Oliver Williamson and asset specificity

by on October 12, 2009 at 3:38 pm in Economics | Permalink

That's his greatest contribution (see Alex on this same point, and Jeff Ely).  Let's say you privatize a water system in Africa and write a 30-year contract with a private French company to run the thing.  As the contract nears its end, and if renewal is not obvious, the company has an incentive to "asset strip," or at the very least not maintain the value of the pipes.  Alternatively, the government might signal, in advance, that it has every intention of renewing the contract.  The company then has the incentive to lower quality to consumers, since it expects renewal a and faces weaker competitive constraints.

In other words, franchise bidding, or "ex ante" competition for the market doesn't always resolve monopoly issues  The key problem is the existence of a fixed investment in the pipes and that the value of the pipes depends on investments from both the government and the company.  It can be hard to write a contract for a good solution, since any allocation of the residual rights creates some distortion or another.  This has in fact been a very real problem with privatization around the world in many settings.  Oliver Williamson outlined these arguments in his debate with Harold Demsetz over privatizing cable TV.  Much of the literature on "mechanism design," such as David Baron's pieces, picks up on this problem and extends Williamson's work.

Williamson is a truly important economist.  If you read him, especially in his later work, he also has lots of taxonomy and verbiage.  The key is to cut through to the substance, which is plentiful.

Here is John Nye on the Prize

Brock October 12, 2009 at 4:42 pm

I’m not familiar with this work, so maybe my question has been asked before …

Is there a reason you can’t contract an “exit” for the monopolist that maximizes value? What if, in the French Water Co. case, the government promises to buy the installed water plant at the end of the contract at some “all future cash flows, minus costs” value? Wouldn’t that provide the incentives to make necessary investments and avoid the other problems?

Yeah, that introduces valuation problems, but valuations based on cash flows are pretty predictable. The government can even promise to “overpay” by 10%, since they’ll also be capturing the social value of the water plant (like increased income, property and sales taxes).

Bill October 12, 2009 at 5:51 pm

To some, the “taxonomy and verbiage” of Williamson is the equivalent of the needless mathematical expressions of the obvious in some other economists’ work. What I like about Williamson is that he understands how organizations work, and, at a more abstract level, when markets work and when they don’t. He’s also a very close observer of the real world.

impersonalcapitalism October 12, 2009 at 6:28 pm

More compromises could be made about what constitutes natural public monopoly (water, rail, …) at any point in time and in context. If the relatively few basic natural monopoly issues were perpetually revisited and researched in light of technological advances and changes in natural environments and social systems, the theory of minimal state could correspondingly be flexibly adjusted without sacrificing market freedom for service delivery over most of the economy. Government that is not overloaded with political and welfare discretionary functions can focus on its central task, i.e. procedurally controlling *itself*, e.g. impartially orchestrating the information and decision process regarding systemic risk regulation, natural monopoly, and enforcement. It’s a Buchanan sort of theme but without the contractarianism.

Kevin Carson October 12, 2009 at 11:39 pm

That’s why the best way to “privatize” public services is to organize them as consumer co-ops financed entirely by user fees. When the people who consume the water internalize all the costs–AND benefits–of maintaining the pipes, conflict of interest is eliminated.

Unfortunately, the debate is polarized by those who see no alternatives besides ownership by either 1) an inefficient and unaccountable government bureaucracy, or 2) Evil Global Megacorp LLC.

Anthony October 13, 2009 at 10:11 am

Speaking of asset specificity: Williamson teaches at Berkeley. Parking on campus is notoriously restricted. Williamson is now eligible for one of Berkeley’s “NL” parking permits.

The administration faces a difficulty. Unless a previous Nobel laureate has become inactive, there is now one more NL permit than there are NL spaces. Creating a new NL space would displace someone; while not creating the space will devalue the permit. If you were Berkeley’s chancellor, what do you do?

srp October 14, 2009 at 4:37 am

N+1 contenders for N slots…sounds like a round of musical chairs is called for.

Nimai Mehta October 14, 2009 at 8:31 am

Tyler, it is not clear whether Williamson’s notion of asset specificity added much value to the existing conclusions of the theory of natural monopoly. Jack Wiseman had discussed the potential for the opportunistic exploitation under conditions of natural monopoly in utilities much earlier, in his 1957 (Oxford Economic Papers) piece on the problem of common costs and public utility pricing. Asset specificity, shorn of the technological conditions that make for natural monopoly, it seems to me, looses much of the explanatory power that Williamson has bestowed on it.

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