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Empirical Microeconomics: Another Perspective

Oliver E. Williamson University of California, Berkeley owilliam@haas.berkeley.edu

September 2000

Empirical microeconomics: another perspective Oliver E. Williamson*

What was obvious to many of us at the time has become even more evident since: the Graduate School of Industrial Organization at Carnegie-Mellon (then Carnegie Tech) had assembled an extraordinary group of faculty and students in the 1950s and early 1960s and the Ph.D. program was an inspiring experience. Studies by the Ford Foundation and the Carnegie
1 Foundation record some of the programmatic successes. Nobel Prizes and other awards for

research that was done by the GSIA faculty at Carnegie also speak to the intellectual vitality of
2 those years. As a student of Carnegie, I can only marvel at the project.

Of the many distinguished faculty at Carnegie, none cast a larger shadow than Herbert Simon. Everything seemed to be within his purview—as he made contributions to economics, political science, sociology, organization theory, statistics, philosophy, cognitive science and the list goes on. Then and since, he has expressed concerns that economic theories of the firm and of consumer choice worked off of implausible cognitive assumptions. Both were deeply problematic as a consequence. The common response that a theory should be judged not by the reasonableness of its assumptions but by the ‘comparison of its predictions with experience’ (Friedman 1953, p. 9) does not wash, moreover, if the resulting predictions are few in number and often bear a weak relation to the phenomena of interest, and if the empirical tests are limited and/or ambiguous or contradictory. Simon continues his criticisms of orthodoxy in the recent book, An Empirically Based Microeconomics (1997). The recent criticisms, moreover, go beyond orthodoxy to indict the New Institutional Economics, of which transaction cost economics is a part. Without question, transaction cost economics (TCE) is different from the behavioral economics program that flourished at Carnegie in the late 1950s/early 1960s. But while TCE is ‘more neoclassical’, it nevertheless relates to the Carnegie project in many respects—or at least that is my position (as developed elsewhere and repeated here). Also, contrary to Simon,

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transaction cost economics is an empirical success story. I have no illusions, however, that mine is the last word. TCE always stands to benefit from good critics, of which Simon has been one and Mark Granovetter (1985) is another. The dialogue will continue and the outcome will be decided by others. The Simon critique of orthodoxy and of TCE is briefly summarized in Section 1. The ways in which the TCE perspective draws on and differs from the work of Simon and Carnegie are reviewed in Section 2. As set out in Section 3, TCE and Simon/Carnegie deal with different phenomena and are often complementary. The empirical research accomplishments of TCE are summarized in Section 4. Concluding remarks follow.

1.

The Simon critique Simon is a self-described ‘scold’ of orthodoxy, going back at least to Models of Man

(1957). Although some mainline economists immediately took issue (Solow 1958), many have recognized that uncritical use of heroic assumptions (especially hyperrationality) by orthodoxy could lead to implausible constructions. Not only has Simon received recognition and awards from economists—witness his publications in leading economics journals, his presentation of the prestigious 1978 Richard T. Ely Lecture before the American Economics Association and the award of the Nobel Prize in Economics in 1978—but there is growing appreciation for the need to find ways to model bounded rationality (Rubinstein 1998; Kreps 1999; Maskin and Tirole 1999). Simon nevertheless despairs that the applied and theoretical efforts of economists will truly come to terms with bounded rationality (Simon 1991, 1997; Rubinstein 1998, Chap. 11).

1.1

Core position If ‘Nothing is more fundamental in setting our research agenda and informing our

research methods than our view of the nature of the human beings whose behavior we are studying’ (Simon 1985, p. 303), then social scientists should be prepared to name the key

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attributes of human actors. Both the condition of cognition and self-interestedness need to be addressed. Simon early took the position that the hyperrationality assumption out of which orthodox economics works should be supplanted by the less demanding cognitive condition of bounded rationality—according to which human actors are intendedly rational but only limitedly so. The issue of self-interest has received less attention, but Simon has described it as ‘frailty of motive’ (1985, p. 303) and has also featured docility, identification, and loyalty in describing human behavior in organization (Simon 1991, 1997).

1.2

Theory and evidence Simon distinguishes three uses of economic theory: curiosity; a guide to the

management and operation of firms; and a guide to the operation of the economy (1997, p. 63). Achieving these three goals (Simon 1997, p. 63): …requires building an adequate, empirically based, theory of bounded rationality…. The knowledge that economic actors possess and do not possess, the computations that economic actors can make and cannot make must not enter as ad hoc assumptions…but must be shaped and tested by the sharpest empirical methods that we can devise. Although both the ‘experience-based tests’ on which Adam Smith relied and more recent econometric tests are instructive, neither are judged to be adequate to the sharpness needs to which Simon refers. He therefore recommends that these be supplemented by turning to and testing ‘the validity of some or all of the specific assumptions that are built into the models as well as the models as wholes’ (Simon 1997, p. 23). Laboratory experiments and ‘empirical studies that observe the behavior of consumers or of business firms directly’ are what he proposes (Simon 1947, p. 23). He observes in this connection that ‘When we look at organization in the real world, we find much more structure and complexity than is hinted at in the theory of the firm, whether in its

David Kreps. Simon describes the strength of firms as follows: ‘The need for coordination. p. The comparative study of firms and markets requires that the strengths and limitations of each be identified and explicated. Avinash Dixit. whence none are identified or explicated by Simon. That orthodoxy is remiss in dealing with ‘real world’ organizations is widely conceded. (The possibility that some of these features reside in the microanalytic attributes of transactions is nowhere admitted.4 classical or its “New Institutional” versions’ (Simon 1997. but a predictive theory of economic organization would advise on when and why the needs for coordination and the support of organizational loyalties vary with the circumstances. or perhaps piety’ (Simon 1991. That is instructive. But Simon’s view that the TCE and orthodox theories of the firm are two peas in a pod comes not only as a surprise to me but to many others as well—which includes not only NIE economists but Kenneth Arrow. Oliver Hart.) . and that accounts for the large role of organizations in the economic activity of a society like ours’ (Simon 1997. 38). ‘the new institutional economics and related approaches as acts of faith. Jean Tirole and the list goes on. p. p. That is because there are truly fundamental differences between the TCE theory of the firm as governance structure (which is an organizational construction) and the orthodox theory of the firm as production function (which is a technological construction). awaiting empirical testing. Bengt Holmstrom. 49). Empirical research in behavioral economics and in transaction cost economics is examined in Sections 3 and 4. I return to these issues in Section 2. whereupon an empirical research program focused on the key features could be undertaken. along with the possibility of creating organizational loyalties are perhaps the two most important factors that give organizations an advantage over markets in many situations. Simon’s contention that TCE has been remiss in empirical respects—it being his view that. 27)—is likewise one with which I (and others) take exception.

p. 49). Organizations are at least as large a part of the story of Russian disorganization and failure as are markets’ (Simon 1997. Simon’s propensity to operate at a very high level of generality helps to explain Ariel Rubinstein’s remark that ‘The book is missing a chapter with a detailed example where Simon demonstrates the implementation of his approach.4 Inasmuch as young scholars ‘desire to explore new paths. 45). 1712).3 Conclusion Simon concludes that the economics profession needs to be more attentive to the needs of the many students who view ‘mathematical tools with distrust and deplore the necessity of devoting their research time to formalisms that they regard as mainly sterile’ (1997. Williamson 1996). and very likely played such a role before perestroika began. 90). however. then symmetrical attention to the strengths and weaknesses of each is needed. electric power and communications services) as compared with private (usually regulated) firms as inconclusive (Simon 1997. p. p. He therefore expresses skepticism over the need for the privatization of firms in moving from a centralized to a market economy (Simon 1997. invite us to ‘consider the hypothesis that failures in skills of organizing and in enlisting organizational loyalties play a major role in Russian economic difficulties today. 51). nonprofits and government agencies. where he interprets the evidence on the efficiency of government providers of public utilities (such as water. 50). He also discusses the comparative performance of private ownership. Simon is silent on the weaknesses of firms.5 Also. p. including the path of empirical . More generally. and ending with its valuable conclusions’ (1999. Demsetz 1969. if all feasible modes of organization are flawed (Coase 1964. Simon does. starting with data about human reasoning. This lack of a ‘consistent relation between forms of ownership and their operational efficiency’ is explained by the fact that ‘direct participation in profits plays only a small role in motivating the loyalty of employees to business and other organizations’ (Simon 1997. 1. p. p.

(3) a study of the compensation of executives. Econometric tests of macroeconomic theory using quantitative data are also mentioned. which takes the form of a Pareto distribution and can be generated by the assumption that the growth of a firm is proportional to its current size (Ijiri and Simon 1977). 96-97). Examples from cognitive and experimental psychology include tests of the postulates of rationality by Daniel Kahneman and Amos Tversky (1973). Other empirical work to which Simon makes favorable reference include the laboratory experiments on markets by Vernon Smith (1991) and his colleagues. production. and the use of verbal protocols and computer simulation of thinking to produce ‘an extensive and well-tested theory of human cognitive performance over a wide range of tasks”. which demonstrate that human actors are poor Bayesians. we need to revise the curriculum so that students of economics will be exposed to the range of empirical techniques that I have described’ (Simon 1997. etc. (2) a study of the size distribution of firms. with special emphasis on the limits of the data and the estimating procedures (Simon 1997. of which the department store pricing study by Richard Cyert and James March (1963) is an example. according to which span of control and fairness considerations are combined to predict that the salaries of executives will vary directly with the logarithm of the number of subordinates (Simon [1947] 1957). Some of the earlier work at Carnegie to which Simon makes favorable reference includes (1) an examination of how the policy recommendations of business executives responding to the same set of facts are strongly influenced by their training and the business functions (marketing. legal. . Alfred Chandler’s studies of business story (1962). p. 91). and (4) a series of studies of the specific business practices of individual business firms. 80). 23. experimental game theory. p.) to which they were assigned (Dearborn and Simon 1958). pp. both laboratory and practical (Simon 1997. 72-74. and survey techniques by George Katona (1951) and others.6 research….

Also.1 Carnegie origins First and foremost. 16). Carnegie encouraged the student of organization to ask ‘What’s going on here?’ Not only does TCE ask that question but it is furthermore indebted to Carnegie by subscribing to the following: (1) bounded rationality. p. As I have described it elsewhere. and (5) adaptation. Although TCE and Carnegie may divide on how closely to hew to the ‘rational spirit’ to which Arrow refers (1974. to explain the range of complex organizational phenomena with which Carnegie was concerned. 1996). no single social science is able. by itself. (4) discrete structural analysis. (3) near-decomposability. xxiv). (2) process matters. Even if economics is the queen of the social sciences (opinions differ). (a) Bounded rationality TCE subscribes to the proposition that human behavior is intendedly rational but only limitedly so (Simon [1947] 1961.7 2. where the organization theory is predominantly of a Simon/Carnegie kind and economics is the first among equals. 2. be interdisciplinary and have an active mind (Williamson. The transaction cost economics perspective Transaction cost economics can be variously described. I describe it as an interdisciplinary joinder of law. there is no question but that TCE draws extensively on organization theory—although some have questioned the value added. TCE works out of (6) weak-form selection. Economic actors are thus assumed to be attempting effectively to cope but lack the wits to maximize. . economics and organization theory. the imperative at Carnegie was to be disciplined. Carnegie featured interdisciplinary social science. Consider each. Rather than pronounce ‘This is the law here”. p. 5 I begin with a sketch of the Carnegie contributions on which TCE rests and then turn to some of the significant respects in which Carnegie and TCE differ.

As Robert Michels puts it in the context of oligarchy. Unintended consequences and the imperatives of bureaucracy (March and Simon 1958) are among the more important conditions of which the student of economic organization needs to be apprised. 129): (a) in a nearly decomposable system. This serenity and candor apply to the study of organization more generally. p. ‘New questions’ are swept in by the move from complete to incomplete contracts. 370). p. has a life of its own. Failing to be alert to the chief intertemporal propensities of organization. students and practitioners will fail to make allowance for unrecognized costs and benefits. the short-run behavior of each of the component subsystems is approximately independent of the short-run behavior of the other components. like the law. Posing and answering these new questions is where the distinctive TCE contributions reside (Arrow 1987. (b) in the long-run. (b) Process matters If organization. ‘nothing but a serene and frank examination of the oligarchical dangers of democracy will enable us to minimize these dangers’ (1962. then intertemporal process transformations that predictably recur need to be discovered and the ramifications for organizational design wrung out. The main ideas here are these (Simon 1962.8 To concede bounded rationality is one thing. What to make of it is another. (c) Near-decomposability The now widely recognized importance of modularity was anticipated by Simon’s work on nearly-decomposable systems. 734). Near-decomposability is a widely observed design principle in complex social systems and reflects respect for the cognitive overload (bounded rationality) and ease of disclaiming . the behavior of any one of the components depends in only an aggregative way on the behavior of the other subcomponents. p. TCE holds that the principal ramification of bounded rationality for the study of economic organization is that all complex contracts are unavoidably incomplete.

159). For. bureau. hybrid. the microanalytic mechanisms of governance. Not only does TCE view alternative modes of governance—markets. etc. emphasis in original). (2) how is each generic mode of organization (market. which is broadly congruent with Jon Elster’s dictum that ‘explanations in the social sciences should be organized around (partial) mechanisms rather than (general) theories’ (1994. 449). firms.) defined in terms of these attributes and (3) what resulting strengths and weaknesses accrue to each generic mode (Williamson 1991). p. to the effect that. firm. in that case. bureaus. organization reduces to repetition ([1921] 1957. p.—in discrete structural terms. but it takes three additional steps. This argument is akin to one expressed earlier by Frank Knight. It asks (1) what are the principal attributes with respect to which governance structures differ. Given near-decomposability. 75. The first of these was . pp. of which two kinds are distinguished: autonomous and cooperative. etc. The rudiments of a predictive theory of comparative economic organization reside in the answers to these. 267-268). (d) Discrete structural Simon’s idea of discrete structural. p. as against marginal. (e) Adaptation TCE also subscribes to the view that ‘Interdependence by itself does not cause difficulty if the pattern of interdependence is stable and fixed. marginal analysis plays a less significant role in the choice among alternative modes of governance than it does in the analysis of market equilibria (Simon 1978. but for unanticipated disturbances (uncertainty). rather than an overarching theory of organization. Because alternative modes of organization differ in kind rather than degree. become the object of analysis.9 responsibility (opportunism) in fully connected systems. analysis is also one to which TCE subscribes. The central problem of organization on which TCE focuses is that of adaptation. each subprogram can be designed to take into account all the subprograms with which it interacts’ (March and Simon 1958.

(3) subtle procedures of statistical inference to perform empirical testing and (4) ‘most important of all. TCE is an exercise in close reasoning (which I take to be the Carnegie tradition) as opposed to the tight reasoning of mathematical economic theory—which routinely sacrifices plausibility in the name of logical consistency and mathematical rigor. Albeit worthy values. is very conscious about the plausibility of postulates and the relevance of conclusions. In all six of these respects. by contrast. background way on competition to perform a sort between more and less efficient modes of governance. who emphasized spontaneous adaptation realized through markets. 125). their realism and the relevance or usefulness of the conclusions they lead to’ (Koopmans 1957. Thus Koopmans describes the four ‘skills within the economics profession’ as follows: (1) detailed knowledge of the realities of economic life. ‘not everything that is logically consistent is credulous’ (Kreps 1999. (f) Weak-form selection TCE relies in a general. Chester Barnard. the appraisal of postulates with regard to their plausibility. but there is no reason to suppose that they are fittest in any absolute sense’ (Simon 1993. 4). p. 69. TCE.10 featured by Friedrich Hayek (1945). working through administration. As against selection of the fittest. 6 . p. the close reasoning out of which TCE works is acutely attuned to the detailed knowledge to which Koopmans refers. Tjalling Koopmans also has a broad (Carnegie-like) conception of the economic enterprise. TCE makes provision for adaptations of both kinds and holds that alternative modes of governance differ in their capacities to deliver autonomous and cooperative adaptations (Williamson 1991). like Carnegie. p. 145). emphasis in original). it subscribes instead to weak-form selection: ‘in a relative sense. (2) the logical and mathematical skills of reasoning from postulates to conclusions. As discussed elsewhere (Williamson 2000). thereby to link observations with concepts. emphasized cooperative adaptation of a ‘conscious. gives greater priority to plausibility. purposeful’ kind (1938. the fitter survive. deliberate. p. invites empirical testing.7 Interestingly.

in the spirit of Koopmans. this last (full formalism) does not trump all others (Kreps 1999). notes that while the concept of role has been proposed as a sociological unit of analysis. Not only do the computer simulation models of A Behavioral Theory of the Firm (Cyert and March 1963) operate out of routines. p. One of the consequences is that TCE and Simon/Carnegie often deal with different microanalytic phenomena and inform different issues of public policy. in that the human actor is postulated to behave as an information processing system (Newell and Simon 1972). (3) the description of self-interest. for example. Also. xxx). TCE gives different and more prominent attention to contract. By reason of these differences. (a) Unit of analysis: decision premise or transaction Both the choice of a unit of analysis and the subsequent dimensionalization thereof are important to a progressive research agenda. Although subsequent work on human problem solving by Simon (in collaboration with Alan Newell) is in this spirit. whence the latter is often scanted.2 Some differences The significant reliance of TCE on Carnegie notwithstanding. p. He recommends instead that the decision premise be made the unit of analysis and avers that ‘Behavior can be predicted…when the premises of the decision are known (or can be predicted) in sufficient detail’ (Simon 1957b. there are also differences. The most consequential of these are (1) choice and operationalization of the unit of analysis. A more composite variant of the decision premise is to treat the ‘routine’—the decision rules and procedures—as the unit of analysis. ‘the term has never been given sufficiently precise definition’ (1957b.11 and encourages logical and mathematical reasoning. 2. (2) the main lesson for economic analysis of bounded rationality. Simon. but Richard . Of these two steps. naming a unit is easier than dimensionalization. the systematic application of the decision premise as the unit of analysis has yet to produce a widely applicable theory of organization to which predictions about firm and market organization accrue and the data have been applied. (4) the condition of foresight and (5) the role of informal organization. xxx).

This effort to dimensionalize transactions in combination with the aforementioned effort to name the principal attributes with respect to which governance structures differ become the basis for the discriminating alignment hypothesis. p. uncertainty. 4). The large and growing body of empirical research discussed in Section 4 involves the application of this hypothesis to a wide range of phenomena. and frequency as the critical dimensions with respect to which transactions differ. of finding a course of action that is good enough…is an essential step in the application of the principle of bounded rationality’ (1957b. which differ in their attributes. mutuality. thereby to mitigate conflict and realize mutual gains. are aligned with governance structures. ‘A Behavioral Model of Rational Choice’—which appeared in the Quarterly Journal of Economics . however. emphasis in original). to wit: transactions. Not only does TCE view governance as the means by which to infuse order. and may prove to be precisely that. To date. Simon’s 1955 article. pp. neither A Behavioral Theory of the Firm nor evolutionary economic theory has seriously addressed itself to the daunting challenge of dimensionalizing the routine. Commons features in his overarching statement on the study of economic organization: ‘The ultimate unit of activity…must contain in itself the three principles of conflict. p. The unit of analysis out of which transaction cost economics works is the transaction— which John R. This unit is a transaction’ (1932. but it takes the transaction to be the basic unit of analysis and names asset specificity (in its various forms). 204-205. so as to effect a transaction cost economizing result. (b) Bounded rationality: satisficing or incomplete contracting Simon holds that ‘the replacement of the goal of maximizing by the goal of satisficing. That sounds very fundamental. and order. which differ in their cost and competence. Such a reformulation appeals to reason and has broad analytical ramifications.12 Nelson and Sidney Winter make the bold claim that routines are to the evolutionary theory of the firm what genes are to the biological evolutionary theory (1982. 14).

Faced with contractual incompleteness. economists can be thought of as analytical satisficers: they use a short-cut form of analysis (maximizing) that often qualifies as ‘good enough. Such disturbances push the parties to an incomplete contract off of the contract curve. that can be costly. 303) is that most people will do what they say (and some will do more) without self-consciously asking whether the effort is justified by expected discounted net gains. numerous refutable implications accrue thereto. If. p. which helps to explain Robert Aumann’s conclusion that the satisficing approach is not presently broadly applicable (Aumann 1985). the appropriate corrective action can be delayed or defeated by a propensity to bargain over the disposition of the potential gains (see the discussion of self-interest.9 (c) Self-interest: frailty of motive or opportunism My interpretation of Simon’s description of self-interest seeking as ‘frailty of motive’ (Simon 1985. 293)—uses a satisficing setup and potentially heralded a new era. But while inefficiency invites its own demise. which follows). some governance structures have superior adaptive properties than others. Awaiting satisficing apparatus that is easier to implement. it is a normal friction and often a matter of bemusement. . whence inefficiency arises for which relief is sought. TCE holds that the chief lesson of bounded rationality for the study of economic organization is that all complex contracts are unavoidably incomplete. the question is how best to cope when unanticipated disturbances arise. the apparatus out of which satisficing works is very cumbersome. conditional on the attributes of transactions. If they slip. Alas. In contrast with satisficing. The upshot is that an issue of efficient governance is posed.’8 As hitherto indicated. then the mitigation of contractual hazards through the ex ante choice of a better mode of governance will yield efficiency gains. The proposition that routines describe the behavior of most individuals most of the time contemplates (nonstrategic) benign behavior. p. Among other things. The discriminating alignment hypothesis thus applies.13 and has been described by Simon as his ‘chief epistle to the economists’ (1985.

even if frailty of motive describes day-to-day activity most of the time. bilateral dependencies. of the delegates over the delegators. Rather. moreover. the chief role of management is to deal with the exceptions. than pose the issue as frailty of motive (routines) or opportunism (strategic behavior). To be sure. A more constructive and deeper lesson is to make allowance for all such predictable regularities at the outset. 365). Opportunism.14 But while accurate descriptions of what is going on ‘most of the time’ are plainly essential. opportunism is an unflattering behavioral assumption. Serenity and candor nevertheless require us to entertain the possibility that foreseeable contractual hazards will be missed or suppressed by frailty of motive. but that is extreme. the costliness of court enforcement of contracts. opportunism is the operative condition. I submit. whereupon it may be possible to mitigate foreseeable oligarchical propensities at the initial design stage.—will now come into play if. says oligarchy’ (Michels 1962. Recall that Michels’ Iron Law of Oligarchy had its origins in his efforts to understand democracy: ‘It is [hierarchical] organization which gives birth to the dominion of the elected over the electors. One response to unwanted oligarchical outcomes would be to eschew all proposals to introduce democracy in favor of the status quo. of the mandatories over the mandators. Accordingly. p. therefore. Such exceptions arise from contractual incompleteness in combination with the disturbances referred to above. the effects of which are to push the parties to an agreement off of the contract curve. much of what is interesting about human behavior in general and organizations in particular has reference not to routines but to exceptions. which is not to celebrate this condition but to mitigate it. that the odium associated with opportunism is relieved by the main lesson of opportunism. once good routines have been developed. rather than frailty of motive. takes us into the deep structure of contract and organization in ways that frailty of motive does not. Strategic considerations—which arise by reason of information asymmetries. candid reference to opportunism serves to uncover strategic issues that are ignored only at peril. provision needs to be made for both. weaknesses of property rights. . Who says organization. etc. Note. Indeed.

. but what is really meant is that our expectations of the future affect what we do in the present’ (Arrow 2000. At one extreme is myopia—as postulated by A Behavioral Theory of the Firm (Cyert and March 1963): local search. consultants and public policy analysts who are alert to the lessons . whence an important part of the study of economic organization is to look ahead. etc. p.’ Alert practitioners. Attenuating the ex post hazards of opportunism through the ex ante choice of governance is central to the transaction cost economics exercise. even when they have no particular relationship to economics. The proposition that ‘The future influences the present…[may seem] like a violation of the laws of causality. ‘Whenever I see something badly done or not done at all. emphasis omitted). 12. fire-department model of firm behavior. 166). which entails ‘a single gigantic once-for-all forward “higgle-haggle” in which all contingent goods and services (i. capital market. trial-anderror learning.). labor market. I see an opportunity to make a fortune. p. perceive hazards and fold these back into the organizational design—in all significant contractual contexts whatsoever (intermediate product market. take note of variables that may not be directly under consideration’ (Schultz 1995. At the other extreme is the comprehensive contracting model. George Schultz’s reflection on the importance of his training in economics is pertinent: ‘my training in economics has had a major influence on the way I think about public policy tasks. TCE postulates ‘feasible foresight”. Michels had it right: nothing but a serene and frank examination of the hazards of opportunism will enable us to mitigate these hazards. p. Our discipline makes one think ahead. which is located in between. all goods and services at each possible time-cum-environmental condition) are bought and sold once and for all now for money payments made now’ (Meade 1971. (d) Foresight: myopic or farsighted Degrees of foresight can be placed on a continuum. As the businessman Rudolf Spreckels once put it.e.15 That very same lesson applies more generally. 1). Similar skills have value elsewhere. ask about indirect consequences.

A third function is the maintenance of the feeling of personal integrity. p. 44). The informal effects to which Barnard refers occur spontaneously. recognizing potential hazards and choosing governance structures appropriately. construction. a principal criterion we have in mind is the loyalty and devotion of the employees to the organizational goals’ (Simon 1997. Another function is that of maintaining the cohesiveness in formal organizations through regulating the willingness to serve and the stability of objective authority. (e) Informal organization Barnard argued that formal and informal organization always and everywhere coexist (1938. p. while theories that are more concerned with periodic governance alignments will invoke foresight. whereupon the enterprise is factored into manageable parts in which ‘an employee…acquires the goals appropriate to the position’ (Simon 1997. 20) and that informal organization contributes to the viability of formal organization in three significant respects: ‘One of the indispensable functions of informal organization in formal organizations…[is] that of communication…. p. According to Simon. Theories of the firm that deal with short-run operating behavior will feature myopia. He goes on to observe that ‘Loyalty has not only a motivational component—internalization of the organization’s goals—but also a cognitive component’ (Simon 1997. 44). 10 That is the TCE . as a consequence of or in conjunction with formal organization. ‘When we speak of organization as having high morale. The latter has its origins in bounded rationality. informal differences should be taken into account in the decision to use one or the other. 122). p. organizational loyalties are one of the two most important factors that give firms an advantage over markets (the other being coordination). a forced choice is unneeded. Because firm and market organization differ in these respects. of self-respect. p.11 Again. and independent choice’ (Barnard 1938.16 of experience and who possess the skills for and practice the art of feasible foresight will frequently be able to implement discriminating alignment by looking ahead. 44).

162. As is apparent from the foregoing. these considerations are unarguably important. however. 45). Phenomena of Interest Both Carnegie and TCE subscribe to bounded rationality and advance the proposition that organization matters. and (3) because loyalty and identification can have both benefits and costs. Some of the phenomena of interest to Carnegie are therefore different from those dealt with by TCE. The tendency for goals to be subverted through the creation of new centers of interest and motivation inheres in all organizations’ (Selznick 1950. it is customary to speak of organizational identification rather than loyalty’ (Simon 1997. Both deal with more microanalytic phenomena than orthodoxy. as well as a motivational one. In the end. very few issues of firm and market organization (and public policy that pertains thereto). and some . p. there is also a ‘dark side’ to the subgoal pursuit that arises from functional specialization and career concerns: the overarching goals of the organization can be and sometimes are subverted. some issues of price and output. The TCE response to loyalty/identification comes down to this: (1) yes. provision for beneficial identification and subversive subgoal pursuit are both needed.17 ‘Because organizational attachments have this powerful cognitive component. (2) awaiting a more complete description of the mechanisms through which they work. Carnegie is interested in very micro phenomena (individual decision making). By way of locating these phenomena on a continuum. The benefits of identification notwithstanding. No less of an authority than Philip Selznick—who has a deep and abiding interest in identification—treats ‘Michels’ theory about democratic organization…as a special case of the general recalcitrance of the human tools of action.12 3. considerations of loyalty and identification should be incorporated within the economizing calculus. emphasis added). In that event. Carnegie and TCE also differ from one another in consequential ways. p. they remain vague. efforts to ascertain the factors that influence the net effects are needed.

One example is the aforementioned study by Dewitt Dearborn and Simon (1958) of the reactions of 23 executives enrolled in an executive training program. 70-71). Experimental tests of the postulate of rationality. 64). The basic finding was that executives responded to the case study that was presented to them very much in line with their functional responsibilities—legal. as in Newell and Simon (1972). by contrast.18 macro economic issues. many of them of long-standing interest and puzzlement among applied microeconomists. TCE has focused on semi-microanalytic contractual phenomena. and laboratory studies of human problem solving. etc. 3. ‘The most important data that could lead us to an understanding of economic processes and to empirically sound theories of them reside inside human minds…. had its origins with the vertical integration problem and antitrust lessons that accrue thereto. labor market organization. vertical market restrictions and public policy more generally (Dixit 1996). As compared with Carnegie. thereafter studying the governance of contractual relations more generally—including the lessons for regulation/deregulation. This ‘is a vivid demonstration of how strongly identifications by particular functions…focus attention on some phenomena and away from others’ (Simon 1997.1 (a) Microanalytics Individual decision making According to Simon. p.] we must seek to discover what went on in the heads of those who made the relevant decision’ (Simon 1997. production. [Accordingly. accounting. marketing. corporate governance and corporate finance. also operate at the level of the individual. pp. Simon summarizes as follows: experimental tests show that ‘people do not make consistent judgments about uncertain events. violating the axioms of utility maximization and frequently violating the laws of . along the lines of work by Daniel Kahneman and Amos Tversky (1973). TCE.

and about many of the specific design features they required to be able to solve these problems. 81). Leda Cosmides and John Tooby observe in this connection that (1996. evolutionary psychology works differently (Cosmides and Tooby 1994. as against a general-purpose system (using methods drawn from logic. that we were successful 5 out of the last 20 times that we hunted in the north canyon. 15-16): What was available in the environment in which we evolved was the encountered frequencies of actual events—for example. These are noteworthy findings. some of which are more transparent and arguably relate more to evolutionary success than do others (see especially the exchange between Gerd Gigerenzer (1996) and Kahneman and Tversky (1996)). p. Our homonid ancestors were immersed in a rich flow of observable frequencies . pp. mathematics and probability theory). but evolutionary psychologists have begun to challenge the way in which probability events have been posed in the laboratory. 328): By identifying and modeling the adaptive problems humans faced during their evolution. is evident from alternative ways of posing probabilistic problems. That it makes a difference whether we view the mind as a specialized problem-solver. researchers can then design experiments that can detect and map the features of these complex devices-features that no one would otherwise have thought to test for. 78). and computer simulations of cognitive process ‘provide little evidence…[for] utility maximization’ (1997. many individuals perform better when probabilities are expressed in frequentist rather than point estimate terms. p. For example. Armed with these models.19 probability’ (1997. researchers can make educated guesses about the designs of the complex computational devices the human brain embodies. Whereas the usual practice is to model the mind as a general purpose problem solver. p.

variance. (2) upon recognizing that individuals differ in raw ability and expertise. 5 out of 20 contains more information and is easier to update than is . p. If mind is a scarce resource.20 that could be used to improve decision-making. p.. within which specialization can take place and composite solutions worked up (March and Simon 1958.. Mean. There are advantages to storing and operating on frequentist representations because they preserve important information that would be lost by conversion to a single-event probability. the puzzle is that experimental psychologists framed their experiments in nonintuitive (point estimate) ways. Edwin Hutchins expresses ‘surprise that the division of cognitive labor has played such a very minor part in cognitive anthropology’ (1995.25.. 176) and subsequently observes that ‘the cognitive properties of groups are produced by interaction between structures internal to individuals and structures external to individuals. emphasis added). Cosmides and Tooby thereafter ‘suggest that the human mind may contain a series of well-engineered competences capable of being activated under the right conditions. The possibility that many of the limitations of individuals are relieved by specialization also warrants remark. The obvious propositions here are these: (1) very complex problems can sometimes be broken down into ‘subassemblies”. better than average results can be realized by conferring ‘leadership’ (through delegation or imitation) on . 151). p. then organizing so as to deploy this scarce resource to best advantage has a lot to recommend it.. variety and group interaction effects are all relevant. 262. Given that ‘framing’ plays such a prominent role in laboratory experiments.[and that] the performance of cognitive tasks that exceed individual abilities is always shaped by a social organization of distributed cognition’ (1995.. That is. and that a frequentist competence is prominent among these’ (1996. The division of cognitive labor is also underdeveloped in economics. p. given procedures that could take advantage of them. 17).

g. (b) Transactions/governance TCE is predominantly concerned with choice of governance structures by organizations (some of which are very large) rather than by individuals. Contractual complications prospectively arise when there is a need to adapt to disturbances. One is a general purpose technology. Parties have an incentive to devise safeguards to protect investments for transactions of the latter kind. intermediate product market transactions differ in the following respects: (1) firms can be presumed to be more nearly on a parity in information respects and can employ specialists (e. Productive values would therefore be sacrificed if h > 0 transactions were to be prematurely terminated. transactions that use the general purpose technology are ones for which h = 0. (3) end games aside. engineers. The canonical problem of vertical integration out of which TCE works is illustrated by the simple contractual schema shown in Figure 1. reputation effects can be presumed to be more effective. and (3) because cognitive ability can take various forms.21 those with greater ability. and (4) experienced as they are with a wide variety of transactions to which differential hazards accrue. firms can be presumed to craft contractual safeguards in differential degree. an h > 0 condition exists. the other a special purpose technology.. If instead transactions use the special purpose technology. (2) considerations of differential risk aversion are of second order importance. such variations should be factored in. . As compared with individual consumers. Assets here are specialized to the particular needs of the parties. Economies of specialization thereby arise. lawyers) to represent their interests more effectively. A bilateral dependency condition applies to such transactions. Thus assume that a good or service can be supplied by either of two alternative technologies. Using h as a measure of contractual hazards. The special purpose technology requires greater investment in transaction-specific durable assets and is more efficient for servicing steady-state demands.

arbitration) is devised. added information disclosure is provided and specialized dispute settlement machinery (e. Node B poses contractual hazards. Nodes C and D are those for which additional contractual support has been provided (s > 0). Node A corresponds to the ideal transaction in law and economics: there being an absence of dependency (h = 0).g. the transaction may be taken out of the market and organized under unified ownership (vertical integration) instead.. a decision to provide safeguards is reflected by an s > 0 result. In consideration. suppliers are viewed as hard-headed businessmen who will respond to what they perceive to be credible commitments. Such hazards will be recognized by farsighted players. Rather. This is the credible interfirm commitment option. in that specialized investments are exposed (h > 0) for which no safeguards (s = 0) have been provided. One would be to provide interfirm contracts with added support: penalties to deter breach are introduced. An s = 0 condition is one in which no safeguards are provided. . Safeguards can take either of two forms. internal organization is usefully thought of as the organization form of last resort: try markets. That an outside supplier will supply on better terms (supply at a lesser price) at node C than node B is not because it has received ‘simple assurances’ that the buyer will adapt cooperatively should an adverse state realization materialize during the contract implementation interval. who will price out the implied risks.22 Let s denote the magnitude of any such safeguards. either in the form of contractual safeguards (node C) or unified ownership (node D). of which the use of hostages to support exchange is an example (Williamson 1983). A second would be to take transactions out of markets and organize them under unified ownership within which hierarchy (to include fiat) is used to effect coordination. however. such transactions benefit from the safeguard of competition. for the added bureaucratic costs that accrue upon taking a transaction out of the market and organizing it internally. In the event that problems of crafting credible interfirm commitments are perceived to be especially great.

moreover.23 try hybrids and have recourse to the firm only when all else fails. applies not merely to intermediate product market contracts but much more generally. 50). (a) Carnegie Simon’s theory of the employment relation (1951) relates closely to Coase’s (1937) earlier treatment. p. ‘Any standard theory. That has been instructive but. Two other theories that have Carnegie origins or connections are the ‘behavioral theory of the firm’ and the more recent work on ‘competence. The schema. starts from the existence of firms’ (1999. regulation/deregulation. possibly for that reason. not only the neoclassical. some of which is in progress (Baron and Kreps 1999). The latter has broad scope and. then would-be theories of economic organization should be expected to name the theory of the firm out of which they work. Node D. Harold Demsetz contends that ‘It is a mistake to confuse the firm of economic theory with its real-world namesake. the firm. The chief mission of neoclassical economics is to understand . the same master mould will apply when the signs for those attributes are evoked by altogether different elements’ (1967. the employment relation is more in the nature of an incipient theory of the firm. does not name a canonical problem to which variations on a theme can be referred. and. 3. p. as Arrow has observed. Friedrich Hayek’s assessment applies: ‘whenever the capacity of recognizing an abstract rule which the arrangement of those attributes follows has been acquired in one field.2 Theory of the firm If. vii).’ Both differ from orthodoxy. any issue that arises as or can be restated as a contracting problem are variations on a theme. more generally. Whereas the unifying theme for TCE is that of discriminating alignment. for Simon it is bounded rationality. capital markets. awaiting further work. Labor markets. thus comes in only as higher degrees of asset specificity and added uncertainty pose greater needs for cooperative adaptation.

I believe. prices and output. as does Richard . these were price and output decisions. As against the orthodox prescription to set prices on the basis of marginal costs and demand elasticities. Chap. In the first instance. p. Yet despite their view that their computer model ‘lends itself to further elaboration and testing’ (Cyert and March 1963. Rather. Cyert and March maintain that they are set by simple routines. such results simply do not change the way in which economics gets done. George Richardson’s article on ‘The Organization of Industry’ (1972) is seminal. not to understand the inner workings of real firms’ (Demsetz 1983. 7). 148). especially as it relates to technical and organizational innovation. Attention is thus focused on supply and demand. economists are more interested in comparative statics: What changes in the parameters will move prices how and why? Awaiting a display of why they should be interested in pricing routines that predict to the exact penny.24 how the price system coordinates the use of resources. it might be expected to deemphasize price and output. 2. 377). The reason for this. few economists or organization theorists have followed that empirical lead. the core competence perspective draws inspiration from Edith Penrose’s influential book on The Theory of the Growth of the Firm (1959) and Joseph Schumpeter’s earlier work on Capitalism. p. is that few economists are interested in exact prices. subsequently they included internal allocation and market strategy decisions. reads as follows (1963. which is astonishing (Cyert and March 1963. and Democracy (1942). emphasis in original): Focus on a small number for key economic decisions made by the firm. p. The first research commitment listed by Cyert and March. Because Carnegie was plainly interested in the inner workings of real firms. The Cyert and March book (1963) makes the case for a ‘realism in process’ approach to the study of organization. Their department store pricing study correctly predicts prices ‘to the exact penny’ for 384 out of 404 items. however. As I have discussed elsewhere (Williamson 1999). Socialism.

13 . 734. it merges into economic history. the competence perspective relies primarily on success stories to make its case. TCE examines governance structures comparatively. however. the overarching theme of which is the importance of process. Not only is process analysis hard to do.25 Nelson and Sidney Winter’s book on An Evolutionary Theory of Economic Change (1982). whereby each discrete mode of governance is described as a syndrome of attributes to which distinctive strengths and weaknesses accrue. why economic institutions have emerged the way they did and not otherwise. the concept of core competence suffers from a tautological reputation (Porter 1994. p. One of the lessons of Carnegie is that firms have structure and that this structure arises for some reason (Arrow 1999. emphasis added). All have had a significant influence on the strategy literature. Also. Mosakowski and McKelvey 1997). but brings sharper nanoeconomic…reasoning to bear than as been customary’ (Arrow 1987. It is not obvious. The decision to take a transaction out of the market and organize it hierarchically follows from the logic of the simple contractual schema set out above. vii). (b) TCE TCE views the firm as a governance structure (which is an organizational construction) rather than as a production function (which is a technological construction). Always and everywhere. the discriminating alignment hypothesis invites and has benefitted from empirical testing. how to bring the more important processes together in a coherent way. p. What are the priorities? Awaiting operationalization. As matters stand presently. More generally. rather than ‘consist primarily of giving new answers to the traditional questions of economics—resource allocation and the degree of utilization…it consists of [asking and] answering new questions. but there are many important processes.

4). TCE has responded to this lapse by examining nonstandard and unfamiliar organization and contractual practices through the lens of transaction cost economizing. aspects of economic development and reform. p. the corner grocery store. take-or-pay agreements). vertical market restrictions.3 (a) Public policy toward business General The governance structure approach to economic organization has numerous ramifications for public policy toward business: vertical integration. the limits of legal centralism.26 3. p. nonstandard forms of contracting more generally (to include exchange agreements. price discrimination. the New York State Highway Department’ (March and Simon 1958. so is the Red Cross. Simon (and Carnegie) express little interest in public policy as it relates to such matters. reciprocity. corporate governance and corporate finance. 1). Neither individually nor collectively does orthodox appeal to price theoretic ‘wrinkles’—double-marginalization. They thereafter observe that ‘Transactions that take place within organizations. . differential risk aversion—deal with these matters in a systematic way. far more than in markets. labor market organization. the modern corporation (both domestic and multinational) and public policy toward business (antitrust and regulation/deregulation) more generally. Note that these nonstandard practices are very different from the resource allocation issues with which the orthodox theory of the firm was concerned (Demsetz 1983). The United States Steel Corporation is a formal organization. are preplanned and precoordinated’ and that ‘the high specificity of structure and coordination within organizations…marks off the individual organization as a sociological unit comparable in significance to the individual organism in biology’ (March and Simon 1958. (b) Public and private March and Simon’s famous book on Organizations opens as follows: ‘This book is about the theory of formal organizations….

moreover. and public bureaus as discrete structural modes of organization that differ in their attributes. TCE furthermore holds that public utility transactions are intrinsically difficult to organize (as Milton Friedman has put it. there is ‘no good solution’ for natural monopoly (1962. Relatedly. etc. however. and that ‘in the transfer from centralized planning to a market economy it is not obvious to what extent the production organizations need to be privatized’ (1997. the choice of mode will be contingent on the transactions to be organized (Williamson 1991. firms. p. 49). Finally. . whence charitable organizations will be reserved for a subset of transactions different from profit-making enterprise (Hansmann 1996). 128)). public bureaus. nonprofits. 50). p. Lange. whence the lack of sharp differences between public and private operation of public utilities is not altogether surprising (although. TCE. judiciary. 109). regulated firms. regulation.27 Differences among private for-profit firms. bureaucracy—differences appear (Levy and Spiller 1994. upon making provision for variation in the institutional environment—polity. transactions also differ. Simon’s views that public and private firms are indistinguishable in supplying public utility services (1997. By contrast. p. 51) are plainly in the common theory tradition. relegated bureaucratization to the field of sociology rather than economic theory and bureaucratic differences between capitalism and socialism were neglected by economists for the next 50 years. get short shrift in this quest for a common theory of formal organizations. p. Given an institutional environment in which property and contract enjoy legal and constitutional supports. p. 1996)). by contrast. views markets. a finding that public and private ownership has no impact on the manufacture of personal computers or the operation of grocery stores would be a big surprise to TCE (if not to Simon). that the ‘managers of charitable organizations are subject to the same discipline as the managers of the profit-making firm’ (1997. 1999). Because. TCE holds that competition in both product and capital markets does have disciplinary consequences. TCE concurs with Oskar Lange that ‘the real danger of socialism is that of a bureaucratization of economic life’ (1935.

in his judgment. or others—to follow this up with empirical work. Thus Scott Masten remarks that whereas ‘Ronald Coase could justifiably lament the dearth of research on the organization of industry in 1972…. This is not. Sam Peltzman (1991) holds a similar view of Industrial Organization more generally. p. 89). awaiting empirical testing. me. theory of bounded rationality’ is to better ‘understand and guide the operation of the economy’ (1997. But there has been little effort to date—by Wachter. Empirical TCE Bengt Holmstrom and Jean Tirole once described the theory of the firm as a field where ‘the evidence/theory ratio…is currently very low’ (1989. p. but a unified theory from micro through macro is very ambitious. TCE was an act of faith or perhaps piety (1991. and of the role and extent of . Persistent application of the comparative contractual approach to economic organization holds promise for such a purpose. I do not disagree. 63). 27) is broadly in this spirit.28 the idea that privatization encourages economizing (discourages bureaucratizing) is now broadly conceded. 126). of the structure of contractual arrangements between firms. however. 4. Simon’s statement that. is ‘grossly inadequate…for either understanding the events that occur in the whole economy or providing a basis for macroeconomic policy’ (Simon 1997. p. Neoclassical theory. empirically based. p. Those who are closer to empirical TCE (have done empirical work) have a different opinion. My paper with Michael Wachter on ‘Obligational Markets and the Mechanics of Inflation’ (Wachter and Williamson 1978) is illustrative of how this can be done. (c) 14 Macroeconomics One of the reasons that Simon advances for ‘building an adequate. to say that we cannot make piecemeal progress in this direction. the transaction cost literature today [1995] contains scores of empirical studies on the topics Coase viewed as central to our understanding of industrial organization—studies of the allocation of activities among firms.

xi). A still more recent review of the relative contributions of agency theory and TCE to the empirical literature on contracting also bears remark. Econometric refinements. 81). p. It could have been otherwise. Judged comparatively. 10). Bruce Lyons (1996). like everything else. Keith Crocker and Scott Masten (1996) and Aric Rindfleisch and Jan Heide (1997). agency theory is notable for ‘its failure to generate testable hypotheses…[or even] to account for…the more basic features of real world contracts’ (Masten and Saussier 2000. It is furthermore noteworthy that those who have done this empirical TCE work have often collected original data specifically attuned to the microanalytic phenomena in question. ‘this empirical work is in much better shape than much of the empirical work in industrial organization generally’ (Joskow 1991. are being introduced as this work has progressed. p. 10). The theoretical TCE and agency theory literatures both took shape in the 1970s and both have undergone refinements since. Not only are there few empirical tests of agency theory. where this last focuses on empirical applications of transaction cost economics to marketing—agree. offers little support for agency theory’ (Masten and Saussier 2000. where variables of interest in the [two] theories overlap. p. But where TCE has advanced numerous refutable implications. xi).29 participation by government agencies in industry’ (1995. . will benefit from more and better empirical work. but the theory and evidence display a remarkable congruity: ‘Progress in the application and testing of transaction cost economics can only be described as phenomenal’ (Masten 1995.15 A survey of empirical TCE currently in progress (Boerner and Macher 2000) estimates that the cumulative number of empirical TCE studies has grown from 200 in 1994 to over 600 in the year 2000. p. I have no hesitation. Subsequent empirical surveys—by Howard Shelanski and Peter Klein (1995). p. in declaring that transaction cost economics is an empirical success story. transaction cost economics. To be sure. however. moreover. but ‘evidence from transaction cost economics.

30 Progress in science is normally attended by the collection of new and original data (Kuhn 1970). Although TCE does not attempt to implement the program described by Simon. TCE addresses itself to many of the long-standing puzzles of orthodoxy. like Carnegie. it yields numerous refutable implications on a . rather than the decision premise or the routine. But for this empirical research. TCE subscribes to bounded rationality whence focuses on incomplete contracting. the latter will get their attention. It is another to tell economists something different and consequential about phenomena that are of interest to them. I would nevertheless describe it as an empirically based microeconomics. and related. much of the action resides in the mechanisms of private ordering. It is one thing to tell economists that their framework is self-limiting. Conclusions TCE aspires to be both a ‘rational spirit’ and a ‘Carnegie spirit’ construction. Economizing on transaction costs is on the rational spirit side of the ledger. sometimes buttressed by learning from own-experience and that of others. Such comparative institutional analysis invites the description of alternative modes of governance not in technological but in organizational terms. Also. Furthermore. But the unit of analysis for TCE is the transaction. Feasible foresight. Economists being very pragmatic people. Given the limits of legal centralism. For one thing. TCE would merely join the list of plausible but conjectural theories of firm and market organization. It deals always and everywhere with feasible modes of organization. TCE eschews hypothetical ideals in favor of feasible alternatives. all of which are flawed and need to be examined comparatively. yet that is demanding work—for which TCE empirical researchers deserve enormous credit. also supports the idea of efficient alignment (as does weak form selection). 16 5. TCE moves to a more microanalytic unit of analysis. to which the lessons of organization theory apply. Carnegie has had a powerful influence on TCE efforts to understand nonstandard structures and practices for which orthodoxy was poorly suited (Coase 1972). Also.

I am confident that those who have been working the transaction cost economics domain will continue their ‘modest. . definitive’ efforts—piling block upon block until the value added cannot be denied. slow. the data have been generally corroborative.31 wide range of real-world issues. molecular.

Berkeley. 1. vii). The larger Carnegie project. Professor of Economics. ‘Any standard economic theory. rule-based action and organizational learning—have been important to modern economic thinking about the firm. To address this larger project would require a much longer and more ambitious paper. Although economics is an expansive enterprise. Merton Miller (1990) and Robert Lucas (1995) for work they did while on the faculty at GSIA. 89-90) and presumably reflect his assessment of the way in which mathematical social science has taken shape over the period 1957 to 1997. transaction cost economics works principally off of the first two (but concedes merit to all (Williamson 1999)). vis-à-vis transaction cost economics. for which I am grateful. These views differ from those he took much earlier (Simon 1957. and Professor of Law at the University of California. 5. intra-firm conflict and strategic action. 4. not just neoclassical. Kaiser Professor of Business Administration. The Ford Foundation study was done by Robert Aaron Gordon and James Howell (1959).Footnotes *The author is Edgar F. It will not go unnoticed that the paper deals almost entirely with Simon. in which A Behavioral Theory of the Firm (Cyert and March 1963) played a central role. . 3. Nobel Prizes in Economic Science were awarded to Herbert Simon (1978). Suffice it to observe here that four of the central ideas of the ‘Carnegie tradition’—bounded rationality. p. starts from the existence of firms’ (Arrow 1999. All four are featured prominently by Cyert and March (1963). This paper has benefitted from the helpful remarks of James March and Mie Augier. Franco Modigliani (1985). The Carnegie Foundation study was done by Franklin Pierson (1959). Of these four. See the exchange between Richard Posner (1993) and myself (1993) on this issue. 2. pp. is dealt with only in part and often only in passing.

1996. Both are interesting questions. To be sure. 12. see Williamson (2000).2 6. 8. Interestingly. For a broader discussion of close reasoning. but both Aumann and Arrow are thoughtful students of economic organization. short-cut forms of analysis can be and are sometimes used uncritically. whence there is a need to delimit the use of such methods to the ‘appropriate subset. pp. like overuse of natural selection. 37-39. As matters stand presently. Both benefit from a reflective rather than myopic interpretation of events. 11. anthropology. 7. p. p. boundary issues are closer to the subject of firm structure. my efforts to curtail the excesses of calculativeness to which zealous economic reasoning leads have mainly been limited to ‘the economics of atmosphere’ (Williamson 1975. Both work well in some circumstances but break down in others. pp. and the psychology of . is a chronic hazard. 49). p. Richard Pipes holds that ‘the very principles of Communism violated everything that we have learned from sociobiology. 13. TCE has been concerned with the boundary of the firm. Learning through experience and imitation are also relevant. 10. 140-141). As Richard Dawkins observes. Overuse of maximizing. 270-272). As between the two.’ 9. 200). 14. it is the ‘capacity to simulate the future in imagination…[that saves] us from the worst consequences of the blind replicators’ (1976. pp. Ijiri and Simon 1977). 79. Recall that cooperation is one of the two chief advantages that Simon ascribes to organizations in relation to markets (1997. Neither Aumann’s (1985) negative assessment of satisficing nor Arrow’s judgment that TCE has made headway where the Simon agenda and older-style institutional economics did not (1987. 734) are dispositive. See Tjalling Koopmans (1957. Whereas Simon has given prominent attention to the size distribution of firms (Simon and Bonini 1959.

3 human nature. p. the building blocks of every social order”. Theories that cannot pass this test are eventually relegated to the history of economic thought. That is accomplished by asking each candidate theory to advance refutable implications and ascertain whether the data are corroborative or not. whereupon he focuses on ‘the abolition of private property…[as] the quintessence of [the] movement’ (1996. Michael Whinston made similar observations in comparing TCE with the ‘property rights theory of the firm’ (2000). There being many plausible theories. 36). 15. . 16. there is a need to sort the sheep from the goats.

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