The Economic Institutions of Capitalism: An Overview

The book successively sets out the rudiments of transaction cost economics, applies the basic arguments to a series of economic institutions over which there has been widespread disagreement or puzzlement, and develops public policy ramifications.

Chapter 1 provides an overview of the transaction cost economics ap- proach to the study of economic organization. The behavioral assumptions on which transaction cost economics relies and the critical dimensions for dis- tinguishing among transactions are developed in Chapter 2. Alternative ap- proaches to the world of contract are described. What I refer to as the “Fun- damental Transformation”—whereby a large-numbers condition at the outset (ex ante competition) is transformed into a small-numbers condition during contract execution and at contract renewal intervals (ex post competition)—and its pervasive importance for the study of economic organization are developed.

Rather than characterize the firm as a production function, transaction cost economics maintains that the firm is (for many purposes at least) more usefully regarded as a governance structure. A comparative institutional approach to the governance of contractual relations is set out in Chapter 3.

Chapters 4 and 5 deal with vertical integration. Chapter 4 is concerned with theory and policy. Chapter 5 develops the evidence. Vertical integration is not only an important condition in its own right but equally because the transaction cost treatment of the decision to integrate is paradigmatic jsuch apparently unrelated phenomena as the employment relation, aspects of reg- ulation, certain nonstandard contracting practices, corporate governance, and even family organization are variations on a theme.

Chapter 6 attempts to fill a serious gap in the literature on economic organization. It examines the incentive and bureaucratic limits of internal organization in the context of the following dilemma: Why can’t a large firm do everything a collection of small firms can do and more?

Chapters 7 and 8 deal with the uses of nonstandard contracting to effect credible commitments. Nonstandard contracting—customer and territorial re- strictions, tie-ins, block booking, and related restraints—have been the source of much public policy consternation. This follows from the neoclassical view that transactions are properly assigned either to firms or to markets in accordance with some natural (mainly technological) order. Efforts to tamper with this natural order are thus presumed to have anticompetitive purpose and effect. The transaction cost approach discloses that this formulation is simplistic: Many nonstandard or unfamiliar contracting practices serve legitimate transaction cost economizing purposes. Often the parties are en- gaged in an effort to devise contractual safeguards that promote more efficient exchange. Commercial equivalents of hostages arise in this way.

The organization of work is addressed in Chapter 9. This chapter is partly responsive to the recent Radical Economics literature, which holds that hierarchy lacks redeeming economic purposes but operates entirely in the service of power (Marglin, 1974, 1984; Stone, 1974). This argument succeeds mainly by default: Inasmuch as neoclassical economics is preoccupied with production functions and is silent with respect to hierarchy, the existence— indeed the ubiquity—of hierarchy is presumably explained by other factors, of which power is the leading candidate. Addressing the economics of organization in transaction cost terms discloses that hierarchy also serves efficiency purposes and furthermore permits a variety of predictive statements regarding the organization of work to be advanced. I

Chapter 10 deals with efficient labor organization. Unlike the preceding chapter, where the nature of the workers’ status was a variable, here it is assumed that an authority relation prevails between workers and managers. The principal issue of interest is what governance structure supports will be crafted in response to job attributes of differing kinds. The ramifications of the argument for union organization are developed.

The modern corporation is the subject of Chapter 11. The transformation of the corporation from its traditional (unitary) form to its modern (multidivi- sional) form is traced, and the significance is assessed. Subsequent develop- ments—the conglomerate and the multinational corporation—are shown to be extensions of the basic multidivisional structure, the object being to manage diversified product lines in the first instance and to facilitate technology transfer in the second.

Corporate governance issues are considered in Chapter 12. 1 argue that the board of directors is appropriately regarded as a governance structure response to those with diffuse and otherwise unprotected investments in the corporation. So regarded, it is principally an instrument of the stockholders.

Regulation is examined in’Chapter 13. The proposition that franchise bidding can be used to supplant rate of return regulation in natural monopoly industries is disputed. Assessing this in transaction cost terms discloses that the argument goes through in some circumstances but not all. A discriminating approach to the use of franchise bidding is therefore proposed. A focused case study illustrating the contractual problems that beset franchise bidding is set out in an appendix.

Antitrust ramifications of transaction cost economics are summarized in Chapter 14. Transaction cost issues that arise in the context of contracting, merger, and strategic behavior are all addressed. The earlier preoccupation of antitrust with monopoly—to the virtual exclusion of economizing in non- technological forms—is challenged. Circumstances in which troublesome antisocial monopolizing arises are indicated.

The conclusions are set out in Chapter 15. The behavioral assumptions, the main arguments on which transaction cost economics relies, and the principal implications are summarized. The implied research agenda is sketched.

Source: Williamson Oliver E. (1998), The Economic Institutions of Capitalism, Free Press; Illustrated edition.

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