Transaction cost economics is a comparative institutional approach to the study of economic organization in which the transaction is made the basic unit of analysis. It is interdisciplinary, involving aspects of economics, law, and organization theory. It has relatively broad scope and application.[3]
What with a multidisciplinary approach, a broad scope, and a reliance on John R. Commons's insight, this "new institutionalism" or transaction cost economics should be a useful addition to the evolving institutionalist paradigm. Nevertheless, as I will show below, the "new institutionalism" may be new but it is not institutionalist. The "new institutionalism" does provide some new insight into the nature of the modern corporation and it does analyze some of the fraud, waste, and sabotage that Thorstein Veblen attributed to the market interstices of the business system. But it is not a processual paradigm that studies social provisioning for the broad benefit of all mankind--Allan G. Gruchy's definition of institutional economics.[4] Central to institutionalism is the concept of process, while central to "new institutionalism" is the concept of optimum. Institutionalism explains the process of continual change while "new institutionalism" explains the structure of the optimal state. The following comparision will show that Williamson's "new institutionalism" shares none of the unifying characteristics of institutionalism.
The Unifying Characteristics of Institutionalism and Their Absence in "New Institutionalism"
Institutionalism, Allan Gruchy's science of social provisioning, is characterized by considerable diversity. Institutionalists include followers of both John R. Commons and Thorstein Veblen, so disagreement is found on many issues.[5] Nonetheless, institutionalists share at least six unifying characteristics. (1) Institutionalists emphasize the role of power in the economy. (2) Institutionalists approach the study of the institutions of their own economies with the skepticism of reformers. (3) The institutionalist's skepticism is focused through the Veblenian dichotomy of serviceable and predatory activities. (4) Institutionalists take an evolutionary approach to the study of social provisioning. (5) Institutionalists conceive of economies as evolving wholes. (6) Institutionalists, with some significant variations, (see Ingve Ramstad, note 5) are instrumentalists. Each of these characteristics will be discussed in turn.
Appreciation for the Role of Power
Institutionalists conceive of the economy as much more than a system of markets. It is that, but much more. The economy is also a system of power, and institutionalists believe that power is pervasive in the economy. From Thorstein Veblen's Theory of Business Enterprise, through John R. Commons's Legal Foundations of Capitalism, on to John Kenneth Galbraith's The New Industrial State, and continuing with many other works, institutionalists have made power an integral part of their descriptions and explanations.[6] John S. Gambs sums up the importance power plays in institutionalism when he identifies an underlying premise as "the genuinely identifying badge of institutionalism." According to Gambs, "That premise is the one of coercion in economic affairs."[7] "Coercion, Gambs continues, is deemed to be as pervasive as the air we breathe."[8]
Williamson's "new institutionalism" does not share this identifying badge. Power and coercion play insignificant roles in his economics. He simply does not investigate the role that power plays in economic concentration. The possible rise of an economic oligarchy does not concern him. Instead, he is concerned with the efficiency of minimizing transactions costs. According to Williamson, we should take a much more tolerant view of mergers and related transformations because they frequently result in minimizing transactions costs. The search for efficiency, not the exercise of power, drives merger movements. Furthermore, antitrust fears regarding mergers and other agglomerations of power are dismissed by Williamson as the misguided fears of an "inhospitality tradition" in economics.[9] He refers to fears of the power of the giant conglomerate as "bogeyman economics."[10]
Skepticism Toward Existing Institutions
Skepticism toward the existing institutions of one's own society is another unifying characteristic of institutionalism. This skepticism runs particularly deep in Veblen.[11] Although the skepticism is not as pointed in Commons, skepticism toward existing institutions had to be one of his basic characteristics as well. Otherwise, it is impossible to account for his life-long drive to reform the institutions of American capitalism.
Williamson does not share the institutionalists' skepticism toward existing institutions. On the contrary, he views them with considerable favor, perhaps even naivete. According to Williamson, the economic institutions of corporate capitalism have evolved to operate efficiently, to minimize transaction costs. The fittest institutions (most efficient) have survived. Williamson expresses relief over the change in the intellectual climate from the time when Joseph Schumpeter mourned the lack of intellectual support for capitalism in 1942 to the time when Williamson wrote the conclusion to his The Economic Institutions of Capitalism in 1985. Of course, the intellectual climate of 1985, with which Williamson was pleased, was at the very height of a reactionary wave in the United States. At that time, supply-side economic fantasies ruled the roost and skepticism toward existing institutions was quite low. And it pleased Williamson. But he did not gloat. He allowed as how even though the economic institutions of capitalism were awesome marvels, no complex economic organization was unproblematic.[12]
The Veblenian Dichotomy of Serviceable and Predatory Activities
Stronger on the Veblen side than on the Commons side of institutionalism, the dichotomy is still a unifying characteristic.[13] Institutionalists understand human thought and action as two opposing concepts: the serviceable and the predatory. Human thought and action are analyzed as both helping the community even at the expense of the self and as helping the self at the expense of the community. Thought and action are both other-serving and self-serving, both serviceable and predatory, both industrial and pecuniary, both technological and ceremonial. The dichotomy forces the observer to perceive both aspects of institutions--the serviceable and the predatory. The dichotomy led Commons to distinguish between two meanings of wealth. Wealth, Commons insisted, meant ownership and scarcity value on one hand, and on the other hand it meant materials and use value. The dichotomy also led him to contrast efficiency with scarcity.[14] So Commons used the dichotomy, but in his own way.
Williamson makes no use whatsoever of the Veblenian dichotomy. He does not share the dichotomy with institutionalists as a unifying characteristic. The dichotomy plays no role in his "new institutionalism.
The Evolutionary Approach to Social Provisioning
When institutionalists take the evolutionary approach to the institutions of social provisioning, they do not mean the survival of the fittest. If only the fittest survive, then the surviving institutions are obviously the most fit. But that is not at all the way institutionalists approach the existing institutions of their societies and economies. Quite the contrary, extant institutions are viewed with the skepticism of the reformer. The evolutionary approach means the historical approach, the study of change and process through historical epochs, the study of social process and continual change, the study of the dynamic interaction between technology and institutions, and between progress and cultural lag.[15]
Williamson s analytical framework is not dynamic, but static, not historical, but hypothetical. His transactions cost economics uses comparative statics. In particular, he relies on "comparative institutional analysis" to determine that institutional structure which, in a game theory experiment, will yield the optimal level of transactions costs. That is, he compares the transactions costs of one hypothetical state to the transactions costs of another hypothetical state. For example, Williamson sketches out the essentials of his comparative institutional analysis and then applies it to show the optimal characteristics of the company town in the development of coal fields.[16] Williamson's approach to understanding the role of the company town in the early coal mining industry is completely different from the institutionalist approach. The latter would involve case studies, statistical trends, biographies, commission reports, and historical monographs on mining technology, minerals property rights, union organizing, and such. Williamson's "new institutionalism" dispenses with all that.
Holism
Institutionalists conceive the economy to be part of an evolving whole--of a culture. So institutional economics is a cultural science in which the beliefs, values, and actions of individuals come from and make sense within a specific cultural whole. The rational decisionmaking of an isolated individual makes no sense to institutionalism because the individual does not exist separately from a specific culture. This is never to imply that individuals are of little value; nor is it to imply that individuals are irrational. But it is to insist upon the importance of culture to the individual's values and to the individual's rationality. The individual is an integral part of the whole, of the culture. Home economicus of neoclassical economics is the truly rational individual. But homo institutionalis of institutional economics is the culturally rational individual.[17]
Williamson rejects the ominiscient economic rationality of homo economicus, but he does not go all the way to the cultural rationality of homo institutionalis. Instead, he adopts the bounded rationality of Herbert A. Simon. In Williamson's view, individual decisionmaking is bounded internally by the individual's inability to comprehend everything that might impinge on the decision under question. Individual intellect is the bound. This is more realistic than the perfect knowledge of homo economicus, but it is not as realistic as the culturally conditioned mind of homo institutionalis.[18] The mind of Williamson's individual is bounded; the mind of institutionalism's individual is culturally conditioned. Williamson mentions the cultural setting within which individuals function, but only in passing. Culture does not form a central feature of "new instititutionalism."[19]
Instrumentalism
Under the influence of instrumentalism, most institutionalists interpret the contemporary economy as suffering from various forms of cultural lag that require institutional adjustment through some form of democratic economic planning.[20] The economy is seen as not living up to its potential in some way, as not performing the social provisioning function as adequately as it could, under contemporary conditions. The instrumentalist-institutionalist elaborates on new means and new ends and puts them in the context of a never-ending process of self-adjusting value judgments that will transform corporate capitalism through the democratic process.[21]
But Williamson sees the contemporary situation quite differently. He sees the "inhospitality tradition" in economics as hindering the efficiency of corporate capitalism. In particular, antitrust policy should allow mergers and related practices to take place because they minimize transactions cost. The corporate system is driving toward efficiency, if we would just let it do so, argues Williamson in his very sophisticated and contemporary version of laissez-faire.[22] Williamson is not an institutionalist.
New Elements
Williamson may not be an institutionalist but he does have something new to say. His most important contribution is a reconceptualization of the firm as a "governance structure" rather than a mere production function. Throughout his work, Williamson explains that the modern firm--the capitalist corporation--is akin to a government. He understands quite clearly that the modern firm replaces the transaction inefficiencies of the market with the sovereignty of the state. This occurs, he explains, when the "private ordering" of the firm is used instead of the "legal centralism" of the state. Rather than relying on legal traditions and precedents of the state to deal with transaction cost problems, the modern firm deals with them directly through its own adjudication processes. By doing so, Williamson argues, economic efficiency is furthered and cumbersome state procedures are avoided.[23] To Williamson, although he does not say so explicitly, the modern corporation has become state-like in its functions. It is no longer just a firm, but something more--much more. This, I believe, is a profound insight.
Reconceptualizing the Market
Veblen conceptualized the market as a faulty gear in the industrial economy's transmission. Veblenian markets were dangerous interstices in the industrial economy, where fraud, delay, sabotage, and pecuniary predation in general were allowed free play. Mergers and consolidations did not remove the pecuniary element, but they did allow it fewer opportunities to wreak predatory havoc on the underlying population. Williamson is far from a Veblenian, but he does reintroduce into the mainstream of economics the idea that the market is a place where self-serving can interfere with the common good. The interference takes the form of transaction costs, and transaction costs arise because of what Williamson calls bounded rationality, opportunism, and asset specificity.[24] And, much to his credit, Williamson encourages us to eliminate the shortcomings of the market with a "governance structure," but the structure he has in mind is the capitalist corporation rather than the democratic state. The new element in Williamson's otherwise quite mainstream thought, is his understanding of how some markets really work. And, he should be congratulated for introducing this new element into mainstream economics. But he does not go far enough in proposing an institutional adjustment for dealing with the problem.
Conclusion
Williamson's "new institutionalism" is not institutionalism because it does not share the fundamental characteristics of institutionalism. Nevertheless, his "new institutionalism" is new, at least to the mainstream, because it reconceptualizes the firm and the market. His reconceptualized firm and market are real. They are not misleading abstractions. And yet, in the end, the reconceptualization is unfulfilling because it does not go far enough. He identifies the market and the firm as problems, but he fails to grasp the profound nature of the problems posed by the real market and the real firm.
Notes
[1.] Oliver E. Williamson's works include Markets and Hierarchies: Analysis and Antitrust Implications (New York: Free Press, 1975), "The Modern Corporation: Origins, Evolution, Attributes," Journal of Economic Literature 19 (December 1981): 1537-68; and The Economic Institutions of Capitalism (New York: Free Press, 1985). A partial list of other "new institutionalist" works must include Richard N. Langlois, ed., Economics as Process: Essays in the New Institutional Economics (New York: Cambridge University Press, 1986; Richard R. Nelson and S. G. Winter, An Evolutionary Theory of Economic Change (Cambridge, Mass.: Harvard University Press, 1982); Douglass North, Structure and Change in Economic History (New York: W. W. Norton, 1981); and Mancur Olson, The Rise and Decline of Nations (New Haven, Conn.: Yale University Press, 1982).
[2.] William M. Dugger, "The Transaction Cost Analysis of Oliver E. Williamson: New Synthesis?" Journal of Economic Issues 17 (March 1983): 95-114; William M. Dugger, "Review of Oliver E. Williamson's The Economic Institutions of Capitalism," Journal of Economic Issues 21 (March 1987): 93-96.
[3.] Williamson, Economic Institutions of Capitalism, p. 387.
[4.] Gruchy elaborates on this definition in Allan G. Gruchy The Reconstruction of Economics (New York: Greenwood Press, 1987).
[5.] See Ingve Ramstad, "'Reasonable Value' Versus 'Instrumental Value': Competing Paradigms in Institutional Economics," Journal of Economic Issues 23 (September 1989): 761-77.
[6.] Thorstein Veblen, Theory of Business Enterprise (Clifton, N. J.: Augustus M. Kelley, 1975); John R. Commons, Legal Foundations of Capitalism (Madison: University of Wisconsin Press, 1968); John Kenneth Galbraith, The New Industrial State (Boston: Houghton Mifflin, 1967).
[7.] John S. Gambs, Beyond Supply and Demand (Westport, Conn.: Greenwood Press, 1973), p. 11.
[8.] Gambs, Beyond Supply and Demand, p. 13.
[9.] Williamson, Economic Institutions of Capitalism, pp. 192-93 and 200-202. See also the articles from a symposium on Williamson, all published in The Quarterly Review of Economics and Business 24 (Winter 1984): Samuel M. Loescher, "Bureaucratic Measurement, Shuttling Stock Shares, and Shortened Time Horizons: Implications for Economic Growth," pp. 8-23; Felix R. Fitzroy and Dennis C. Mueller, "Cooperation and Conflict in Contractual Organizations," pp. 24-49; Paul Davidson and Greg S. Davidson, "Financial Markets and Williamson's Theory of Governance: Efficiency versus Concentration versus Power," pp. 50-63; and Oliver E. Williamson, "Perspectives on the Modern Corporation," pp. 64-71.
[10.] Williamson, "Perspectives on the Modern Corporation," p. 65.
[11.] See, for example, Thorstein Veblen, The Instinct of Workmanship (New York: Augustus M. Kelley, 1964), p. 25.
[12.] Williamson, The Economic Institutions of Capitalism, pp. 407-8.
[13.] A recent discussion is in John R. Munkirs, "The Dichotomy: Views of a Fifth Generation Institutionalist," Journal of Economic Issues 22 (December 1988): 1035-44. For Veblen's original, see Thorstein Veblen, "Industrial and Pecuniary Employments," in Thorstein Veblen, The Place of Science in Modern Civilization and Other Essays (New York: B. W. Huebsch, 1919), pp. 279-323.
[14.] See John R. Commons, Chapter VIII in Institutional Economics (Madison: University of Wisconsin Press, 1961), pp. 251-389.
[15.] This is particularly true of the evolutionary economics of Clarence Ayres. See C. E. Ayres, The Theory of Economic Progress, 2d ed. (New York: Schocken, 1962).
[16.] Williamson, The Economic Institutions of Capitalism, pp. 30-38.
[17.] Further discussion is in Gruchy, The Reconstruction of Economics, pp. 14-17.
[18.] Further discussion of bounded rationality and culture is in Gruchy, The Reconstruction of Economics, p. 15 and 34.
[19.] See Williamson, Economic Institutions of Capitalism, p. 22.
[20.] See J. Ron Stanfield, Economic Thought and Social Change (Carbondale: Southern Illinois University Press, 1979).
[21.] Further discussion is in Marc R. Tool, Essays in Social Value Theory (Armonk, N. Y.: M. E. Sharpe, 1986).
[22.] Williamson, Economic Institutions of Capitalism, pp. 19, 25-26, 87-89, 101-102, and 129-30.
[23.] Ibid. pp. 13, 16, 41-43, and 164-66.
[24.] Ibid. pp. 61-63 and 295.
