The Transaction Cost Approach: the Divergence Between North and Williamson

Neo Institutional Economics and the Approach to Organization Theory: The Correspondence and Divergence between North and Williamson

New institutional economics (NIE) is a school of thought largely derived from Ronald Coase's (1937, 1960) fundamental insights about the critical role of institutional frameworks and transaction costs for organizational performance.[1] The NIE’s institutional framework is an economic perspective on organizational life that attempts to focus on social and legal norms and rules as a source and determinant of economic and organizational activity. Transaction Cost Theory (TCT[2]) is an integral part of the New Institutional Economics. Within NIE, the TCT concerns itself with the governance segment of the institutional structure. The TCT approach has most fervently been pushed by Olivier Williamson. Organization theory, as a discipline, has extensively integrated the efficiency arguments of Williamson as presented in Markets and Hierarchies (1975) and The Transaction Cost Approach (1981).[3] The 1993 Nobel Price winner in economics, Douglas North, similarly advocates a transaction cost approach and, like Williamson, sees transactions as the connection between institutions and the cost of production. To them, in contrast to commodities, the transaction is the basic unit of research. This is one of the major tenets in both North and Williamson. The assumptions that neoclassical theory of efficient markets is founded on is valid only if it is costless to transact. This observable reality was first stated in Ronald Coase’s article, The Nature of the Firm (1937). According to Wallis and North (1986), 45% of GNP consists of transaction costs and this explains much of the disparity between neoclassical theory and verifiable empirical results.

At this joint origin, however, North and Williamson veer in slightly distinctive directions.[4] Williamson is delving into the details of the organization and the firm, trying to unravel how...