Transaction Cost Economics: Concluding Remarks

Transaction cost economics relies on and develops the following propositions: 

1. The transaction is the basic unit of analysis.
2. Any problem that can be posed directly or indirectly as a contracting problem is usefully investigated in transaction cost economizing terms.
3. Transaction cost economies are realized by assigning transactions (which differ in their attributes) to governance structures (which are the organizational frameworks within which the integrity of a contractual relation is decided) in a discriminating Accordingly:
   1. The defining attributes of transactions need to be identified.
   2. The incentive and adaptive attributes of alternative governance structures need to be described.
4. Although marginal analysis is sometimes employed, implementing transaction cost economics mainly involves a comparative institutional assessment of discrete institutional alternatives—of which classical market contracting is located at one extreme; centralized, hierarchical organization is located at the other; and mixed modes of firm and market organization are located in between.

5. Any attempt to deal seriously with the study of economic organization must come to terms with the combined ramifications of bounded rationality and opportunism in conjunction with a condition of asset specificity.

Note, with respect to this last, that the main differences in the four concepts of contract that are discussed in the text can be traced to variations in one or more of these three conditions. Thus contract as comprehensive ex ante planning and contract as promise both make heroic assumptions about human nature—the absence of bounded rationality being featured by the one (planning); the absence of opportunism being presumed by the other (promise). By contrast, concepts of contract as competition and contract as governance make less severe demands in behavioral respects. Both accommodate and/or make express provision for bounds on rationality and the hazards of opportunism.

Thus it is the condition of asset specificity that distinguishes the com- petitive and governance contracting models. Contract as competition works well where asset specificity is negligible. This being a widespread condition, application of the competitive model is correspondingly broad. Not all invest- ments, however, are highly redeployable. Use of the competitive model outside of the circumstances to which it is well-suited can be and sometimes is misleading.

Whereas the competitive model of markets has been developed to a refined degree, the formidable difficulties that attend contracting in the context of nonredeployable investments have only recently come under scrutiny. This is largely because the sources and economic importance of asset specificity had previously been undervalued. Extending the theory of economic organization to deal with asset specificity has been a central preoccupation of the New Institutional Economics research agenda. This book advances and employs a private ordering approach to economic organization in which the concept of contract as governance is featured.

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