixas, X., & Rochet, J.-C. (2008). Microeconomics of banking. Cambridge, MA: MIT Press.
Furubotn, E. G., & Richter, R. (2005). Institutions & economic theory. The contribution of the new institutional economics (2nd ed.). Ann Arbor, MI: University of Michigan Press.
Hayek, F. A. (1945). The use of knowledge in society. American Economic Review, 35, 519–530.
Hellwig, M. (2000). On the economics and politics of corporate control. In X. Vives (Ed.), Corporate governance. Theoretical and empirical perspectives (pp. 95–134). Cambridge: Cambridge University Press.
Hellwig, M. (2008). Systemic risk in the financial sector: An analysis of the subprime-Mortgage financial crisis. Preprints of the Max Planck Institute for Research on Collective Goods, Bonn, 2008/43. Electronic copy available at: <http://www.univie.ac.at/vwl/TheoretischerAusschuss/Papers/2009/Hellwig_Subprime-MortgageFinancialCris.pdf>.
Hicks, J. R. (1946). Value and capital: An inquiry into some fundamental principles of economic theory (2nd ed.). Oxford: Clarendon.
Hinds, M. (1990). Issues in the Introduction of Market Forces in Eastern European Socialist Economies. World Bank Reports No. IDP-0057. Washington, DC: World Bank.
Hirshleifer, J. (1970). Investment, interest, and capital. Englewood Cliffs, NJ: Prentice-Hall.
Holmstrom, B. R., & Tirole, J. (1989). The theory of the firm. In R. Schmalensee & R. D. Willig (Eds.), Handbook of industrial organization (Vol. 1, pp. 63–133). Amsterdam: North-Holland.
Hume, D. (1739–40) (1969). A treatise of human nature. edited by E.C. Mossner. London: Penguin.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3, 305–360.
Kaufman, G. G. (1995). Comment on systemic risk. In G. G. Kaufman (Ed.), Research in financial services: Banking, financial markets, and systemic risk (Vol. 7, pp. 47–52). Greenwich, CT: JAI.
Keynes, J. M. (1936). The general theory of employment, interest, and money. London: Macmillan.
Keys, B. J., Mukherjee T.K., Seru A., & Vig, V. (2008). Does securitization lead to lax screening? Evidence from subprime loans. EFA 2008 Athens Meetings Paper, electronic copy available at: <http://ssrn.com/abstract=1093137>.
Kirkpatrick, G. (2009). The Corporate Governance Lessons from the Financial Crisis. Report published under the responsibility of the OECD Steering Group on Corporate Governance prepared under the supervision of Mats Isaaksson; pre-publication version for Financial Market Trends, Vol. 2009/1, © OECD 2009, available at: <http://www.oecd.org/daf/corporateaffairs>.
Knight, F. (1921). Risk, uncertainty, and profit. Boston and New York: Houghton Mifflin Co.
Menger, C. (1963). Problems of economics and sociology. Urbana: University of Illinois Press. translation by F.J. Nock of C. Menger (1883). Untersuchungen über die Methode der Socialwissenschaften, und der Politischen Ökonomie insbesondere. Leipzig: Duncker & Humblot.
North, D. C. (1990). Institutions, institutional change, and economic performance. Cambridge: Cambridge University Press.
Olson, M. (1965). The logic of collective action: public goods and the theory of groups. Cambridge, MA: Harvard University Press.
Posner, R. A. (1980). A theory of primitive society with special references to primitive law. Journal of Law and Economics, 23, 1–53.
Richter, R. (1987). Money: Lectures on the basis of general equilibrium theory and the economics of institutions. Berlin, et al.: Springer 1989) (translated by W. Stolper from the German edition: Geldtheorie. Vorlesung auf der Grundlage der Allgemeinen Gleichgewichtstheorie und der Instiutionenökonomik (Berlin, et al., Springer 1987)).
Ricketts, M. (2002). The economics of business enterprise. An introduction to economic organisation and the theory of the firm. Cheltenham, UK: Edward Elgar.
Schumpeter, J. A. (1911). Theorie der wirtschaftlichen Entwicklung. Berlin: Duncker & Humblot.
Schumpeter, J. A. (1942). Capitalism, socialism and democracy. New York: Harper & Brothers.
Scott, K. E. (2009, July 30). Why toxic assets are so hard to clean up. The Wall Street Journal, A 13
The Economist (2010, 13 February). The gods strike back. A special report on financial risk (p. 16).
Vives, V. (Ed.). (2000). Corporate governance: Theoretical and empirical perspectives. Cambridge: Cambridge University Press.
Welcker, J. (1978). Neuordnung der Bankenaufsicht. Frankfurt a.M.: Knapp.
Williamson, O. E. (1975). Markets and hierarchies: Analysis and antitrust implications. New York: Free Press.
Author information
Authors and Affiliations
Rights and permissions
Copyright information
© 2015 Springer International Publishing Switzerland
About this chapter
Cite this chapter
Richter, R. (2015). Entrepreneurs as Surrogate Forward Traders of Goods and Services, Seen from the Viewpoint of New Institutional Economics. In: Essays on New Institutional Economics. Springer, Cham. https://doi.org/10.1007/978-3-319-14154-1_5
Download citation
DOI: https://doi.org/10.1007/978-3-319-14154-1_5
Publisher Name: Springer, Cham
Print ISBN: 978-3-319-14153-4
Online ISBN: 978-3-319-14154-1
eBook Packages: Business and EconomicsEconomics and Finance (R0)