Many economists, especially those of a liberal disposition, believe entirely in the market. They state that the free market is the best way to allocate resources to those who need it most and that if it was left to individuals, we’d all be much worse off. Yet in the real world, no-one ever questions whether or not we should get rid of firms, many have become household names throughout the world. So if the market is perfect, why do we also have firms? How do they fit together?

Since firms are widely accepted to be part of the community, they provide jobs and supply us with all the products we need, should they have a social conscience? This is often an issue as we here of large companies such as Nike and Apple exploiting workforces and oil producers like BP polluting our environment and there is normally an outcry against them. Whilst the public opinion suggests that they should have a conscience, in pure economic terms, I don’t think they should. Ronal Coase argued that the reason firms existed was to reduce transaction costs.

A transaction cost is a cost incurred in making an economic exchange, such as enforcing contracts, negotiating prices and hiring workers. With a firm put in place, the hassle and time used up with the transaction can be dramatically reduced in several ways. Firstly, if a firm is in place, then it provides a much easier structure to simply repeat a process, for example, a car company buys 10,000 tonnes of steel each month and they can have this as almost a prescription, there is no need to renegotiate every time and try to work out the logistics.

Secondly, firms allow a greater degree of a specialisation. Within a firm, there can be several different departments such as marketing, transport and logistics and this means people can specialise in what they’re best at, reducing training costs (as you don’t have to train people for every role) and vastly increasing efficiency- when someone specialises in one job, they become experienced and tend to become better at that task. Some liberal thinkers would argue that we could do this merely with a partnership such as we see with the John Lewis Partnership.

Surely people would be rational enough to see that it makes sense to work together and specialise in that sense. However, the issue with this is that it’s likely some workers will be able to just be able to produce more or work harder, thus being more efficient and this is where the difficulty comes. Do they receive more money for producing more output or do they earn the same as everyone else? If the answer was the former, then you have essentially produced a firm, where people rise based upon success and thus they can become the boss. Whilst this is the most efficient way, it does mean some are better off than others.

As the John Lewis Partnership shows, you can have a worker owned business but at the end of the day, to be as productive as possible, you have to promote people and pay them more to increase the output of the business as a whole. There is no way that the Chairman, Charlie Mayfield, would work for the same wage as the average shop floor worker, the value he brings to the businesses is much larger and thus he is rewarded. However, if you believe that the workers that excel should earn the same as the less capable workers, then the issue is even larger.

In this case, there is no incentives for the workers to work hard as they can’t earn any more money and thus they become disincentivised and the business as a whole becomes less efficient. The alternative to either of these would be a planned economy. A planned economy is a type of economy that gives the government total control over the allocation of resources. A planned economy alleviates the use of private enterprises and allows the government to determine everything from distribution to pricing.

Planned economies basically give the government dictatorship type control over the resources of the country. However, there are many problems with this, most importantly this hints on growth because once again, you are disincentivising workers. Planned economies have traditionally been associated with communist dictatorships and if we look at the economic success of them, it’s quite clear that they simply don’t work as well as the free market mechanism. If we compare the GDP of Chile and Cuba, we can see how this planned, government controlled government inhibits economic growth.

They both had long standing dictatorships who controlled the economies throughout the 70s and 80s. The difference came that in 1993, Augusto Pinochet fell from power in Chile and since then, there has been huge GDP growth, meanwhile Cuba is still under the control of Fidel Castro and we can see how far it fell behind. Despite in 1979, their economies having equal GDPs of around $20 billion, by 2008, Chile’s GDP had risen to $180 billion, whilst Cuba could muster barely a third of this with $60 billion thus providing clear evidence that a market economy leads to higher growth.

Whilst I do believe in this principle, it has to be said that there are other reasons for the disparity in growth such as Chile having some precious metals as well. The role of a firm is to please its stakeholders; therefore, whether or not it should have a social conscience is depending on whether or not it would be in the interest of the stakeholders. The most obvious stakeholder is the owner or shareholders. I think in general, they have risen to becoming the owner of a business by being ruthless in business and by having great business awareness.

This means that in general, the owners are willing to ignore perhaps moral responsibilities in favour of larger profit margins. This is how businesses rise to the top, brands like Nike, Adidas and Apple wouldn’t be in the privileged situation they’re in if it wasn’t for exploiting cheap labour in South-East Asia. However, this isn’t entirely always the case, especially with small possibly family-run firms.

In these cases, we often see that their objectives are as much to serve the community as it is to make a profit e. g.

Elphicks department store who are a family run business not making a profit yet refusing to lay off staff. Also, there’s an argument that whilst these workers in sweatshops may be underpaid, they do still get a job and without this big business, they would be unemployed and be living in even worse conditions, therefore it’s possible to argue that big business does have a social conscience. If we look at the example of Ben & Jerry’s ice cream, we can see that sometimes the owners may have a conscience yet the law can overrule them. Several firms were bidding to buy it.

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