The neo-classicals abhor government regulation, so naturally government setting prices (by caps and subsidies) has little appeal to the - hence they are left with self-regulating markets as the only alternative.
The problem with self-regulating markets is transaction costs (such as lawyer fees to draft and enforce contracts, imperfect information, but also marketing research, infrastructure, certain externalities etc.). The more complex the economy the higher the transaction costs. Therefore, while a self-regulating market may work in a relatively small system in which transaction costs are minimal, in a complex system such as any modern economy, they will grow exponentially, and start adding quite substantially to the cost of production, and consequently price.
Vertical integration or "hierarchy" (i.e. corporation or similar organizational form), the argument goes, can substantially reduce these exponential transaction costs, mainly by cutting contract enforcement cost, but also by adding economies of scale to improve research and marketing, thus reducing information imperfections. Consequently, the reduction of transaction cost leads to lower production cost and thus prices vis a vis free markets.
Of course that hinges on two assumptions: (i) that the transaction cost of hierarchies (such as substandard performance or fraud by organization's officers, or lower flexibility or liquidity) are lower than those of the markets; and (ii) that there some mechanism in place that prevents monopolistic practices (e.g. some form of competition or regulation). Managerial fraud and substandard performance is self-explanatory. Lower flexibility (or liquidity) can lead to higher overhead that it would be the case of market-based system. Here is why.
Suppose that manufacturer A contracts the Y amount of widgets from manufacturer B. He uses the widgets as a component part of his gizmos. After a while, A decides to save on contracting and enforcement cost and create a subsidiary that makes widgets for his needs. As a result, he let go the contract lawyers he employed and saved a bit of money. So far, so good, as the transaction cost argument claims.
But now suppose that the market for gizmos collapses. In the free market system, A would probably break the contract with B (i.e. incur some transaction cost), and B would need to find another buyer for the gadget, most like A's competitor. However, in the vertically integrated system, (A owning a subsidiary making widgets), A would be stuck with his "sunk cost" he invested in the widget production line and the unused widgets - as it is unlikely that he would sell the widget to his competitor, as B could easily do.
So the bottom line is that the "hierarchy" may not work as the transaction cost folks claim, unless there is considerable planning, coordination, and regulation involved.
Wojtek