Is There a Role for Transaction Cost Economics If We View Firms as Complex Adaptive Systems?

Article excerpt

JOHN FOSTER [*]

This article assesses the usefulness of transaction cost economics when we view economic organizations, such as firms, as complex adaptive systems. Modern complexity science is a radically different in orientation to neoclassical economics, which deals with decision making in contexts that are presumed to be simple and, therefore, disconnected from complex reality. However, transaction cost economics can be related to aspects of modern complexity science: bounded rationality, opportunism, and asset specificity are all associated with behavioral complexity. Furthermore, the emphasis of transaction cost economics on hierarchy and organizational rather than technological considerations is also consistent with complexity science. Drawing on literature in psychological economics, this article synthesizes transaction cost economics with aspects of complexity science in a manner that offers a new research agenda, not only in the context of the organization of production but in economics generally Such theoretical d evelopments are vital if policy makers are to have at their disposable analytical perspectives that are coherent and applicable in complex historical settings. (JEL A12, A13, D23, L14, L22, O31, Z13)

I. INTRODUCTION

Over the past decade, transaction cost economics (TCE) has provided a major stimulus to research on the firm and other organizational forms in the economic system. Developed and promoted vigorously by Oliver Williamson (see particularly Williamson, 1985), it represents an important departure from the conventional neoclassical vision of the firm and its activities: Rationality is bounded, the firm is not viewed through the lens of a production function but is seen as a governance structure; uncertainty is acknowledged; the specific character of human capital is recognized. We can trace TCE back to Coase (1937), who argued that the existence of transaction costs explains the extent of the firm relative to a subcontracting arrangement. The firm, as an organizational structure, achieves lower transaction costs than would prevail in a set of market transactions. This is because subcontracting involves asymmetric information that can result in moral hazard and, therefore, contractual uncertainty that is costly to monitor. In recent years, TCE has dealt with many of the implications of asymmetric information and attendant opportunism in a range of contexts. With regard to intrafirm contracts, TCE adopts a principal-agent perspective on relations between, for example, managers and workers that also involve monitoring costs. However, TCE is an approach that has generated controversy:

Economists object to it because limits on rationality are mistakenly interpreted in non-rationality or irrationality terms. Regarding themselves as they do as the "guardians of rationality" (Arrow, 1974, p. 16) economists are understandably chary of such an approach. (Williamson, 1985, p. 45)

Also, those who belong to a much older dissenting tradition that emphasizes the importance of institutions have been critical of attempts to deal with institutions in a conventional maximizing setting and see TCE as no more than "old wine in new bottles" (see Rutherford, 1989). However, although "bounded rationality invites attacks from both sides" (Williamson, 1985, p. 45), TCE has proved to be a congenial analytical compromise for many economists and economic historians (e.g., North, 1990) who feel that institutions should play a more prominent role in economic analysis.

Over roughly the same time that TCE has developed, we have witnessed a rapid expansion in interest in the manner in which complex structures emerge, particularly in the natural sciences. This began in physics and chemistry, where the phenomenon of "self-organization," that is, an endogenous tendency for both complexity and organization to increase, was identified in "dissipative structures," that is, structures capable of importing free energy and exporting high entropy waste. …