Fear prudence: Hobbes and Williamson on the morality of contracting.

Author:Holt, Robin

Theories of new institutionalism, and specifically Oliver Williamson's theory of transaction cost economics, argue that complete presentiment in contracts is an abstract design of classical economics, not a pragmatic product of contingent experience. Exchange is not a costless activity, nor the market "free." The ex ante costs of negotiation (finding a price) and the ex post costs of clarifying, executing, enforcing, sanctioning, and renegotiating are idiosyncrasies that interfere with the smoothness of an exchange. These idiosyncratic dimensions of contracting, in which transactions are "neither faceless, nor instantaneous" (Williamson 1985, 56), expose decision making to the contingent influence of habit, perceived vested interest, and limited knowledge and capacity.

Organizations are a response to this decisional incompleteness and the attendant non-value-adding costs. An organization is a set of authority relations established by a "general contract, whereby agents agree essentially to 'tell and be told'" (Williamson 1985, 221) in order to minimize transaction uncertainty and hence costs (Spekle 2001). For Williamson, then, the driver behind organizational form is less the reduction in production costs (through specialization, etc.) than the increased certainty of exchange. This is realized by repressing the pursuit of localized interests; using decisional fiats rather than costly arbitration; having a "bird's eye" view of information flow facilitating the integration of activities both externally (for example, production with demand) and internally (for example, operations with strategy); and reducing the opportunity for shirking and embezzlement (1986, 143-146).

Critics of Williamson's transaction cost analysis point to its apparent institutional naivete. In addition to the transaction, there are other units of analysis that influence organizational form, such as production or prevailing culture. Moreover, even within the transactional unit, the alignment of hierarchies does not always tend toward equilibrium (efficiency). At the heart of these critiques are theories of human nature. The root problem with transaction cost economics is its reputed insistence on economic agents having invariant preference functions, ignoring the lesson of old institutionalism that any such preferences are conceived and expressed under the rubric of social power and localized experiences of learning (Hodgson 2000; Ghoshal and Moran 1996). Williamson has appeared reluctant to accept the influence of power because the explanatory force of transaction theory (roughly, that organizations are more hierarchical the greater the complexities of their operational environment) requires agents who are able to rationally determine and affect the efficient level and nature of transactions in advance of their happening. This farsightedness assumes a set of unchanging futures (Slater and Spender 2000), a command of which cannot possibly be within the purview of an organizational agent beset with institutional habit, vested interest, and the founding logic of localized compliance.

This paper argues that while transaction cost economics relies upon a somewhat stochastic causal story linking bounded rationality and opportunist assumptions of human nature to organizational structures, its identification of the contract as a primal organizational form remains a vital insight--vital because the contract presents what is a near generic structural condition by which economic analysis might be made, without presupposing any neoclassical representation of a reality that persists outside of the peculiarities and localized perspectives of agents. Given this, a possible response to criticisms of transaction cost theory, and one hinted at but not actively pursued by Williamson's (1998) recent discussions of trust and human nature, is an analysis of contracting seen as an activity rather than as a unit, or object, of analysis. The paper develops this change of perspective by invoking, first, the work of John R. Commons and then that of Thomas Hobbes. It was Commons who pointed out that what distinguishes a transaction is the acquisition and alienation of the right to control scarce resources. In other words, the transaction only makes sense within an already existing setting of institutional distribution and regulation of scarce resources, codified as rights (Kaufman 2003). Commons' insight means any analysis using contracts is beholden to investigate the character and legitimacy of the institutional authority by which organizational form is realized from potentially chaotic states of affairs. It is this kind of investigation that remains muted in Williamson's theory.'

The use of contractually framed authority, or sovereignty, to further human "wealth" through compulsion has been a traditional concern of political theory and finds a seventeenth century apotheosis in Thomas Hobbes' Leviathan. A crucial connection between Williamson and Hobbes is an apparently causal story linking the nasty, brutish, and short life of unrestrained agents to the necessity of creating and maintaining institutional power through the use of contracts. Hobbes argued that without the sovereign power of the Leviathan, "vainglorious man" is left free to vent "his" rent-seeking urge, realizing in the process nothing more than the "warre of all against all." His Leviathan figure is a third party creation of agents who have realized that were they to continue to make decisions from within the bounds of their existing relations (using what Hobbes termed "prudence") they would be forever under the shadow of unceratinty and death. Hobbes used the contract to tease people away from their immediate relational bias insofar as that bias realizes incommodious outcomes. The Leviathan acts as a political architect, able to see how, through social manipulation, agents might live peaceably.

Hobbes realized, as might Williamson, that contracting as an activity is not governed by algorithmic limits of causal "if ... then ..." equations but moral limits articulated in the relations of power and responsibility the contracts bring about. By making clear the authorial and moral dimensions of the activity of contracting, Hobbes showed that far from repressing learning and being impervious to the effects of power, contracting is the practice by which such knowledge and awareness is realized. Williamson's transaction cost theory tends to repress this contractual "scene setting." It prefers to emphasize the distributional aspects of the contractual unit (the rational assessment of differing distributional patterns of legal title) at the expense of the moral aspects by which agents use sovereignty to authorize each distributional pattern and hence, as the authors, incur duties arising from them. The paper concludes that any concern with these moral aspects, and so with what Commons called the "right relations" of transacting, is a concern with how to use institutional devices to escape the opportunistic consequences of prudential reasoning. Far from being an expression of prudence, Hobbes made it clear that contracts are an institutional device that allows the excesses of prudence to be tempered by a moral concern with consistency, clarity, and imaginative appeal.

Markets and Organizations

Transaction cost economics is institutionally aware insofar as it assumes that without organizations the event and contractual decision trees of traders are impossible to define with any degree of consistency. The market-the raising and revising of contracts-forms the most basic and efficient mode of governance, but this minimal condition of hierarchy is less effective the more complex is the exchange. Exchange complexity is a function of three combined states of affairs: asset specificity, agent uncertainty, and agent familiarity (Williamson 1986, 105; 1985, 52-61).

Asset specificity refers to the durable investments in sites and physical, dedicated, and human assets that cannot be, or can only partially be, redeployed. Agent uncertainty stems from the limits in the rational capacity of agents to know all that might be relevant to their decisions. Often, this is the result of outside disturbances that cannot be predicted fully (such as a change in consumer preference) or of unwitting activity (a breakdown in communication). Compounding this parametric uncertainty, however, is behavioral uncertainty: the tendency of people to deliberately exploit these asymmetries with rent-seeking strategies, so creating value at the expense of others. Agent familiarity describes how the more frequent, short, and regular a transaction, the less costly it is. The specialized modes of governance required by unique and/or prolonged transactions incur costs that are difficult to recover because of their infrequent nature. Together, these three states of affairs inflict non-value-adding costs to exchange that need to be managed through an alternative mode of governance: organization.

Organizations are an efficient mode of governance because they allow exchange relations to be designed around what actually happens, ex post, as well as what may happen, ex ante. To do this they manifest an authority reached by a general contract by which labor agrees to respond to management and owner control in exchange for the security of a consistent and secure standard of living. Where the relation between activities and outcomes is known, control is configured using explicit measures governing unit rates, levels of profitability, procedural rules, activity breakdowns, and the like. Where the organization cannot know what will be required in terms of activity, control is configured as a generalized acceptance of authority (using offices and roles) coupled to the use of boundary controls such as common organizational values (Ouchi 1980). Control is manifest in longer-term contracts that provide space and time enough for the "exchange...

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