Transaction costs theory and the imperfect markets.

Williamson’s successful complementation of the Coases approach of the firm as an alternative to reduce the cost of using the price mechanism, with Herbert Simon’s organizational theory, gave birth to the Transaction Costs Theory (TCT)1. This meant a big step, which evolved the theory of the firm, from its obsolete neoclassical toots and assumptions -of a perfect competitive market and a perfect rationality-, by adding the issues of bounded rationality and opportunism to Coases work2. Williamson opened the path to new ways of conceiving and complementing the theory of the firm in general, and the transactions costs theory in particular. By enabling to the economic theory the enhancing and the building of new connections between cognitive psychology and economics. Connections that have allowed, among other things, the development of a larger view in the roll of the firm, no only as an avoider of costs, but also as a creator of knowledge. All in better accordance with the modern firms logic of making business.
In order to understand the transaction costs theory, one has to comprehend that the competitive market structure, is only a reference to be taken into account, when one analyses the observed structure of markets, which are called “imperfect competitive”,
For the market is not given under a homogenous form to all economic agents, but is continuously changing under agents decisions and behaviours 3 . Further more the neoclassical perfect rationality, which is an essential assumption for the competitive market structure, doesn’t takes into account the problems of processing the uncertainty due to the imperfect information, the limits to the human capacity and the difficulties due to the interdependencies among different agents 4 . Under the neoclassical approach the standard model of the firm, study the “imperfect competitive” markets as through the “violations” of one or more hypothesis of the neoclassical competitive market model, and do not takes into account any real discussion about the nature and characteristics of the participants involved5.
As Walras once said, under the neoclassical view, the transaction cost due to the asymmetries of information, would be to the market, like a friction to a machine. And
“The most obvious sort of friction, and undoubtedly one of the most important, is the cost of transferring assets from one form to another” as John Hicks once said6. In
1940, Tibor Scitovsky introduced the label of “transaction costs” into the economic vocabulary7. And in 1937 Ronald Coase published his paper in which he attributed the existence of the firm as a way to lower the cost of using the price mechanism 8 , considering the firm and the market to be alternative methods of coordinating resource allocation. Coase argued that the cost of using the market price mechanisms could be reduced if agents internalized activities, so the entrepreneur becomes consequently an administrator, who directs and supervises the required activities, in order for the firm to

1 Hardt, 2009

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4 Textbook 5 Textbook 6 Hicks, John. 1935. A suggestion for simplifying the theory of money. Economica, 2 (5): 1-­‐19. 7 Hardt 2006 8 Coase 1937

allow agents to economize their market costs9.
In 1979 Oliver Williamson’s article “Transaction cost economics: the governance of contractual relations” appears in the Journal of Law and Economics, in it, he opens the way to the study of economic activity as undertaken by agents characterized by limited cognitive capacity, and opportunistic behaviour 10 . In this way he continues the departure from the perfect rationality assumptions initiated in the fifties by Herbert
Simon, who with the insights from cognitive psychology –that is the notion that men can be “intentionally rational, but only to a limited extent” 11 - gave birth to the organizational theory. Williamson then uses Simon’s organizational theory assumptions and combines it with the analytical framework of neoclassical economics12, translating the ideas from organization literature, into concepts observable in the performance of firms and markets, in order to explain that the reasons for vertical integration lie in the behavioural characteristic of contracting actors, and particularly in bounded rationality.
Then and as a consequence of the development of the former insights, he develops the theoretical foundations incomplete contracts, opportunism and merges them with the neoclassical cost minimization into this conceptual framework13.
According to Williamsons work, there are three general dimensions, along which transactions can differ: assets specificity, uncertainty and frequency. Being the first one, the most significant, when considering the firm structure as a better alternative than the market, in order to economize in both bounded rationality and opportunism. In this sense, internal organization is more efficient in the decision-making process for the allocation of resources, due to the elimination of information asymmetries. Due to its internal organization, a class of governance, in which making permanent appointments to a group that has the authority to make efficient decisions, is necessary in order to make gains from comparative advantages. Thus an “elite” is created as the head of a hierarchical organization system14.
This developments embodied in the transaction costs theory, have stressed the need of acquiring a larger understanding in the field of (the new) behavioural economics, which deals with various sorts of cognitive biases characteristic of contracting agents15.
Thus strengthening the most needed bridge (at least from the economics side) between the academic discipline of Psychology and the social science of Economics.
On the other hand, in the beginning of the 1990s, it became evident that in a modern economy what really matters are the knowledge transactions16, because as Daniel Bell pointed out, “post-industrial society is built upon knowledge rather than things”17. So the next step for de TCT, is to be up to the challenges offered by the modern economy and the modern firms logic of making business. In this regard and in spit of the early

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10 Hardt, 2006 11 Simon,

1957 1999 13 Hardt, 2006 14 Textbook 15 Foss 200 16 Starbuck, 1992 17 Hardt, 2006 12 Allen,

literature on the TCT, (in which firms exist in order to avoid the market costs of coordination, implicitly assuming that knowledge can be equally well shared on the market and within the firm18), it should also be noted as Lukazs Hardt points out, that even in the pre-Williamsonian theory many claimed that knowledge can be more easily transmitted within the firm, because of the fact that it often needs a stable environment to be efficiently shared19.

Therefore because of this new requirements of modern economy the role of the firm is to produce and to transfer knowledge, as a consequence there most be continuity between the Williamsonian approach and the more recent developments in the TCT, as the so-called knowledge governance approach (KGA), which focuses on the problem of how to organize transactions to efficiently generate knowledge and capabilities20. The KGA analyses four dimensions of knowledge transactions: tacitness versus explicitness, system quality versus standalone, teachability versus nonteachability, and complexity versus noncomplexity21. In this sense so TCT opens the door for a new kind of theory of the firm, in which an enterprise is treated not only as minimizer of costs, but also as a creator of positive value, being the KGM literature which is still of part the TCT-, the one which analyses the organizational structures of firms that facilitate these processes.
In conclusion, as we can see it has been a long journey, from the neoclassical assumptions of the competitive market structure and perfect rationality, to the modern transaction costs theory, which not only takes into account the information asymmetries, the bounded rationality of the agents and their opportunistic behaviour, but also is beginning to see the Firm as a creator of positive value (Knowledge), instead of just a minimizer of costs in response of the necessities of modern economy.
And on the other this advances have opened the path for new assimilations of the many insights of cognitive psychology, which are most needed for the further development of the TCT and the theory of the firm. In ordered that we can truly and better comprehend the interactions amongst the agents in the economy.

18 Hardt, 2006 19 Hardt, 2006 20 Nickerson
21
Nickerson

and Zenger 2004 and Zenger 2004

References
Hardt, Luksz, (2009). The history of transaction cost economics and its recent developments. Warsaw, Poland: Erasmus Journal for Philosophy and Economics
Nickerson, Jackson, and Todd Zenger, (2004). A knowledge-based theory of the firm: the problem-solving perspective. Organization Science.
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