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Orders and Organizations: Hayekian Insights for a Theory of Economic Organization
Author(s): Stavros Ioannides

Source: The American Journal of Economics and Sociology , Jul., 2003, Vol. 62, No. 3
(Jul., 2003), pp. 533-566
Published by: American Journal of Economics and Sociology, Inc.
Stable URL: https://www.jstor.org/stable/3487810
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NOVEL INSIGHTS ABOUT ORGANIZATION
Orders and Organizations
Hayekian Insights for a Theory of Economic

Organization
By STAVROS IOANNIDES*
ABSTRACT. We explore the relevance to the theory of economic

organization of the distinction introduced by Hayek between two
kinds of social order: spontaneous orders and organizations. We argue
that Hayek's ideas lead to an understanding of the business firm
as a process, which comes very close to some of the core notions of
the evolutionary theory of the firm, while they still view the firm as
the outcome of a contract among asset owners. First of all, we put
forth a simple conceptual schema in order to differentiate between
contracts that lead to the formation of an organization and ordinary
market contracts. We then explore the conditions for an understand-
ing of the firm as a set of interconnected processes, rather than as an
end state. Finally, we introduce the concept of purposeful direction
as an important condition for the existence of the firm and we show
the history-contingent character of the firm's growth.
Introduction
ACCORDING TO THE standard periodization of Hayek's work, we have

to distinguish between early Hayek, the analytical economist, and the
*The author is Associate Professor of Economics at the Department of Political

Science and History, Panteion University, Athens, Greece. E-mail address:
stioan~panteion.gr. His research focuses on Austrian economics, evolutionary a

tutional economics, and the theory of the firm. A first version of this paper was pre-
sented to the Austrian Economics Colloquium at New York University in April 1999
and to the conference "Economic Analysis and Political Economy in the Thought of F.
A. Hayek" in Paris in May of the same year. The author wishes to thank David Harper,
Sanford Ikeda, Israel Kirzner, Roger Koppl, Mario Rizzo, Frederic Sautet, and Joe
Salerno for helpful comments. The usual disclaimer applies.
American Journal of Economics and Sociology, Vol. 62, No. 3 (July, 2003).
C 2003 American Journal of Economics and Sociology, Inc.

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534 American Journal of Economics and Sociology
mature Hayek, who focused on wider spheres of the social sciences

like social philosophy, political theory, and cognitive psychology.1
Taken literally, this periodization seems to imply that it is his early
period that may be of relevance for today's analytical economics. Con-
trary to this view, we will argue that contemporary economics has a
lot to learn even from that part of Hayek's work that is not purely
economic.
We focus here on Hayek's distinction between two types of social
order: spontaneous orders and organizations. Although he introduced
the two concepts in his effort to distinguish between the organizing
principles of the "Great Society" and those that pertain to purposeful
associations, we will argue that this distinction offers an important
starting point for a theory of economic organization, and especially
of the business firm. Of course, given that Hayek never attempted to
construct a theory of economic organization,2 our task here is not to
find in his work ideas that are simply not there but, rather, to "extract"
some insights from his analysis that are of central importance in the
modern theory of the firm.
This raises the question of how these insights relate to the two per-
spectives into which modern research on the firm is divided. The first
stems from the work of Coase (1937), Alchian and Demsetz (1972),
and Williamson (1975, 1985a) and is usually described as "contrac-
tarian." What unifies this work is that it views the firm as an optimal
contractual arrangement for the cooperation of a bundle of assets,
which comes about through a contracting process among their
owners. The second perspective comprises the "capabilities" theories
of the firm that stem from the work of Penrose (1959), Richardson
(1972), and Nelson and Winter (1982). This views the firm as a bundle
of capabilities, which are largely tacit and shared by the human assets
that constitute it. The latter strand has also developed an "evolution-
ary" branch, which, among other issues, emphasises (a) the endoge-
nous nature of the creation of the firm's capabilities, (b) the constant
emergence of variety in the characteristics of firms, and (c) the history-
contingent character of the firm's growth.3
We will show how Hayek's ideas lead toward this latter evolution-
ary approach to the study of business firms.4 Much more importantly,
however, we will argue that the insights we can extract from his

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Hayek and a Theory of Economic Organization 535
distinction between spontaneous orders and organizations allow us

to construct an evolutionary approach to the firm that is character-
ized by two attributes. First, it introduces an understanding of the
business firm as a process, in contrast to the static outlook of con-
tractarian theories, while still allowing us to describe the firm as the
outcome of a contracting process among asset owners. The impor-
tance of this line of analysis cannot be overestimated, because it indi-
cates the possibility of constructing a unified theoretical framework
for the analysis of firms, in which the concepts of contracts, growth
processes, capabilities, and historical contingency can be applied
simultaneously to the study of business organization.
Our analysis proceeds as follows. We begin (Section II) with a pres-
entation of Hayek's distinction between spontaneous orders and
organizations, as it appears in his mature work and especially in
Volume 1 (1973) of his Law, Legislation and Liberty. We then proceed
(Section III) to put forth a simple conceptual schema in order to
differentiate between contracts that lead to the formation of an
organization and ordinary market contracts. In Section IV we set the
conditions for an understanding of the firm as a process, rather than
as an equilibrium phenomenon, as conceptualized by contractarian
theorists. Section V introduces the concept of purposeful direction as
an important condition for the existence of the firm and establishes
the history-contingent character of its exercise. Finally, Section VI
summarizes our conclusions.
II
Hayek on Spontaneous Order and Organization
ONE OF THE FEATURES of Hayek's work that makes it especially relevant

for the study of economic organization is the fact that, in his mature
work, he abandoned the concept of equilibrium of mainstream eco-
nomics in favor of that of order. Hayek explains the reasons for this
conceptual innovation as follows:
The concept of an "order" which ... I prefer to that of equilibrium, has
the advantage that we can speak about an order being approached to
varying degrees, and that order can be preserved throughout a process of
change. (1968:184)

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At least three points must be noted in the above statement. The

first is that the concept of order is entirely compatible with "a process
of change," therefore, it is independent of end states and has time as
an essential element. The second is that an order can be approached
"to varying degrees." In other words, we may describe a phenome-
non as forming an order even though, at any point in time, it
may not display all the characteristics that the theorist considers as
describing-belonging to-that order. Finally, if an order is produced
through human action it must also be constantly maintained and
reproduced through that action.5
The fact that an order is perceived as a continual process unfold-
ing in real time means that its essence must not be sought in the
uniformity of the actions of the individuals that constitute it, nor in
the physical continuity of the individuals themselves. Rather, the con-
tinuity must be sought in the general character of the actions that the
social scientist observes in its functioning.6 On this basis, Hayek
proceeds to define an order:
[Als a state of affairs in which a multiplicity of elements of various kinds
are so related to each other that we may learn from the acquaintance with
some spatial or temporal part of the whole to form correct expectations
concerning the rest. (1973:36)
Let us note here Hayek's emphasis on the notion of acquaintance,

which opens up a whole series of epistemological questions on how
the social scientist "gets acquainted" with the patterns of actions that
arise in a spatial or temporal part of an order and how he or she pro-
ceeds to construct mentally the overall order on that basis. However,
epistemological considerations aside, Hayek does raise a problem that
this acquaintance faces, which arises from the character of the order
itself. Thus, he introduces the distinction between "abstract" and "con-
crete" orders. Regarding the former, and taking the market order as
a case in point, Hayek maintains that:
We cannot see, or otherwise intuitively perceive, this order of meaning-
ful actions, but are only able mentally to reconstruct it by tracing the rela-
tions that exist between the elements. We shall describe this feature by
saying that it is an abstract and not a concrete order. (1973:38)
By contrast, the orders that he describes as "concrete" can be per-

ceived intuitively by inspection, i.e., without the social scientist having

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to mentally reconstruct their function or having to construct a theory

in order to explain them. Taking now man-made order, rather than
spontaneous order, as a case in point, Hayek proceeds to describe
concrete orders:
Such orders are relatively simple or at least necessarily confined to such

moderate degrees of complexity as the maker can still survey; they are
usually concrete in the sense just mentioned that their existence can be
intuitively perceived by inspection; and, finally, having been made delib-
erately, they invariably do (or at one time did) [our emphasis] serve a
purpose of the maker. (1973:38)
There are a number of points that need to be stressed in connec-

tion with Hayek's distinction between abstract and concrete orders.
First, in the above two quotations, spontaneous and man-made orders
are depicted as examples of abstract and concrete orders, respectively.
However, they are just that: examples or illustrations. Hayek does not
mean that there is a one-to-one relation between these concepts, i.e.,
that spontaneous orders are necessarily abstract and man-made orders
necessarily concrete.7 In fact, he stresses (ibid.) that what distinguishes
spontaneous from man-made orders is the degree of complexity they
can achieve. Therefore, their respective abstractness or concreteness
is directly linked to their complexity.
There is a second point that is even of greater interest in the second
of the above quotations. Hayek seems to suggest that one reason that
explains the concreteness of a man-made order is the fact that it is a
deliberately constructed arrangement, which thus serves a purpose of
its maker. However, he immediately qualifies this position when he
says, as we have emphasised, "or at one time did." What he means
is that even man-made orders can develop to such a degree of com-
plexity that their character may change from concrete to abstract.
There is a third important consideration. If man-made orders can
evolve to an ever increasing degree of complexity-and, therefore,
abstractness-and if they can evolve to be independent of purpose,
as Hayek implies, can their character change through that process to
that of a spontaneous order? Hayek's statement does not seem to pre-
clude such an eventuality. On the other hand, that would entirely
undermine his insistence-which, after all, constitutes the cornerstone
of his social theory-on a rigid distinction between the two types of

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order. Given this, we interpret his statement as meaning that, as a

man-made order develops in complexity, the purpose that it serves,
or the original agency behind the original purpose, may change. On
this account, therefore, purpose remains a distinguishing feature of
man-made orders, even though the purpose itself may change as
the complexity of the order increases. The importance of these con-
siderations for a theory of economic organization will become evident
in Section V below.
We have already touched upon Hayek's distinction between two
broad categories of order: "grown" and "man-made" orders or, accord-
ing to the terminology he chooses after the brief introduction of this
distinction: spontaneous orders and organizations. Note that both
categories are simply divisions of the same general concept, that of
order. This is important because, to the extent that we agree with
Hayek that the concept of order constitutes an alternative to that of
equilibrium, then the concept of order becomes relevant for a theory
that attempts to explain economic organization not in terms of static
equilibrium but rather in terms of dynamic processes. But before we
proceed to examine how Hayek's ideas might help us in that direc-
tion, it is important that we examine in greater detail how he
supports the distinction between the two types of order.
The key here is the role of purposeful agency. A spontaneous order
is one that is produced and reproduced through the actions of indi-
viduals, although the exact form of the resulting order was not, and
could not have been, designed by any one individual. By contrast,
the distinguishing element of organizations is precisely the fact that
they are, both in their creation as well as in their operation, the result
of a directing intelligence. Hayek makes the distinction starkly:
The distinction of this kind of order [i.e., spontaneous] from one which
has been made by somebody putting the elements of a set in their places
or directing their movements is indispensable for any understanding of
the processes of society as well as for social policy. (1973:37)8
If the existence or non-existence of a directing intelligence consti-

tutes the major element on which Hayek builds the distinction
between the two types of order, the question of how order is created
and maintained is only relevant for that class of orders that he

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describes as spontaneous. Organizations, on the other hand, are

both created and maintained through the purposeful action of a com-
manding authority that puts "the elements of a set in their places."
Hayek's answer is that "the formation of spontaneous orders is the
result of their elements following certain rules in their responses to
their immediate environment" (ibid., p. 43). This statement raises
further questions that concern the nature of these rules, their origin,
and the exact ways in which their following leads to the formation
of spontaneous orders.
The first point that must be stressed concerning the nature of the
rules of conduct is that they are largely tacit. Although, as we will
see below, Hayek admits that some part of the rules governing the
behavior of the elements of a spontaneous order may be formally
constituted and, thus, explicit, he insists that there must always exist
a sub-stratum of tacit rules for a spontaneous order to exist:
[T]he term rule is used for a statement by which a regularity of the conduct
of individuals can be described, irrespective of whether such a rule is
known to the individuals in any other sense than that they normally act
in accordance with it. (1967:67)
Therefore, although rules of conduct have to be known by the ele-

ments of a spontaneous order, for only if they are known can they
be obeyed, this knowledge need not be articulable. In fact, it cannot
be an entirely articulable kind of knowledge, for, if it were, rules
could be scrutinized rationally and thus become the object of collec-
tive action, a possibility that would undermine the character of
spontaneous orders as independent of a directing intelligence.
Secondly, the rules of conduct must be largely negative rather than
positive; i.e., they must mostly determine what range of actions is
permissible in a specific situation, rather than particular actions.
Again, if rules were to prescribe particular actions, then we might as
well not talk about spontaneous order but rather about the unifor-
mity of all actions in specific circumstances. Hayek makes the point
explicitly:
[Rules] will often merely determine or limit the range of possibilities within
which the choice is made consciously. By eliminating certain kinds of
action altogether and providing certain routine ways of achieving the
object, they merely restrict the alternatives on which a conscious choice

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is required.... [The] rules which guide an individual's action are better

seen as determining what he will not do rather than what he will do.
(1967:56)
Precisely because the nature of the rules of conduct is negative

rather than positive, Hayek often refers to them as abstract. In fact,
he directly links the abstract character of the rules individuals follow
with the abstract nature of the resulting order.9 Indeed, we have
already seen that the abstractness of the resulting order is linked to
its complexity. Therefore, if the rules were not abstract-i.e., if they
prescribed concrete actions-the resulting order would be neither
abstract nor of any significant degree of complexity. In turn, the
abstractness of the rules of conduct implies also that they must be
general, in the sense that they must be valid for all individuals and
that they must be applicable to an infinite number of future instances.
We can now turn to the problem of the origins of the rules
of conduct. Hayek maintains that these rules originate from three
different sources:
Some such rules all individuals of a society will obey because of the
similar manner in which their environment represents itself to their minds.
Others they will follow spontaneously because they will be part of their
common cultural tradition. But there will be still others which they may
have to be made to obey, since, although it would be in the interest of
each to disregard them, the overall order in which the success of their
actions depends will arise only if these rules are generally followed.
(1973:45)
Some discussion of the three sources of rules of conduct is now

needed. The first source lies outside the objects of social science, as
it relates to human physiology. By contrast, the second source is,
according to Hayek, the object of social science. In fact, he bases
his whole social theory on this type of rules and on how they have
evolved spontaneously through the ages. Now, the third source is
interesting because it comprises rules, the obedience to which must
be enforced. The significance of this category of rules lies in the fact
that, since they have to be enforced by some public authority, they
must be explicit rather than tacit.
It is important to note that what in fact Hayek proposes in the
above quotation is only a classification of the various origins of the

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rules, and not a hierarchical ranking of the importance of each for

the formation of spontaneous orders. Of course, the primacy of the
first source-human physiology-is self-evident. With reference to the
other two sources of rules, however, things are not so straightforward.
Furthermore, Hayek maintains that it is conceivable that a sponta-
neous order may rest entirely on rules that have been deliberately
designed:
Although undoubtedly an order originally formed itself spontaneously

because the individuals followed rules which had not been deliberately
made but had arisen spontaneously, people gradually learned to improve
those rules; and it is at least conceivable that the formation of a sponta-
neous order relies entirely on rules that were deliberately made. The spon-
taneous character of the resulting order must therefore be distinguished
from the spontaneous origin of the rules on which it rests, and it is
possible that an order which would still have to be described as spon-
taneous rests on rules which are entirely the result of deliberate design.
(1973:45-46, emphasis added)"0
There are two points worth stressing here. The first is Hayek's dis-
tinction between the spontaneous origins of the rules on which an
order rests and the spontaneous character of the order itself. The
significant argument here is that, even if all rules are deliberately
designed, a spontaneous order may still result provided that these
rules have all the attributes that we have discussed above, i.e.,
abstractness, generality, and independence of purpose.
But there is a second point, which is of special relevance for a
theory of economic organization. As we have emphasised, Hayek
maintains that a spontaneous order "undoubtedly" formed itself
originally through the obedience of individuals to rules of conduct,
which were themselves spontaneous. He adds, however, that people
gradually learned to improve these rules, thus transforming them to
deliberately designed rules. What Hayek seems to imply here, there-
fore, is that a spontaneous order resting on deliberately designed rules
is only conceivable if these rules are merely improvements of the
original spontaneous rules that gave rise to the order in the first place.
Therefore, to the original criterion for the characterization of orders-
spontaneous orders resting on abstract rules, organizations resting on
specific commands-he now adds a further criterion: whether the

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origins of each type of order are spontaneous or deliberately

designed. What is implied here is an ontogenetic approach to the for-
mation of orders, where the original traits are supposed to determine
fully the final character of every structure, at least as far as the general
class of structures to which it will belong-i.e., spontaneous orders
or organizations-is concerned.
There remains a final issue concerning the role of rules of conduct:
the way in which the following of rules leads to the creation of an
order. Central for this are Hayek's views on ignorance, as the condi-
tion that may best describe the situation that every agent faces when
contemplating what sort of action to pursue. The fact that humans
are depicted as acting in conditions of ignorance means that whether
their actions will lead to the formation of an order or, possibly, to
complete disorder depends on whether the social environment
allows them to pursue actions that tend to be coordinated or not.
Fleetwood describes precisely this link between ignorance and
coordination:
Any notion of order that is more than a formal description of the condi-
tions necessary for equilibrium must explain how agents initiate actions
that are relatively spatio-temporally coordinated with one another under
the really existing situation of incomplete knowledge ... Hayek reasons
that actions may be coordinated if plans are coordinated, which depends
upon the coordination of expectations, which in turn is based upon agents
having access to knowledge ... of what others are doing or intend to do.
(1995:94)
What Fleetwood in fact describes here is the knowledge require-

ments for the creation of an order. It is precisely these requirements
that are met by the obedience to rules. In the case of organizations,
the creation of order is ensured by the fact that the commands that
actually create them flow from one central intelligence. In the case
of spontaneous orders, on the other hand, no such central intelligence
exists. Therefore, in this case, the obedience to rules of conduct helps
agents cope with the perennial condition of ignorance in which they
inescapably find themselves, by augmenting the knowledge at their
disposal in a double sense: first, by allowing them to draw from the
experience of dealing with specific situations that is embodied in
these rules, and second, by making the actions or expected actions

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of other agents intelligible, for the simple reason that they themselves
are based on obedience to the same rules of conduct.
Therefore, rules help the spontaneous creation of orders through
the coordination of the plans and actions of individual agents. In turn,
this is achieved because rules assist agents to pierce through the igno-
rance in which they find themselves and to obtain knowledge-or to
act as ifthey possessed knowledge, which in actual fact they do not.
Thus, it is not only that rules facilitate action by dispersing the veil
of ignorance that confronts individual action, but they also allow
agents to make fuller use of the tacit knowledge that they uncon-
sciously possess. It follows that, the more abstract and negative the
rules are, i.e., the more they do not restrict freedom of action, the
more complex the resulting order, in the sense that the observed
range of actions will tend to be greater.
We have seen that, according to Hayek, the issue of rules versus
commands constitutes the major distinguishing characteristic of
spontaneous orders and organizations. However, he feels the need to
somewhat qualify this statement by accepting a role for rules in
organizations, although in this case the rules differ in important
respects from the rules that lead to the formation of spontaneous
orders. For a theory of the firm this is an important conceptual
development because, as we have argued elsewhere (loannides
1999a), the acceptance of even a limited role of rules in the firm takes
us away from the neoclassical view of the firm as a production
function-an arrangement in which all the elements obey a single
will in pursuing the maximization of profits. In terms of Hayek's
schema, this is an important qualification for a further reason. An
organization run entirely by commands could only reach a limited
degree of complexity, as it would be unable to make use of the
tacit knowledge possessed by its members. Therefore, as Hayek
maintains:
Every organisation in which the members are not mere tools of the organ-
iser will determine by commands only the function to be performed by
each member, the purpose to be achieved, and certain general aspects of
the methods to be employed, and will leave the detail to be decided by
the individuals on the basis of their respective knowledge and skills.
(1973:49)

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Hayek admits that even in organizations, and depending on the

degree of complexity the commanding authority wishes to achieve,
the latter may also employ rules rather than merely commands for
the operation of the organization:
The more complex the order aimed at, the greater will be the part of the
separate actions which will have to be determined by circumstances not
known to those who direct the whole, and the more dependent control
will be on rules rather than on specific commands. In the most complex
types of organizations, indeed, little more than the assignment of partic-
ular functions and the general aim will be determined by commands of
the supreme authority, while the performance of these functions will be
regulated only by rules. (1973:50)
However, Hayek adds that "[r]ules of organization are thus sub-

sidiary to commands, filling in the gaps left by commands" (ibid., p.
49). Thus, he implies that the rules of organization are themselves the
creation of purposeful authority, and can only develop on a substra-
tum of authority relations. Furthermore, the fact that the rules of
organization originate in authority means that their character is essen-
tially different from that of the rules that lead to the formation of
spontaneous orders. Therefore, Hayek (ibid., p. 48) maintains that the
rules in the context of organizations are characterized by three attrib-
utes that distinguish them from the rules that are pertinent in the case
of orders: (1) they are not as abstract, since they must still guide the
actions of agents in specific directions; (2) they are not tacit but
explicit, since the commanding authority needs to ensure that all
agents will obey them; and (3) they are specific to the particular posi-
tion in the organization that an agent occupies.
III
In the Beginning There Were Markets?
THE TIThE OF THIS SECTION is derived from Oliver Williamson's (1975:20)

well-known remark. The deeper meaning of this statement, which
incidentally is shared by all theorists in the contractarian per-
spective on the firm, is that any form of economic organization,
including the business firm, must be thought of as having evolved
out of market exchange. Implicit in this statement is, therefore, a

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demand on theory to explain under what conditions resources with-

draw from the market in order to commit themselves to an organi-
zation. Coase (1937) explains it on the basis of the concept of
transaction costs. Alchian and Demsetz (1972), on the other hand,
explain it on the basis of the increase in technical efficiency brought
about by "team production." The former thus describes the emergence
of the firm as involving the supercession of the market, while the latter
view the firm itself as a quasi-market. The important thing to note,
however, is that for both approaches, it is the market that is given
conceptual priority.
Hayek's position on this issue is less straightforward. The sponta-
neous order of the market is a rather recent historical phenomenon.
Arguably, therefore, in historical time organizations may have pre-
ceded orders that approached the ideal of spontaneity. One can think
of a whole array of such organizations, some of them still around
today, from clans, families, states, and armies, to amateur sport
teams.11 In each of these cases the central characteristic of organiza-
tion is present-members are subject to a command structure-but
their emergence may have taken place in contexts that have nothing
to do with the spontaneous market order.
However, here we are interested in one specific kind of organiza-
tion: the business firm. Although, historically, firm-like forms may
have emerged in institutional frameworks that differ greatly from the
spontaneous market order as we know it today, there can be little
doubt that the modern business firm presupposes the existence of
that order, i.e., it is embedded in it. There are two attributes of the
firm that necessitate this. The first is that it is an organization whose
membership is entirely voluntary.12 The second stems from the fact
that it constitutes a unitary actor in the markets for inputs and outputs.
Therefore, its operation in these markets presupposes an institutional
framework that makes this operation possible. Thus, there seems to
be a prima facie similarity between the views of Hayek and those of
contractarian theorists.
And yet that would be a misleading conclusion. The fact that the
organization of the modern business firm is embedded in the spon-
taneous market order should not be taken to mean that it has emerged
out of ordinary market contracting. But this only begs the question:

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In what way does the contracting process that brings the firm into
existence differ from ordinary contracting in the marketplace? The
answer we can derive from Hayek's distinction between orders and
organizations is that the latter are always characterized by the exis-
tence of a purpose or, to put it in different terms, that an organiza-
tion presupposes an "organizer," not necessarily as a physical person
but certainly as a locus of purpose. Therefore, while we can envis-
age the firm as coming about through a process in which various
resource owners contract, in the organization, its existence itself
hinges on something distinct from this contracting process: the
fact that the organization is already-i.e., even before its formal
emergence-infused with a purpose.
Let us try to work out the microanalytics of this assertion. Imagine
three types of agents (A, B, and C), who all enter into contracts for
the exchange of resources, goods, and services with agent D. For our
purposes here, we can think of agent D as constituting the legal
person of "the firm." Agents of type A enter into spot transactions
with D; thus we can think of them either as suppliers or as customers
of D. Each transaction between a type A agent and agent D is always
perceived by both as an one-off deal that does not build a relation
between them after its completion. Agents of type B enter into long-
term relations with D, in the sense that, although they remain the
owners of their assets, the value of those assets is affected by D's
behavior. Their relation with D may be upstream (e.g., subcontrac-
tors, long-term suppliers, creditors, workers, etc.) or downstream
(e.g., customers of D who value the continued relation with the firm).
Finally, type C agents enter into a special kind of contractual relation
with D under which they transfer the ownership of their assets to
D in exchange for a share of D. Obviously, the value of this share
is affected by D's behavior. Table 1 summarizes the major attributes
of these three types of contracts.
The important thing to note is that the contracts between any type
of A, B, or C agents and agent D can be thought of as standard con-
tracts governing the exchange of property rights to assets or final
goods and services. Presumably, every agent must be considered as
having his or her own purpose for entering such a contract. However,
there is an important difference between A-D contracts, on the one

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Table 1
Type of Character of Submission to Exit or voice options for

contract exchange D's authority agents A, B, and C
A-D Spot NO (symmetry Exit

of agents'
purposes)
B-D Long-term YES (asymmetry Voice but possibility

of agents' of exit on contract
purposes) completion
C-D Transfer of YES (asymmetry Voice but possibility

ownership of agents' of exit by abandoning
purposes) ownership of D
hand, and B-D and C-D, on the other. The former, having as they do
the character of spot exchanges, are characterized by a symmetry of
the agents' purposes, in the sense that neither party in the contract
can impose his or her purposes on the other. In contrast, the latter
are characterized by an asymmetry, for although both parties in the
contract have their own purposes for entering it, it is D's purposes
that acquire special importance as soon as the contract is entered into,
i.e., expostfacto.
The above schema is very close to the idea described by Williamson
(1985a:61) as the "fundamental transformation" in contractual rela-
tions, which stems from the fact that contracts have both ex ante as
well as ex postfacto implications for the relations between the con-
tracting parties."3 With Williamson, we view B-D and C-D contracts
as giving rise to an organization, whereas A-D contracts do not.
However, unlike Williamson-who insists that this transformation can
be explained by transaction cost considerations-and with Hayek, we
consider this transformation to arise from the fact that agent D is in
a special position through which he or she is able to subject the
resources of agents B and C to his or her purposes. Therefore, agent
D must be viewed as a special kind of agent: an entrepreneur. Note
that this description is consistent both with Israel Kirzner's (1973)

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theory of entrepreneurship as well as with that of Ludwig Lachmann

(1956). For the former, the major characteristic of entrepreneurial
behavior is the discovery of profit opportunities, while, for the latter,
the entrepreneur is the agent who decides the structure of capital
goods in a process of production.14 Obviously, agent D can do exactly
that with the resources that agents B and C contribute.
However, in Hayek's ideas, whose relevance for economic organ-
ization we are exploring here, organizations are not only character-
ized by purpose, but also by the fact that they constitute command
structures. Actually, it is the fact that commands are needed for the
running of the organization that ensures that purpose will always be
a distinguishing characteristic of this type of order. But how consis-
tent is the fact that organizations are run by commands with the frame-
work proposed above? Or, to put the same question in different terms,
how can the concept of authority-which the notion of command
implies-be reconciled with the idea of voluntary participation in the
organization, which is implied by the fact that all agents enter into
their contracts with agent D entirely voluntarily?
In fact, the ideas of voluntary contracting and authority can be rec-
onciled if we consider the submission to the authority of agent D to
be part of the contract that agents B and C decide to accept.15 There-
fore, in order that type B-D and C-D contracts do not amount to an
abolition of voluntary contracting, we have to assume that the parties
to these contracts retain the option to exit the arrangement at con-
tract completion. In fact, we can think of type A-D, B-D, and C-D
contracts as a continuum from arrangements that grant priority to the
exit option, to arrangements that represent mixes of both exit and
voice options.16 It is precisely because the possibility to exit the organ-
ization remains open that the fact that the parties agree to a contract,
which gives agent D effective authority over their resources, does not
violate the voluntary nature of the contracting process, nor does it
thereby cancel the fact that organizations must still be viewed as
springing from spontaneous orders.'7
Is the above schema consistent with Hayek's views on spontaneous
orders and organizations? We believe that it is, as it retains two of his
key ideas: first, that organization springs from spontaneous order and
second, that the major distinguishing characteristic of organization is

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that it is infused with a purpose. In this account, therefore, business

firms must be viewed both as emerging from the market process and
as being something distinct from the spontaneous market order. The
question we now have to address is how this account of the nature
of business firms compares with the ideas of the contractarian
perspective on the firm.
The nexus-of-contracts strand of the contractarian perspective
(Alchian and Demsetz 1972; Jensen and Meckling 1986; Fama 1980)
views the firm as a quasi-market. Agents participating in the firm are
thus viewed as entering into spot contracts with it, through which
they are able to effectively control the value of their resources and
to ensure optimization. Because contracts binding all parties are
viewed as ensuring efficiency ex ante, there is no such thing as a
"fundamental transformation." Thus purpose is not seen as an essen-
tial element of the organization, except in the trivial sense that it is
diffused among all contracting parties in the same sense that all
market dealings presuppose that agents have their own purposes for
conducting them. On these grounds, in the original formulation of
this approach, Alchian and Demsetz (1972:779) explicitly criticize
Coase (1937) for admitting a role for authority in his account of the
nature of the firm.'8 Viewing the firm as a nexus-of-contracts, this
approach considers the exit option as the only available option for
contracting parties, quite in line with standard market exchanges.
By contrast, our Hayekian view of the business firm seems to share
important insights with the transaction costs approach. The empha-
sis on the issue of authority was already explicit in the first formula-
tion of the paradigm by Coase (1937:393), where he describes the
firm as coming about through the decisions of asset owners to assign
the use of their resources to an entrepreneur-organizer, based on
transaction costs considerations. This attitude is also evident in
Williamson's notion of the fundamental transformation of contractual
relations (1985a), which we have already mentioned.'9 It is also
evident in the "incomplete contracts" theory of the firm (Grossman
and Hart 1986; Hart 1995)-arguably an off-shoot of the transaction
costs approach-which does not merely emphasize ownership but
also argues that which of the parties in a vertical relationship becomes
the owner of joint assets has vast efficiency implications. The rele-

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vance of the latter approach for our Hayekian schema are even more
important, as Hart's account seems to be in a position to decisively
link the locus of command with that of purpose.
However, unlike transaction costs theory, the Hayekian approach
that we are developing here does not depend on the type of trans-
actions that the parties contract for and the costs associated with them.
In our account, what distinguishes economic organizations such as
the firm from the market is the special purpose of a specific agent to
set up an organization (agent D in our schema), i.e., the entre-
preneurial element in firm creation. It follows that, although the
specific attributes of a transaction may indeed have important impli-
cations for the organizational arrangement that the parties will seek
to establish, the business firm as a general category of economic
organization must be thought of as independent of these specific
attributes of transactions.
Let us sum up our discussion in this section. Hayek's approach to
organizations is certainly consistent with the view that "in the begin-
ning there were markets." However, the "in the beginning" part of
this sentence has a different meaning for Hayek. It does not merely
refer to the fact that the contracting process that brings the firm into
existence is taking place within the context of market institutions-
i.e., the spontaneous market order-but, most importantly, that this
contracting process is driven by the purpose of an agency that is
aiming to set up an organization.
IV
The Firm: Equilibrium or Order?
WHAT UNIFIES THE contractarian perspective on the firm as a research

program is that it attempts to analyze the existence, function, and
scope of economic organization by applying the tools of standard
neoclassical theory.20 Prominent among these is the notion of equi-
librium. This prominence is most evident in what is usually described
as the nexus-of-contracts approach to the firm. Thus, Demsetz
(1988:194) describes the theory of the firm as the theory of the equi-
librium business organization. Jensen and Meckling argue that "the
behavior of the firm is like the behavior of a market: i.e., the outcome
of a complex equilibrium process" (1986:220). However, transaction

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costs theory broadly shares this preoccupation with equilibrium, as it

is evident from Coase's (1937) account of the determination of the
boundaries of firms. By contrast, we have seen that Hayek explicitly
introduces the concept of order as an alternative to that of equilib-
rium. In his account, as we have also seen, what distinguishes orders
from equilibrium states is, first, that they must be conceived of as
processes unfolding in real time and, second, that they must be
thought of as structures within which the operation of their con-
stituent elements is constantly coordinated. Based on Hayek's concept
of order, and bearing in mind that organizations constitute orders of
a special kind, the question that arises is in what way this view differs
from the equilibrium account of the business firm of contractarian
approaches.
We will now attempt to construct a concept of the business firm
as an order. We may begin by establishing the factors that must be
thought of as maintaining the firm as a productive organization.
Obviously, the benchmark we propose here is one that says that the
firm will either exist or not, and, if the former is the case, we need
to establish the conditions for its existence in a dynamic framework.
This means that these conditions must not be thought of as static
requirements for the firm to exist, but that they must be themselves
perceived as processes.
Condition 1
Agent D-i.e., the "firm"-must maintain positive participation rents

for agents of types A, B, and C, in order to ensure their continued
participation in the organization. Note that the concept of rent is here
used in a subjectivist sense, i.e., it relates to the subjective opportu-
nity remuneration that each agent believes to be feasible. It follows
that what is important for the maintenance of the firm as a produc-
tive organization is not the continuity of the participation of specific
agents but, rather, the continuity of the supply of specific services.
Condition 2
Agent D must be in a position to coordinate the actions of agents A,

B, and C. There are two senses in which agent D must be thought

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of as coordinating the actions of others. First, this coordination must

bring about a structure of the resources that agents A, B, and C
contribute, which is appropriate for the attainment for the firm's
objectives-i.e., agent D's purpose, as we discussed in the previous
section. Second, agent D must be in a position to (a) absorb the
knowledge obtained by the constituents of the firm in the process of
production, (b) take this knowledge into consideration in the pursuit
of his or her purpose and, most importantly, (c) revise the initial
purpose on the basis of it.21 It is obviously in this latter sense that the
idea of coordination acquires a really dynamic quality.
Condition 3
The purpose of agent D, the "firm," must be accepted by the market;

to put it another way, the firm's products must find customers. Note
that this is not meant to signify anything more than that, somehow,
the objectives of the firm do not prove to be entirely unsustainable
by the market environment, an eventuality that would mean that the
firm has no reason to exist. On the other hand, it is not supposed to
signify anything more than that; it is not a statement on whether the
price that the products fetch in the market and the quantity that the
firm sells are acceptable. Let us describe this condition as "the market
test."
Let us point out that all three conditions are genuinely "dynamic"
in the sense that each one of them constitutes a "process." Further-
more, the three processes are obviously interconnected; thus each
one of them affects the way the other two unfold in real time. For
example, if Condition 1 is not met, the firm will lose assets, which
will affect the coordination of its resources and, of course, the effi-
cacy with which it meets the market test. If Condition 2 is not met-
i.e., if the firm coordinates its resources poorly-its position in the
market for outputs will deteriorate and, with it, its ability to ensure
rents for its assets. Finally, if the firm performs badly in output
markets, this will affect both its ability to pay rents, as well as the
way its resources will be coordinated in the future.
How do the above relate to the equilibrium conceptualization
of the firm? To answer this question, we need to establish the exact

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conditions of the contractarian conceptualization. According to Foss

(1998:182-83), there are three such conditions:22 (1) an implicit
assumption that alternatives are given, thus depicting agents as having
to choose among a very clearly defined set of contractual alternatives;
(2) a suppression of process, which implies a view that the optimal
solution to the contract-design problem continues to be optimal
throughout contract execution; (3) a set of strong knowledge assump-
tions, thus leaving no room for theory to conceptualize the discov-
ery by agents of what was hitherto unimagined. Obviously, all three
problems have a special bearing on the concept of equilibrium, in
the standard neoclassical meaning of the term. The first abolishes
uncertainty; the second ensures the static nature of the analytical
framework; and the third rules out the possibility that agents may
behave entrepreneurially, in the Kirznerian sense.
By contrast, the conceptualization we have introduced avoids these
problems, thus transcending the equilibrium notion of the firm. Let
us see why. Our Condition 1 implies that the firm must strive to retain
its resources. Obviously this striving must really be understood as a
process, for the rents that must be paid to the members are not given
and known to the firm in any relevant sense, first, because they are
constantly affected by market developments-the competitive strug-
gle for resources by other firms-and second, because we have char-
acterized rents as subjective estimates, which may change as agents'
subjective expectations of opportunity rents change. Therefore, in
terms of Condition 1, the maintenance of the firm as an order depicts
a ceaseless process unfolding in real time in conditions of uncertainty
and, thus, creating the need for entrepreneurial discovery, even in
the simplest sense of trying to keep one step ahead of developments
in the markets for resources.
Our second condition calls for the coordination of resources within
the firm. Again, we have here a conception that avoids the problems
of the contractarian perspective that Foss points out. First, the fact
that the firm must coordinate its resources to achieve its purpose and,
more importantly, to coordinate the knowledge created in the process
of production means that the process of coordination itself constantly
creates novel situations that the firm must "learn" in order to be able
to coordinate successfully. This is the really complex problem that

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precludes a view of coordination as the optimal ex ante solution to

a principal-agent setup. Second, our Condition 2 describes a situation
where novelty-not only in the market but even within the firm
itself-is created and thus has to be discovered and exploited if coor-
dination is to be effective.
Finally, our third condition introduces entrepreneurship in output
markets as an essential factor for the existence of the firm. In the
dynamic perspective we are trying to develop, the firm's market per-
formance cannot but be entrepreneurial, for the simple reason that
the market is perceived as a process that creates novelty. In this
context, therefore, the idea that the firm has to choose among a clearly
defined and especially bounded set of alternatives cannot be sus-
tained. Moreover, our schema implies that profit opportunities are no
only "out there"-in the marketplace-for the firm to discover and
exploit, but are also to be found within the firm. They are created by
the learning processes set in motion by the firm's specific production
activities; thus, creating capabilities and the discovery of their poten-
tial is as an entrepreneurial a function as that of the discovery of
opportunities in the market proper.
The approach we are proposing here in order to conceptualize the
firm as an order rather than an equilibrium phenomenon is essen-
tially an "evolutionary" one in the sense that we referred to that strand
in the Introduction. The emphasis on entrepreneurship and, espe-
cially, on the internal capabilities of the firm as objects of entrepre-
neurial discovery establishes that change must be perceived as an
endogenous phenomenon, rather than as response to exogenous
shocks. On the other hand, the fact that the resources employed by
the firm are heterogeneous and yield multiple capabilities, that the
firm's success in coordinating them may be variable and that the firm's
behavior is itself entrepreneurial, in the sense of unpredictable on a
priori considerations, means that the operation of firms tends con-
stantly to produce a variety of characteristics. Finally, it is precisely
this variety of characteristics that forms the "pool" on which the selec-
tion process-i.e., the market test-operates.23
Let us sum up our discussion in this section. We have attempted
to construct a conceptualization of the firm as an order, rather than
as an equilibrium phenomenon. We have thus proposed a view of

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the firm as a set of interconnected processes. The analysis here has

been inspired by Hayek's distinction between spontaneous orders and
organizations and his insistence that the latter constitute a special class
of the general category of order. The relevance of this analysis for a
theory of the firm stems from the fact that it highlights such issues as
entrepreneurship, endogenous change, variety, and the importance
of the capabilities of the firm. On these grounds, a conception of the
firm based on Hayek's notion of order, signifying a process unfold-
ing in real time, leads to a view of the firm that differs significantly
from the static outlook of contractarian theories.
Rules, Commands, and Purposefil Direction
So FAR, OUR ARGUMENT has proceeded taking Hayek's distinction

between spontaneous orders and organizations-the former resting
on rules, the latter on commands-literally; i.e., our discussion of the
business firm has been compatible with a view of its essence merely
as a command structure. However, we have seen that Hayek admits
a role for rules in organizations, although he argues that the charac-
ter of these rules will have important differences from the rules that
lead to the formation of spontaneous orders. We now broaden the
analysis and introduce rules as an essential element for the running
of business firms.
The introduction of rules in organizations raises two distinct but
interrelated questions. The first concerns the reasons for this intro-
duction and the ways that it affects the nature of economic organi-
zation. The second, and perhaps more fundamental, question is
whether the introduction of rules blurs the distinction between spon-
taneous orders and organizations as proposed by Hayek. If the latter
is indeed the case, the question that naturally arises is whether
rule-following behavior within organizations may transform their
character into that of spontaneous orders.
We address these questions in turn. The necessity of rules in organ-
izations stems essentially from the same knowledge argument-we
could equally well interpret it as an ignorance argument-that per-
meates the whole of Hayek's social theory.24 If business firms were

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to be run on the basis of commands alone, the commanding author-

ity would have to concentrate the knowledge possessed by its
members in order to be able to come up with the most appropriate
specific command for every instance. Although such an operation is
not unthinkable in the context of small-scale business organizations,
it obviously becomes increasingly difficult as the firm grows both in
size and, especially, in complexity. It is not just the fact that the sheer
volume of knowledge with which the commanding authority would
have to cope would set limits to that growth. More importantly, a firm
operating on commands alone would lose the possibility to tap
two sources of knowledge: (a) the tacit knowledge possessed by its
human assets25 and (b) the discovery, again by the firm's human
assets, of new opportunities for more effective use of the firm's
resources. In other words, just as in the case of spontaneous orders,
rules in organizations promote the effective use of knowledge.
But while the introduction of rules increases the level of complex-
ity that the organization may attain, this complexity itself cannot but
affect the balance between rules and commands in a variety of ways.
To begin with, the more complex the organization becomes, the more
commands will tend to acquire a character of generality, thus blur-
ring the distinction between rules and commands.26 Further, the intro-
duction of rules affects the character of the organization by gradually
changing the nature of organizations from concrete to abstract orders.
Recall that Hayek's distinction between the two types of order rests
on whether their operation can be realized intuitively or whether the
observer requires a theory relating the various elements of the order.
Obviously, the more that general rules, rather than commands, are
relied upon for the operation of the organization, the more this oper-
ation will defy intuitive understanding and will require the construc-
tion of a theory to explain the relations among the elements that
compose it. And there is a third point. According to Hayek, abstract
orders tend to rest on abstract rules. But if that is the case, one
of the major distinguishing characteristics of rules in the context of
organizations, compared to rules in the context of spontaneous
orders, tends to disappear.
These considerations surely lead us toward a conception of organ-
ization as an entity whose growth necessarily entails ever-increasing

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degrees of complexity and abstractness. Thus we come to the second

question we raised above: whether organizations can evolve to
become spontaneous orders. In essence, this question is the reverse
of the one we explored in Section III. Instead of asking whether
organizations grow out of spontaneous orders, we now ask whether
they can evolve back to spontaneous orders. We have already seen
in Section II why this is not likely in Hayek's account-his emphasis
on purpose as the defining characteristic of organizations. However,
before we can investigate the adequacy of Hayek's argument, we
need to analyze the matter in greater detail.
We begin by asking why this is a valid question. There are several
issues to consider here. First, we have seen that, according to Hayek
(1973:43), spontaneous orders can emerge out of systems of delib-
erately constructed rules. Of course, Hayek maintains that the rules
of organization differ significantly from the sort of rules that may lead
to the formation of spontaneous orders. However, the essence of this
argument is static, in the sense that it refers to the typical nature of
rules in the context of the two kinds of orders without addressing the
dynamic issue we raised above: that as organizations become more
complex and abstract, the rules themselves that govern their opera-
tion cannot but tend to become more abstract.
The second, and even more important, issue relates to the changes
in the nature of organizations that result from the fact that their oper-
ation is guided by rules rather than by commands alone. The intro-
duction of rules means that the human assets of the business firm are
given the opportunity to exercise judgment and act accordingly,
within the general framework set by the rules. But what this freedom
of action means is that, within the firm, the interactions among its
members will tend to establish ever-new rules for the coordination
of their activities, within the rules of organization set by the com-
manding authority. These rules will be largely spontaneous, in the
sense that none of the agents of the firm will have planned them.
They will surely have unintended consequences, as no agent will be
in a position to foresee how each of these evolved rules is likely to
affect the operation of the firm in the future.27 Finally, the persistence
or disappearance of these evolved rules must be thought of as taking
place in the same way that Hayek has described for the rules of

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conduct in the case of spontaneous orders. The interaction among

firm members tends to create ever-novel mutations of the rules.
Following Nelson and Winter (1982), we can think of these spon-
taneously evolved rules of organization as routines that the operation
of the firm (we should add: the growth of the firm both in size and
complexity) will tend to produce. Given their spontaneous nature,
these routines must be thought of as embodying a knowledge that is
both tacit and shared by the human assets of the firm. As the rules
in the case of spontaneous orders, their role is to allow agents to
cope with ignorance and to act in ways that make their actions com-
patible with each other, thus promoting the survival of the overall
organization. Richard Langlois offers a concise description of the char-
acter of these routines and links the concept to Hayek's theory: "The
... personnel of a firm follow, invent, learn and imitate routines that
persist over time. As in Hayek's theory of culture, the routines are
often tacit and skill-like, followed unconsciously because they
produced success in the past" (1992:176).
A third issue relates to Langlois's observation that routines tend to
"persist over time." This is not merely a general property of routines.
It is an essential characteristic of their ability to effect coordination
not only in the contemporaneous sense of making mutual actions
compatible, but also in the inter-temporal sense of allowing action to
take into account past experience of successful actions. This aspect
of rules is no less pertinent in the case of business organizations than
in the case of spontaneous orders. It establishes the fact that an
attempt to reconstruct spontaneously evolved rules-both in sponta-
neous orders and in organizations-may involve a great cost, which
may not be immediately obvious. For although it may appear to be
able to bring about a more effective coordination of contemporane-
ous acting, it may destroy the possibility of agents to tap the accu-
mulated knowledge that past experience, embodied in spontaneously
evolved rules, entails. The significance of this realization will become
evident below.
There is a fourth issue that has to do with the relation between
rules set by the commanding authority and routines or "spontaneously
evolved" rules. We have seen in Section II that Hayek (1973) talks
about three different origins of rules of conduct. He also (1979:159)

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talks about "layers" of rules. Man-made rules are described as "the

thin layer of rules, deliberately adopted or modified to serve known
purposes." Hayek's discussion of this issue refers to spontaneous
orders exclusively. However, there is no reason to believe that this
"layered" account of the relations between various types of rules
cannot be extended to business organizations. In the latter instance,
the thin layer of rules that Hayek refers to would include both com-
mands and rules that are set by the commanding authority. There
would still be, however, a layer of routines or spontaneously evolved
rules beneath that layer. We will argue below that the important issue
in the context of business organizations concerns the relations
between the two layers. But the important thing to stress is that the
layer of routines will always be there, forming, as it were, an integral
part of the organization's makeup.
We can now turn to the question of whether the recognition of the
existence, reproduction, and spontaneous growth of routines within
business firms may lead to a transformation of their nature from
organizations to spontaneous orders. We have seen that this trans-
formation cannot be rejected on the grounds of Hayek's distinction
between the types of rules that are pertinent in each of these two
kinds of order. Therefore, if this possibility is to be denied, the argu-
ments must be sought elsewhere.28 We believe that the important
notion here is that of purpose, which, according to Hayek, is the major
distinguishing characteristic of organizations.
We saw in Section II that Hayek proposes the concept of purpose
in order to describe the character of man-made orders prior to any
discussion of the distinction of the nature of the rules that are perti-
nent in spontaneous orders and organizations. We have also stressed,
again in Section II, the ontogenetic character of this argument when
we observed that, according to Hayek, a further criterion for the dis-
tinction between orders and organizations is whether their origin is
spontaneous or deliberately designed. We can now give to this inter-
pretation a more dynamic flavor by arguing that it is precisely the
existence of purposeful direction that precludes a business organiza-
tion from being transformed into a spontaneous order. Therefore, a
business firm will retain its character as an organization for as long
as purposeful direction is effectively exercised.

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We can easily transfer the notion of purposeful direction to the

context of our discussion of the relation between organizational rules
and spontaneously evolved routines. Hayek's idea of layers of rules
is again useful here. What purposeful direction means in this context
is that the commanding authority of the firm can effectively, if it so
chooses, alter the relation between the two kinds of rules. For
example, it may decide to widen the scope of commands and rules
of organization and, at the same time, restrict the scope of sponta-
neously evolved routines. In Hayek's schema of layered rules, this
would mean that the top level of designed rules would be thickened
at the expense of the lower layer of spontaneously evolved rules.
Alternatively, if the spontaneously evolved routines are judged to
enhance the chances of the firm to be profitable, the commanding
authority may decide to restrict its reliance on commands and
centrally imposed rules and thereby encourage the growth and
reproduction of routines.
The above line of argument seems to suffice in order to account
for the stability of the organization of the business firm, in the sense
that the firm retains the character of an organization rather than slip-
ping into the status of spontaneous order, despite the fact that it tends
to encourage the spontaneous creation and adoption of routines.
However, it is precisely this line of argument that also reveals the
evolutionary character of Hayek's schema by introducing historicity
into our understanding of the firm. We will end this section by
showing why this is necessarily the case.
While the exercise of purposeful authority can be thought of as
aiming at "putting the elements of a set in their places" (Hayek
1973:37), this should not be taken to mean that this exercise is entirely
unconstrained. Our focus here is not on the constraints imposed by
markets and prices but, rather, on the internal constraints arising from
the past evolution of routines within the firm. We have seen that these
routines have two significant attributes: (a) they evolve as unintended
outcomes-unintended both by the commanding authority and by the
human assets employed in the firm-of human interactions within the
organization; and (b) they embody the experience of the organiza-
tion and thus are instrumental in bringing about inter-temporal coor-
dination. What this means is that, although the aim of the exercise
of purposeful direction may be to restructure the balance between

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commands and spontaneously evolved routines, it will inevitably

operate on a terrain of historically given facts. Therefore, both the
decision of the commanding authority to act in order to alter the mix
of commands and spontaneously evolved routines, as well as the
options for action that are open to the commanding authority, will
be heavily constrained by the history of the organization. In other
words, they will be history-contingent.
Importantly, it is not just the history of past decisions and actions
of the commanding authority itself that create these constraints, but
the history of the unintendedly created routines and capabilities of
the firm's operation. Thus, the situation within which the command-
ing authority contemplates what action to pursue is one that, to a
large extent, was unintended by its actions in the past. It is precisely
here that the evolutionary element of our construction comes out most
prominently. For however rationally the commanding authority
intends to act, its actions will be necessarily constrained by the muta-
tions-the spontaneously created routines-that the operation of the
organization will constantly tend to produce.
Let us sum up our discussion. We have argued that the operation
of the firm leads to the spontaneous creation of routines. This could
lead to a process where, as the firm grows in complexity, it tends to
be transformed from an organization into a spontaneous order. The
denial of this possibility cannot be grounded on Hayek's distinction
between the kinds of rules that are pertinent in the case of sponta-
neous orders and those that are pertinent in the case of organizations
but, rather, on his insistence that the notion of purpose constitutes
the major distinguishing characteristic of organizations. However, we
have argued that it is precisely the fact that purposeful direction is
exercised within the context of spontaneously evolved organizational
routines that introduces historicity as an essential notion for the analy-
sis of firms' development.
VI
Concluding Remarks
WE HAVE ATTEMPTED in this paper to apply to the theory of the firm

some insights we have drawn from Hayek's distinction between spon-
taneous orders and organizations. First of all, we have argued that

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these insights allow an understanding of the firm as the outcome of

a contracting process that, however, is distinct from ordinary market
contracting. The importance of the argument lies in the fact that it
seems to be able to avoid the market-hierarchy dichotomy, which is
taken as a given in most research on the firm. Second, we have seen
that Hayek insists that order should be understood as a process rather
than as an end state. On these grounds, we have constructed a view
of the firm as a set of interconnected processes. Finally, we have
argued that, as the firm grows in complexity, it becomes a nexus of
both spontaneous and purposefully initiated processes. It is the latter
processes that maintain the firm as an organization, through the exer--
cise of what we have termed purposeful direction.
Our Hayekian insights lead to a restatement of the evolutionary
perspective on the firm, as they support in a novel way (a) the
endogenous nature of the forces of the development of the firm, (b)
the fact that this development incessantly produces novelty and
variety in the characteristics of firms, and (c) that the growth of the
firm must be understood as a history-contingent process. The impor-
tance of this analysis stems from the fact that our "evolutionary"
approach to economic organization introduces an understanding of
the firm as a process, while it still views the firm as a contractual
arrangement among asset owners. Therefore, if our line of argument
is valid, it seems that Hayek's ideas may provide the starting point
for the construction of a unified theory of the firm, capable of incor-
porating the key ideas both of the contractarian and the capabilities
perspectives.
Notes
1. Although most Hayek scholars would agree on such a periodization,

there is considerable disagreement concerning the underlying reasons for his
shift in focus. As far as Hayek's methodology is concerned, Gray (1986)
explains it as a move away from the a piorism of Ludwig von Mises toward
a sort of Popperian falsificationism. As far as his analytical concepts are con-
cerned, he is believed to approach a fuller understanding of the role of
knowledge in social processes (Caldwell 1997), especially tacit knowledge.
Finally, in terms of his underlying philosophical positions, Fleetwood (1995)
describes this shift as a move away from empirical realism toward what he
terms "quasi transcendental realism."

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2. At least, not in the sense that this term is used nowadays. Of course,
in a broader sense, the organization of social economic activity has always
been the focus of Hayek's work.
3. See Witt (1994), Langlois and Robertson (1995:Chs. 2 and 3), Foss
(1993), and Hodgson (1998a, 1998b).
4. Which, given the evolutionary character of his social theory, should not
come as a surprise.
5. See Fleetwood: "order, unlike equilibrium, is not an alternative descrip-
tion of an end state but rather a continual process of reproduction and trans-
formation" (1995:141).
6. On this basis Hayek (1964) considers the phenomena of society as
"complex," and concludes that the most the social scientist may hope to estab-
lish is a prediction of the "pattern" of actions.
7. See Hayek's discussion of the general character of spontaneous order:
"Spontaneous orders need not be what we have called abstract, but they will
often consist of a system of abstract relations between elements which are
also defined only by abstract properties, and for this reason will not be intu-
itively perceivable and not recognizable except on the basis of a theory
accounting for their character. The significance of the abstract character of
such orders rests on the fact that they may persist while all the particular ele-
ments they comprise, and even the number of such elements, change. All
that is necessary to preserve such an abstract order is that a certain structure
of relationships be maintained, or that elements of a certain kind (but vari-
able in number) continue to be related in a certain manner" (1973:39).
8. We have already mentioned that it is the concept of spontaneous order
that forms the cornerstone of Hayek's entire social theory. As he himself
stresses: "It would be no exaggeration to say that social theory begins with-
and has an object only because of-the discovery that there exist orderly
structures which are the product of the action of many men but are not the
result of human design" (1973:37).
9. See Hayek: "What man probably found most difficult to comprehend
was that the only common values of an open and free society were not con-
crete objects to be achieved, but only those common abstract rules of conduct
that secured the constant maintenance of an equally abstract order which
merely assured to the individual better prospects of achieving his individual
ends but gave him no claims to particular things" (1979:164).
10. A few lines later Hayek adds: "That even an order which rests on
made rules may be spontaneous in character is shown by the fact that its
particular manifestation will always depend on many circumstances which
the designer of these rules did not and could not know" (p. 46).
11. See Vanberg (1994:267) on the variety of organizations.
12. Thus a slave plantation in the pre-Civil War American South would
not qualify as a modern business firm, despite the fact that it was character-
ized by the second attribute.

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13. There is one difference from Williamson, however, as his analysis

focuses on only one specific characteristic of the ex post facto situation: the
bilateral monopoly character of long-term interpersonal contracts.
14. The present author has attempted to construct an "Austrian" theory of
the firm on the basis of Kirzner's theory of entrepreneurship (Ioannides
1999a). For a similar attempt based on Lachmann's theory, see Dulbecco and
Garrouste (1999).
15. Obviously, this is not the case for type A agents.
16. We adopt here, of course, the framework introduced by Hirschman's
(1970) distinction between the two options.
17. This should not be taken to mean that agents are indifferent between
the two options. This is obviously not the case, as we have assumed that the
value of their resources depends on agent D's behavior. Thus, each option
entails costs that the agent may decide to incur or not.
18. The monitoring function, which Alchian and Demsetz (1972) describe
as an essential feature for the existence of the firm, does not constitute a
locus of authority, for it is assumed that the constituents of the firm recog-
nize this function as one that leads to optimization, by reducing moral hazard
(i.e., free-riding).
19. And it is especially evident in his account of vertical integration
(1975:Chs. 5, 6, and 7), where he stresses the fact that only joint ownership
can ensure the continuation of the firm as a command structure. In our
schema, this is equivalent to giving emphasis to C-D type of contracts as
setting up the core of the firm, i.e., its locus of command.
20. See the description of the research program by three of its most dis-
tinguished proponents: Ronald Coase (1984), Oliver Williamson (1985b), and
Douglas North (1986).
21. This idea draws, of course, from the concept of the firm as a "bundle
of resources" of Edith Penrose (1959).
22. Arguably, Foss refers here to the general problems of the contractual
perspective of the firm, which, in his view, make an Austrian theory of the
firm relevant. He does not refer specifically to the equilibrium conceptual-
ization of the firm. However, the problems he describes are especially impor-
tant in the context of that conceptualization.
23. However, the important thing to notice in this account is that the
"mutations" of firms' characteristics on which the selection process operates
are purposeful entrepreneurial actions, rather than random events.
24. See Langlois (1992:176) and Vanberg (1994:114).
25. A kind of knowledge, in other words, which is uncentralizable because
of its very character. See Hayek (1963:61).
26. See Vanberg (1994:114).
27. Arguably, what is usually referred to as "business culture" must be
viewed as comprising the rules and business practices of both kinds, i.e.,

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Hayek and a 7heory of Economic Organization 565
both the ones set by the commanding authority as well as those that evolve
spontaneously within the firm.
28. See loannides (1999b) for further discussion on this issue.
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Orders and Organizations: Hayekian Insights for a Theory of Economic Organization

Author(s): Stavros Ioannides

Stable URL: https://www.jstor.org/stable/3487810

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Orders and Organizations

Hayekian Insights for a Theory of Economic

ABSTRACT. We explore the relevance to the theory of economic

ACCORDING TO THE standard periodization of Hayek's work, we have

*The author is Associate Professor of Economics at the Department of Political

stioan~panteion.gr. His research focuses on Austrian economics, evolutionary a

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mature Hayek, who focused on wider spheres of the social sciences

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distinction between spontaneous orders and organizations allow us

Hayek on Spontaneous Order and Organization

ONE OF THE FEATURES of Hayek's work that makes it especially relevant

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At least three points must be noted in the above statement. The

Let us note here Hayek's emphasis on the notion of acquaintance,

By contrast, the orders that he describes as "concrete" can be per-

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to mentally reconstruct their function or having to construct a theory

Such orders are relatively simple or at least necessarily confined to such

There are a number of points that need to be stressed in connec-

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order. Given this, we interpret his statement as meaning that, as a

If the existence or non-existence of a directing intelligence consti-

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describes as spontaneous. Organizations, on the other hand, are

Therefore, although rules of conduct have to be known by the ele-

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is required.... [The] rules which guide an individual's action are better

Precisely because the nature of the rules of conduct is negative

Some discussion of the three sources of rules of conduct is now

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rules, and not a hierarchical ranking of the importance of each for

Although undoubtedly an order originally formed itself spontaneously

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origins of each type of order are spontaneous or deliberately

What Fleetwood in fact describes here is the knowledge require-

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Hayek admits that even in organizations, and depending on the

However, Hayek adds that "[r]ules of organization are thus sub-

In the Beginning There Were Markets?

THE TIThE OF THIS SECTION is derived from Oliver Williamson's (1975:20)

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demand on theory to explain under what conditions resources with-

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Type of Character of Submission to Exit or voice options for

A-D Spot NO (symmetry Exit

B-D Long-term YES (asymmetry Voice but possibility

C-D Transfer of YES (asymmetry Voice but possibility

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theory of entrepreneurship as well as with that of Ludwig Lachmann

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