Transcript The Information and Services Economy a.k.a. Business

The Information and Services Economy
a.k.a.
Business Architecture and Services Science
IS210, Week 3
Profs Bob Glushko & Anno Saxenian
UC Berkeley School of Information
Fall 2006
The view from the 1960s: fun facts
 All but two of the world’s largest companies based in US
 US cos. produced 50% of world output
 US cos. produced more manufactured output than next 9
industrial nations collectively
 General Motors earned as much in profits as ten biggest
cos. from France, UK, Germany combined (30 cos. total)
Theoretical foundations: the classics
 Economics: Organize in firm v. market
Adam Smith
Ronald Coase
Oliver Williamson
 Production: How to maximize output
Karl Marx
Henry Ford
Frederick Taylor
Alfred Chandler
Adam Smith & the wealth of nations
 An Inquiry into the Nature and Causes of the Wealth
of Nations, 1776
The magnum opus of Scottish economist, Adam
Smith
The founding work of “modern” economics and
political economy
Written on the eve of industrial revolution in Britain
 Smith’s main theoretical contributions:
the specialized “division of labor”
the “invisible hand” of self-interest/ the market
Smith on the division of labor
 Book 1, Chapter 1: “Of the division of labour”
“The greatest improvement in the productive powers of
labour…seem to have been the effects of the division of
labour.”
 The division of labor in pin manufacture
Pin making can be divided into some18 distinct
operations
If tasks performed by ten individuals, can make over
48,000 pins/day
If tasks all performed by the same individual, might only
make 20
Sources of productivity growth
 Division of labor at two scales
Specialization of tasks within the firm (e.g. pins)
Separation of tasks between firms/industries in
the economy (e.g. philosophers)
 Sources of productivity growth
Increased dexterity when working on single task
Time savings due to passing from one sort of
work to another
Machinery that increases individual productivity
. . . the extent of the market
 Book 1, chapter 3: “That the division of labor is
limited by the extent of the market”
The greater the demand that a firm, industry, or
economy faces, the more that firm, industry, or
economy can deepen the division of labor.
The more specialized the division of labor, the
greater the productive powers of workers
 In a well-governed society, with division of labor and
multiplication of the productive arts, we find
“universal opulence that extends itself to the lowest
ranks of the people”
Smith and the “invisible hand”
 Book 1, chapter 2: “It is not from the benevolence of
the butcher, the brewer, or the baker, that we can
expect our dinner, but from their regard to their own
interest.”
 Individuals/households acting solely in their own selfinterest generate collective good/ general interest
 The proper functioning of the free market, even though it
appears chaotic, maximizes economic benefit overall
 Book 4, chapter 2.”... by directing that industry in
such a manner as its produce may be of the greatest
value, he intends only his own gain, and he is in this,
as in many other cases, led by an invisible hand to
promote an end which was no part of his intention.”
Ronald Coase “The nature of the firm”
 Coase’s question: Why is there any economic
organization? Why is economic activity organized
into firms rather than by individual proprietors?
 D. H. Roberston: We find “islands of conscious
power in this ocean of unconscious cooperation like
lumps of butter coagulating in a pail of buttermilk”
For mainstream economists, prices and markets
are exclusive mechanisms for allocating
resources and coordinating economic activity
When do organizations/ firms supercede the price
mechanism, eliminate market, and allow
“entrepreneur” to coordinate economic activity
The costs of using the price mechanism
1.
2.

The cost of discovering the relevant prices
(imperfect information)
The cost of negotiating and concluding contracts
for each exchange
Firm will expand until costs of organizing an extra
transaction within the firm become equal to the
costs of carrying out the same transaction by
means of an exchange on the open market or the
costs of organizing in another firm.
Why isn’t all production in one big firm?
1. Decreasing returns to “entrepreneur”
(managerial) function: rising costs to
organizing transactions within firm
2. As transactions organized internally,
misallocation of resources raises costs
3. Rising “supply price” of factors of
production
 “Diminishing returns to management”
Ronald Coase ”The nature of the firm”
Firm will expand until costs of organizing an extra
transaction within the firm becomes equal to the
costs of carrying out the same transaction by
means of an exchange on the open market or the
costs of organizing in another firm.
Why? There are costs associated with using the market
1. Cost of discovering prices (imperfect
information)
2. Costs of negotiating and concluding contracts
for each transaction
Theory of the firm: Oliver Williamson
Markets and Hierarchies: Analysis and Antitrust
Implications (1975)
The Economic Institutions of Capitalism (1985)
 Develops insight from Coase that firm boundaries
can be explained by efficiency considerations
 Identifies more precisely the nature and sources of
transaction costs in differing circumstances
 Focus on role of firm boundaries in providing
incentives (less than coordination problems)
Transaction cost economics

Williamson identifies key dimensions of individual
transactions and maps every transaction to a most
efficient institutional arrangement (market or firm)

Assumptions
1. In the beginning there were (efficient) markets
2. Bounded rationality: human behavior
intentionally rational but only limitedly (Simon)
3. Opportunism: “self-interest seeking with guile”
(economic agents use strategic behavior to gain
self-interest)
Opportunism: the “hold-up problem”
Classic version: Klein, Crawford, Alchian (1978)
One party makes a relation-specific investment to
transact with another (value is lower, or zero, to
other uses than transaction between those parties)
Impossible to draw a complete contract that will cover
all possible issues that might arise in transaction –
might affect returns on investment
 e.g. Very expensive dies used to shape steel into specific forms
needed for sections of body of a particular car model, paid for
and owned by supplier
Supplier vulnerable to hold-up; the efficient solution is
vertical integration
Williamson’s conditions
BOUNDED RATIONALITY
UNCERTAINTY/COMPLEXITY
INFORMATION
IMPACTEDNESS
OPPORTUNISM
SMALL NUMBERS
ADVANTAGES OF INTERNAL ORGANIZATION IN RELN TO MARKETS
Later developments, Williamson
Three crucial transaction characteristics
1. Frequency
2. Uncertainty
3. Asset specificity (foregone benefits of
discontinuing relationship)
Higher levels of uncertainty, higher degrees of asset
specificity (esp in combination) result in complex
contracting relationship with need for ongoing
adjustments. Better resolved within firm than
market (easier to resolve disputes)
Firm and hierarchy
Advantage of firm for Williamson:
Hierarchical relationships in which one party has control over
both sides of the transaction and power to resolve disputes.
A Hobbesian solution to opportunism:
Market for Williamson is like Hobbes’s state of nature, and only
possible resolution is through internalization of transactions
within hierarchical structure
Hierarchy: originally, rule by priesthood, heavenly beings; today,
rule by single ruler with control over organization, authority
passed through a series of subordinate rules, and so on
through a pyramid.
Challenges to transactions cost model
1.
2.
3.
4.
5.
Overlooks extent to which economic or “market”
relations are intertwined in social relationships,
both within and between firms and at all levels
Vastly overstates efficacy of “fiat” within
organizations (internal conflict, cheating, etc.)
Observation of multiple forms of firms, not pure
market or hierarchy: hybrids, LT subcontracting
Alternative models exist even in same industries
e.g. Japanese v. U.S. auto industries
Depends upon relatively stable environments