Transaction Costs Flashcards
(17 cards)
Search and Information Costs (In the economy)
Even before a formal contract is drafted, parties must locate each other and gather information about prices, quality, reliability, and other attributes. Williamson emphasizes that bounded rationality makes it impossible to gather and process all relevant information perfectly, so there will be costs involved in discovering suitable exchange partners and negotiating the terms.
Bargaining and Contracting Costs (In the economy)
Once potential buyers and sellers have been identified, negotiation consumes resources—time, effort, and sometimes payments for legal or intermediary services. Since real‐life contracts are incomplete (no contract can anticipate all future contingencies under bounded rationality), the contracting process must account for “the three critical dimensions of transactions” (Williamson 2010):
Asset specificity (the degree to which investments are redeployable),
Complexity (or uncertainty about future states), and
Disturbances (unanticipated events requiring adaptations).
Enforcement and Policing Costs (In the economy)
Once agreements are in place, parties must ensure they are honored. Opportunism—which Williamson (building on Herbert Simon) sometimes refers to as “frailty of motive”—can lead to breaches of contract or strategic defection if there are loopholes. This necessitates monitoring and potentially legal enforcement. However, court‐based enforcement can itself be expensive, uncertain, and time‐consuming.
Implications for Market Governance (In the economy)
Because transaction costs in markets can be high—especially when asset specificity or potential opportunism is significant—parties may prefer alternative governance structures to reduce these costs. This is why some transactions move from the market to a hierarchy (a firm) or to hybrid arrangements (e.g., long‐term contracts, joint ventures). Coase (1937) and Williamson both point to this dynamic to explain the boundary of the firm (i.e., “make” vs. “buy” decisions).
Hierarchy as Governance (Internal)
According to Williamson, “hierarchy is its own court of ultimate appeal” (Williamson 1991). Internally, disputes between divisions of a single firm typically cannot be litigated in external courts (the “forbearance” concept), so they are resolved by administrative command and control. Although this can reduce some external contracting hazards, it also creates internal transaction costs—the costs of bureaucracy, managerial oversight, and internal bargaining over resource allocation.
Selective Intervention and Internal Opportunism (Internal)
in theory, a larger organization could replicate a smexaller unit’s operations and only intervene when beneficial. Yet in practice, such perfect intervention fails because the necessary promises are not self‐enforcing. Conflicts arise over how to share the gains from any internal reorganization. In government bureaus or political parties, internal opportunism can manifest as bureaucratic infighting, political positioning, or attempts to distort information for personal or factional advantage.
Credible Commitments and Internal Governance (Internal)
Even within organizations, there remains the need for credible commitments—mechanisms that assure individuals or subunits that others will adhere to established rules. For instance, a trade union and management might set up dispute‐resolution procedures that resemble private ordering (e.g., arbitration, internal committees). Such procedures reduce internal transaction costs by handling disagreements in a structured, lower‐cost manner than courts or external enforcement.
Political and Bureaucratic Transaction Costs (Internal)
In government agencies, public policy problems often arise when external observers treat public institutions as if their transaction costs were zero—an assumption Williamson criticizes. Bounded rationality, incomplete contracts, and opportunism can exist just as much in the public sector. The “remediableness criterion” that Williamson highlights says we must ask whether government intervention (with its own organizational frictions) can truly outperform private or alternative arrangements once we factor in the full range of transaction costs, including those inside bureaucracies.
Scaling Up and Complex Organizational Structures (Internal)
Williamson also addresses how internal governance might scale in large organizations, from multi‐divisional firms to expansive political parties or unions. As organizations grow, the interface between different internal “stages” (e.g., local chapters, regional offices) becomes an important site of transaction costs, with negotiation over budgets, influence, or decision‐making. The same transaction cost logic—bounded rationality, opportunism, and asset specificity—applies within internal divisions or agencies just as it does among external buyers and sellers.
Coordination and Negotiation Costs (collective action dilemmas)
Collective action typically requires multilateral agreement . As Williamson emphasizes, bounded rationality makes it challenging for parties to foresee every future state of the world. Coupled with information asymmetries, this can inflate the costs of reaching and enforcing agreements among multiple stakeholders.
Opportunism, Strategic Defection, and Free‐Riding (collective action dilemmas)
In large‐scale collective action problems, opportunism often manifests as free‐riding or strategic defection—where one or more parties exploit the good faith efforts of others. This is consistent with Williamson’s notion that “if they slip, it is a normal friction” (building on Herbert Simon’s concept of “frailty of motive”), but such slip‐ups in collective settings become highly costly because they can unravel agreements or drastically reduce net gains from cooperation.
Private Ordering vs. Public Intervention (collective action dilemmas)
One of Williamson’s recurring concerns is that public policy sometimes treats governmental solutions as if they had zero transaction costs, while pointing to “market failures” on the private side. TCE argues that “collective action” in the public realm can itself be subject to high transaction costs—bureaucratic infighting, incomplete information, political opportunism, etc. Thus, in collective action contexts, it is crucial to compare all governance options (markets, hierarchy, and hybrid solutions) on a symmetrical basis using Williamson’s “remediableness criterion.”
Credible Commitments and Larger‐Scale Governance (collective action dilemmas)
Williamson’s concept of credible commitments is directly relevant to collective action dilemmas. When large groups or coalitions must trust each other to follow through, the use of third‐party arbitration, specialized dispute resolution, or internal governance frameworks can reduce the chance that one party will exploit everyone else. These frameworks lower the “transactional friction” that so often besets multi‐party cooperation.
Bounded Rationality: Adaptations and Incomplete Contracts
Williamson (drawing on Herbert Simon) holds that humans are “intendedly rational, but only limitedly so.” Consequently, all contracts are incomplete—they cannot anticipate all future states. Economizing on bounded rationality means designing organizational forms or contractual arrangements that facilitate adaptation to unpredictable changes, whether that involves internal hierarchy (where disputes can be resolved administratively) or hybrid forms (where credible commitments and long‐term relationships moderate complexity).
Opportunism: The “Frailty of Motive”
Real‐world transactions inevitably feature the risk of strategic behavior or “defection” when it is profitable for one side to renege on prior commitments. Williamson’s emphasis on opportunism (sometimes referred to as “frailty of motive”) leads to the conclusion that safeguards are needed—ranging from legal contracts and private dispute mechanisms to vertical integration or long‐term relational ties. Economizing on transaction costs thus means putting protective structures in place before opportunistic behavior can undermine cooperation.
Matching Transactions to Governance Structures
A central premise of transaction cost economics is the “efficient alignment hypothesis”: transactions that are high in asset specificity, uncertainty, or frequency of disturbance will often be internalized within a hierarchy (or sometimes handled via complex, hybrid governance) to best safeguard against opportunism. Conversely, more generic transactions, with low specificity and minimal hazard, can be handled via simple market contracts at lower cost.
Hence, minimizing transaction costs involves systematically “pushing the logic” of matching each transaction’s characteristics to an appropriate governance structure, thereby containing the costs of opportunism and incomplete contracting.
Credible Commitments as a Safeguard
Finally, credible commitments reduce both opportunistic inclinations and the costs of bounded rationality by providing explicit or implicit enforcement mechanisms. Examples from Williamson’s discussion include “private ordering” (e.g., internal arbitration within a firm or union, specialized committees, self‐enforcing norms), as well as the “forbearance law regime” that discourages litigation between divisions of the same organization. These arrangements effectively save on transaction costs by handling internal friction quickly and reliably.
