Division of Labor and the Firm

In an article recently accepted for publication in the Quarterly Journal of Austrian Economics, I draft a model for explaining how firms emerge in the market place. Whereas theories of the firm generally attempt to explain the rationale for firms, their boundaries, and how they are internally organized, there are pretty much no studies at all on how firms emerge and what the process looks like.

This process is targeted in my article, and I use the fact that division of labor provides a production process with increasing returns to scale but that this division of labor is also restrained by the contextual degree of specialization. In the market, therefore, we will find a somewhat homogeneous specialization degree. Any actor choosing to limit the scope of his or her productive activities to a much further degree will find the products of his efforts incompatible with the surrounding market. Therefore, there is a trade-off between the increased efficiencies of division of labor and the cost of incompatibility. This means the process towards greater efficiency in production processes will only slowly adopt an increased division of labor, which means there is no reason for firms: all factors are quite compatible as is.

The rationale for firms, I argue, lies in the entrepreneurial aim to establish new structures of production that take advantage of previously unseen and unforeseen specialization and divisions of labor. In order to establish such structures, the entrepreneur must create an environment that is input- and output-compatible to the surrounding market while providing sufficient internal density between factors to support extra-market division of labor. The firm, therefore, is a vehicle with which the entrepreneur manages to realize production structures that are not only unimagined by others – but impossible to realize through market contracting.

This article, at present titled “Division of Labor and the Firm: An Austrian Attempt at Explaining the Firm in the Market,” drafts a model for the process in which entrepreneurs organize firms in order to establish their imagined structures of production. In another article, recently presented at the Southern Economic Association’s meeting in Atlanta, Ga., I attempt a further formalization of the model.

These articles (and others) are available on my SSRN page.