June 14, 2022
Yoram Barzel’s 2005 “Organizational Forms and Measurement Costs” is one of the last papers he’s solo-authored, as far as I can tell.
Receiving, by my calculations, around ten or eleven citations a year, this paper is underrated.
It builds on Barzel’s 1982, classic and most-cited work. Barzel deploys his understanding of measurement costs to endogenize the organizational form to goods’ attributes. Between-organization exchange may take the form of caveat emptor, auctions, long-term relations (typically referred to as “relational contracting”), contractual enforcement, or enforcement stemming from multiple sources in Barzel’s schema. As is typical of Barzel, his elegant theories yield pattern predictions. For example:
“The buyer operating under long-term relations enforcement saves the cost measuring at purchase time as caveat emptor buyers do. This is significant attributes that are especially costly to measure at transaction time relative to measuring them later. For example, the commodity's durability and shelf life are usually expensive to measure at purchase time, whereas they are often measured cheap with use. I predict that durability or shelf life would not be a significant attribute commodities traded under caveat emptor or in auctions.”
Using variation in goods’ attributes to explain variation in the organization of exchange is pregnant with potential explanatory power. For instance, Alan Kirman has noted that fish markets look quite different all over the world, though this fact remains unexplained. Perhaps this approach would be fruitful.
Similarly:
“Attributes that are easy to measure and to verify are likely to be contracted for. The lower the cost of measuring commodity attributes, then, the more attractive is exchanging them by contract. On the other hand, the information required to guarantee that something is "beautiful" or "delicious" is more ephemeral, and so is its standing in court. Such difficult-to-measure attributes, however, may be stipulated in long-term exchange agreements.”
One important insight here is that goods’ attributes may be governed by different sources. Presumably competitive pressures align the governance mechanism with the relevant attribute in cost-minimizing fashion, in a way that sounds reminiscent of Williamson.
Speaking of Williamson, an overlooked part of this underrated paper (thus doubly overlooked) is Barzel’s discussion of how his understanding of transaction costs relates to Williamson’s and Klein/Crawford/Alchian. Williamson refers to Barzel’s theorizing as part of the “measurement” branch of TCE, as distinguished from his “governance” branch. And to my knowledge, this is the most extensively that Barzel has ever commented on he sees the relationship between their work.
In a nutshell, he views the measurement cost theory as more expansive—asset specificity is but a special case. Secondly, the asset specificity view, in Barzel’s reading, focuses narrowly on vertical integration as a means of reducing transaction costs, whereas Barzel treats and explains a number of alternative organizational arrangements. (He also takes issues with Williamson’s notion of “opportunism,” seeing it as superfluous to good ol’ “maximizing,” though this issue might have more to do with conventions than with substance). He does say: “In my view, the two models do not differ fundamentally from each other.”
However, on the first point, that asset specificity is a special case of measurement:
“The existence of capture opportunities implies that (economic) property rights are not well delineated. well delineated. When measurement is costless, writing and enforcing complete contracts is trivial, and ownership is well defined. Neither specialized assets’ quasi rents nor anything else will then be captured. Measurement, however, is costly and subject to error, so transactors are not certain how they will fare in their exchanges; and their economic rights are not well defined. Capture opportunities exist everywhere, and transactors will spend resources to capture what they can. This behavior characterizes any dispute, as disputes consist of the competition between parties to capture the difference in their valuation (or quasi rent) of the disputed entity.”
On the second point, that vertical integration is but one means of reducing transaction costs:
“Maximizing individuals attempt to reduce the resource expenditures associated with capture. Vertical integration is one such action. Standardizing idiosyncratic assets is another method for avoiding disputes…The use of long-term contracts is yet another method for sidestepping quasi-rent capture…Finally, firms may acquire a reputation for not engaging in capturing the quasi rent. Consider the relationship between the owners of a small-town newspaper and a printing plant. As an alternative to vertical integration, one or both might merge with a chain having a reputation for honoring agreements.”
On this point, it seems doubtful Williamson would have disagreed. While Williamson may have focused on the “polar opposites,” of “market” and “hierarchy” initially, he acknowledged the importance of studying “hybrids.” Indeed, subsequent work inspired by Williamson examines a host of other arrangements beyond standard vertical integration.
Interestingly, Barzel himself may underestimate the vast array of contractual enforcement mechanisms that clever market participants have devised when he writes: “Long-term relations require investment in the relationship; contract enforcement requires the existence of a state and of a rule of law.” I’d love to see Barzel interact with the arguments made here and here.
If we are to examine “exchange the institutions within which exchange takes place, “ I hope this great paper gets more traction.