This neglect of other aspects of the system has been made easier by another feature of modern economic theory – the growing abstraction of the analysis, which does not seem to call for a detailed knowledge of the actual economic system or, at any rate, has managed to proceed without it.

Holmstrom and Tirole, writing on The Theory of the Firm in the recently published Handbook of Industrial Organization, conclude at the end of their article of 63 pages that "the evidence/theory ratio… is currently very low in this field". Peltzman has written a scathing review of the Handbook in which he points out how much of the discussion in it is theory without any empirical basis.

What is studied is a system which lives in the minds of economists but not on earth.

I have called the result "blackboard economics". The firm and the market appear by name but they lack any substance. The firm in mainstream economic theory has often been described as a "black box". And so it is.

This is very extraordinary given that most resources in a modern economic system are employed within firms, with how these resources are used dependent on administrative decisions and not directly on the operation of a market.

Consequently, the efficiency of the economic system depends to a very considerable extent on how these organisations conduct their affairs, particularly, of course, the modern corporation.

Even more surprising, given their interest in the pricing system, is the neglect of the market or more specifically the institutional arrangements which govern the process of exchange.

As these institutional arrangements determine to a large extent what is produced, what we have is a very incomplete theory.