Saturday Aug 16, 2008

Organizing Production

In his Contemporary Strategy Analysis, Robert M. Grant describes a more recent phase in the long evolution of economic organizations:

As late as 1840s, the largest enterprises in the US in terms of numbers of workers were agricultural plantations. Most manufacturing was organized through networks of self-employed, home-based workers. The English woolen industry consisted of home-based spinners who purchased raw wool (on credit) from a merchant to whom they sold the yarn; the merchant resold the yarn to home-based weavers from whom he purchased cloth. This "putting-out" system survived until the onset of the Industrial Revolution. With the advent of water-powered looms, weavers moved to factories where, initially, they rented looms from factory owner by the hour. Factory-based manufacture made this system of independent contractors inefficient—it was difficult to schedule machine time, and there was little incentive for the independent workers to look after their rented machines. The emergence of firms where market relationships among workers, machine owners, and merchants were replaced by employment relationships between the owner of capital and the workers was a more efficient means of organizing production.

The issue of relative roles of firms and markets is a central aspect of economic organization. In the capitalist economy, production is organized in two ways: in markets (by the price mechanism) and in firms (by managerial direction). The relative roles of firms and markets is determined by efficiency… 

Monday Jan 08, 2007

Shifting Transaction Costs

Regulatory measures can impose, shift or reduce transaction costs for business operations.

For example, the Committee on Foreign Investment in the U.S. (Cfius) has recently moved to impose security requirements on the proposed Nokia Siemens venture.

It is not clear whether Cfius is going beyond its mandate by imposing such requirements. "The process has become a tool for Cfius to impose security requirements on foreign companies, while government lacks the legal authority to impose them on U.S. companies," a U.S. business lawyer David Marchick told Financial Times. (Reuters cites the FT report in its own story on the same subject.) 

Saturday Dec 23, 2006

A Transaction Cost Economics View of the Bullwhip Effect

I'm posting another one of my papers form the Haas years: "A Transaction Cost Economics View of the Bullwhip Effect." It was written in May of 2004. It does need another good round of editting. So, I might edit and repost it at a later time.

In short, this paper gives a TCE assessment of the bullwhip effect observed in supply chain systems. It was written as part of an independent study with professor Oliver Williamson, who was kind enough to review the work and provide some very valuable suggestions. It was an honor to learn a few things about TCE from him, and of courses, errors in this paper, including the typos and techincal ones, are all of my own.

Monday Dec 18, 2006

Securing Property Rights

In cultured societies1, the state secures personal property against wanton takeover. Such protection encourages personal investment in productive social activity.

In a sense, private property becomes, and indeed is, sacred.

Nowhere is this more clear than the severe, albeit varying punishment vetted against thieves in various cultures and societies throughout history.

For example, consider the law in the U.S. that called for the execution of a man who stole the horse of another. Presumably, stealing a horse could be tantamount to stealing another's livelihood if not his or her life. As another example, if some score of  conditions hold, a thief of a personal property might lose a limb--starting with a piece of a finger--according to the sharia law. One of those score of hard-to-meet conditions that must exist for this particular law to apply involves a lack of a survival need to steal. So, the punishment may apply to a Wall Street magnet who has provenly and intentionally stolen from an old lady's pension or some orphans' trust, wrecking their lives as a consequence, but will not apply to a hungry beggar who takes an apple. 

Furthermore, and beyond the proofs in stipulated punishments, we have the proof in taboos against taking what belongs to others. These taboos run deep. For example, consider the emphasis, in both Jewish and Islamic law, regarding payment of debt as a religious obligation. Most reasonable people experience the relevant acculturation and live by these taboos and commendations.

Without the protection of private property, no one can be expected to give of his own or contribute anything for she or he will receive nothing of worth in return. There would be no incentive to contribute anything of worth without the protection of private property and rights in what is of worth. The history of the artificial beliefs in the sanctity of communal property extending to all things worth owning makes it quite clear that when incentives of private ownership disappear, people stop contributing willingly.

However, all protection of private and personal "property" has come at a price. States levy taxes on assets presumably to compensate themselves for cost of securing the conditions for ownership of such assets. The owners pay taxes and return something to the society that harbored their ownership rights. There are similar limits in other cases.

While IP and copyrights have been treated by some as private property, the protections granted to them had a different purpose. It was not an eternal protection but simply a safeguard for a limited time in order to grant the creative forces some security so that they may achieve and earn a return on the novelty they had created. Indefinite or long-term protection would create other problems such as slow propagation of novel ideas and innovations, not to mention the cost of enforcing such "rights." However, there were limits imposed on the duration of such protection in order to return the ideas to the mix of the community that had helped foster them. 

Lawrence Lessig has written enough about this topic, and today, in The Wall Street Journal, we read how sums are invested for the very protection of copyrights. ("Copyright Tool Will Scan Web for Violations," WSJ, December 18, 2006, Page B1.)

When a society pays more for securing what only needs limited protection, it increases its cumulative transaction costs at a time when better, lower-cost, alternatives exist for safeguarding what needs protecting. (This forumla also holds with aggressive wars as a means to provide "security" or with dubious prisons and gulags as a means to provide "justice." These techniques remind us of the analogy of a hammer used to kill a fly. Indeed, they are far worse.)

To the extent creative commons get a chance to grow beyond a certain threshold, we are in a position to see a more free culture. Cultural production means creating new cultural products against and upon what history has handed to us. To the extent that history can be frozen in a particular era by some few owners of its cultural products, we stand to suffer because we lose our flexibility as a cultured community to respond to the changes that go on around us.

Notes

1. The phrase "cultured societies" reads like an oxymoron. No society can exist in the long run without a culture to sustain it. Perhaps, I should have said in "Sustainable societies". Then again, we aree dealing with a bit of a tautology here. Without culture a society cannot be sustained, and no society is sustainable without culture.

Saturday Nov 25, 2006

Unintended Transaction Costs on the Web

Other transaction costs on the web which have recently received much attention have to do with unintended operations such as click fraud and e-mail spams. To what extent do the costs of handling such unintended or undesired behavior affect any overal savings in marketing, search or communications costs afforded on the web? What potential new schemes can inoculate transactions against costs related to spam and click fraud on the Internet? Or will we have to look for another transformation of far broader impact on transactions than what Internet has brought so far?

Wednesday Nov 15, 2006

The Real Thing

Over the years I've been blogging here, I've said quite a few things about Transaction Cost Economics (TCE).

However, my understanding of the topic is actually quite rudimentary based on naive readings of works by Oliver Williamson and others as well as some conversations and seminars with transaction cost economists at Berkeley.

Visiting Williamson's webpage recently, I noticed that it includes a video interview with Williamson, in which he gives an account of the evolution of his ideas and the evolution of TCE. It is worth a viewing.

Monday Nov 13, 2006

Transaction Costs and Search

Transaction Costs Economics (TCE) has gradually evolved its own specific tools of trade.

While works by Ronald Coase, Oliver Williamson and Douglass North have disclosed the basic tenets of TCE, a significant group of econometricians and neoclassical (or should I say analytic) economists have turned to the development of formal tools for analyzing transaction costs.

Earlier, econometricians focused on the structure of deals and whether core concepts of TCE such as specific investments, hybrid schemes, etc., had any conceptual validity. Neoclassical economists focused on applying the "costs of search" concept to the analysis of transaction costs.

Let me  motivate the neoclassical approach to formalizing transaction costs as search costs.

The cost of doing business can be imagined as the cost of searching for suppliers and customers, for example, the cost of finding good employees or good business partners.

As another example, consider real estate deals. A good deal of the cost of a real estate transaction is the search cost. In fact, the agents' fees themselves can be said to do with search costs.

Another case has to do with brands. Brands are themselves used to reduce transaction costs by reducing search efforts. A brand says what it is that you get and you know you'll get that. Unless you get what the brand promises, the brand value will be lost, and you'll start a search for another trustworthy brand. In a sense, the brand value is embedded in all the savings in search. If you have good brand value, people come to you instead of searching. You buy a certain brand of audio equipment, computers, etc., instead of searching for them every single time. Even in things as common as food, some retailers have exerted great effort to develop a brand. So, you go buying meat or oranges at Whole Foods or Trader Joe's, etc., because they just taste different and are more "natural" or "organic." You don't have to keep searching for the right orange or the right piece of beef. In the old times, the local butchers or grocery relied on their reputation to develop a kind of "brand." So, we went to Joe's butcher or Jack's grocery.   

So, does Internet search engines reduce such search-related transaction costs. I'm of the view that they bring mixed blessings.  

There are two problems here. First, there is a problem in imagining all transaction costs as search. Second, there is a problem in equating search in real transactions with search on the Web .... (To be continued) ...

...(I did want to continue from here but Richard Veryard anticipated some things I wanted to say.)

First, the concept of "search" does not capture all transaction costs. The cost of maintaining a certain level of expertise while can be seen as a way to avoid search costs is not itself a search cost although it may involve search costs such as search for methods that would lead to a successful maintenance. Furthermore, actual calculation of transaction costs in their true sense can be quite complex. So, modeling transaction costs as "search" costs is methodologically similar to the modeling of human beings as utility-maximizing machines. Both are gross abstractions.

Second, "search" on the Web hardly proves even a poor replacement for actual "search" in the real transactions. In real transactions, we rely on relationships. The fact that we rely much more on our real world relationships than on what we find on the web, proves my point.

Sunday Oct 15, 2006

Credible Commitments vs. Credible Threats

As part of my interest in transaction cost economics, I've also been fascinated by the follies and excesses of modern strategy theory which focuses, almost exclusively, on a view of economic and social relationships based on anti-social power differentials as opposed to social interdependencies.

Here, I'm posting an essay (PDF) I wrote in May of 2003 on the concept of "credible commitments" in contrast to the-so-called "credible threats." The former concept has been used by prominent transaction cost economists while the latter remains a part of the common terminology in much of game theory.

(Again, anyone may use the essay  as long as the user provides appropriate reference to its origin and author.)

Friday Oct 13, 2006

Efficient Adaptation in Long-term Contracts

Here is a commentary (PDF) I wrote in 2003 on “Efficient Adaptation in Long-term Contracts: Take-or-Pay Provisions for Natural Gas” Scott E. Masten and Keith J. Crocker (American Economic Review, vol. 75 (5), 1985).

If you want to make use of my commentary for a business school paper or otherwise, make sure you give an appropriate reference to it. In other words, use the well-known, common principle: No plagiarizing!

Monday Oct 10, 2005

Existential Phenomenology Of The Internet

Søren Kierkegaard

The Internet has introduced, among other things, new modes of transactions, mostly involving what one can buy from a relatively competitive market. The Internet has reduced some transaction costs while increasing others.

The pundits have often exaggerated the effectiveness of the Internet in organizing and searching for "information," in distant "learning," and in citizen participation and "democratization" even if we include more recent phenomena such as blogs and podcasts. Much more has been said about the role, importance, expansion and revolutionary effects of the Internet than about how it can stultify action and movement.

Hubert Dreyfus is the one philosopher who has paid attention to these other concerns regarding the Internet. Earlier, on this weblog, I have written short entries on Dreyfus' book On The Internet. Now, I'd like to point to an essay of his whose content can also be found near the end of this book: "Kierkegaard on the Internet: Anonymity vrs. Commitment in the Present Age".

In this essay, Dreyfus explains why "Kierkegaard would have hated the Internet."

This is a must-read essay for anyone who wants to know what is going on with the Internet. I will quote a few paragraphs to titillate your interest:

Kierkegaard would surely have seen in the Internet, with its web sites full of anonymous information from all over the world and its interest groups which anyone in the world can join and where one can discuss any topic endlessly without consequences, the hi-tech synthesis of the worst features of the newspaper and the coffee house. On their web page anyone can put any alleged information into circulation. Kierkegaard could have been speaking of the Internet when he said of the Press, "It is frightful that someone who is no one ... can set any error into circulation with no thought of responsibility and with the aid of this dreadful disproportioned means of communication" (Journals and Papers, Vol. 2, p 481.) And in interest groups anyone can have an opinion on anything. In both cases, all are only too eager to respond to the equally deracinated opinions of other anonymous amateurs who post their views from nowhere. Such commentators do not take a stand on the issues they speak about. Indeed, the very ubiquity of the Net generally makes any such local stand seem irrelevant.

What is striking about such interest groups is that no experience or skill is required to enter the conversation. Indeed, a serious danger of the Public Sphere, as illustrated on the Internet, is that it undermines expertise. Learning a skill requires interpreting the situation as being of a sort that requires a certain action, taking that action, and learning from the results. As Kierkegaard understood, there is no way to gain wisdom but by making risky commitments and thereby experiencing both failure and success. Studies of skill acquisition have shown that, unless the outcome matters and unless the person developing the skill is willing to accept the pain that comes from failure and the elation that comes with success, the learner will be stuck at the level of competence and never achieve mastery. Since expertise can only be acquired through involved engagement with actual situations, what is lost in disengaged discussion is precisely the conditions for acquiring practical wisdom. Thus the heroes of the Public Sphere who appear on serious radio and TV programs, such as the United States's MacNeil/Lehrer News Hour, have a view on every issue, and can justify their view by appeal [to] abstract principles, but they do not have to act on the principles they defend and therefore lack the passionate perspective that alone can lead to risk of serious error and also to the gradual acquisition of wisdom.

Kierkegaard even saw that the ultimate activity the Internet would encourage would be speculation on how big it is, how much bigger it will get, and what, if anything, all this means for our culture. This sort of discussion is, of course, in danger of becoming part of the very cloud of anonymous speculation Kierkegaard abhorred. Ever sensitive to his own position as a speaker, Kierkegaard concluded his analysis of the dangers of the present age and his dark predictions of what was ahead for Europe with the ironic remark that: "In our times, when so little is done, an extraordinary number of prophecies, apocalypses, glances at and studies of the future appear, and there is nothing to do but to join in and be one with the rest" (85).

From Hubert Dreyfus, "Kierkegaard on the Internet: Anonymity vrs. Commitment in the Present Age"

Tuesday Jun 08, 2004

Economizing and strategizing

So, here I go, testing this Weblog system . . .

Oliver Williamson, the great contemporary economist, notes that there has been too much focus on triangles formed by supply-demand curves, i.e. on strategizing, and not enough attention on the larger rectangles, i.e. on economizing. A good place to read about this is in his book of essays on transaction cost economics, Mechanisms of Governance.

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