Date sent:        Sun, 28 Apr 1996 00:17:12 -0700

Business Economics Course Work


Evaluate the basis of the disagreement between Williamson’s and Hayek’s views of the
efficiency of markets. The following essay will introduce the two economists basic outline
of their respective theories. Then further try to explain the reasons for Williamson to
refute Hayek’s overruling ideas and to evaluate the disagreements between the two
economists. Firstly an introduction to the two economists. ‘Friedrich Hayek was born in 1899
in Vienna, Austria. He earned degrees in law and politics at the University of Vienna in
1921 and 1923, and in 1940, he recieved the Doctor of Science degree in economics from  the
University of London. In 1974, he was awarded the Nobel Memorial Prize in Economic Science.
Oliver Williamson was born in Superior, Wisconsin in 1932. He received his Ph.D. in
economics at Carnegie-Mellon University in 1963. He is currently Gordon Tweedy Professor of
Economics of Law and Organisation at Yale University’  Louis Putterman 1989. A market, is an
environment where business organisations do their buying and selling. Hayek further
describes how markets operate ‘as whole sphere of scattered commercial activity that goes on
in the market’ F.V.Hayek.. This ‘commercial knowledge’ of these particular circumstances of
time, place know how of a special nature where every individuals has some advantage over all
others, therefore individuals who possess this unique information of situation /
circumstance. Beneficial use might be made if the person was to use this knowledge. This
knowledge can never be collected and concentrated or integrated in a single form and given
to a single source (mind or firm). This information can’t also be expressed in some
statistical form but remains a highly valuable asset to the individual who possesses it.
Therefore if an assumption was made that there was perfect knowledge. This would have the
effect that there would be no competitive advantage. This is due to most firms and
individuals; competitive advantage stems from possession of special knowledge about the
market and as there is no special knowledge in a perfect market; as everyone acquires the
same information therefore competitive advantage cannot exist. Planning has to be carried
out this requires the ‘body’ to make decisions on how to allocate the available resources.
Then the problem arises of how to gather this special knowledge from the individual so as to
utilise this information to the maximum. We therefore come to a question of what sort of
‘body’ is to provide for this planning. Should the planning be carried out  centrally by one
authority for the whole of the economic system or decentralised by many separate individuals
i.e. competition. The ‘half way house’ which Hayek talks about is where whole industries
come under central planning known as Monopolies. But as the question may arise which of
these systems is more efficient?  Where Hayek proclaims that “ where the fuller use will be
made of existing knowledge” F.V.Hayek. The central planning is likely to succeed only if all
knowledge can be gathered which ought to be used but is dispersed initially to all the
individuals. Hayek further on concludes that if all knowledge was translated as scientific
knowledge then it could be concluded that the decision makers could be the various experts
in the various fields but the problem arises that Hayek says ‘Beyond question  a body of
very important but unorganised knowledge which cannot possibly be called scientific in the
sense of knowledge of general rules: the knowledge of the particular circumstances of  time
and place.’ F.V.Hayek. If economic problems of society can be associated mainly with rapid
adaptation  to changes in the particular circumstances of time and place. This would have
the effect that the final decision must be left to the individuals  who are accustomed with
the circumstances, who can observe the following changes directly. Therefore to obtain the
resources immediately so as to meet the changes  brought about. If  this problem was to be
resolved   by    a central body the effect would be that all knowledge would have to be
communicated back then after acquiring   all knowledge it would have to decide what orders
to give. The answer to this is decentralising the procedure of directives to be given at a
lower level so as the problem can be resolved immediately. But you must remember that ‘the
man on the Spot’ F.V.Havek can’t decide solely on the basis of his limited but intimate
knowledge of the facts of his immediate surroundings since he requires further information
to make his decisions in to the whole economic framework. The individual will only be
interested in how much the good or service costs through the price mechanism not why the
prices have gone up or down unless they are effecting his own environment which are causing
the fluctuations in price. This can be shown by example if  a producer of good A suddenly
finds that the demand for his good has increased as consumers switch from good B to C he is
only interested in the new demand and not of how this was bought about. ‘The price mechanism
can be seen as mechanism for communicating information where only the most essential
information is passed on and passed on to only those concerned.’ F.V.Havek Therefore for one
company to transact with another firm , assuming that they have varying information, they
conduct the transaction  on the judgement of price; this assume that  price is sufficient
statistic to perform exchange. Adam Smith also believed that it was this price system that
indicated to the individual, by means of price/profit incentive., to seek one’s own
interest. It also can be shown that the price mechanism acts as a guide to efficient
resource allocation where the solution is found in the mechanism by the interaction of all
the people each of whom posses only partial knowledge. Hayek has acknowledge the fact that
individuals try and use this unequal  distribution of knowledge to their own betterment.
Society may feel that the individual is achieving his goals in a dishonest fashion but it is
important that society uses these opportunities. Hayek argues that markets are more
efficient and the most appropriate of allocating resources. This makes central planning
redundant, which would include governments in interfering and trying to manipulate the
market. But there are certain goods which the price mechanism does not provide for these are
public goods such as defence, roads, railways where no individual is responsible for the
cost. There are also market failure when the market does not take into consideration of
externalities i.e. when in the production of electricity through coal combustion there is
sulphur emission which pollute the atmosphere. Hayek describes monopoly as ‘delegation of
planning to organised industries’ F.V Hayek and states theses are a midpoint between
centralised and decentralised planning. However Hayek’s argument of prices being a
sufficient statistic could be questionable with the existence of monopolies as there is no
basis for comparison to decide whether price is acceptable or not. A recent example of the
price mechanism to overlook social costs is  the coal industry where Britain has been
importing cheap coal (attracted by the competitive price), but as consequence resulting in
the downfall of the coal industry in Britain and resulting in severe job losses. Other
arguments opposing Hayek’s idea could be the importance of repetition, quality and
reliability which may be significant factors within transactions. Williaimson argues that if
markets were efficient, then you wouldn’t have any firms as there would be no reason to
internalise the function of the market as there would be no reason for a firm to produce
anything. When a firm internalises a function it produces the good within the firm instead
of obtaining it from the market. Williamson believes the inability of the market to provide
goods and services are market failures and the growth of the firm is a consequence of this.
Markets and firms are a alternative form for competing transactions and Williamson argues
there is a cost of using the market. The firm will determine whether to use the market or
internalise the function, depending on the relative cost of transaction under the two
alternatives. The major cause of market failure, which gives rise for the tendency for the
firm to internalise, are transaction difficulties and the inability of the firms to form
contracts. Williamson maintains that markets fail because the excess cost of writing ,
executing  and enforcing contingent  claims of contracts. Where ‘ contracts made contingent
upon the uncertainty involved’  O.E.Williamson. Williamson identifies two reasons for this;
1)	Environmental factors which include uncertainty and complexity and small numbers of firms
2)	Human factors which include bounded rationality and opportunism.

’The term bounded rationality was  coined by Simon to reflect constraint on the ability to
processing (receiving, storing, retrieving, transmitting) information.’ O.E.Williamson.
Whereas the second human factor Opportunism is related to but is a somewhat more general
term that the condition of  moral hazards to which Knight referred in his classic statement
of economic organisation. ‘Opportunism effectively extends the usual assumption of
self-interest seeking to make allowance for self-interest seeking with guile.’
O.E.Williamson. Williamson argues that firms operate in a  environment where each firm is
trying to gain an advantage over the other through opportunism. He defines this behaviour in
two methods. Withholding information from the other party and entering into contract with no
 intention of fulfilling the terms of the contracts. Opportunism is the driving force of
capitalism where if firms do not take advantage of asymmetric information the firm would be
depriving itself from its true potential. Opportunistic behaviour may occur leading to all 
the information not being available before the transaction  resulting in hidden information
coming to light after the transaction this would have the resulting factors of moral hazard,
some form of hidden action, may cast doubt and uncertainty over the compliance of the
contractual agreements. Bounded rationality will only pose a problem in environments that
are characterised by uncertainty and complexity, where there is much doubt in the
transaction (i.e. not every day purchases). Firms will try and economise on bounded
rationality by internalising market function and using available knowledge. This being less
complex and more certain then using the market. Idiosyncratic knowledge  is where an
individual posses certain specialist information that others do not have. This sort of
knowledge is tended to be used to gain advantage. e.g. An interpreter has the ability to
translate from one language to another to initiate communication with the two parties. There
are not only  saving on transaction and contractual  which are partly  reasons for a firm to
internalise, Williamson has also stressed other reasons also. 1)	‘the opportunities for
opportunistic behaviour within firms is restricted causing 		individuals agents and mangers
to have a “more nearly joint profit maximising 		attitude” 2)	“internal organisation can be
more effectively audited ” 3)	“Internal organisation realises an advantage over market
mediated exchange in 		  dispute settling respects.”  ‘ Douma & Schreuder 

The above statements can be redesigned to  keywords that  state ‘ the properties of the firm
that commend internal organisation as a market subsitude would appear to fall into the three
categories : Incentives, Controls and what may be referred to broadly as inherent Structural
Advantages.’ O.E.Williamson In conclusion Hayek’s study of firms and markets has dismissed
equilibrium economics with the observation of a dynamic model where ‘  the economic problem
of society is mainly one of adaptation to changes in particular circumstances of time and
place’ F.V.Hayek and  who has emphasised the ‘marvel’ of the price system which accomplishes
this without ‘conscious direction’ F.V. Hayek. The three important observation made by Hayek
‘First in his emphasis on change and the need to devise adaptive institutional forms.
Second, his reference to particular circumstances, as distinguished from statistical
aggregates, reflects a sense that economic institutions must be sensitive to dispersed
knowledge of a microanaylytic kind. Thirdly was his insistence that attention to the details
of social processes and economic institutions was made necessary by the unavoidable
imperfection of man’s knowledge.’ O.E.Williamson But where Hayek is to be criticised is he
has not recognised the limits of the markets which have been glossed over. e.g. Transaction
costs.  The  adherence to markets to be all domineering in Hayek’s view can be dispelled
objectively as 85% of world trade is done by 10% of multinationals. Whereas Williamson has
concluded that with the existence of (environmental and human) factors that therefore price
is not the overruling statistic that dictates to form market exchange. Williamson does admit
that in certain markets that price is a sufficient statistic, e.g. spot markets where price
is an overruling factor that equates the margin of uncertainty. Williamson has also
emphasised the prospect of opportunistic behaviour. It is certain to a large extent that
firms are  present  in deceiving one other but there are firms who on mutual basis are there
to co-operate with each other and to conduct their business amicably. Also there are laws
present with contractual obligations for  firms to complete contracts and comply to terms
and business law. Every individual may have a tendency to behave opportunistically but 
there are in some way bounded by the social and legal constraints. Williamson has neglected
to discuss the value of economies of scale. Where if production of a firm was increased so
that the firms unit costs fell it could pass on the benefits to its customers. This new
price could compensate the customer who is experiencing transaction costs, but this is only
feasible where there is large numbers of customers exist. 
  Bibliography

The economic nature of the firm Louis Putterman
The use of knowledge in society F A Von Hayek
Markets and Hierarchies Oliver E Williamson
Economic Organisation Oliver E Williamson
Economic approaches to organisation Douma and Schreuder



