Williamson TCE How It Works Where It is Headed

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DE ECONOMIST 146, NO. 1, 1998 TRANSACTION COST ECONOMICS: HOW IT WORKS; WHERE IT IS HEADED** BY OLIVER E. WILLIAMSON* Key words: firms, transactions, governance, economizing, mechanisms, institutional economics The transaction cost economics program that is described herein is the product of two recent and complementary fields of economic research. The first one is the New Institutional Economics; the second one has been described as the ‘new economics of organization’ Moe 1984, 1990 . A key conc
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  TRANSACTION COST ECONOMICS:HOW IT WORKS; WHERE IT IS HEADED** BYOLIVER E. WILLIAMSON* Key words: firms, transactions, governance, economizing, mechanisms, institutional economics The transaction cost economics program that is described herein is the product of two recent and complementary fields of economic research. The first one is theNew Institutional Economics; the second one has been described as the ‘new eco-nomics of organization’  Moe  1984, 1990  . A key conceptual move for bothwas to push beyond the theory of the firm as a production function  which is atechnological construction  into a theory of the firm as a governance structure  which is an organizational construction  .Work in both of these areas began to take shape in a concerted way in the1970s and has grown exponentially since. The economics of organization is themore theoretical of the two and more closely relates to public policy issues tra-ditionally associated with the field of industrial organization. The New Institu-tional Economics is more interdisciplinary and has applications to the contiguoussocial sciences.Although transaction cost economics has a broad reach – any issue that arisesas or can be reformulated as a contracting problem is usefully examined throughthe lens of transaction cost economizing – it does not tell you everything. More-over, within the ambit of issues to which transaction cost economics is related, ithas greater application value in some areas than in others. Transaction cost eco-nomics thus takes its place alongside other – partly rival, partly complementary –perspectives on the theory of firm and market organization. Jon Elster’s dictumthat ‘explanations in the social sciences should be organized around  partial  mechanisms rather than  general  theories ’  1994, p. 74; emphasis in srcinal  isone to which transaction cost economics subscribes.I begin with a sketch of the New Institutional Economics. Section 2 sets out aseries of questions which any theory of economic organization should be ex- * The author is Edgar F. Kaiser Professor of Business, Professor of Economics, and Professor of Law at the University of California, Berkeley. e-mail: owilliam@haas.berkeley.edu.** The paper was delivered as the 1997 Hennipman Lecture in Amsterdam on May 13, 1997. Ibenefited from the comments there and from an earlier presentation at the University of Toronto, aswell as from comments by Witold Henisz.DE ECONOMIST 146, NO. 1, 1998  De Economist  146 , 23–58, 1998.© 1998 Kluwer Academic Publishers. Printed in the Netherlands.  pected to address. Section 3 deals with implementation of the transaction costeconomics project. Background conceptual moves out of which transaction costeconomics works, some of which are still controversial, are examined in section4. Extant and potential applications are sketched in section 5. Concluding re-marks follow in section 6. 1 THE NEW INSTITUTIONAL ECONOMICS 1.1 General The New Institutional Economics comes in two parts. Part one deals with theinstitutional environment – the rules of the game – and traces its srcins to RonaldCoase’s 1960 paper on ‘The Problem of Social Cost.’ Part two deals with theinstitutions of governance – the play of the game – and srcinates with Coase’s1937 paper on ‘The Nature of the Firm.’ Both parts got underway in the early1970s  Davis and North  1971  , Williamson  1971  , and Alchian and Demsetz  1972  and progressively took shape over that decade  North  1981  , Williamson  1975, 1976, 1979  , Klein, Crawford, and Alchian  1978  . Exponential growthoccurred in the 1980s and since. Two Nobel Prizes – one to Ronald Coase in1991; the other to Douglass North in 1994 – celebrate its influence.In addition to major intellectual debts to Coase, both levels of analysis havebenefited from interim developments. Especially important to the institutional en-vironment was interim work in economic history during which cliometrics took shape  Fogel and Engerman  1971, 1974  . Related work on property rights  Dem-setz  1969  and path dependence  David  1985  , Arthur  1989  have also beenimportant. Work on the institutions of governance benefited from the extensivemarket failure literature, as summarized in Kenneth Arrow’s paper on ‘The Or-ganization of Economic Activity: Issues Pertinent to the Choice of Market versus Nonmarket Allocation’  1969  , from research on organization theory, especiallythat done at Carnegi  March and Simon  1958  , Cyert and March  1963  , andfrom business history  Chandler  1962  . 1 The work at Carnegie aside, which took exception with economic orthodoxybut had much more influence on organization theory than on economics, the neweconomics of organization had no obvious predecessor. By contrast, there defi-nitely was an earlier institutional economics movement – which had fallen onhard times.Criticisms of the older style of institutional economics in America have beenscathing. Unable or unwilling to offer a rival research agenda, the older institu-tional economics was given over to methodological objections to orthodoxy 1 As discussed below, the economics of property rights is also pertinent to the institutions of gov-ernance.24 O.E. WILLIAMSON   Stigler  1983  , p. 70, Coase  1984  , p. 230, and Matthews  1986  , p. 903  . Likethe American Legal Realism movement, with which older style institutional eco-nomics shares many common intellectual and public policy attributes, older styleinstitutional economics ‘ran itself into the sand.’ 2 The problem was not that theeconomic and legal orthodoxies with which these two movements took exceptionwere beyond legitimate criticism. Orthodoxy always needs good critics. Themaxim that it takes a theory to beat a theory  Kuhn  1970  nevertheless applies.Both older style institutional economics and American Legal Realism were re-miss by failing to advance a positive research agenda.Moreover, it does not suffice to prescribe a general approach – for example,‘study institutions’ – or, for that matter, to describe institutions, such as the lum-ber industry in Wisconsin  Hurst  1964  in detail. Focus is needed, whence is-sues of purposefulness and choice of the unit of analysis are important. Of themany purposes served by institutions, what is the ‘main purpose’? Going beyondthe proposition that institutions matter  with which now almost everyone agrees –although it was not always so  to demonstrate that institutions are susceptible toanalysis has been the major challenge. Accepting and responding to that chal-lenge is what distinguishes the NIE from its predecessors  Matthews  1986  ,p. 903  . Arrow’s overview is pertinent  1987, p. 734; emphasis added  :Why ... has the work of Herbert Simon, which meant so much to us all,nevertheless had so little direct consequence? Why did the older institu-tional school fail so miserably, though it contained such able analysts asThorstein Veblen, J.R. Commons, and W.C. Mitchell? ...  One answer isthat  in fact there are important specific analyses, particularly in the work of the New Institutional Economics movement. But it does not consistprimarily of giving new answers to the traditional questions of econom-ics – resource allocation and the degree of utilization. Rather it consistsof answering new questions , why economic institutions have emerged theway they did and not otherwise; it merges into economic history, butbrings sharper  microanalytic  ... reasoning to bear than has been cus-tomary.1.2 A Framework  Four levels of social analysis are distinguished in Figure 1. 3 The solid arrowsthat connect a higher with a lower level signal that the higher level imposes con- 2 This is the way John Henry Schlegel describes the demise of the American Legal Realism  1979,p. 459  . For an overview of the older institutional economics, see the three volume collection of articles in Warren J. Samuels  ed.  , Institutional Economics  1988  .3 This figure is not exhaustive. An evolutionary level in which the attributes of human actors havetheir srcins in the pleistocene could also be introduced  Cosmides and Tooby,  1996  .25TRANSACTION COST ECONOMICS  straints on the level immediately below. The reverse arrows that connect lowerwith higher levels are dashed and signal feedback. Although, in the fullness of time, the system is fully interconnected, for my purposes here, these feedbacksare largely neglected. The NIE has mainly concentrated on action at levels 2and 3. Figure 126 O.E. WILLIAMSON
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