In his podcast Vance Crowe has a discussion with Rick Holton about venture capital and why firms can't innovate. Vance uses a great analogy about the nature of firms and innovation:
"you think of these large capitalist companies....but once you are inside the walls of a company there's a form of communism that goes on"
This remark is very similar to what Ronald Coase (who won the Nobel prize in economics in part because of his insights about the existence of large firms) said about firms in his famous article The Nature of the Firm. He effectively described firms as little islands of socialism:
"we find “islands of conscious power in this ocean of unconscious co‐operation like lumps of butter coagulating in a pail of buttermilk...Why are there these “islands of conscious power”?
Indeed why? And how?! Doesn't this conflict with Hayek? If the very idea of socialism is impossible due to the knowledge problem, then how can firms get away with it? Coase explains:
Outside the firm, price movements direct production, which is coordinated through a series of exchange transactions on the market. 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....the distinguishing mark of the firm is the supersession of the price mechanism.…“related to an outside network of relative prices and costs."
Innovation happens largely as part of the entrepreneur's (including venture capital) response to the uncertainty that firms face and their inability to 'calculate.' The role of the entrepreneur and profit and loss system (capitalism) is to maintain alignment with the 'outside network of relative prices and costs' or else firms could not exist, and we would have no innovation.
It's the profit system that allows firms to thrive despite their internal struggle with the knowledge problem. The market, venture capital, and the entrepreneurial response to uncertainty represents a set of institutions for managing innovations that are not possible within the planned economies of individual firms.
References:
The Vance Crowe Podcast. Rick Holton: Venture Capitalist on failed deals why corps can't innovate & helping the imprisoned. March 15, 2021. https://share.transistor.fm/s/0b9824be (14:50)
Coase, R.H. (1937), The Nature of the Firm. Economica, 4: 386-405. https://doi.org/10.1111/j.1468-0335.1937.tb00002.
The Use of Knowledge in Society. F.A. Hayek. The American Economic Review Vol 35 No 4 (Sept 1945) p. 519-530
See also: The Knowledge Problem in Firms
