The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2009
Elinor Ostrom, Oliver E. Williamson
Oliver E. Williamson
Born: 27 September 1932, Superior, WI, USA
Affiliation at the time of the award: University of California, Berkeley, CA, USA
Prize motivation: "for his analysis of economic governance, especially the boundaries of the firm"
Field: Economic governance
Contribution: Provided a theory of why some economic transactions take place within firms and other similar transactions take place between firms, that is, in the marketplace. The theory informs us about how to handle one of the most basic choices in human organization. When should decision power be controlled inside an organization, and when should decisions be left to the market.
I was born in Superior, Wisconsin on September 27, 1932 as the second child of Scott and Lucille Williamson. Both of my parents had been high school teachers but my father left teaching when he married my mother and joined my grandfather, Oliver E. Dunn, in the family real estate business. My father was a successful small businessman and active participant in the life of the community, culminating with nine years of service as President of the Superior City Council. My mother had been the principal of the small high school in Minnesota where my parents met. The prevailing rule on married women required that my mother retire from teaching, but her knowledge of the subject matter was undiminished. Her recall of Latin after 20 years was such that she could have resumed teaching where she left off on a moment's notice.
I attended the public schools in Superior. This was a very egalitarian experience. Superior is the most democratic community I have ever lived in. Talent took many forms and was respected in all.
I was a good student, a mediocre athlete, and had many good high school friends I hung out with – attended Saturday night dances, went bowling, played basketball and pool, and, especially, played Friday night poker. Many of them remain close friends to this day.
My university teacher and mentor Kenneth Arrow remembers me as a student who asked good questions. Although I had not previously thought of myself in that way, on reflection I think that Arrow was right. I was forever curious about how things worked (or didn't work), which led me to identify lapses or anomalies and/or to push the logic to completion. Such an orientation would serve me well throughout my academic career.
My initial thoughts of becoming a lawyer changed in high school as I became more attracted to math and science and began talking about being an engineer. My mother declared that M.I.T. was the place to go and, with the advice of the physics teacher at the local college, I enrolled in Ripon College, which had a combined plan with M.I.T.
That combination worked out well. My first jobs after graduation in 1955 were as a project engineer for G.E. and later with the U.S. government in Washington, D.C., where I met and married my wife, Dolores Celini. I applied to and was accepted into the Ph.D. program at the Graduate School of Business at Stanford, where I enrolled in 1958. To my surprise and delight, I discovered that much of my engineering training in mathematics and statistics and model building carried over. But there was more to it than that. My engineering training gave me a much more grounded foundation than would most undergraduate programs in any of the social sciences.
Although I would not come to appreciate this last until later, there was a major difference between engineering and economics with respect to hypothetical ideals. Thus whereas assumptions of weightlessness or perfect gas laws or frictionlessness etc. served the purpose of simplification in engineering, these assumptions would give way to realities (in the form of friction, resistance, turbulence, and the like) as engineering applications were attempted. In economics, however, assumptions of frictionlessness (of which the standard assumption of zero transaction costs was one) often went unquestioned or, even worse, were invoked asymmetrically. Thus whereas markets were subject to "failures" for which corrective public policy measures were prescribed, there was no corresponding provision for failures in the public sector. A more symmetrical approach would be to recognize that positive transaction costs were the economic counterpart of friction and that all forms of organization experience such costs – albeit in variable degree (depending on the attributes of the transaction to be organized). I credit my engineering background with giving me a receptive attitude toward transaction costs, to include an interest in pinning down and working out the organizational ramifications of such costs.
My move from business into economics was accomplished with the aid of four events: (1) I first became intrigued with economics when I took an economics class from James Howell, who had just joined the business school faculty and recognized (before I did) that I had economic interests and intuitions; (2) on Howell's advice I took a class with Kenneth Arrow, whose class confirmed Howell's perception and greatly whetted my appetite; (3) on the advice of another new appointment to the business school, Charles Bonini, I came to learn about and became intrigued with the interdisciplinary program in economics and organization theory at Carnegie; and (4) I was awarded a portable three-year fellowship to support my graduate studies by the Ford Foundation.
Dolores and I and our first two children, Scott and Tamara, moved to Pittsburgh, Pennsylvania in the fall of 1960, where I found my niche: the combination of economics and organization theory, as taught by the small but remarkable faculty of the Graduate School of Industrial Administration to classes with a small but remarkable group of students. Seven Nobel Prizes in Economics have since been awarded to faculty and students at GSIA in its halcyon years. Jacques Drèze, who was a visitor, speaks for me and many others in his observation that "Never since have I experienced such intellectual excitement."1
My dissertation on "The Economics of Discretionary Behavior: Managerial Objectives in a Theory of the Firm" was completed in 1963 and, as a winner in the Ford Foundation dissertation competition, was published by Prentice-Hall the following year. I joined the faculty of the Economics Department at the University of California, Berkeley in the fall of 1963.
The field in economics that most closely related to my training at Carnegie was that of industrial organization, which is the field into which I was hired. I had never, however, taken a course in industrial organization – which was both an advantage and a disadvantage, more the former than the latter. With the benefit of hindsight, the field of industrial organization, especially its public policy applications to antitrust and regulation, had fallen on hard times in the 1960s. As Victor Fuchs put it in his introduction to National Bureau of Economic Research Colloquium on Policy Issues and Research Opportunities in Industrial Organization, "Whither industrial organization?… All is not well with this once flourishing field" (1972, p. xv). Never having been "indoctrinated," I had no hesitation in taking exception with the prevailing orthodoxy.
The basis for the hard times within IO to which I refer can be variously described. Mainly I would ascribe them as due to three related misconceptions. First, there was undue reliance within the field of industrial organization on the neoclassical theory of the firm according to which the firm, to include the modern corporation, was described as a "black box" for transforming inputs into outputs according to the laws of technology. This was fine for some purposes but not for all and led to the second misconception: the internal organization of the firm could be ignored because it was inconsequential. Third, as mentioned above, frictions were ignored or suppressed by selectively invoking the assumption of zero transaction costs.
The propositions that (1) organization is often important and (2) economics and organization theory need to be joined if we are to develop a deeper understanding of complex contract and internal organization are ones that I introduced into the classrooms in the industrial organization and public policy courses that I taught at Berkeley (from 1963–65) and thereafter at the University of Pennsylvania. But my experience in 1966–67 as Special Economic Assistant to the Head of the Antitrust Division of the U.S. Department of Justice was in many ways the defining event.
Although the leadership and staff of the Antitrust Division in the late 1960s were both superlative, the prevailing attitude toward nonstandard and unfamiliar contractual practices and organization structures was that such "abnormalities could be presumed to have anticompetitive purpose and effect." Indeed, given that the prevailing price theoretic orientation effectively disallowed economies of a non-technological kind, it could hardly have been otherwise. That economies could result from organizational and contractual design was simply outside the canon.
Vertical integration and vertical market restrictions were regarded as especially problematic. Absent "technical or physical aspects," the unified ownership of successive stages of production or the application of vertical market restrictions by a manufacturer on a distributor were routinely taken to be anticompetitive (as in the Schwinn case, which was argued before and decided by the U.S. Supreme Court in 1967). I therefore resolved to re-examine the antitrust ramifications of vertical integration when I returned from Washington, D.C. to resume teaching and research at the University of Pennsylvania.
Teaching can be learning, especially if student curiosity with the question "What's going on here?" can be elicited. This was a recurrent question in the graduate seminar that I organized to examine the literature on vertical integration and vertical market restraints. Although parts of this were instructive, almost none of this literature recognized that markets and hierarchies differed in kind, much less that such differences had efficiency ramifications. Given this lapse, I decided to reformulate vertical integration from a combined economics and organization theory perspective in which express provision for positive transaction costs were made.
My 1971 paper on "The Vertical Integration of Production: Market Failure Considerations" differed from orthodoxy in the following respects: (1) the orthodox lens of choice is supplanted by the lens of contract/governance (which leads into an examination of more microanalytic detail and treats markets and hierarchies as alternative modes for mediating contracts); (2) the assumption of hyperrationality is supplanted by bounded rationality (on which account all complex contracts are incomplete); (3) the conveniently narrow view of simple self-interest seeking is expanded to make provision for strategic behavior, to include defection from the spirit of interfirm cooperation when the stakes are great; (4) the standard assumption of zero transaction costs is supplanted by a focus on positive transaction cost differences (conditional on the attributes of transactions, as between markets and hierarchies); (5) adaptation (of autonomous and coordinated kinds, which correspond, roughly, to market and hierarchy) is taken to be the main problem of organization; and (6) much of the comparative institutional action is shown to reside in the condition of bilateral dependency (which could vary from slight to great, depending on whether the investments made in supporting assets were generic or specific) in combination with disturbances to which adaptations were needed.
This reformulation revealed that the contractual hazards and maladaptation costs that would be incurred under market procurement (outsourcing) of a good or service for which the aforementioned condition of bilateral dependency was significant could be mitigated if the buyer were to produce to its own needs (integrate) – although, to be sure, bureaucratic cost differences attributable to a sacrifice of incentive intensity would also need to be taken into account. By contrast with the ideal transaction in law and economics, where each party could go its own way at little cost to the other if the requisite supporting investments were generic, a fundamental transformation sets in if the requisite investments are transaction specific (hence are nonredeployable to alternative uses and users except at the sacrifice of productive value) and the supporting long-term contracts are incomplete.
The seeds of a predictive theory of firm and market organization resided therein, but this was unfamiliar territory and would require more research before it would take hold. As, however, extensions to and refinements upon the basic framework were made, as additional contractual phenomena were interpreted as variations on a theme, and, especially, as empirical tests were corroborative of the predictions of the theory, "transaction cost economics" gained momentum.
Publications of mine that contributed to the progressive development of transaction cost economics include: Markets and Hierarchies (1975), which received a surprisingly favorable reception for a book that was difficult to write and put a heavy burden on its readers; "Franchise Bidding for Natural Monopoly" (1976), which demonstrates that doing public policy on regulation heedless of the contract relevant details is parlous; "Transaction Cost Economics: The Governance of Contractual Relations" (1979), which gave more structure to the theory and invited empirical work on transaction cost economics; "Credible Commitments: Using Hostages to Support Exchange" (1983), which develops the importance of credible contracting to support interfirm exchange and would serve as an introduction to "Comparative Economic Organization" (1991), which paper explicates the hybrid mode of contracting (located between markets and hierarchy) and makes the case for supplanting the all-purpose contract law of "legal rules" by making provision for "contract as framework" and introducing "forbearance law"; The Economic Institutions of Capitalism (1985) pulled the foregoing together and expressly addressed the burdens of bureaucracy by showing that limits to firm size arise because of the impossibility of implementing replication and selective intervention. Also, "Corporate Finance and Corporate Governance" (1988) and "Corporate Boards of Directors" (2008) interpret debt and equity not merely as modes of finance but also as modes of governance to which corporate governance ramifications accrue; and my 2000, 2002, and 2005 articles on "The New Institutional Economics," "The Theory of the Firm as Governance Structure," and "The Governance of Contractual Relations" make a place for differences in the rules of the game (the institutional environment) as well as the play of the game (the institutions of governance) and broaden the reach and perspective.
My appointment in the Economics Department at the University of Pennsylvania was expanded to include appointments to the faculty of the Law School and the School of Public and Urban Policy in the late 1960s, which turned out to be a productive mixture with many good colleagues and students in all three places. It was with reluctance, therefore, that I accepted an offer for what I thought would be an even more productive appointment to the School of Organization and Management, the Law School, and the Economics Department at Yale in 1983. Organizing workshops on law and organization in the Yale Law School, on economics and organization in the School of Organization and Management, and serving as founding editor of the Journal of the Law, Economics, and Organization were all gratifying. The complexities of the Yale appointment turned out to be considerable, however, and Dolores and I returned to the University of California, Berkeley in 1988 where we have been since.
Unmentioned in the foregoing, but nonetheless pertinent, is that our five children – Scott, Tamara, Karen, Oliver, Jr., and Dean – were troopers in all of the moves that we made between 1958 and 1983. (All had "left the nest" before our last move in 1988.) A factor that mitigated the dislocation costs of these moves is that we purchased my parents' summer home at Lake Nebagamon, Wisconsin in 1972 after my father died. We found that I could both work and play at the Lake and that the entire family enjoyed the change of pace – which would include tennis, golf, swimming, sailing, water skiing, and bridge, as well as canoeing in the Boundary Waters and flat out relaxation and periodic repairs to the property. Northern Wisconsin would become a fixture in the lives of all of us – parents, kids, grandchildren – over the years.
Life at Berkeley has been good. We have a home near the campus that looks out on San Francisco and the Bay with many marvelous sunsets. My main appointments in the University have been in the Haas School of Business and the Economics Department, to which the Law School generously extended an appointment as well. Creating a new field in the Economics of Institutions (in the Economics Department) and reshaping the Business and Public Policy curriculum (in the Haas School) have both been rewarding experiences. I am surrounded by outstanding colleagues in both places and have supervised the dissertations of a large number of excellent students who have gone on to have successful research, teaching, and administrative careers. They have been a joy to work with. Dolores has always adapted quickly to new surroundings. She worked with the League of Women Voters during our first two years at Berkeley and continued her League work to become President of the League when we lived in Lower Marion Township, where she also was President of the neighborhood library and took art classes at the Barnes Foundation. These classes would serve her well when we moved to Guilford, where she took a job with the Greene Gallery, which sold fine art by contemporary local artists. She adapted again when we moved back to Berkeley in 1988, where she has been active in the Section Club (serving as President and as a member of the Italian Section, and working with SOS and University Village), as Chair of the Parks and Recreation Committee for the City of Berkeley, as an active member of Town and Gown, and as Judge of elections at the polls.
My main administrative stint was to serve as Chair of the Academic Senate at Berkeley in 1995–96, which was a demanding but fulfilling experience. Working with Chancellor Chang-Lin Tien and with faculty across the entire campus gave me a deeper appreciation for the unique qualities of the University of California, Berkeley. The "Berkeley Triple," as I have come to understand it, is this: excellence, energy, and joy – in that the commitment to excellence applies across the length and breadth of the campus, merely to step onto the campus is energizing, and a sense of joy and satisfaction go with the job.
I retired from teaching in 2004 but continue to remain active in research and I attend and sometimes present workshops (my colleagues renamed a workshop after me, to my surprise and delight). I also selectively participate in recruiting and fund raising. And, weather permitting, I play doubles tennis with Dolores as my partner every Sunday and golf with my high school friend John Salmela every Tuesday. Travel, nearby and abroad, for both pleasure and business, gets worked in.
|The Economics of Discretionary Behavior: Managerial Objectives in a Theory of the Firm, Prentice Hall, Englewood Cliffs, N.J., 1964.|
|Markets and Hierarchies: Analysis and Antitrust Implications, The Free Press, New York, 1975.|
|The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting, The Free Press, New York, 1985.|
|"The Vertical Integration of Production: Market Failure Considerations," American Economic Review, May 1971, 61, 112–23.|
|"Franchise Bidding for Natural Monopolies – in General and with Respect to CATV," The Bell Journal of Economics, Spring 1976, 7, 73–104.|
|"Transaction Cost Economics: The Governance of Contractual Relations," Journal of Law and Economics, October 1979, 22, 233–261.|
|"Credible Commitments: Using Hostages to Support Exchange," American Economic Review, September 1983, 73, 519–40.|
|"Corporate Finance and Corporate Governance," Journal of Finance, July 1988, 43, 567–91.|
|"Comparative Economic Organization: The Analysis of Discrete Structural Alternatives," Administrative Science Quarterly, June 1991, 36, 269–296.|
|"The New Institutional Economics: Taking Stock, Looking Ahead," Journal of Economic Literature, 38 (September), 2000, pp. 595–613.|
|"The Theory of the Firm as Governance Structure: From Choice to Contract," Journal of Economic Perspectives, 16 (Summer), 2002, pp.171–195.
|"The Economics of Governance," American Economic Review, 95 (May 2005), 1–18.|
|"Corporate Boards of Directors: In Principle and in Practice," Journal of Law, Economics, and Organization, 24 (October 2008), 247–272.|
From Les Prix Nobel. The Nobel Prizes 2009, Editor Karl Grandin, [Nobel Foundation], Stockholm, 2010
This autobiography/biography was written at the time of the award and later published in the book series Les Prix Nobel/Nobel Lectures. The information is sometimes updated with an addendum submitted by the Laureate.Copyright © The Nobel Foundation 2009
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