Williamson's Back Door: Transaction Costs and the Efficient Firm (1)
Freedman, Craig, History of Economics Review
Abstract: Oliver Williamson has made an acknowledged contribution to the theory of the firm by incorporating Coase's idea of transaction costs in his analysis. However, by identifying market efficiency with the minimisation of transaction costs, Williamson has linked rhetorically two concepts which are not by necessity connected.
[Morishima] attributes the continuous frustration which has beset the development of economic theory over the last thirty years or more to 'failure of economic theorists to carry out sweeping systematic research into the actual mechanisms of the economy and economic organisation, despite being aware that their own models are inappropriate to an analysis of the actual economy.' (Feiwel quoted in Williamson 1985, p. 386)
By drawing attention to transaction costs, Oliver Williamson (1985) deliberately took up the challenge first laid down by Coase (1937) (2). According to this formulation, corporate configurations necessarily reflect decisions to retain certain operations in-house, while others remain the province of market exchange. Thus the competitive imperative of minimising the cost of transactions determines the limits of a firm. Though a useful categorisation, it still has the static feel of a catalogue featuring a typological division of existing organisational structures (3). Fixing a butterfly on a mount may provide the chance for dissection but it need not convey an image of the insect in flight. We are left instead with a series of unrelated snapshots. Missing are the limitations imposed by an historical context and its concomitant prior choices. Because of this distinct approach, transaction costs under Williamson's tutelage do not emerge as an alternative but rather as a complement to the standard neoclassical theory of the firm. What Williamson ultimately tries to demonstrate is that markets, when endowed with a richer economic environment of positive transaction costs, still yield efficient outcomes even if only in a relative rather than an absolute sense as Williamson puts it (1985, p. 22) (4). Unfortunately, positing such an end result serves only to confuse Williamson's analysis. The peculiar economic issue of optimal or even relative efficiency is not intrinsically related to the body of his analysis (5). Nothing inherent in the notion of transaction costs leads inevitably to issues surrounding firm or even market efficiency. This will cause any serious student of Williamson's work to suspect that its intrusion into what is essentially only a methodological approach has more the status of a conjuring trick than a necessary cornerstone supporting a theoretical framework.
My objective is to explain what Williamson did and to unearth a possible rationale which can explain why he would choose to adopt such an approach. By pointing this out, I am not denying the potential usefulness that the transaction cost approach may yield. Instead, it serves as a clear example of how such analysis can be captured and enlisted for rather peripheral purposes. To use the language of von Clausewitz, some economists by capturing the high ground of economic debate can hope to determine how future campaigns will be conducted. In Williamson's case, whatever interest the question of efficiency may have, it need not have come to be identified with or to dominate this quite separate issue of transaction costs. Moreover, by separating the two, we can make a definite break with the standard economic technique of postulating the a priori existence of economic efficiency (6).
1 Williamson's Crusade
... the transactions cost approach maintains that these institutions have the main purpose and effect of economizing on transaction costs (Williamson 1985, p. 1).
Oliver Williamson self-consciously sees himself as an institutionalist, an economist for whom the stylisation of the firm as a production function is an inadequate explanation of corporate activity (7). …