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Transaction Cost Theory And Lacity And Willcocks Data Economics Essay

Transaction cost is defined as “cost of establishing, using, maintaining and changing’ “A transaction occurs when a good or service is transferred across a technological separable interface. One stage of activity begins terminates and another begins”.(Williamson 1985) Transaction cost is also called as transaction of economics theory of the firm, markets and hierarchies/electronic hierarchies and electronic markets. Transaction costs consist of costs incurred in searching for the best supplier/partner/customer, the cost of establishing a supposedly “tamper-proof” contract, and the costs of monitoring and enforcing the implementation of the contract. Main dependent construct(s)/factor(s) Governance structure, degree of outsourcing, outsourcing success, inter-organizational coordination and collaboration

Transaction cost economics further recognizes that different governance modes are supported

by different legal regimes, ranging from contract law for market governance to employment

law for hierarchy (Masten 1988; Williamson 1991). Market-based disputes between parties

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are either costlessly resolved by exiting the relationship or resolved with deference to classical

contract law (MacNeil 1978). Hybrid forms of organization rely instead on neoclassical

Contract law and excuse doctrine, while hierarchies rely on forbearance (fiat), rather than legal

recourse, to resolve disputes between and among parties.

The empirical TCE literature contains a number of excellent case studies. These include

analyses of cable television franchising (Williamson 1976); organizational arrangements in

the aluminum industry (Stuckey 1983), between rail operators and freight (Palay 1984),

between tuna harvesters and processors (Gallick 1984), and between coal mines and electric

utilities (Joskow 1985); contracts in the petroleum coke (Goldberg and Erickson 1987) and

shoe (Masten and Snyder 1993) industries. Other case studies examine variations in ocean

shipping contracts (Pirrong 1993), organizational arrangements in the French poultry industry

(Menard 1996), the interaction of political institutions, regulatory processes and economic

conditions for telecommunications regulation (Levy and Spiller 1994); divisional coordination

problems created by technological interdependence (Argyres 1995), and the acquisition of

Fisher Body by General Motors (Coase 2000; Klein 2000)

Williamson argues that three dimensions of a transaction affect the type of governance structure chosen for the transaction: asset specificity, uncertainty, and frequency. As asset specificity and uncertainty increase, the risk of opportunism increases. Thus, decision-makers are more likely to choose a hierarchical (firm-based) governance structure. As frequency increases, the compara-

tive advantage of using market governance structures decreases because the costs of hierarchical governance structures can be amortized across more instances of the transaction.

Transaction Cost Theory and Lacity and Willcocks’ Data

Lacity and Willcocks (1996; p. 218) use only asset specificity and frequency to determine which governance mode should have been chosen according to TCT for the IT transactions undertaken by their sample of firms. For some reason, they did not consider the effects of uncertainty (pre-sumably they were unable to measure uncertainty). Particularly at the margin, however, TCT predicts that the level of uncertainty is likely to affect whether a decision-maker chooses to out-source or insource. Lacity and Willcocks recognize, therefore, that the effects of uncertainty may account for some of the anomalies they found.

To measure frequency, Lacity and Willcocks allowed participants to specify a transaction as either occasional or recurrent. In most cases the choice made seems appropriate (e.g., data center operations were recurrent). In some cases, however, the choice is questionable. For example, systems development is designated as an occasional transaction. If an organization regularly engages in systems development work, however, the transaction is more likely to be recurrent.

Our major concern, however, is with Lacity and Willcocks’ measure of asset specificity. Williamson (1985, p. 52) is unequivocal about the primacy of asset specificity in TCT: “The principal dimensions with respect to which transactions differ are asset specificity, uncertainty, and frequency. The first is most important and most distinguishes transaction cost economics from other treatments of economic organization, but the other two play significant roles” (our emphasis). Having a valid and reliable measure of asset specificity, therefore, is central to undertaking robust tests of TCT.

The following excerpts from Lacity and Willcocks (1996) illustrate the bases they used to designate whether an asset had generic, mixed, or idiosyncratic specificity (in all cases below, our emphasis):

Participants from FIRMS 18, 29, and 32 view data center operations as a support commodity rather than a strategic asset requiring specialized knowledge. We therefore classified these transactions as non-specific (p. 218).

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When participants perceived that transactions required specialized knowledge, we classified the transaction as “idiosyncratic” (p. 219).

Because participants in half of the sourcing decisions used an entire information tech-nology department as a unit of analysis rather than treating information technology activities separately, we characterized the 14 total outsourcing and 15 total insourcing decisions as “mixed recurrent.” Participants perceived that some information tech-nology functions involved in the transaction, such as some new system development projects, required highly specialized skills while they perceived that other information technology functions, such as data processing, were standard (p. 219).

• • •

In short, if the assets supporting a transaction were specialized, Lacity and Willcocks designated them as specific (mixed or idiosyncratic). Moreover, where organizations took a decision of total outsourcing or total insourcing, their assets were deemed to be at least partly specialized and therefore designated as mixed specificity.

We argue, however, that the specialization dimension of an asset is not the same as the specificity dimension of an asset. In this regard, Williamson (1985, p. 53) is explicit in terms of what he means by specificity: “Transactions that are supported by durable, transaction-specific assets experience ‘lock in’ effects, on which account autonomous trading will usually be sup-planted by unified ownership (vertical integration).” The essence of asset specificity, therefore, is that lock-in effects occur, which potentially lead to hold-up problems. One party invests in an asset to support a transaction with another party. Specialization, on the other hand, refers to “the process by which different individuals, functions, divisions, or organizations invest in different kinds of skills and assets so that, over time, each develops a comparative advantage over others in a specific kind of activity” (Jones 1998, pp. 9-10). The essence of specialization is that the functions performed by an asset (person, machine, work team, firm, etc.) can be performed by only a subset of all assets. Given that no asset can perform all functions, all assets are specialized to some extent. The focus, however, is the cardinality of the subset. As the cardinality decreases, the subset becomes increasingly specialized.

An asset that is specialized, however, is not necessarily specific. For example, consider a surgeon who specializes in some abstruse aspect of oncology, perhaps to the point where she or he has only a few peers in a major city (or country). The surgeon is highly specialized, but no hold-up problem exists. If a patient engages in a transaction with the surgeon and then threatens to withdraw, the value of the surgeon’s specialized skills is unlikely to drop dramatically. The patient cannot prevent the surgeon engaging in transactions with other patients. Similarly, if a hospital or clinic engages in a transaction with the surgeon and then threatens to withdraw, no hold-up problem arises.

There are a number of fundamental issues relating to transaction cost measurement, which underlie the subsequent discussions of typology, chronology, and measurement methodologies. These can be grouped as: (1) integrating transaction costs in policy analysis; (2) defining transaction costs; (3) the effect of time on transaction costs; and (4) the tradeoff between precision and measurement cost. 2.1. Integrating transaction costs in policy analysis Transaction costs need to be measured within a larger framework of the overall costs and benefits of a policy. Many transaction cost measurement studies have implicitly or explicitly assumed that the benefits provided by different policies are similar so that a cost-effectiveness framework is sufficient.A related issue is that the factors that are assumed to affect transaction costs, and thus

decision making in the private sector (frequency, uncertainty, and asset specificity) may not be the most important factor for environmental and natural resource policy.

Example 2:

In some cases, however, specialization and specificity are intertwined. For example, managers may be more valuable to an organization to the extent they have specialized knowledge about the organization (e.g., its history, operating procedures, culture). If a manager were to leave the organization, however, other organizations might deem only some part of this knowledge to be valuable (that which also has generic elements). The organization and the manager face a joint hold-up problem. To entice the manager to acquire specific, specialized knowledge, the organization must be willing to compensate the manager for the risk associated with investing in knowledge that has no value outside the organization. Having invested in the knowledge, the organization can then hold up the manager by decreasing her or his compensation. The manager can also hold up the organization, however, by threatening to leave. The organization then has to consider the loss in value that will occur with having less knowledgeable managers and training new managers versus paying the extra compensation demanded by the manager.

Figure 1 : Classification of Assets

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In summary, an asset may be neither specialized nor specific, specialized but not specific, specific but not specialized, and both specialized and specific (Figure 1). In the context of TCT, recall that only the latter two types of assets bear on the sourcing decision.

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2.What are the basic assumptions of economic theory of democracy and main insights derived from this theory, which for example derived from the can be demonstrated by means of special models? which phenomenon are addressed by the terms centripetal and centrifugal forces.

According to Anthony downs: economic theory of democracy(1957) is defined as realistic view of competition between politicians for voters from the electorate. His analysis s has shaped subsequent research. The idea of of special party competition -in which the space is interpreted not geographically but rather as the positions of party programmes-has been formalized for the case of two competing parties.

Assumptions of the model: 1. Agrarian politicians only pay attention to the preferences of agricultural voters; non-agricultural voters are assumed to be indifferent vis-á-vis agricultural policies.

(2) Agricultural voters only decide on their voting behaviour according to their evaluation of

agricultural policies; as far as other political problems are concerned.they behave neutrally.

In his economic theory of democracy, Anthony Downs (1957) presented three additional theoretical claims, which are quite different from each other but related. First, he gave us a model of how candidates must locate themselves in order to maximize their chances of being elected. This is the median voter model, which says that a candidate must take a position at the median of a normal distribution of voters. A candidate who does not do this can be outflanked by another candidate who takes a position between the first candidate and the median voter. This model assumes away Arrow’s problem by supposing that all policy issues aggregately reduce to a single left-right dimension.

Second, Downs supposed that voters actually have little incentive to vote, because they cannot expect to have any impact on the outcome of any given election. Indeed, they have so little impact that any costs of voting, such as suffering through long queues or foul weather, trump any direct benefit from voting. This claim is a specific instance of the logic of collective action, as generalized later by Mancur Olson (1965).

The third major theoretical claim of Downs is that individual citizens have no incentive even to learn enough to be able to vote their interests intelligently. This immediately follows from the second claim if we suppose that gaining relevant knowledge entails some costs. Oddly, however, this claim seems to run against the first of Downs’s theses, which seems to entail that candidates should attempt to influence voters’ knowledge

In the simplest case the position of individual voters is marked on a (unified) scale (in fig; from left to right).curve D gives the density of various ideological views, i.e the percentage of voters having a particular political view. In the figure it is assumed that most voters have a ” medium” position and that there are only

Task;2(b)

What Is particular regarding the party preferences of the farmers and what has shaped their party preferences.

According to farmers point of view party competition provides only a very imprecise control of agriculture policy decision. A more detailed control by parliament, the system of interest groups, buerauocracy and so on is therefore indispensibel. By means of his vote, a farmar can opt for a global party programme, but not for particular agriculture policy measures. Farmers certainly have a great interest in choosing between different agriculture policy programmes becaz they are passionate minority.

Farmers also behave as different voters like median voters, floating voters,regular voters and flexible voters. Farmers as a medium voters behave as passionate minority, might be expected to vote in a flexible way; instead of they show little voting mobility and one sided party preferences predominately for conservative parties.Most of the farm families political preferences are stable.

Agricultural politicians will respond to the demand for politics by agriculture with a supply of agriculture policies only if the farmers and their families behave as flexible voters.

Farmers as floating voter model is pure allocation model includes additional gains of voters by means of policy measures that redistribute incomes. Optimal distribution strategy in the model of pure democracy. Maximum favors for a minimum majority and maximum burdens for a maximum minority.

A combined analytical framework seems to offer a better explanation of political co-ordination mechanisms, especially for agricultural policies, than an approach exclusively based on any one separately, the very limited regulation potential of electoral control and party competition cannot adequately coordinate, so differentiated a task on the formulation of agricultural policy. The political parties can be depicted more realistically- the behavior of voters, political parties, politicians and beuracrtaes is also regarded as a function of interest groups. Agriculture policy is an exemplary case of this type of interest representation.

The process of competition and co-operation among these groups determine the “equilibrilium structure” of taxes, subsidies and other political burdens and flavors. “political equilibrilium” and the groups of position of power deprived on their different abilities to influence government institutions. This is important we if want to find out why farmers as a minority have succeeded in protecting their interests against the majority of non-agricultural groups and voters. And the assumption Is that this is due to relative efficiency advantages of agriculture in producing political influence compared to those groups and voters who might be intended in less costly agricultural policies.

Due to the farmers high party identification, not only the number of voters, but also the voting flexibility of most of the consumers and tax payers is considerably higher. Consequently the gain of agriculture votes achieved by a policy f favoring the farmers interests would be over compensated by the resulting loss of non-agriculture votes .Many more votes could be mobilized in other groups with lower party identification by means of the same redistribution budget. In other wards the electoral opportunity costs caused by redistribution in favor of agriculture would be much higher then the benefits.

Those are the reasons why farmers and farm politicians have a common interest in protecting agriculture policy against electoral control of this sort, which could lead to political acceptance of reform concepts.

Please describe and explain the Economic Theory of Collective Action developed by

Mancur Olson. Which groups and determinants does he distinguish as regards the

emergence and feasibility of collective action? Please use graphs. (20 pts.)

b) Which mechanisms for collective action to come into being play a role in the Economic

Theory of Olson? What mechanisms are used for organising collective action in the case

of the German Farmers Union and in the case of a drainage association at the coast of the

North Sea, and why do they differ? (20 pts.)

Collective action theory was explained by mancur olson.

Most of the members of this interest groups should always neglect their own individual interests. An essentially selfish group interest would not normally attract members who were completely selfless.

The existence of large group with a common interest does not automatically give rise to collective action. There must be an individual intensive to join in or there must be compulsion.

The individuals in any group attempting collective action will have incentives to “free ride” on the efforts of others if the group is working to provide public goods. Individuals will not “free ride” in groups which provide benefits only to active participants.

Public goods are goods which are non-excludable (i.e. one person cannot reasonably prevent another from consuming the good) and non-rival (one person’s consumption of the good does not affect another’s, nor vice-versa). Hence, without selective incentives to motivate participation, collective action is unlikely to occur even when large groups of people with common interests exists.

According to olson that large groups will face relatively high costs when attempting to organize for collective action while small groups will face relatively low costs. Furthermore, individuals in large groups will gain less per capita of successful collective action; individuals in small groups will gain more per capita through successful collective action. Hence, in the absence of collective incentives, the incentive for group action diminishes as group size increases, so that large groups are less able to act in their common interest than small ones.

Thye thing is that, not only will collective action by large groups be difficult to achieve even when they have interests in common, but situations could also occur where the minority (bound together by concentrated selective incentives) can dominate the majority

Olson, noted that pluralist assumption of the time, that common interests among individuals are automatically transformed into group organisation and collective action

Acc to olson small groupsprevileged becaz of their advatage in overcoming the free riding,coordination, and conflict of interets problems of collective action.

Farmers interest groups are usually long established, yet their very existence seems puzzling in an industry characterized by family ownership of farmers, physical isolation or dispersal and indualistict ethics.the political success of farmers has become a major testing ground for generalizations about the power of organized interests with a political systems.

Membership and Structure: Though the “density”of an interest membership has been seen as a major determinate of its influence

The most obvious influence on the number of farmer organization is the structure of the industry itself.It seems reasonable to suppose that farmers are more likely to form one united organization if they live in a country, where there is relatively homogenous.

Impact of political system: The term “pressure group”coupled with such misleading simple accounts of policy making as input-output models, may lead as to forget that not only do pressure groups affect the political system, but also political groups effects pressure groups.

Olson(1968) distinguies between collection groups as (small groups), intermediate groups and latent groups. Farmers form a latent group with many small members, each of whom feels that his contribution will have no impact on the provision of the collective good “farm policy”.However farmers associations can also solve the problem,becaz they can make use of numerous selective incentives and effective group ideologies creating solidarity among farmers.

According to olson Group size and intensity of preferences are play role on economic theory of democracy. If the intensity of the preference is same for the small and large groups then the voluntary provision of the collective good is very unlikely fro large group and is not sure for small group.If the intensity of preferences are unequal then the voluntary provision of the collective good is not sure for the for the large group and the voluntary provision of the collective good is very likely in case of small group.

In medium sized groups an individual who considers to join the group will try to predict the responses from the other group members, and he will decide to join if the collective good will no longer be produced if he or she does not participate in its production(otherwise he will stay outside the group and continue to profit from the public good as free rider.)

Mechanisams for the provision of collective goods are selective incentives, coercion, Irrationality.

Task 3(b)

Role of german farmers unions:

Foundation of the german farmers union in 1947 as un umbrella of organization with the objective of prevent fragmentation of the system of agriculture associations in order to maintain the political monopoly of the german farmers union as an interest group of farmers.After reunification of germany in the early 1990s there was a post socialist farmers union established in eastern germany in the umbrella organization in spite of ideological discrepancies.

The farmers union group the farmers came together as a common interest group not necessarily pay for the selective incentives from their own budget. Politicians can be put under pressure only by a withdrawal of votes(exit).i.e in a tacit manner, but also by arguments.

Where as in case of drainage association at north coast the members of the association has to pay the membership in order to get the benefit from the private goods.



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