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Transaction Costs Economics

Introduction

Nowadays, much attention is paid to the study and explanation of the nature of organizations, their behaviors, actions and motives of employees at different levels. The reason is in the enormous spread and development of organizations. They are vastly represented at the local and global levels relating to all aspects of human life. This contrastive essay provides the description, analysis, and juxtaposition of theories which explain the formation and operation of organizations. These theories are transaction cost theory introduced by Ronald Coase and Oliver Williamson and theory of organizational performance developed by Karl Marx. The major emphasis is placed on their ideas concerning the aim and nature of the creation of firms. The description and precise analysis of organizational theories enables one to understand the core principles of existence of organizations.

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Nature of the Firm

The current work provides the description and analysis of the nature of companies from the standpoints of several scientists. Ronald Coase and Oliver Williamson represented the nature of firm on the grounds of transaction cost theory, while Karl Marx introduced his own notion concerning the creation and existence of institutions.

Transaction Costs Theory. Strengths and Weaknesses

Ronald Coase can be considered to be a founder of transaction cost theory. In 1960, the researcher stated that companies are formed as institutional arrangements to avoid exhausting trade gains (Foss & Klein 2010). The major Coase’s ideas formed the guidelines for the organizations to follow, thereby minimizing the losses and improving efficiency by the application of various institutional arrangements (Samuals 1996). However, Coase’s ideas fail to depict what types of institutions were more preferable than the others due to the lack of “the direct comparison of the costs of each” (Samuals 1996, p. 385). Thus, the researcher’s final claims that one form of institutions is more preferable than the other are ungrounded.

Oliver Williamson continued the development of the transaction cost theory by determining behavioral traits which cause transactional frictions and creating the interconnection between these frictions and structures of organizations (Ding, Akoorie & Pavlovich 2009). In the cases when transaction costs could not be directly compared, Oliver Williamson assessed the efficiency of companies.

One of the major achievements was presentation of a consistent and at the same time economically sound model of company’s behavior targeted “on utility maximization rather than profit maximization” (Samuals 1996, p. 392). The researchers have discovered that company’s behavior does not align with the behavior of human beings, especially in such aspects as rationality and “efficacious enforcement of promises” (Samuals 1996, 386). For better explanation of the organizational behavior, Oliver Williamson introduced such concepts as bounded rationality and opportunism (Samuals 1996). Hereby, bounded rationality represents the idea that rationalism of human beings in acting and behaving is limited by the extent of the available information (Boyle 2015). As a result, this affects their ability to formulate, process, and solve complex problems. On the other hand, opportunism emphasizes that individuals act and behave with self-interest, for example they can act with guile with the aim of maximizing their profits. As per Williamson’s opinion, “individuals are…less competent optimizers, and better lies, cheaters and shirkers” (Samuals 1996, p. 386). Thereafter, their individual actions can cause significant financial losses.

Williamson’s major idea is that organizations are created with the aim of lowering expenses on transactions which occur due to bounded rationality and opportunism. To achieve this, they should “organize transactions so as to economize on bounded rationality while simultaneously safeguarding them against the hazards of opportunism” (Samuals 1996, 386). Thus, internal labor markets enabled organizations to overcome the above-mentioned concepts by the development of employees’ specific skills and improvement of efficient rationality.

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The formation of organizations is associated with the reduction of the possibility of delays caused by court proceedings because courts will not hear disputes between internal divisions of one single company (Samuals 1996). Moreover, Oliver Williamson introduced the limitations of efficiency and size of organizations by the managerial incentive intensity and their limited capacity to administer transactions.

The primary focus of transaction cost analysis is made on choice between forms of structures, having freedom and autonomy in bargaining with the application of various tactics to obtain more favorable gains. The involved parties “may haggle, stall, or walk away” (Samuals 1996, p. 387). Thus, the actual occurrence of transaction is dependent on the extent of gain that is believed to be obtained after its performance reflected and affected by the actual cost of commodities and the cost of their exchange (Groth n.d.).

The major benefit of the introduced approach is the explanation of behaviors of organizations and separate individuals. Oliver Williamson provided “a set of normative rules for choosing among alternative organizational arrangements” (Samuals 1996, p. 398). However, researchers which tested his ideas in real-life cases faced difficulties in obtaining the necessary information due to Williamson’s level of detail (Samuals 1996). In fact, they have been required to handle measurement issues and problems while accessing necessary information. As a result, this model was found to be inconsistent with contracting. The reason is that it provides insufficient explanations of terms and duration of contracts between involved parties. Moreover, the assessment of benefits of a particular organization can be possible only in comparison with the organization that has similar structure and operates in similar conditions (Samuals 1996). Furthermore, this theory does not give benefits of transactions significant consideration (Boudreau et al. 2007).

Marxist Account. Strengths and Weaknesses

Karl Marx represented outstanding ideas concerning the nature of organizations and behavior of all involved participants. According to his studies, organizations are created for the maximization of profits and control instead of organization of work flow in the most effective and efficient manner. Labor is considered to be a commodity that is produced for sale. In fact, this happened because workers were obliged to exchange their working capacity for money as they were expropriated alternative means of consumption and production (Adler 2009). Talking about objectively determined value, it can be defined as “the socially necessary labor time invested in the product’s production” (Adler 2009, p. 65). At the same time, the fluctuation of the price of a commodity (i.e. employees’ labor) is dependent on the supply and demand.

Organizations’ appearance and existence is greatly reliant on their ability to extract value from the labor. They legally appropriate part of the value for coverage of non-labor expanses and investors’ profit. The additional attention should be paid to the role of managers. On the one hand, they act as common employees who engage in labor. However, on the other hand, they perform the exploitation of groups of individuals with the aim of obtaining greater benefit for organizations, for example “managers fulfill a mission of shareholder wealth maximization” (Adler 2009, p. 71). As per Marx’s notion, the whole concept of the existence of organization represents the exploitation of employees as they cannot control the use of all benefits obtained from their labor.

The major strength of Marx’s theory is the explanation of the nature of interrelationships between the employee and employer, approaches to obtaining benefit and exploitation. At the same time, it has several weaknesses. Firstly, it should be reassessed for the application to modern companies due to the transition from the production economy to the service economy (Adler 2009). Secondly, Marx devotes insufficient attention to the private ownership and ability of an individual to use it in interrelationships with other people and organizations (Lombardo 2015).

Similarities of Transaction Cost Theory and Marx’s Theory

Both theories aim to describe the nature of companies and the background of their existence. Ronald Coase and Oliver Williamson the same as Karl Marx aimed to understand the behavior of companies and their employees inside and outside their working environment. In fact, this was made to determine the most suitable and beneficial course of actions and explain the choice one made. In a like manner, scientists placed significant emphasis on the source of gaining profit despite the fact that in two theories, this source is different. Ronald Coase, Oliver Williamson and Karl Marx strived to understand how companies generate their profits and how these profits can be increased by adopting or eliminating certain behaviors.

Contrast of Transaction Cost Theory and Marx’s Theory

Nevertheless, transaction cost theory and Marx’s theory provide different perspectives on the major aim of creation and operation of forms. According to the first theory, employees are organized in the single institution for the minimization of transaction costs. Companies can change their behavior and structure on the basis of price of transactions. On the contrary, the second theory emphasizes that the aim of the formation of firms is to extract value from the labor of employees through their exploitation.

As per personal understanding, the transaction theory does not fully depict the concept of organizational existence. As per its concepts, in the situation when the transaction costs in the market are lower than the similar costs within the organization, it will fail. This notion is questionable as the companies may exist even in such situations since the extent of value extracted from labor is sufficient to cover all needs. The cost of labor is dependent on the supply and demand which are influenced by numerous factors and can be affected by employers such as “integrated competitive abilities and value creation brought about by this particular inter-organizational cooperative form” (Ding, Akoorie & Pavlovich 2009, p. 49). As opposed to Marx’s theory, being more oriented on the explanation of companies’ behaviors, this theory provides insufficient explanation of the formation of value. It neglects the role of social relationships which have an enormous influence on market conditions. Furthermore, it has numerous weaknesses in the application to real-life cases.

In contrast to transaction cost theory, Marx’s organizational theory gives a clearer explanation of interrelationships between employers and employees and the ways of extracting value. The weaknesses of this theory are to a great extent related to the necessity of its modernization and aligning to conditions of the modern world. Thereafter, Marx’s theory is seen to be more appropriate for the understanding of the nature of firms.

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Conclusion

The current work provides the precise explanation of the core principles of existence of organizations. This paper provided information with regard to the precise analysis of transaction cost theory and Marx’s theory. Transaction cost theory has been introduced by Ronald Coase and Oliver Williamson. The researchers stated that the major aim of organization is to minimize transaction costs. These costs occur due to such distinct characteristics of human behavior as opportunism and bounded rationality. Their research is targeted on the explanation of company’s behavior. Their theory can be hardly appropriate for the analysis of existence and behavior of real organizations. Marx’s theory is grounded on the idea that organizations are created for the extraction of value from the labor of common employees who are working there. The major weakness of this theory lies in the necessity of its reassessment due to recent changes which took place in the modern economy. The precise analysis of these two theories leads to the conclusion that the existence and nature of the firm are best explained in terms of its ability to successfully extract value from employees that are working within the organization rather than any transaction cost minimizing properties it may possess.

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