Ronald Coase was an economist who created the economic model for the Blockchain Economy – in 1937!70 years before the Global Financial Crisis and Satoshi’s White Paper, this academic gave us us the model that underpins the Blockchain Economy.
This is Part 1/chapter 14 in The Blockchain Economy book. This serialised book is a practical guidebook for investors, entrepreneurs and employees who want to learn how to prosper during the transition to an economy where value exchange is permissionless and disintermediated. For the index please go here.
Professor Coase, Please Explain in under 280 characters
Coase’s 1937 essay The Nature Of The Firm asked why hire employees instead of contracting tasks? His answer – a company exists because it is cheaper to do transactions within a company than outside. Blockchain has resurfaced this theory by dramatically reducing transaction costs.
In 1954, Fortune 500 companies accounted for around 1/3 of GDP in America.
By 2000, after decades of financialization, that share had become 2/3.
Hidden in those numbers are the countless family farms that could not withstand the onslaught of Agribusiness and the Mom & Pop shops that closed when Walmart came to town.
Imagine a world where that cycle reversed. Imagine that small businesses got back the 1/3 of the economy that they lost in the 50 years of the financialization economy. This may be about to happen thanks to a dramatic reduction in transaction cost thanks to the Internet. This shift will have dramatic implications for investors, entrepreneurs and employees.
Some behemoths will crumble. Big companies based on traditional economies of scale will have the complexity of size without the advantages of scale. Competitors will aggregate scale through networks rather than investing in vertical integration. For example, consider Amazon vs Walmart.
The biggest behemoth of all is government. When Big Co and Big Govt get together, we get crony capitalism. Both are vulnerable to Blockchain disruption. Governments that decide to empower small business using Blockchain will get the economic growth and empowerment that their citizens want (and those politicians will be rewarded with their citizen’s loyalty aka votes).
Companies that empower millions of small business entrepreneurs scale very well – think Amazon, AirBnB, Uber, Alibaba, Google, Microsoft. The threat to this model is when those millions of small business entrepreneurs get together in digital cooperatives to share in the economic rewards of those networks. There will still be intermediation but the take/vigorish is dramatically reduced and reduces further with scale as the digital cooperative does not need to satisfy external shareholders and so can use profits to lower prices.
Insourcing through the lens of Amazon
Amazon sits at the heart of this debate – what to insource vs outsource – in two ways:
- Amazon started by delivering through third-party companies such as FedEx, USPS, UPS, etc. Amazon has now reached the scale that it makes sense to insource this.
- Digital startups usually outsource their data centers to services such as Amazon Web Services (AWS). At a Google or Facebook level of scale it clearly makes sense to insource this. There is debate about what level of scale drives insourcing, but it is clearly scale driven.
What is notable is that the vendors being replaced – FedEx, USPS, UPS, AWS – are themselves behemoths. Amazon could hire all those drivers on payroll, but could just as easily outsource/subcontract to thousands of free agents. A Big Tech company building their own data centre still uses lot of vendors, albeit smaller niche ones.
For the vast majority of companies that scale decision is academic. For all those companies it is cheaper to do a transaction externally. I wish that Ronald Coase, who died at the ripe old age of 102, could be here to witness this.
However, the DAO (Decentralized Autonomous Organisation) vision of corporations run entirely by software, without any human employees, is unlikely to happen. For a more likely scenario, we turn to Another great thinker, Charles Handy.
The concept of a Shamrock Organisation, appropriately created by an Irish thinker in his book called The Age Of Unreason, describes an alternative to the traditional hierarchical structure where workers were closely supervised.The shamrock leaf shape symbolises an organization with three types of workforce:
- 1. Management core, which defines what the company does and what business it is in and manages the external workers. They are essential to the continuity and growth of the organisation. Their pay is tied to organisational performance and their relations will be more like those among the partners in a professional firm than those among superiors and subordinates in today’s large corporation.
- 2. Self-employed professionals or technicians or smaller specialised organisations who are hired on contract, on a project-by-project basis. They are paid in fees, with a big % based on for results. They frequently telecommute. No benefits are paid by the core organisation, and the worker carries the risk of insecurity but also gets either a lot of financial upside or the freedom to choose their lifestyle.
- 3. Contingent work force, where “employment” derives from the external demand for the organisation’s products – think Uber driver. There is no career track for these people and they perform routine jobs.
Shamrock is more likely than human-less DAO, because it enables corporations to develop intellectual property and strategic advantage.
Governance matters says Professor Case
Ronald Coase died at the ripe age of 102, reportedly disappointed that his insight was misused. There are issues with transaction costs that we addressed in an earlier chapter about governance. The biggest issue is around negative externalities aka the the fallacy of free-riders (such as pollution or costs related to growing inequality) as these cannot can be addressed simply through price discovery between producer and user. Nor can a software designer program in all exceptions (the unknown unknowns) so we have t resort to ye olde courts/judges. This is why governments exist.
Establishing trust is in itself a transaction cost. There will always be middlemen, albeit taking a much smaller fee in the Blockchain Economy.
Blockchain will change capitalism and enable a new relationship between producers and consumers. In the 20th century models, producers were shielded from the market. They were employees and consumers and their employers were producers.
Amazingly a British Academic gave us the model for this over 70 years ago before the semiconductor, PC, Internet or Blockchain was even a gleam in the eye.
Bernard Lunn is the CEO of Daily Fintech and author of The Blockchain Economy. He provides advisory services to companies involved with Fintech (reach out to julia at daily fintech dot com to discuss his services).