Does Transaction Cost Economics Need Opportunism?

6 October 2006 at 1:14 am 4 comments

| Peter Klein |

During a recent discussion of transaction cost economics a commentator asked: “I am always puzzled by why we need opportunism when we have individuals pursuing their self-interests as a postulate.” Opportunism, of course, is Oliver Williamson’s concept of “self-interest seeking with guile.” In a world of opportunism individuals cannot be assumed to keep their promises, to fulfil their obligations, and to respect the interests of their trading partners unless “safeguards” are in place. The task of economic organization, in Williamson’s terms, is to “organize transactions so as to economize on bounded rationality while simultaneously safeguarding them against the hazards of opportunism.”

But is opportunism just another word for self-interest? Neither Klein, Crawford, and Alchian (1978) nor Grossman and Hart (1986) nor Baker, Gibbons, and Murphy (2002) nor other contemporary treatments of the economic theory of the firm invoke the concept of opportunism. Instead, they rely simply on the economists’ usual notion of self-interested, maximizing behavior. What, then, is the point of introducing opportunism?

I think the basic holdup or asset-specificity theory of the theory of the firm can be presented without reference to opportunism, as distinguished from conventional notions of self-interest. But this was not true at the time of Markets and Hierarchies (1975). In his landmark book Williamson introduces opportunism to distinguish self-interest from what he called “stewardship” behavior, the idea that individuals always keep their promises, and that therefore a promise is as good as a contract. In The Economic Institutions of Capitalism (1985) Williamson distinguishes opportunism from “simple self-interest” in terms of informational assumptions. Self-interest applies to conditions of symmetric information, perfect enforcement of agreements, and low transaction costs — in short, the world of neoclassical price theory. “Initial positions will be fully and candidly disclosed upon inquiry, state of the world declarations will be accurate, and execution is oath- or rule-bound” (Williamson, 1985, p. 49). There is no room for moral hazard or adverse selection. Opportunism, then, is simply self-interest extended over a larger set of margins; it refers to”the incomplete or distorted disclosure of information, especially to calculated efforts to mislead, distort, disguise, obfuscate, or otherwise confuse.” Self-interest is the attempt to maximize one’s benefit without lying, cheating, and stealing, while opportunism is self-interested behavior in which everything is on the table.

Clearly modern economics includes lying, distorting information, reneging, and even law-breaking as simply particular forms of self-interest. Williamson was developing the concept of opportunism in the 1970s, before the explosion of interest in informational economics brought these issues to the attention of mainstream economists. Today, however, the distinction between opportunism and self-interest probably confuses more than it clarifies.

Ultimately, Williamson’s purpose in introducing opportunism is instrumental. He is not trying to make a point about human nature, as critics like Ghoshal and Moran (AMR, 1996) appear to believe. He is simply trying to explain contracts. Opportunism “(a) . . . avoids the contractual naivete that arises when contract as mere promise (unsupported by credible commitments) is invoked and (b) . . . invites the identification, explication, and mitigation of hazards that have their origins in opportunism” (The Mechanisms of Governance, 1996, p. 50). As long as you accept that contractual hazards arise in the absence of safeguards, I don’t think it matters whether you attribute this to opportunism, self-interest, self-love, or any other term of your choice.

Entry filed under: - Klein -, Management Theory, Methods/Methodology/Theory of Science, Theory of the Firm.

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4 Comments Add your own

  • 1. Joe Mahoney  |  6 October 2006 at 10:03 am

    Opportunism entails “playing outside the rules of the game.” For example, some people embezzle funds and some people rob banks (because that is where the money is). Therefore, the amount of safeguards needed is much greater than one might imagine under assumptions of “mere” self-interest, where it is assumed that folks play by the rules.

    Thus, for the FULL implications of transaction costs economices to be realized, the assumption of opportunism is necessary. For example, see Nicolai Foss’ (1996) article in ORGANIZATION SCIENCE: “Knowledge-Based Approaches to the Theory of the Firm: Some Critical Comments” Volume 7, issue 5, pp. 470-476, which persuasively maintains that the assumption of opportunism is essential.

  • 2. Peter Klein  |  6 October 2006 at 10:33 am

    Joe, you shouldn’t believe everything you read, especially by authors of this blog!

    Seriously, I think we are saying the same thing. My point is that opportunism is not conceptually different from self-interest, but is simply self-interest in situations where the rules of the game are endogenous, or where agents can choose whether to obey them. The underlying behavioral assumptions are the same, we have simply expanded the set of margins over which the agent can optimize. In this sense, opportunism refers to a different application of the economic model of behavior rather than a distinct behavioral model. And, as you point out in your first paragraph, the point is not to formulate behavioral assumptions per se, but to explain the existence of safeguards.

  • 3. Vic Fleischer  |  6 October 2006 at 11:51 am

    Great post, Peter. I always liked the formulation that “not all people are saints all of the time.” But I need to think more about whether this means opportunism or just self-interest vs. altruism.

  • 4. Chris Bell  |  29 March 2009 at 8:09 pm

    Given the explosion of interest in behavioral and neuro-economics over the past decade, could it be that at some point in the near future a similar argument will be made about bounded rationality?

    Thinking about this question may shed light on the heat Peter’s question generated a generation ago!

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