When the news broke last week that Ronald Coase, the economist and Nobel laureate, had died at the age of 102, what came immediately to mind was Keynes' observation that "practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist." Most of the people running the great Internet companies of today have probably never heard of Coase, but, in a way, they are all his slaves, because way back in 1932 he cracked the problem of explaining how firms are structured, and how and why they change as circumstances change. Coase might have been ancient, but he was certainly not defunct.
As an economics student at the London School of Economics in the 1930s, Coase was puzzled by the fact that economic theory ignored the workings of the firms that make up the economy. Economists were obsessed with the big picture — the way prices act as Adam Smith's "invisible hand," bringing supply and demand into equilibrium. But like Edwardian aristocrats disdaining "trade," they seemed blandly uninterested in the ways in which businessmen actually made decisions. "What is studied," Coase observed, "is a system that lives in the minds of economists but not on Earth."
So he got a scholarship and went to the United States to examine how companies actually worked. The thing that puzzled him was this: Economic theory postulated that the market provided the most efficient way of coordinating economic activity, and yet no large company seemed to use the price mechanism as a way of coordinating its internal activities. Instead, big corporations operated as command-and-control mini-economies of the kind despised by economists. How come?