Organization economist Peter Klein on his thesis advisor Oliver Williamson. I found this section of particular interest:
the black-box approach to the firm that [once] dominated neoclassical economics omits the critical organizational details of production. An equally serious omission is that production is typically treated as a one-stage process, in which factors are instantly converted into final goods, rather than a complex, multi-stage process unfolding through time and employing rounds of intermediate goods. Capital is treated as a homogeneous factor of production, the K that appears in the production function along with L for labor. Following Solow (1957) models of economic growth typically model capital as what Paul Samuelson called shmoo — an infinitely elastic, fully moldable factor that can be substituted costlessly from one production process to another.
In such a world, economic organization is relatively unimportant. All capital assets possess the same attributes, and thus the costs of inspecting, measuring, and monitoring the attributes of productive assets is trivial. Exchange markets for capital assets would be virtually devoid of transaction costs. A few basic contractual problems — in particular, principal-agent conflicts over the supply of labor services — may remain, though workers would all use identical capital assets, and this would greatly contribute to reducing the costs of measuring their productivity.
Williamson, by contrast, emphasizes that resources are heterogeneous, often specialized, and frequently costly to redeploy. What he calls asset specificity refers to “durable investments that are undertaken in support of particular transactions, the opportunity cost of which investments are much lower in best alternative uses or by alternative users should the original transaction be prematurely terminated” (Williamson 1985, p. 55). This could describe a variety of relationship-specific investments, including both specialized physical and human capital, along with intangibles such as R&D and firm-specific knowledge or capabilities. Like Klein, Crawford, and Alchian (1978), Williamson emphasizes the “holdup” problem that can follow such investments, and the role of contractual safeguards in securing the returns (what Klein, Crawford, and Alchian call quasi-rents) to those assets.
Austrian capital theory focuses on a different type of specificity, namely the extent to which resources are specialized to particular places in the time structure of production. Menger famously characterized goods in terms of orders: goods of lowest order are those consumed directly. Tools and machines used to produce those consumption goods are of a higher order, and the capital goods used to produce the tools and machines are of an even higher order. Building on his theory that the value of all goods is determined by their ability to satisfy consumer wants (i.e., their marginal utility), Menger showed that the value of the higher-order goods is given or “imputed” by the value of the lower-order goods they produce.
Moreover, because certain capital goods are themselves produced by other, higher-order capital goods, it follows that capital goods are not identical — at least by the time they are employed in the production process. The claim is not that there is no substitution among capital goods, but that the degree of substitution is limited. As Lachmann (1956) put it, capital goods are characterized by multiple specificity. Some substitution is possible, but only at a cost.
Mises and Hayek used this concept of specificity to develop their theory of the business cycle. Williamson’s asset specificity focuses on specialization not to a particular production process but to a particular set of trading partners. His aim is to explain the business relationship between these partners (arms-length transaction, formal contract, vertical integration, etc.). The Austrians, in other words, focus on assets that are specific to particular uses, while Williamson focuses on assets that are specific to particular users. But there are obvious parallels, and opportunities for gains from trade.
Austrian business-cycle theory can be enhanced by considering how vertical integration and long-term supply relations can mitigate, or exacerbate, the effects of credit expansion on the economy’s structure of production. Likewise, transaction cost economics can benefit from considering not only the time-structure of production, but also Kirzner’s (1966) refinement that defines capital assets in terms of subjective, individual production plans — plans that are formulated and continually revised by profit-seeking entrepreneurs (and Edith Penrose’s concept of the firm’s subjective opportunity set).