Capabilities and governance: The rebirth of production in the theory of economic organization

This paper argues that, since Coase's seminal 1937 paper on 'The Nature of the Firm', the economics of organization has focused too exclusively on issues of incentive alignment and has ignored issues of imperfect knowledge in production. However, there is now emerging an approach to economic organization - which we call 'the capabilities approach' - that places production center-stage in the explanation of economic organization. We argue that the capabilities approach complements incentive-based theory (1) by considering the problems of imperfect knowledge in production as well as in governance and (2) by considering issues not only of incentive alignment but also of qualitative coordination among holders of specialized, distributed, and often tacit knowledge.