Firms and politicians both plan, but they do so for completely different reasons, yielding completely different results.
Firms and politicians both plan, but they do so for completely different reasons, yielding completely different results.
F irms are islands of central planning in the economy, according to Ronald Coase. In his 1937 article “The Nature of the Firm,” for which he would later win the Nobel Prize in Economics, he writes that, “Outside the firm, price movements direct production,” but “Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur-co-ordinator, who directs production.”
That dichotomy raises an interesting question: If markets work so great, then why isn’t the price system always used to direct production?
Coase answers that question by writing that “there is a cost of using the price mechanism.” Coase is most known for pointing to the cost of contracting as a reason for firms to exist. It’s much easier to have the firm as a central contracting agent than having every worker contract with every other worker and every customer for every transaction. Ultimately, that contracting process is based on price-informed economic reasoning: “When we are considering how large a firm will be the principle of marginalism works smoothly. The question always is, will it pay to bring an extra exchange transaction under the organising authority?”
But before launching into his discussion of contract costs, Coase writes, “The most obvious cost of ‘organising’ production through the price mechanism is that of discovering what the relevant prices are. This cost may be reduced but it will not be eliminated by the emergence of specialists who will sell this information.”
In those two sentences, Coase is essentially describing the necessity of fields such as market research and inventory management. Businesses invest loads of money in trying to surmise consumer preferences and tastes so that they can calibrate their inventories to match demand.
It’s very difficult work.
Think about when you go to the store and see two different brands of the same product. How do you decide which one to buy? The obvious choice is the one with the lower price, but of course, you don’t automatically choose the cheaper one. Sometimes you prefer a specific brand for non-price reasons. Maybe it’s the brand your mother always bought growing up. Maybe there’s something you prefer about the packaging. Maybe you would actually prefer to buy the cheaper one, but other members of your family prefer the more expensive option.
The company that makes the product naturally wants you to buy its brand. But it doesn’t know why you bought it or didn’t buy it. There aren’t company representatives standing in the aisle of the store asking you about your purchase. And even if there were, you might not give them an honest answer or any answer at all (because it’d be pretty weird). So the company basically has to guess.
The guesses they make inform such important decisions as what the suggested price should be and how much of the product to send to the store. When you think about how difficult this task is, it’s really quite impressive that businesses ever get inventory and stocking questions right at all. But by and large, they do. We expect products to be in stock, they usually are, and it’s news when they aren’t. That’s the result of countless professionals who make their living getting these guesses right.
But right now, even these professionals are having a rough go of it. Retail inventory is way out of whack, according to Ben Unglesbee at RetailDive. Consumer-spending patterns have changed faster than expected post-pandemic. In response to inflation, retailers are now expecting less spending in discretionary categories, such as home goods, and more in essential categories, such as food.
The problem is that retailers amassed larger-than-normal inventories in response to supply-chain issues and the boom in spending on discretionary categories that came with the rounds of stimulus checks from the federal government. Those extra goods still need to be sold, which will require steep discounts, cutting into profits and growth projections. What were shortages not that long ago could turn into gluts soon, especially in categories such as furniture, apparel, and workout equipment.
“All of this shows how an adaptation to one extreme circumstance suddenly became a disadvantage,” Unglesbee writes. Indeed, and it should be a warning to those who would have government in charge of business. As Andrew Stuttaford pointed out when Target and Walmart announced huge earnings misses in May, “It’s almost as if it is extremely difficult for a company, even one of those wicked ‘big’ companies, to manage its way through an inflationary surge.”
The blame for the inflationary surge rests on government (as inflation is always and everywhere, if not a monetary phenomenon, at least a political one), and if the people whose job it is to research consumer preferences and project inventories couldn’t figure out how to align supply with demand, we have no reason to believe the people whose job it is to give speeches and lie for votes would do better.
Politicians desire to become central planners so they can replace the price system with their own preferences. Firms are islands of central planning that are organized by economic reasoning to allow the price system to function better. When diagnosing “market failure,” be sure that the cure isn’t worse than the disease.