Buecon Essay, Research Paper

Business Economics Course WorkEvaluate the basis of the disagreement between Williamson s and Hayek s views of theefficiency of markets. The following essay will introduce the two economists basic outlineof their respective theories. Then further try to explain the reasons for Williamson torefute Hayek s overruling ideas and to evaluate the disagreements between the twoeconomists. Firstly an introduction to the two economists. Friedrich Hayek was born in 1899in Vienna, Austria. He earned degrees in law and politics at the University of Vienna in1921 and 1923, and in 1940, he recieved the Doctor of Science degree in economics from theUniversity 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. ineconomics at Carnegie-Mellon University in 1963. He is currently Gordon Tweedy Professor ofEconomics of Law and Organisation at Yale University Louis Putterman 1989. A market, is anenvironment where business organisations do their buying and selling. Hayek furtherdescribes how markets operate as whole sphere of scattered commercial activity that goes onin the market F.V.Hayek.. This commercial knowledge of these particular circumstances oftime, place know how of a special nature where every individuals has some advantage over allothers, therefore individuals who possess this unique information of situation /circumstance. Beneficial use might be made if the person was to use this knowledge. Thisknowledge can never be collected and concentrated or integrated in a single form and givento a single source (mind or firm). This information can t also be expressed in somestatistical 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 theeffect that there would be no competitive advantage. This is due to most firms andindividuals; competitive advantage stems from possession of special knowledge about themarket and as there is no special knowledge in a perfect market; as everyone acquires thesame information therefore competitive advantage cannot exist. Planning has to be carriedout 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 toutilise 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 oneauthority for the whole of the economic system or decentralised by many separate individualsi.e. competition. The half way house which Hayek talks about is where whole industriescome under central planning known as Monopolies. But as the question may arise which ofthese systems is more efficient? Where Hayek proclaims that where the fuller use will bemade of existing knowledge F.V.Hayek. The central planning is likely to succeed only if allknowledge can be gathered which ought to be used but is dispersed initially to all theindividuals. Hayek further on concludes that if all knowledge was translated as scientificknowledge then it could be concluded that the decision makers could be the various expertsin the various fields but the problem arises that Hayek says Beyond question a body ofvery important but unorganised knowledge which cannot possibly be called scientific in thesense of knowledge of general rules: the knowledge of the particular circumstances of timeand place. F.V.Hayek. If economic problems of society can be associated mainly with rapidadaptation to changes in the particular circumstances of time and place. This would havethe effect that the final decision must be left to the individuals who are accustomed withthe circumstances, who can observe the following changes directly. Therefore to obtain theresources immediately so as to meet the changes brought about. If this problem was to beresolved by a central body the effect would be that all knowledge would have to becommunicated back then after acquiring all knowledge it would have to decide what ordersto give. The answer to this is decentralising the procedure of directives to be given at alower level so as the problem can be resolved immediately. But you must remember that theman on the Spot F.V.Havek can t decide solely on the basis of his limited but intimateknowledge of the facts of his immediate surroundings since he requires further informationto make his decisions in to the whole economic framework. The individual will only beinterested in how much the good or service costs through the price mechanism not why theprices have gone up or down unless they are effecting his own environment which are causingthe fluctuations in price. This can be shown by example if a producer of good A suddenlyfinds that the demand for his good has increased as consumers switch from good B to C he isonly interested in the new demand and not of how this was bought about. The price mechanismcan be seen as mechanism for communicating information where only the most essentialinformation is passed on and passed on to only those concerned. F.V.Havek Therefore for onecompany to transact with another firm , assuming that they have varying information, theyconduct the transaction on the judgement of price; this assume that price is sufficientstatistic to perform exchange. Adam Smith also believed that it was this price system thatindicated to the individual, by means of price/profit incentive., to seek one s owninterest. It also can be shown that the price mechanism acts as a guide to efficientresource allocation where the solution is found in the mechanism by the interaction of allthe people each of whom posses only partial knowledge. Hayek has acknowledge the fact thatindividuals 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 isimportant that society uses these opportunities. Hayek argues that markets are moreefficient and the most appropriate of allocating resources. This makes central planningredundant, which would include governments in interfering and trying to manipulate themarket. But there are certain goods which the price mechanism does not provide for these arepublic goods such as defence, roads, railways where no individual is responsible for thecost. There are also market failure when the market does not take into consideration ofexternalities i.e. when in the production of electricity through coal combustion there issulphur emission which pollute the atmosphere. Hayek describes monopoly as delegation ofplanning to organised industries F.V Hayek and states theses are a midpoint betweencentralised and decentralised planning. However Hayek s argument of prices being asufficient statistic could be questionable with the existence of monopolies as there is nobasis 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 beenimporting cheap coal (attracted by the competitive price), but as consequence resulting inthe downfall of the coal industry in Britain and resulting in severe job losses. Otherarguments opposing Hayek s idea could be the importance of repetition, quality andreliability which may be significant factors within transactions. Williaimson argues that ifmarkets were efficient, then you wouldn t have any firms as there would be no reason tointernalise the function of the market as there would be no reason for a firm to produceanything. When a firm internalises a function it produces the good within the firm insteadof obtaining it from the market. Williamson believes the inability of the market to providegoods 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 arguesthere is a cost of using the market. The firm will determine whether to use the market orinternalise the function, depending on the relative cost of transaction under the twoalternatives. The major cause of market failure, which gives rise for the tendency for thefirm to internalise, are transaction difficulties and the inability of the firms to formcontracts. Williamson maintains that markets fail because the excess cost of writing ,executing and enforcing contingent claims of contracts. Where contracts made contingentupon the uncertainty involved O.E.Williamson. Williamson identifies two reasons for this;1)Environmental factors which include uncertainty and complexity and small numbers of firms2)Human factors which include bounded rationality and opportunism. The term bounded rationality was coined by Simon to reflect constraint on the ability toprocessing (receiving, storing, retrieving, transmitting) information. O.E.Williamson. Whereas the second human factor Opportunism is related to but is a somewhat more generalterm that the condition of moral hazards to which Knight referred in his classic statementof economic organisation. Opportunism effectively extends the usual assumption ofself-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 istrying to gain an advantage over the other through opportunism. He defines this behaviour intwo 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 ofcapitalism where if firms do not take advantage of asymmetric information the firm would bedepriving itself from its true potential. Opportunistic behaviour may occur leading to allthe information not being available before the transaction resulting in hidden informationcoming 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 thecontractual agreements. Bounded rationality will only pose a problem in environments thatare characterised by uncertainty and complexity, where there is much doubt in thetransaction (i.e. not every day purchases). Firms will try and economise on boundedrationality by internalising market function and using available knowledge. This being lesscomplex and more certain then using the market. Idiosyncratic knowledge is where anindividual posses certain specialist information that others do not have. This sort ofknowledge is tended to be used to gain advantage. e.g. An interpreter has the ability totranslate from one language to another to initiate communication with the two parties. Thereare not only saving on transaction and contractual which are partly reasons for a firm tointernalise, Williamson has also stressed other reasons also. 1) the opportunities foropportunistic behaviour within firms is restricted causing individuals agents and mangersto have a more nearly joint profit maximising attitude 2) internal organisation can bemore effectively audited 3) Internal organisation realises an advantage over marketmediated exchange in dispute settling respects. Douma & SchreuderThe above statements can be redesigned to keywords that state the properties of the firmthat commend internal organisation as a market subsitude would appear to fall into the threecategories : Incentives, Controls and what may be referred to broadly as inherent StructuralAdvantages. O.E.Williamson In conclusion Hayek s study of firms and markets has dismissedequilibrium economics with the observation of a dynamic model where the economic problemof society is mainly one of adaptation to changes in particular circumstances of time andplace F.V.Hayek and who has emphasised the marvel of the price system which accomplishesthis 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 statisticalaggregates, reflects a sense that economic institutions must be sensitive to dispersedknowledge of a microanaylytic kind. Thirdly was his insistence that attention to the detailsof social processes and economic institutions was made necessary by the unavoidableimperfection of man s knowledge. O.E.Williamson But where Hayek is to be criticised is hehas not recognised the limits of the markets which have been glossed over. e.g. Transactioncosts. The adherence to markets to be all domineering in Hayek s view can be dispelledobjectively as 85% of world trade is done by 10% of multinationals. Whereas Williamson hasconcluded that with the existence of (environmental and human) factors that therefore priceis not the overruling statistic that dictates to form market exchange. Williamson does admitthat in certain markets that price is a sufficient statistic, e.g. spot markets where priceis an overruling factor that equates the margin of uncertainty. Williamson has alsoemphasised the prospect of opportunistic behaviour. It is certain to a large extent thatfirms are present in deceiving one other but there are firms who on mutual basis are thereto co-operate with each other and to conduct their business amicably. Also there are lawspresent with contractual obligations for firms to complete contracts and comply to termsand business law. Every individual may have a tendency to behave opportunistically butthere are in some way bounded by the social and legal constraints. Williamson has neglectedto discuss the value of economies of scale. Where if production of a firm was increased sothat the firms unit costs fell it could pass on the benefits to its customers. This newprice could compensate the customer who is experiencing transaction costs, but this is onlyfeasible where there is large numbers of customers exist. BibliographyThe economic nature of the firm Louis PuttermanThe use of knowledge in society F A Von HayekMarkets and Hierarchies Oliver E WilliamsonEconomic Organisation Oliver E WilliamsonEconomic approaches to organisation Douma and Schreuder

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