| In this book, Williamson presents a refined and | | | | integration, mergers and monopolies, and joining |
| elaborated version of his transaction cost theory | | | | issues with anti-trust enforcements. He believes |
| that he had first outlined in his 1975 book Markets | | | | that vertical integration results not because of |
| and Hierarchies: Analysis and Anti-trust | | | | technological determinism or a desire for |
| Implications. His book attempts to systematically | | | | monopolistic power but from a pragmatic desire |
| examine those economic issues that classical | | | | to economize on transaction costs. In the similar |
| economic theory simply assumes away. The | | | | vein, he contends that non-standard contracting |
| classical economics believes that markets are | | | | practices such as long-term contracts are not |
| perfect, and if they are not then the action to | | | | monopolistic practices, but perfectly justifiable |
| remove market failures needs to be initiated. | | | | attempts at minimizing transaction costs. Further, |
| Williamson, on the other hand, focuses on these | | | | he attributes such decisions "to a condition of |
| economic issues that are acknowledged to be | | | | asset specificity (P86)" since asset specificity in |
| widely prevalent in any economic system. "If | | | | conjunction with uncertainty "makes it more |
| complexity is deep in the nature of things | | | | imperative to organize transactions within the |
| economic then that ought to be acknowledged | | | | governance structure that have the capacity to |
| rather than suppressed. An equilibrium approach to | | | | work things out (P79)." The author makes a |
| economics is thus preliminary to the study of | | | | persuasive case for five out of six hypotheses on |
| main issues (Hayek on P8)." This book, then, is a | | | | the boundaries of firm. However, his fifth |
| scrutiny of such economic phenomenon as | | | | hypothesis that claims that "firms will never |
| market structures, monopolies, anti-trust policies, | | | | integrate for production reasons alone" seems a |
| labor policies, public utility regulation, vertical | | | | little far-stretched. The fact that some firms |
| integration and other economic institutions that | | | | organize for efficiency reasons doesn't and can't |
| have traditionally been neglected by the economic | | | | automatically preclude the fact that some firms |
| theory. | | | | organize for monopolistic or technological reasons. |
| His basic proposition that most of us are familiar | | | | Once again, the author's case would have been |
| with by now is that the transaction costs should | | | | better served by refraining from such |
| be treated as a fundamental unit of analysis for | | | | overstatements. |
| understanding such issues. Drawing on three | | | | Next, Williamson turns his attention to analysis of |
| streams of research- economics, organization | | | | such arrangements as can neither be classified as |
| theory and contract law, he repeatedly highlights | | | | market contracts nor as hierarchical structures, |
| the need to consider the governance (or | | | | but fall somewhere in between. Also known as |
| transaction) costs. "Rather than characterize the | | | | hybrid structures, these include credible |
| firm as a production function, transaction cost | | | | commitments, joint ventures, relational |
| economics maintains that the firm is more usefully | | | | contracting, hostage models, reciprocal |
| regarded as a governance structure (P13)." While | | | | arrangements, and network relationships. His main |
| his basic argument appeared sound and plausible, I | | | | claim is that even when such arrangements |
| got an impression that Williamson attributed more | | | | appear to be exercise of monopolistic power, |
| to transaction costs than it deserved. Why should | | | | they may be justifiable from transaction cost |
| we regard only governance costs? Why should | | | | perspective. "A comparative institutional |
| we think that the firm is only a governance | | | | assessment of contractual alternatives discloses |
| structure? In other words, in my view, instead of | | | | that efficiency purposes are often served by |
| correcting an existing flaw in the theory, he | | | | hostages and it is in the mutual interest of the |
| seems to be, to borrow the stock market | | | | parties to achieve that result. Not only can |
| jargon, proposing an over-correction. The field | | | | producers be induced to invest in the mutual |
| would be better off considering a cost function | | | | interest of the parties to invest in the most |
| that combines both production and governance | | | | efficient technology, but buyers can be induced to |
| costs or at least choosing the concept based on | | | | take delivery whenever demand realizations |
| the specific requirements of the situation or | | | | exceed marginal cost." Interesting proposition, but |
| problem at hand. | | | | it doesn't explain the impact on the hostage (e.g. |
| Having said that, let's now delve into the | | | | P&G) if the monopoly (e.g. Wal-Mart) decides |
| foundations of the transaction cost economics | | | | to dump it! His second main claim derives from |
| which is first three chapters in the book. Until this | | | | Coase's 1960 article on problem of social cost. |
| book, Williamson considered opportunism, bounded | | | | Recall Coase's claim that when people are left to |
| rationality, frequency and uncertainty to be the | | | | bargain among themselves, most economic |
| building blocks of TCE. However, in this book, he | | | | externalities can be better resolved than when |
| rightly puts forth asset specificity alongside | | | | courts or other non-market interventions take |
| opportunism and bounded rationality as the three | | | | place. Williamson develops on this proposition and |
| legs of TCE. "Any attempt to deal seriously with | | | | claims that parties to a contract don't normally |
| the study of economic organization must come to | | | | take recourse to courts, but try to use "private |
| terms with the combined ramifications of bounded | | | | ordering" to resolve their disputes. I would |
| rationality and opportunism in conjunction with a | | | | presume this would chiefly be out of concern for |
| condition of asset specificity" (P42), which is | | | | future business relations. |
| assumed to be the most critical dimension of TCE | | | | Let's wrap up this review with a summary of |
| (P30). Without asset specificity, markets are | | | | strengths and weaknesses. For the strengths, I |
| believed to be in a competitive world even if | | | | will let the Williamson speak for himself. To quote |
| people are opportunistic and rationally bounded. | | | | him, |
| This is because buyers and sellers can freely | | | | "As compared with other approaches to the |
| move between market players. | | | | study of economic organizations, transaction cost |
| In contrast, uncertainty and frequency drop down | | | | economics (1) is more micro-analytic (2) is more |
| a tad bit in the scheme of things. Now, they are | | | | self-conscious about its behavioral assumptions (3) |
| supposed to be meaningful in presence of first | | | | introduces and develops the economic importance |
| three elements only. Conceptually, this makes a | | | | of asset specificity (4) relies more on |
| lot of sense. Take for example, if market players | | | | comparative institutional analysis (5) regards the |
| are uncertain about the outcomes, but they | | | | business firm as a governance structure rather |
| believe in the fairness of the parties to contract, | | | | than as a production function and (6) places |
| the market mechanism would be adequate to | | | | greater weight on the ex-post institutions of the |
| deal with all the contingencies since the players | | | | contract, with special emphasis on private ordering |
| would share equitably in the profits. However, we | | | | as compared with court ordering." |
| understand that such a behavioral assumption | | | | -Williamson, P387 |
| would be wrong since opportunism and bounded | | | | While the theory is conceptually persuasive and |
| rationality are common behavioral traits. What | | | | logically sound, a principal weakness of transaction |
| intrigues me, albeit, is that if they are such | | | | cost analysis lies in its post-facto nature of |
| common traits, then why they should even be | | | | analysis. Notwithstanding Williamson's superb |
| made variables in the model. After all, a variable | | | | efforts, it has been rather difficult to define it in a |
| that doesn't vary is no variable at all. It is not | | | | way that it can be measured and tested. The |
| surprisingly, therefore, to see most literature to | | | | theory in its current formulation continues to be |
| refer only to asset specificity, uncertainty and | | | | plagued with a criticism that it's tautological in |
| frequency as the three pillars of TCE. Williamson | | | | nature, after all ex-post facto any system can be |
| himself seems to acknowledge this in a | | | | shown to be economizing on transaction cost or |
| subsequent chapter when he mentions that | | | | at least that it will be eventually replaced if it |
| "principal dimensions for describing transactions are | | | | doesn't. Therefore, transaction cost economics |
| frequency, uncertainty and asset specificity | | | | needs to find variables with predictive powers. |
| (P242)." | | | | Williamson mentions three limitations of his work- |
| After outlaying his conception of economic | | | | its crude form, instrumentalism, and |
| fundamentals, Williamson proceeds on to explain | | | | incompleteness. To me, these appeared more to |
| the boundaries of firm, which is to say what | | | | be challenges for future research rather than any |
| transactions will take place in market and what | | | | weaknesses in the theory. Besides occasional |
| within the hierarchically organized structures. In his | | | | excessive enthusiasm and exaggerations and the |
| opinion, if the expected costs or risk of | | | | difficulty in operationalization of the concept, a |
| transacting in a marketplace are higher than the | | | | major challenge in reading this book is to be |
| cost of organizing the functions internally, then | | | | prepared to learn a new language! Williamson's |
| such transactions will take place within the firm. If | | | | choice of words lives a reader with no less an |
| we ignore his exaggerated claims, this is indeed | | | | impression. |
| novel and useful approach at looking the firm size | | | | Overall, Williamson does a superb job in developing |
| and boundaries. No longer is the size of firm held | | | | the transaction cost economics that had first |
| irrelevant as is the case in classical economics. No | | | | appeared in Coase's 1937 article 'nature of firm', |
| longer is it believed that the firms will operate at | | | | but had been left untouched until this work |
| marginal cost whether they produce internally or | | | | because of difficulties in operationalization and |
| buy externally. It opens up a can of worms that | | | | empirical testing. Williamson succeeded in |
| classical economics under its perfect market and | | | | overcoming most of these challenges and it is for |
| equilibrium economics assumptions puts aside as | | | | the future researchers to meet the rest. |
| aberrations. This is a welcome change in the | | | | Reference: |
| approach to the study of industrial economics. | | | | Williamson, Oliver. The Economic Institutions of |
| Next, Williamson moves on to the main theme of | | | | Capitalism. 1st. New York: The Free Press, 1985. |
| the book: providing alternative explanations vertical | | | | |