A Coasian critique of central planning

The optimal firm size is not the national economy

The nature of the firm (Coase 1937) argues that firms exist because it’s cheaper to perform some tasks internally rather than outsourcing them. As Ronald Coase explained, a firm grows only as long as the marginal cost of organizing an additional transaction in-house is lower than the cost of coordinating that transaction via the market. This creates an optimal firm size—a point where internal costs and market costs are balanced. The key insight here is that comparative transaction costs, in-house vs outsourced, drive decisions about what is outsourced or not, and thus about firm growth.

Now, when central planners try to run an entire economy, they are effectively managing one enormous “firm” that performs every economic activity in-house. But just as in private firms, once a firm grows beyond its optimal size, rising bureaucratic costs—inefficiencies in communication, management, and coordination—set in. These rising internal costs, or diseconomies of scale, mean that a single, centrally planned system becomes increasingly inefficient compared to a decentralized market where many independent firms each operate at or near their own optimal scale.

Put simply, firms try to minimize transaction costs, and they tend to adopt the size which achieves that goal. Imposing one massive firm controlling all of the economy does not optimize transaction costs. Otherwise firms would choose to grow to this size.

Empirical evidence supports this idea. The 2006 paper by Canbäck, Samouel, and Price demonstrates that large firms, despite benefiting initially from economies of scale, eventually experience significant efficiency losses as they expand beyond their optimal size. Their structural equation modeling of nearly 800 large U.S. manufacturing firms shows that as firm size increases, diseconomies of scale—such as bureaucratic insularity, communication distortion, and incentive limitations—become more pronounced, negatively impacting firm performance.

Thus, instead of having many firms, each operating efficiently up to its own optimal size, central planning forces the entire economy to function as one oversized entity. The result is inefficiency: tasks that could be more cheaply handled by specialized, market-based firms are instead burdened with the heavy costs of a massive bureaucratic organization.

This argument also applies to the public sector in market economies. Decision makers being insulated from the profits and losses resulting from their decision makes them particularly prone to grow governmental entities beyond the optimum point where internal transaction costs equal market transactions costs.

While Hayek’s argument emphasizes the loss of decentralized knowledge and the essential role of market prices, the Coasian perspective underscores that even with complete information, the rising internal costs of managing an oversized entity would render central planning inefficient. In summary, an economy organized as a collection of many optimally sized firms is far more efficient than one managed centrally as if it were a single massive firm.