Brief Thought on Arrow's The Limits of Organization

tap, tap...cloud of dust...feeeeeeeedback whiiiiiiine, VU meters peg

Still works, so at least that much is right with the world. 

The world turns apace even in a COVID-19 shutdown. As part of my research (into interfirm collaboration in relatively complex B2B markets) I'm reading Arrow's The Limits of Organization (1974, ISBN10 0393055078). I wish to post some early-draft impressions here.

Arrow takes an economist's perspective on organization (the "why do organizations form?" question, for one example). On page 22 he makes the following assertion: "The price system (emphasis mine) then does not provide within itself any defensible income distribution, and this is a key drawback."

At first blush I'm not sure the price system per se is supposed to perform the function Arrow seems to wish it to do. Rather than reject the assertion out of hand, though, let us try to unpack it (bounded by the limits imposed by the angle of my forehead).

The price system provides information about underlying supply, demand, and preference/utility. The factors acting on supply, demand, and preference/utility (enduring or ephemeral circumstances in the external environment, including the presence or absence of coercion) are not part of or a product of the price system.

It is arguable that the price system cannot distinguish easily among what we might call undistorted and distorted supply, demand, and utility/preference information. Further, it may well be fair to characterize that condition as a drawback. The next question is: what would constitute distortion? We may argue that coercion is the chief -- perhaps the sole -- source of distortion in the price system. Absent coercion actors are free to transact or not.

When I teach pricing in my marketing courses, I offer the following to my students in the early going (following Wroe Alderson, more or less): We don't truly know what the price of a thing is until both parties say "okay, you got a deal." Until then we have competing opinions about what the price of the thing under consideration is. If the parties can't come to a satisfactory agreement they walk away and the market doesn't clear.

If the thing is more scarce or less scarce or one or both parties have more or less utility/preference for the thing, the agreed-upon price will be different than it would be at another time, place, and situation. Each of these might be amplified or attenuated by conditions in the external environment which may be ephemeral (temporary) or enduring (permanent). Coercion distorts price system information by changing supply (quotas, for example) or demand. Coercion can mandate or prohibit consumption (and therefore exchange), or it can incentivize (via subsidy) or disincentivize (via tax or penalty) consumption.

To explain all this better, I'll have to read more Mises and reread Hayek. More soon.