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The Efficiency of Markets


 Evaluate the basis of the disagreement between
Williamson's and Hayek's views of the efficiency of
markets. The following essay will introduce the two
economists basic outline of their respective theories. Then
further try to explain the reasons for Williamson to refute
Hayek's overruling ideas and to evaluate the disagreements
between the two economists. Firstly an introduction to the
two economists. 'Friedrich Hayek was born in 1899 in
Vienna, Austria. He earned degrees in law and politics at
the University of Vienna in 1921 and 1923, and in 1940, he
recieved the Doctor of Science degree in economics from the
University of London. In 1974, he was awarded the Nobel
Memorial Prize in Economic Science. Oliver Williamson was
born in Superior, Wisconsin in 1932. He received his Ph.D.
in economics at Carnegie-Mellon University in 1963. He is
currently Gordon Tweedy Professor of Economics of Law and
Organisation at Yale University' Louis Putterman 1989. A
market, is an environment where business organisations do
their buying and selling. Hayek further describes how
markets operate 'as whole sphere of scattered commercial
activity that goes on in the market' F.V.Hayek.. This
'commercial knowledge' of these particular circumstances of
time, place know how of a special nature where every
individuals has some advantage over all others, therefore
individuals who possess this unique information of
situation / circumstance. Beneficial use might be made if
the person was to use this knowledge. This knowledge can
never be collected and concentrated or integrated in a
single form and given to a single source (mind or firm).
This information can't also be expressed in some
statistical form but remains a highly valuable asset to the
individual who possesses it. Therefore if an assumption was
made that there was perfect knowledge. This would have the
effect that there would be no competitive advantage. This
is due to most firms and individuals; competitive advantage
stems from possession of special knowledge about the market
and as there is no special knowledge in a perfect market;
as everyone acquires the same information therefore
competitive advantage cannot exist. Planning has to be
carried out this requires the 'body' to make decisions on
how to allocate the available resources. Then the problem
arises of how to gather this special knowledge from the
individual so as to utilise this information to the
maximum. We therefore come to a question of what sort of
'body' is to provide for this planning. Should the planning
be carried out centrally by one authority for the whole of
the economic system or decentralised by many separate
individuals i.e. competition. The 'half way house' which
Hayek talks about is where whole industries come under
central planning known as Monopolies. But as the question
may arise which of these systems is more efficient? Where
Hayek proclaims that " where the fuller use will be made of
existing knowledge" F.V.Hayek. The central planning is
likely to succeed only if all knowledge can be gathered
which ought to be used but is dispersed initially to all
the individuals. Hayek further on concludes that if all
knowledge was translated as scientific knowledge then it
could be concluded that the decision makers could be the
various experts in the various fields but the problem
arises that Hayek says 'Beyond question a body of very
important but unorganised knowledge which cannot possibly
be called scientific in the sense of knowledge of general
rules: the knowledge of the particular circumstances of
time and place.' F.V.Hayek. If economic problems of society
can be associated mainly with rapid adaptation to changes
in the particular circumstances of time and place. This
would have the effect that the final decision must be left
to the individuals who are accustomed with the
circumstances, who can observe the following changes
directly. Therefore to obtain the resources immediately so
as to meet the changes brought about. If this problem was
to be resolved by
a central body the effect would be that all knowledge would
have to be communicated back then after acquiring all
knowledge it would have to decide what orders to give. The
answer to this is decentralising the procedure of
directives to be given at a lower level so as the problem
can be resolved immediately. But you must remember that
'the man on the Spot' F.V.Havek can't decide solely on the
basis of his limited but intimate knowledge of the facts of
his immediate surroundings since he requires further
information to make his decisions in to the whole economic
framework. The individual will only be interested in how
much the good or service costs through the price mechanism
not why the prices have gone up or down unless they are
effecting his own environment which are causing the
fluctuations in price. This can be shown by example if a
producer of good A suddenly finds that the demand for his
good has increased as consumers switch from good B to C he
is only interested in the new demand and not of how this
was bought about. 'The price mechanism can be seen as
mechanism for communicating information where only the most
essential information is passed on and passed on to only
those concerned.' F.V.Havek Therefore for one company to
transact with another firm , assuming that they have
varying information, they conduct the transaction on the
judgement of price; this assume that price is sufficient
statistic to perform exchange. Adam Smith also believed
that it was this price system that indicated to the
individual, by means of price/profit incentive., to seek
one's own interest. It also can be shown that the price
mechanism acts as a guide to efficient resource allocation
where the solution is found in the mechanism by the
interaction of all the people each of whom posses only
partial knowledge. Hayek has acknowledge the fact that
individuals try and use this unequal distribution of
knowledge to their own betterment. Society may feel that
the individual is achieving his goals in a dishonest
fashion but it is important that society uses these
opportunities. Hayek argues that markets are more efficient
and the most appropriate of allocating resources. This
makes central planning redundant, which would include
governments in interfering and trying to manipulate the
market. But there are certain goods which the price
mechanism does not provide for these are public goods such
as defence, roads, railways where no individual is
responsible for the cost. There are also market failure
when the market does not take into consideration of
externalities i.e. when in the production of electricity
through coal combustion there is sulphur emission which
pollute the atmosphere. Hayek describes monopoly as
'delegation of planning to organised industries' F.V Hayek
and states theses are a midpoint between centralised and
decentralised planning. However Hayek's argument of prices
being a sufficient statistic could be questionable with the
existence of monopolies as there is no basis for comparison
to decide whether price is acceptable or not. A recent
example of the price mechanism to overlook social costs is
the coal industry where Britain has been importing cheap
coal (attracted by the competitive price), but as
consequence resulting in the downfall of the coal industry
in Britain and resulting in severe job losses. Other
arguments opposing Hayek's idea could be the importance of
repetition, quality and reliability which may be
significant factors within transactions. Williaimson argues
that if markets were efficient, then you wouldn't have any
firms as there would be no reason to internalise the
function of the market as there would be no reason for a
firm to produce anything. When a firm internalises a
function it produces the good within the firm instead of
obtaining it from the market. Williamson believes the
inability of the market to provide goods and services are
market failures and the growth of the firm is a consequence
of this. Markets and firms are a alternative form for
competing transactions and Williamson argues there is a
cost of using the market. The firm will determine whether
to use the market or internalise the function, depending on
the relative cost of transaction under the two
alternatives. The major cause of market failure, which
gives rise for the tendency for the firm to internalise,
are transaction difficulties and the inability of the firms
to form contracts. Williamson maintains that markets fail
because the excess cost of writing , executing and
enforcing contingent claims of contracts. Where ' contracts
made contingent upon the uncertainty involved'
O.E.Williamson. Williamson identifies two reasons for this;
1) Environmental factors which include uncertainty and
complexity and small numbers of firms 2) Human factors
which include bounded rationality and opportunism. 'The
term bounded rationality was coined by Simon to reflect
constraint on the ability to processing (receiving,
storing, retrieving, transmitting) information.'
O.E.Williamson. Whereas the second human factor Opportunism
is related to but is a somewhat more general term that the
condition of moral hazards to which Knight referred in his
classic statement of economic organisation. 'Opportunism
effectively extends the usual assumption of self-interest
seeking to make allowance for self-interest seeking with
guile.' O.E.Williamson. Williamson argues that firms
operate in a environment where each firm is trying to gain
an advantage over the other through opportunism. He defines
this behaviour in two methods. Withholding information from
the other party and entering into contract with no
intention of fulfilling the terms of the contracts.
Opportunism is the driving force of capitalism where if
firms do not take advantage of asymmetric information the
firm would be depriving itself from its true potential.
Opportunistic behaviour may occur leading to all the
information not being available before the transaction
resulting in hidden information coming to light after the
transaction this would have the resulting factors of moral
hazard, some form of hidden action, may cast doubt and
uncertainty over the compliance of the contractual
agreements. Bounded rationality will only pose a problem in
environments that are characterised by uncertainty and
complexity, where there is much doubt in the transaction
(i.e. not every day purchases). Firms will try and
economise on bounded rationality by internalising market
function and using available knowledge. This being less
complex and more certain then using the market.
Idiosyncratic knowledge is where an individual posses
certain specialist information that others do not have.
This sort of knowledge is tended to be used to gain
advantage. e.g. An interpreter has the ability to translate
from one language to another to initiate communication with
the two parties. There are not only saving on transaction
and contractual which are partly reasons for a firm to
internalise, Williamson has also stressed other reasons
also. 1) 'the opportunities for opportunistic behaviour
within firms is restricted causing individuals agents and
mangers to have a "more nearly joint profit maximising
 attitude" 2) "internal organisation can be more
effectively audited " 3) "Internal organisation realises an
advantage over market mediated exchange in dispute
settling respects." ' Douma & Schreuder The above
statements can be redesigned to keywords that state ' the
properties of the firm that commend internal organisation
as a market subsitude would appear to fall into the three
to broadly as inherent Structural Advantages.'
O.E.Williamson In conclusion Hayek's study of firms and
markets has dismissed equilibrium economics with the
observation of a dynamic model where ' the economic problem
of society is mainly one of adaptation to changes in
particular circumstances of time and place' F.V.Hayek and
who has emphasised the 'marvel' of the price system which
accomplishes this without 'conscious direction' F.V. Hayek.
The three important observation made by Hayek 'First in his
emphasis on change and the need to devise adaptive
institutional forms. Second, his reference to particular
circumstances, as distinguished from statistical
aggregates, reflects a sense that economic institutions
must be sensitive to dispersed knowledge of a
microanaylytic kind. Thirdly was his insistence that
attention to the details of social processes and economic
institutions was made necessary by the unavoidable
imperfection of man's knowledge.' O.E.Williamson But where
Hayek is to be criticised is he has not recognised the
limits of the markets which have been glossed over. e.g.
Transaction costs. The adherence to markets to be all
domineering in Hayek's view can be dispelled objectively as
85% of world trade is done by 10% of multinationals.
Whereas Williamson has concluded that with the existence of
(environmental and human) factors that therefore price is
not the overruling statistic that dictates to form market
exchange. Williamson does admit that in certain markets
that price is a sufficient statistic, e.g. spot markets
where price is an overruling factor that equates the margin
of uncertainty. Williamson has also emphasised the prospect
of opportunistic behaviour. It is certain to a large extent
that firms are present in deceiving one other but there are
firms who on mutual basis are there to co-operate with each
other and to conduct their business amicably. Also there
are laws present with contractual obligations for firms to
complete contracts and comply to terms and business law.
Every individual may have a tendency to behave
opportunistically but there are in some way bounded by the
social and legal constraints. Williamson has neglected to
discuss the value of economies of scale. Where if
production of a firm was increased so that the firms unit
costs fell it could pass on the benefits to its customers.
This new price could compensate the customer who is
experiencing transaction costs, but this is only feasible
where there is large numbers of customers exist.

The economic nature of the firm Louis Putterman The use of
knowledge in society F A Von Hayek Markets and Hierarchies
Oliver E Williamson Economic Organisation Oliver E
Williamson Economic approaches to organisation Douma and


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