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Theory of the Firm
Siena 2006
Economics and Scarcity
Even if we accept the orthodox definition of Economics
as Scarcity,
Institutional Economics
is more general
than standard Neoclassical Economics
because it does not rely on the restrictive assumptions
that:
only physical resources are scarce
and rationality, social positions and institutions are
free goods.
Additional Dimensions of
Scarcity and Institutional
Economics
1) Cognitive Scarcity and Bounded
Rationality
2) Social Scarcity and Positional Goods
3) Institutional Scarcity and Incomplete
Orderings
Samuelson’s statement:
"In a perfectly competitive economy it doesn't really matter
who hires whom...." (1975 p. 894)
expresses well the view that:
in a world of perfectly rational individuals (no cognitive scarcity),
unaffected by power and status (no social scarcity)
and organized by a complete market ordering (no institutional
scarcity)
the problem of natural scarcity will be solved
in equivalent and efficient ways
by capital hiring workers and by workers hiring capital.
If an individual is hired by another individual, she is always
able
to protect her investments in human capital in all the perfectly
known future circumstances by the means of a complete
contract.
The status and power that are directly involved in the relation
1) Bounded rationality as constrained
maximization?
If we include maximization costs in the maximization
approach we apply consistently the general paradigm of scarcity
to our limited rational capabilities but the maximization
assumption becomes logically contradictory.
Assume that maximization activity is costly.
Reformulate a new (second order) maximization problem in which
an individual decides:
- how many resources to allocate to the maximization activity
- and how many resources to employ in the other activities
Unfortunately this involves a new maximisation problem with
new (second order) maximization costs.
A reformulation of a (third order) maximization problem would run
in the same problem and so on ad infinitum.
(Scarcity and bounded rationality)
The idea that one could deal with maximization costs by simply
adding new constraints is wrong. A problem with more constraints
is computationally more complex. The individual, who could not
solve the rationally unbounded maximization problem, cannot solve
bounded rationality problem.
Unbounded outside observers (God) could tell us which one is the b
solution for us without being bounded by our own constraints. But
we are not God and we must face the problem of cognitive scarcity.
If we ignore the maximization costs faced by the different individuals
we are assuming a strange economy where individuals face costly
resources and “free” rationality (as well as “free” institutions).
Under this assumption the maximization hypothesis is saved
but the general neo-classical paradigm of scarcity is abandoned
2) Positional Goods and Social Scarcity
(Veblen)
Positional Goods like power and status imply a social scarcity
constraint that is different from the standard economic constraint
that characterises private and public goods. The standard scarcity
constraint concerns limited positive amounts of resources.
Positional goods are scarce because positive consumption must
go together with negative consumption.
Pure private goods: other individuals consumes a zero amount of
what each individual chooses to consume.
Pure public good: each agent must consume the same positive
amount that other agents decide to consume
Pure positional good: given the consumption choice of an agent,
the other agent must consume a corresponding negative amount
of what the other agent chooses to consume.
(Legal Relations and Social Scarcity)
Legal relations are characterised by some form of social
scarcity in the sense that:
no increase in rights is possible without some increase in
duties and some decrease in liberties
and
no increase in powers is possible without some increase in
liabilities and some decrease in immunities (Commons).
While public goods are typically undersupplied,
positional goods are typically oversupplied.
Legal goods such as rights, liberties and powers may share
this problem and some form of legal disequilibrium may
typically arise.
3)Institutional Scarcity and
Incomplete Orderings
Both Cognitive Scarcity (for obvious reasons) and Social
Scarcity (because of legal disequilibrium) imply that well
functioning consistent institutions are scarce.
Independently of these types of scarcity, also standard
economic scarcity implies that institutions, absorbing time
energy and many other resources, are scarce.
Public orderings are necessarily incomplete and market
contracts are
also necessarily costly and incomplete.
In such a situation, public orderings and market transactions
may be substituted by firms and private orderings and vice
versa.
The extension of the economic problem of scarcity to
institutional scarcity and the importance of the problem of
Two architectures of economic theory
Consumers
Firms
Markets
Individuals
Markets Firms
Coase Contributions
Technological explanation: firms exist because of increasing
returns to scale.
Coase (1937): In a world of zero transaction costs firms would
not exist. Firms exist only when market transaction costs are
positive.
Coase (1960): In a world of zero transaction costs (and well
defined property rights) all externalities (harmful and beneficial
effects) are internalised (taken into account) by market
transactions.
Question 1: Is the old Coase contradicting the young Coase?
Question 2: Why isn’t the technological explanation of the
firm sufficient to motivate the existence of the firm?
What did Coase really say?.
VI The Cost of Market Transaction Taken into Account.
(plurality and incompleteness of institutions)
“The argument has proceeded up to this point on the assumption that
there were no cost involved in carrying market transactions.”
(1960, p. 114)
"It is clear that an alternative form of economic organization which
could achieve the same result at less cost that would be incurred
by using the market would enable the value of production to be
raised. As I explained many years ago the firm represents such an
alternative to organising market transactions" (1960, p. 115).
"But the firm is not the only possible answer to this problem…. "an
alternative solution is direct governmental regulation" (Coase 1960
p. 116).
Coase (1960) implies Coase (1937)
Coase (1960) : zero transaction costs ---> externalities arising from
increasing returns are internalised ---->
constant returns --->
under any technology there are no reasons
for the existence of the firm --->
the technological view is wrong:
(dis)economies to scale cannot justify
the existence of the firm. --->
Coase (1937): market transaction costs <--- existence of the firm.
Limitations of the Coasian approach
1)Efficiency bias: firms exist because markets are imperfect
but the firms-markets mixture is supposed to be efficient
in a market economy.
2) Transaction costs without transition costs
3) No disequilibrium transaction costs.
(Relative advantages of Marx and Hayek)
Disequilibriun Transaction
Costs
Forms of
Co-ordination Forms of authority
Command Competition
Ex-ante (A) Marx (B) Rational
expectations
Ex-post (C) Lange (D) Hayek
Within a firm, its members:
(a) can act under the authority of a single plan derived
from a single model,
(b) can learn how to formulate the plan according to consistent
learning rules the authority of which is accepted
by the members of the firm,
(c) can save the costs which they would incur if each member
of the firm had to formulate her own complete plan
on the basis of her own model,
(d) can avoid costly inconsistencies by co-ordinating ex-ante
the actions before they are implemented
(e) can eliminate unforeseen ex-post inconsistencies in the
plan by constantly monitoring the emergence of ex-post
The firm as a private ordering
In a firm a central authority replaces markets
(and state authorities) in enforcing and co-ordinating
the relations among the agents.
However central governance has the disadvantage that the
agents will exercise their influence on the central authority to
enhance their privileges.
In order to work well firms need to develop adequate forms of
Private
Ordering.
Fuller: the firm as a decentralization of the public ordering
Coase: the firm as a centralization of market transactions
Coase Fuller
The monitoring problem
Employer with hiring
Team work
and firing rights
But why capitalist ownership of the means of
Production?
Hard to monitor
capital Capitalist ownership
The same argument can be applied to hard to
monitor labour.
The argument can be inverted.
The Specificiy Problem
Specificity, Liquidity and Irreversibility
Analogy with monitoring: rights should go to the
most specific factors.
Difference with monitoring: asset specificity
cannot be
defined by referring to a single relationship
Specificity, Competition and the Fundamental
Transformation.
The monopoly branch The efficiency branch
Transaction cost efficiency under
alternative behavioural assumptions
Bounded Opportunis Asset Contracting
Rationality m Specificity Process:
0 + + Planning
+ 0 + Promise
+ + 0 Ex-post
competition
+ + + Governanc
e
Grossman, Hart and Moore Model
a) Specificity is both absolute and a marginal.
b) Contractual incompleteness is justified by the
facts
that specific investments in human capital are
observable but not verifiable.
c) Agents are characterised by unbounded
rationality
and decide their investments in the 1th period on
the
basis of the anticipated bargaining of the 2nd
M1 (Input) M2
_______ <------ _______
a1 a2
Ex-ante relationship-specific investments are made at date 0 and the widget is
supplied at date 1.
There is only uncertainty about the type of widget M1 requires and this
uncertainty is resolved at date 1.
Assume that:
-the parties are risk-neutral and have large (unlimited) amounts of initial wealth
and the interest rate to be zero;
-it is too costly for the parties to specify particular uses of assets a1 and a2 in a
date 0 contract.
Non-integration: M1 owns a1 and M2 owns a2.
Type 1 integration: M1 owns a1 and a2
Type 2 integration: M2 owns a1 and a2
i non-negative number expressing level and cost of M1's relationship-specific
investment.
If trade occurs:
M1's revenue is denoted by R(i);
his ex post payoff is R(i) - p where p is the agreed
widget price
his ex-ante payoff is R(i) - p - i
If trade does not occur:
M1 buys a "non-specific" widget from an outside supplier at price p that
may lead to lower-quality output
M1's revenue is indicated by r(i;A)
his ex-post payoff by r(i;A) - p
Remark: lower-case r indicates the absence of M2's human capital and the
argument A refers to the set of assets M1has access to in the event that
trade does not occur.
Under non-integration A = {a1}
under type 1 integration A = {a1, a2}.
under type 2 integration A ={F}
e denotes M2's relationship-specific investment at date O
If trade occurs
M2's production costs are denoted by C(e)
her ex-post payoff is p-C(e)
her ex-ante payoff is p - C(e) -e
If trade does not occur
M2 will sell her widget on the competitive spot market for p
but will have to make some adjustments to turn it into a general-purpose
widget. In this case
M2's production costs are denoted by c(e; B)
her ex-post payoff is p-c(e;B)
Remark: lower-case c indicates the absence of M1's human capital and the
argument B refers to the set of assets M2 has access to in the event that trade
does not occur.
Under non-integration B = {a2}
under type 1 integration B ={F}
under type 2 integration B = {a1, a2}.
If trade occurs
the total ex-post surplus is:
R(i)-p+p-C(e) = R(i) - C(e)
If trade does not occur:
the total ex-post surplus is:
r(i;A) - p + p - c(e;B) = r(i;A) - c(e;B)
Assumption 1: because of the specific investments
there are always ex-post gains from trade:
(2.1) R(i) - C(e) > r(i;A) - c(e;B) O
for all i and e and for all A,B
where A B = F
and A U B= {a1, a2}
Remark : (2.1) captures the idea that the
investments i and e are relationship-specific: they pay
off more if trade occurs than if it does not.
Assumption 2: relationship-specificity also applies in a marginal sense:
the marginal return from each investment is greater the more assets in the
relationship, human and otherwise, to which the person making the
investment has access.
(2.2) R' (i) > r' (i; a1, a2) r' (i; a1) r'(i; F)
for all 0 < i < ∞
(2.3) |C'(e)| > |c'(e; a1, a2)| |c' (e; a2)| c' (e; F)
for all 0 < e < ∞.
where: r'(i;A) = ∂r(i;A)/∂(i) and c'(e) = ∂c(e;B)/∂e
R' > 0, R" < 0 r' 0 r" 0
C' < 0 C" > O c' 0 c" 0
Assumption 3:
(Swiss Cheese)
R,r,C,c (the results) and i, e (the investments) are
observable to both parties, but are not verifiable to
outsiders. Thus, neither the results of the investments
in human capital nor the levels investments
themselves can be part of an enforceable contract.
The Physical Assets a1, a2 can be exchanged at zero
transaction costs.
Ex-post division of surplus.
Consider what happens at date 1 given particular investment decisions i and e.
Take also the asset ownership structure as fixed for the moment.
We can suppress i, e and the set of assets A and B that M1 and M2 control.
Denote M1's revenue and M2 costs by:
R and C if trade occurs
r and c if trade does not occur.
Assumption 1---> there are ex post gains from trade given by:
[(R-C) - (r-c)].
Assumption 3 ---> they cannot be achieved under the initial contract.
Since the parties have symmetric information, it is reasonable to expect them to
realise the gains through negotiation.
Assumption 4 Bargaining is such that the ex-post gains from
trade [(R-C) - (r-c)] are divided 50/50 as in the Nash bargaining
solution. Then M1 and M2 ex-post payoffs equal:
(2.4) 1 = R-p = r - p + 1/2 [(R-C) - (r-c)] =
= - p + 1/2R + 1/2r - 1/2C + 1/2 c
(2.5) 2 = p - C = p - c + 1/2[(R-C) - (r-c)] =
p - 1/2C - 1/2 c + 1/2R + 1/2r
and the widget price is given by:
(2.6) p = p + 1/2 (R-r) - 1/2 (c - C)
The first-best choice of investments
(We assume no wealth effects)
In a first-best world the parties would maximise the date 0 (net)
present value of their trading relationship.
(2.7) R(i) - i - C(e) - e
Denote the unique solution to the first-best problem by (i*, e*)
The first-order conditions for maximising 2.7 are:
(2.8) R' (i*) = 1
(2.9) | C' (e*) | =1
The second-best choice of investments.
Now consider the second best incomplete contracting world, where the parties
choose their investments non-cooperatively at date O.
Suppose that the ownership structure is such that:
M1 owns the set of assets A
M2 owns the set of assets B
(2.10) 1 - i = - p + 1/2R(i) + 1/2r(i;A) - 1/2C(e) + 1/2 c(e;B) - i
(2.11) 2 - e = p - 1/2C(e) - 1/2 c(e;B) + 1/2R + 1/2r(i;A) - e
Differentiating (2.10) with respect to i and (2.11) with respect to e yields the
following necessary and sufficient conditions for a Nash equilibrium:
(2.12) 1/2 R'(i) + 1/2 r'(i; A) = 1
(2.13) 1/2 |C'(e)| + 1/2 |c'(e;B) | = 1
(2.12) and (2.13) can be written as follows for the three leading ownership
structures:
Non-integration.
(2.14) 1/2R'(io) + 1/2 r'(io, a1) = 1
(2.15) 1/2 |C'(eo)| + 1/2 |c'(eo; a2)| = 1
Type 1-integration.
(2.16) 1/2R'(i1) + 1/2 r'(i1; a1,a2) = 1
(2.17) 1/2 |C'(e1)| + 1/2 |c'(e1; F )| = 1
Type 2-integration.
(2.18) 1/2R'(i2) + 1/2 r'(i2; F ) = 1
(2.19) 1/2 |C'(e2)| + 1/2 |c'(e2;a1,a2)| = 1
Proposition 1. Under any ownership structure there is underinvestment
in relationship-specific investments. That is, the investment choices in
(2.12) and (2.13) satisfy i < i*, e < e*.
Proof. Suppose i,e satisfy (2.12) and (2.13). Then, by (2.2) and (2.3)
R'(i) > 1/2 R'(i) + 1/2 r'(i;A) = 1
| C'(e)| > 1/2 |C' (e)| + 1/2 | c'(e;B)| = 1
The result follows since R" < 0, C" > 0.
Intuition: M1's payoff increases by less than R'(i); the remaining gains
go to M2. M1 does not take M2 payoffs into account and hence invests
too little.
1) All ownership structures imply under-investment.
2) Relative to non-integration, type 1 integration raises M1's investment,
but lowers M2's.
3) Relative to non-integration, type 2 integration raises M2's investment
but lowers M1's.
(2.20) i* > i1 io i2
(2.21) e* > e2 eo e1
Efficient ex-post bargaining implies that the total surplus from the
relationship is given by:
S = R(i) - i - C(e) - e
where i and e satisfy the necessary and sufficient Nash bargaining
conditions (2.12) and (2.13).
The ex-ante choice of the ownership structure.
Simply compare the total surplus from the various arrangements:
So = R(io) - io - C(eo) - eo
S1 = R(i1) - i1 - C(e1) - e1 (2.23)
S2 = R(i2) - i2 - C(e2) - e2
The theory predicts that the ownership structure that yields the highest
value of S will be chosen in equilibrium.
Example: If at the starting point of their relationship M1 owns a1 and M2
owns a2, and S1 > Max(So S2),
then M1 will buy a2 from M2 at some price that will make both better off.
Remark: Any change in ownership structure that increases r'(i.)) (resp.
increases |c'(e; .)|) without decreasing |c'(e; .)| (resp. decreasing r'(i; )) or,
more generally that increases i or e without decreasing the other moves the
parties closer to the first best.
Definition 3. Assets a1 and a2 are independent if
r'(i; a1,a2) = r'(i; a1) and c'(e;a1,a2) = c'(e;a1).
Intuition: Independent assets should be owned separately because with
respect to no-integration concentrating ownership of independent assets
does not increase the investment of the owner while it reduces the incentive
to invest of the non-owner.
Definition 4. Assets a1 and a2 are strictly complementary if either r'(i;a1) =
r'(i; F ) or c'(i;a2) = c'(e; F ).
Intuition: Complementary assets should be owned together because with
respect to non-integration concentrating the ownership of complementary
assets increases marginal return from investment of the owner without
decreasing the incentive to invest of the non-owner.
Proposition 2(C) If assets a1 and a2 are independent, then non
integration is optimal.
Proof. Because of the definition of independence the solution to:
(2.14) 1/2R'(io) + 1/2 r'(io, a1) = 1
(2.16) 1/2R'(i1) + 1/2 r'(i1; a1,a2) = 1
is the same; that is i1 = io. Since e1 eo non-integration dominates type
1 integration. Also, the solutions to:
(2.15) 1/2 |C'(eo)| + 1/2 |c'(eo; a2)| = 1
(2.19) 1/2 |C'(e2)| + 1/2 |c'(e2;a1,a2)| = 1
are the same; that is eo = e2. Since i2 io non-integration dominates
also type 2 integration.
Proposition 2 (D) If assets a1 and a2 are strictly complementary, then
some form of integration is optimal.
Proof: Suppose first that:
r'(i;a1) = r'(i; F)
Then the solutions to
(2.14) 1/2R'(io) + 1/2 r'(io, a1) = 1
and
(2.18) 1/2R'(i2) + 1/2 r'(i2; F) = 1
are the same; that is io = i2. Since eo e2 type 2 integration dominates
non-integration. The same argument shows that, if c'(e;a2) = c'(e, F) type
1 integration dominates non-integration.
Limitations of the GHM model.
One way relation between technology and
property rights.
Identification between ownership and
control.
No genuine theory of the firm as private
governance.
Swiss Cheese Assumption.
The Notion of Institutional Complementarity (Aoki, 2001)
• Economic agents face different domains of games in selecting their choice in
a given institutional framework; choices in one domain act as exogenous
parameters in other domains and vice-versa
EXAMPLE:
• two domains of choices X and Y; {X1, X2} and {Y1, Y2}, with agents i
choosing in X and agents j choosing in Y, according to their utilities
(respectively, u for i and v for j).
• a) for agent i u( X1;Y1 ) u( X 2 ;Y1 ) u( X1;Y2 ) u( X 2 ;Y2 )
• b) for agent j v(Y2;X2 ) v(Y1;X2 ) v(Y2;X1) v(Y1;X1)
• There can be one Nash equilibrium, but also two pure Nash equilibria
(institutional arrangements) for the system as (X1,Y1) and (X2,Y2).
•
When such multiple equilibria exist, we say that
(i) X1 and Y1 are institutional complements;
(ii) X2 and Y2 are institutional complements.
Complementarities and
Evolution.
Complex organisms and survival of the
fittest.
Epistatic Relations, Stasis and
Punctuated Equilibria.
Allopatric Speciation and the Continuity
of Evolution.
New Institutional theory has emphasized that owners of
specific and
hard-to-monitor resources tend to acquire rights and
safeguards more than the owners of general purpose and
easy-to monitor resource. This claim can be stated as:
(1) In the property right domain, a property right system
PC is marginally better than another property right
system PL if the corresponding technology Tc instead of
the technology TL prevails in the technology domain.
Where
Tc : a technology where capital is intensively used as a
specific and hard to monitor resource
TL : technology where labour is intensively used as a specific
and hard to monitor resource
PC : a governance system where the owners of capital have
strong rights and safeguards
PL : a governance system where workers have strong rights
Inverting the Argument.
In a word of positive transaction costs the owners of
resources enjoying rights and safeguards tend to become
more specific and hard to monitor than those without rights
and safeguards. This claim can be stated as:
(2) In the technology domain a technology TL is
marginally better than a technology Tc if a property right
system PL instead of property right system PC prevails in
the property right domain.
This is an argument that has been typical
emphasized by radical economists against the
efficiency predictions of NIE. However, it is consistent
when NIE when one assumes positive transaction
costs.
(1) In the property right domain a property right system PC
is marginally better than another property right system PL
if the corresponding technology Tc instead of the
technology TL prevails in the technology domain.
(2) In the technology domain a technology TL is marginally
better than a technology Tc if a property right system PL
instead of property right system PC prevails in the property
right domain.
Where
Tc : a technology where capital is intensively used as a specific
and hard to monitor resource
TL : technology where labour is intensively used as a specific
and hard to monitor resource
PC : a governance system where the owners of capital have
strong rights and safeguards
PL : a governance system where workers have strong rights
and
safeguards.
Pagano Rowthorn 1994
(2) Inverted argument:
Under capitalist ownership (PC) firms maximise:
Rc = Q (k,K,l,L) - [rk + RK +wl + (H+W)L] (1) ----->(Tc)
Under labour ownership (PL) firms maximise:
RL = Q (k,K,l,L) - [rk + (Z+R)K + wl +WL] (2) ----- >(TL)
(1) Original NIE argument:
Capitalist property rights PC can prevail if Rc RL or,
ZK - HL 0 (3) <----- (Tc)
workers' property rights PL can prevail if RL Rc, or:
HL - ZK 0 (4) <----- (TL)
We can have multiple self-enforcing equilibria
(PC, Tc) and (PL, TL ) that are institutional complements.
Conditions for organizational equilibria
Let:
(kc,,Kc, lc, Lc) = argmax Rc (k, K, l, L) (5)
(kL, KL, lL, LL)= argmax RL (k, K ,l, L) (6)
Then a firm will be in a capitalist organisational equilibrium
(COE) if:
ZKc - HLc 0 (7)
and in a labour organisational equilibrium (LOE) if:
HLL - ZKL 0 (8)
Or:
Multiplicity of organizational equilibria
Kc/Lc H/Z (7')
KL/LL H/Z (8')
Because: (H+W)/R W/(Z+R) we have:
Kc/Lc KL/LL (9)
We have therefore 3 cases:
1) Kc/Lc H/Z KL/LL (10)
(multiple organisational equilibria).
2) Kc/Lc KL/LL > H/Z (11)
(only a COE exists).
3) H/Z > Kc/Lc KL/LL (12)
(only a LOE exists).
Organizational equilibria and
complementarities
a) because of (1) and (2) when a property right system PC
(instead of the property right system PL) prevails, a technology
Tc (characterised by a higher ratio K/L than a technology TL)
does marginally better than TL.
b) (3) and (4) imply that, when a technology Tc instead of a
technology TL prevails PC, does marginally better than PL.
Thus, the supermodularity conditions are satisfied in the model
and we can have multiple organizational equilibria where PC is
an institutional complement of Tc and PL is an institutional
complement of TL
Role of the elasticity of substituion in the model.
Role of the elasticity of substituion as an anti-virus.
Multiplicity of equilibria and elasticity of substitution
Efficiency and elasticity of substituion
Institutional stability and elasticity of substituion.
Some questions on IPR.
• What are the effects of intellectual property
rights on human capital investments?
• Is there a “second best” allocation of
intellectual property rights?
• What is the dominant force? The efficient
drive to second best or path dependency.
• Could we do better with a reward system
operating in the public sphere of the
economy?
• What are the effects of Trips on the open vs.
closed science boundaries?
Framework.
• We start by treating intellectual assets like
other assets over which property rights
can be defined.
• We see to what extent the standard NPR
approach (Grossman, Hart, Moore) model
dealing with ordinary assets (in a
framework of incomplete contracts) can be
utilised to deal the IPR case.
• We propose an “extension-inversion” of
the NPR model that will lead to emphasise
the role of coevolution and of path
dependency .
• We try to re-consider the public vs. private
efficiency issues and the effects of
Tension
paradox:
– The NPR theory is better interpreted as a theory of the allocation of
intellectual ownership
– The “inverted” NPR logic is also more stringent when IP assets are
involved
• This apparent paradox suggests that the self-reinforcing
interaction between property rights and technology may have
particularly perverse consequences that hinge upon the direction
of technological development and contribute to the perpetuation
of inequalities.
• Both redistributive interventions and the adoption of incentive
mechanisms based on disclosure may be justified by the need to
avoid excessive monopolization of knowledge and to ensure
greater equality as well as greater overall efficiency.
Allocation of ownership as an incentive
mechanism
• Contractual environment characterized by
incompleteness (due to non-verifiability) and asset-
specific investments. (Swiss cheese assumption:
Public Markets, Private Orderings and Corporate
Governance. International Review of Law and
Economics, December 2000)
• Ownership (interpreted as control of residual rights)
increases the owner’s bargaining power and therefore
constitutes a safeguard against the possibility of
opportunistic behavior by other parties
• Asset owners have a greater incentive to make
unverifiable specific investments in “human capital” in
The efficient allocation of the property of
productive assets.
• The optimal ownership allocation entails the ex-ante attribution of
residual control rights over physical or nohuman assets to the agents
who value them the most, i.e. to the parties that can make the most
relevant and specific investments in human capital
• The “correct” property rights allocation entails only second-best
efficiency
– The asset owner is exposed to the possibility of hold up of the agents
who have invested in specific human capital
– the parties excluded from ownership are exposed to the possibility of
hold up of both physical and human capital
• The gap between the first-best and the second-best solution will be
wider the higher the number of agents who could make useful
investments in human capital specific to the same asset
Why is the NPR approach better
interpreted as a theory of intellectual
ownership?
• When technological knowledge is involved to a significant
extent the degree of contractual incompleteness is likely to
be high. The higher the degree of incompleteness, the
more important the role performed by residual rights of
control in promoting the realization of unverifiable
investments
• The notion of asset specificity has a clear-cut content
when the specific investments at stake concern assets
that, because of IP protection, cannot be legally replicated
without the owner’s consent
– Because of IP protection, intellectual assets become scarce and
indeed, unique resources, whose control represents a source of
bargaining power in a trading relationship
– By contrast, even when the physical asset is presently unique, the
specificity of human capital may only last a relatively short time if the
asset effect of private
The incentivecan be reproducedproperty are likely to be greater for IPRs
Characteristics of the optimal ownership
allocation
• Property of intellectual assets should be given to the
agents that are going to make the most relevant
investment in human capital specific to these assets.
• Complementary intellectual assets should be under
common ownership.
• Independent intellectual assets should be owned
separately.
Implications of the characteristics of non-
rivalness and non-excludability for the theory
• Non-rivalness
– Efficient ex-post use of intellectual assets involves
simultaneous access by many agents
– Absent IP protection, many agents could have
simultaneously invested in human capital specific
to the assets.
• Non-excludability
– The incentives, provided by an efficient allocation
of ownership, may not display the full effects that
the theory predicts
Transaction costs and anti-commons
tragedy.
• Standard GHM models assume that third parties can verify contracts
for the exchange of assets at zero costs and contracts for the results
or the efforts of human capital investments at an infinite cost (Swiss
Cheese Assumption)
• When assets are interpreted as intellectual assets, relaxing this
assumption becomes even more important than in the original setting
of the model: IPRs are very unlikely to be exchanged at zero
transaction costs.
• If transaction costs are taken into account, the efficiency gains from
the “correct” property rights allocation may be outweighed by the
costs of exchanging the rights
• The “tragedy of the anticommons” follows immediately when
transaction costs for intellectual assets are high.
• Observe that here the nature of tragedy is different: there is under-
investment in the human skills that have as inputs the intellectual
assets.
Transaction costs and inversion the skills-
IPR direction of causation.
• If transaction costs prevent property rights from being
attributed to the “efficient owner”, whoever is the current
owner will invest in human capital specific to the assets
• The logic of the NPR approach can therefore be inverted
• A double relation of causation should be considered. If
property rights are chosen on the basis of given
technologies and abilities, also the opposite is true: abilities
and technologies are chosen on the basis of existing
property rights. (Concept of Organizational Equilibrium and
of Institutional Complementarities).
Firms Capabilities Intellectual Property
A simple model on the institutional
complementarity between IPRs and
technology
• Consider two different (sets of) agents G and B and
consider two different domains of choice:
– the property rights domain (P)
– the technology domain (T)
G B
• P and P denote, respectively, the cases in which the
assets A are attributed to the individuals G and the case in
which they are given to the individuals B at the beginning
of the period
G B
• T and T denote two different technologies characterized
by the fact that the intensity of the specific investment of
agents G
G
• with respect to agents B is relatively higher in T than in
B
T
• Denote by x the extra-agency cost that G must pay to
induce B to invest in capabilities when G owns A
G
Given the property rights system P , the firm will maximise::
(1) RG = Q(IG, IB) – [IGcG+ (x + cB) IB] ----->TG
B
Given the property rights system P , the firm will maximise::
(2) RB = Q(IG, IB) – [(y +cG) IG+ cB IB] -----> TB
According to the logic of the NPR approach, given an (optimal)
technology T, defined by (IG, IB) , property rights over assets A will be
attributed:
to agents G when the benefit U(PG) of the property rights structure PG
exceeds the benefit U(PB) of the property rights structure PB, that is when
RG ≥ RB, or:
(3) yIG ≥ x IB -----> PG
to agents B if the benefit U(PB) of the property rights structure PB is greater
that the benefit deriving of the property rights structure PG , i.e. when RB ≥
RG, or:
(3) yIG ≥ x IB PG
(4) x IB ≥ y IG PB
can be rewritten as:
(3’) TG =IG /IB ≥ x / y PG
(4’) TB =IG /IB ≤ x / y PB
From which it is straightforward to derive the following proposition:
Proposition 1. In the domain of property rights P the benefit from choosing
the
property rights structure PG (instead of choosing PB) increases when a
technology characterized by a relatively higher intensity of investment by
agentsBG is selected in domain T, that is when TG is selected instead of
T .
G G B G G B B
(1) RG = Q(IG, IB) – [IGcG+ (x + cB) IB]
(2) RB = Q(IG, IB) – [(y +cG) IG+ cB IB]
imply that:
TG =IG /IB ≥ TB =IG /IB
That implies:
Proposition 2. In the domain of technology T the
benefit from choosing technology TB, characterized
by a relatively higher intensity of investment by
agents B, increases when the property rights
structure selected in domain P is PB instead of PG.
U(TB, PB) - U(TG , PB ) ≥ U(TB, PG ) - U(TG , PG )
The combination of proposition 1 and 2 implies that the
choices made in the property rights domain P and the
choices made in the technological domain T satisfy the
standard supermodularity conditions
Definition 1 The set of choices (PG, TG) is a green (organizational)
equilibrium
for the set of values for which the property rights structure PG maximizes
profits under the prevailing technology TG and, in turn, the choice of
technology TG maximizes profits given the property rights structure PG .
This occurs when the values of the arguments (IGG, IBG) that maximize
(1) satisfy also (3’), i.e. when:
(5) IGG / IBG ≥ x / y
Definition 2 The set of choices (PB, TB) is a brown (organizational)
equilibrium for the set of values for which the property rights structure
PB maximizes profits under the prevailing technology TB and, in turn,
the choice of technology TB maximizes profits given the property rights
structure PB. This occurs when the values of the arguments (IGB, IBB)
that maximize (2) satisfy also (4’), i.e. when:
(6) IGB / IBB ≤ x / y
Since:
the ratio x / y is positive and IGG / IBG ≥ IGB / IBB
x / y can either fall in the interval defined by IGG / IBG and IGB / IBB
0r outside it.
We have therefore the following proposition:
Proposition 3.
a) Multiple property rights-technology equilibria (PG, TG) and (PB,
TB) exist when the following condition is satisfied:
IGG / IBG ≥ x / y ≥ IGB / IBB
i.e. when both condition (5) and (6) are satisfied.
b) A unique equilibrium (PG, TG) exists when: IGG / IBG ≥
x/y
i.e. when condition (5) is satisfied but condition (6) is not satisfied.
c) A unique equilibrium (PB, TB) exists when: IGB / IBB ≤ x / y
i.e. when condition (6) is satisfied but condition (5) is not satisfied.
Greenland and Brownland
• When multiple equilibria exist and we interpret the
individuals as representatives of different countries
we may have that the individuals from Greenland
may be stuck in a low-skill-IPR-poor equilibrium and
the individuals from Brownland may enjoy the
advantages of a high-skill-IPR-rich equilibrium.
• In Greenland, individuals find it too costly to invest
in human capital because they do not have the
related IPR and they do not find it convenient to
acquire the IPR because they have not sufficiently
invested in human capital.
• The upstreaming of patents to forms of basic
knowledge makes the situation of Greenlanders
increasingly difficult.
Is there an optimum degree of upstreaming of
patents?
• In a continuum that goes from “downstream” to “upstream” patents, there
will be an optimum choice for each country, depending on the desired level
of IP protection and on the nature of technology.
• In a world of positive transaction costs, the main advantage of a reward
systems is that, unlike patents, it is not blocking many innovations that may
require the intellectual asset as an input.
• However, in a world of positive transaction costs, setting the correct reward
may be very difficult.
• For downstream knowledge that is embodied in some consumption goods
patents may have the advantage that the blocking effect of other innovations
is low and information advantage of knowing from the markets the benefits of
innovation is high.
• For upstream knowledge the innovation blocking effect of patents becomes
high and the information benefits from physical product markets become
very low. After a certain degree of upstreaming a reward system will become
more advantageous. Essential facility reasoning and patents pool could,
however, move the point upwards.
There is an optimal degree of public research in the sense that more-
upstream (basic) knowledge should be developed in the public sphere.
Upstreaming and TRIPS:
efficiency.
• If IPRs are effective in restraining knowledge spillovers at the
international level, in a multi-countries setting the optimum choice
for countries with a high IPRs/investment intensity will move
towards more upstream patenting.
• Trips may exacerbate the problems posed by the dispersion of
complementary assets (“Tragedy of the anticommons).
– some inventions may never be realized
– the prospect of incurring high transaction costs may bias the choice
of technology towards research paths deliberately and excessively
independent one from the other.
• In general because of Trips the upstreaming of patents may be
set at level that is:
efficient at country level when the national internalization
of the spillover is considered
inefficient for the world economy.
Upstreaming and TRIPS:
distribution.
The “upstreaming” of patentability has the following effects:
– It makes better off all the countries that have the skills to produce
knowledge knoledge that can be patented with respect to those
countries that do not have these skills (for instance have specialised in
tacit skills)
– it makes better off those countries that have a comparative advantage
in carrying out more science based research with respect to those
that have a comparative advantage in producing “more downstream
patents” based on “upstream knowledge” and “bottom-up” production
experience
– It makes better off countries that start with a greater endowments of
IPR.
– More important it has long term distributional consequences. IPR rich
countries have the incentive to invest in the related skills and become
even more IPR rich. While the IPR poor countries are trapped in a
vicious circle characterised by low skills and IPR poverty.
Open Science and Trips:
policy.
• As members of the open science community
we are directly under pressure.
• We should continuously remind
governments that their upstreaming choices
are inefficient at global level and have
adverse distributional effects against the
poorest countries.
• We can some times use IPRs to defend
open science (Linux is an obvious example).
Universities themselves could be patented
as a collective mark.
Patenting vs. reward systems.
• Patenting may reinforce the “winner-takes-all” nature of the patent
system
– individuals may tend to invest above the efficient level in the
“scramble for the prize of priority” (David, 1993)
– individuals may reduce the level of their investment because they
anticipate the possibility of “wasting” it in case they do not
succeed in being the first to obtain patent rights over the
invention.
• Under a reward system:
– absent formal property rights on the research results of the first-
comer, other researchers will be able to “publish” their results
even if they overlap to some extent those of the first-comer.
– Given the rule of disclosure, second-comers will be able to use
the results obtained from the first to invent incorporating them into
their own research and might therefore “leapfrog” first-comers.
The tragedy of the anti-commons.
• “Upstream” patenting may exacerbate the problems posed
by the dispersion of complementary assets – the so-called
“Tragedy of the anticommons”.
– some inventions may never be realized
– the prospect of incurring high transaction costs may bias the
choice of technology towards research paths deliberately and
excessively independent one from the other
• Reward systems, because of the associated rule of
disclosure, may facilitate the aggregation of
complementary assets to the extent that efficient
mechanisms for the diffusion of innovations are put in
place and avoid the anti-commons tragedy.
The New Property Right Approach has stressed the incentive
effect of ownership of specific assets in a world of incomplete
contracts. However, these incentive effects are much stronger for
“intellectual capitalism”.
The complementarity between the accumulation of skills and
intellectual capital may generate increasing inequality:
-----> Ownership of Intellectual Capital ----->
Incentive to acquire new IPR-specific skills --
-----> Ownership of more Intellectual Capital -
-------->
A new model of accumulation?
Innovation inside and outside the
firm.
Here we have a new paradox:
IPR should allow a “market” for innovation.
But:
Strong and upstreamed IPR may favour the
internalization of innovative activity within the firm.
Firms may exploit the advantage of reward systems
within their organizations and avoid the high
transaction costs that are associated to the
anticommons tragedy. The complementarities
associated to innovative activity may favour its
internalization within firms. Cross-licensing and
patent pools may be alternative solutions. While
they imply a monopolization of the economy, this
is better than the existence of complementary
Complementary monopolies
(Parisi and Deporter 2002)
When a monopoly produces two substitutes,
breaking up the firm into firms producing each good
implies that each firm may not take into account
the losses of the other firm due to the negative
effect that increased quantity has on price. The
break-up brings about increased quantities and
lower prices.
When a monopoly produces two complementary
goods breaking up the firm implies that a firm
increasing the price may not take into account the
reduction of the quantity of the complementary
good sold by the other firm.The break-up brings
Institutional Complementarity between financial and
technological structures.
Williamson (1988) describes a direction of causality moving
from asset specificity to firm’s financial structure, and then to
firm’s governance:
Prevalence of specific assets ------> Equity Finance
Prevalence of general-purpose assets -----> Debt
Finance
In the language of institutional complementarites:
Equity finance is marginally better than Debt Finance in the
financial domain when a technology characterised by a
prevalence of specific assets over general-purpose assets is
adopted in the technology domain.
In word of positive transaction costs the
argument can again be inverted:
Equity Finance ------> Prevalence of specific assets
Debt Finance -----> Prevalence of general-purpose
assets
In the language of institutional complementarites:
An asset-specific intensive technology is marginally better
than a general purpose technology in the technology domain
when a financial structure with equity funding over debt
funding is adopted in the financial domain.
A high degree of equity finance and a prevalence of specific
assets are institutional complements and, similarly, also a
high degree of debt funding and general purpose assets are
institutional complements.
The US Tayloristic model
(PA): A distribution of rights that gives shareholders and
management strong liberties including the liberty to fire easily the
workers.
The workers are exposed to this liberty and have no right to a well-
defined occupation or to some generic job within a certain firm.
The firm can be traded as a commodity and takeovers often imply
that the implicit contracts of the workers can be easily broken by
new management.
(TA): The centralization of knowledge in the hands of management
and top-down co-ordination and innovations; workers at the
bottom of the hierarchy perform very detailed jobs and have to
execute very narrow and rigid instructions.
The Tayloristic model as an
organizational equilibrium
PA -----> TA
Weak rights decrease the intensity of Labour as a high-agency cost factor.
TA -----> PA
Because workers tend to be low-agency-cost factors they rarely have
organizational or occupational rights.
Self-reinforcing organizational equilibrium:
-----> PA -----> TA -----> PA ----->
The U. S: a. Market-led economy?
(i) market for low-skilled jobs
(ii) market for companies.
The Japanese Model.
(PJ): A distribution of rights limiting some shareholders and
management liberties including the liberty to fire the workers
who hold the right to a job of unspecified nature in the
organization. Main banking and cross-shareholding isolate the
firm from the stock exchange and protect the workers implicit
contracts from the risk of take-takeovers.
(TJ): The decentralisation of a great deal of knowledge and
some bottom-up co-ordination and innovations; workers have
to rotate among different jobs and acquire remarkable firm-
specific jobs as well as an overall vision of the way in which
production could be improved.
The Japanese Model as an
Organizational Equilibrium.
Also here:
-----> PJ -----> TJ -----> PJ ----->
PJ -----> TJ
Because workers have rights in the organization some agency cost
(monitoring and specificity risk) are "cancelled". This biases the
technology towards a high intensity of high-agency-cost labour.
TJ -----> PJ
Because the technology is intensive in high-agency-cost workers (very
specific and difficult-to -monitor), more agency costs can be
"cancelled" by giving them rights in the organization.
The German Model: property
rights
(PG): A distribution of rights limiting some shareholder and
management liberties including the liberty to organise some
aspect of the division of labour and of job specification.
Unions and employers' associations acquire the right to
interfere with the organization of production of each single firm.
Co-determination with union representatives hold for the
firms with more than 200 employees. Banks have an important in
corporate governance through credit, direct acquisition of shares
and proxy voting, they make it very difficult hostile take-takeovers
and their presence in many board of directors favours the co-
ordination among firms.
The German Model:
Technology.
(TG): The decentralisation of a great deal of knowledge and some
bottom-up co-ordination are also a characteristic of the German
system; jobs are standardised across firms and workers can
change organization finding equivalent occupational slots in the
different firms that share a similar division of labour.
The German Model as an
Organizational Equilibrium
PG----> TG
Occupational Rights bias technology toward firm-general-purpose but
occupational specific rights.
TG ----> PG
A technology intensive of occupational specific rights makes it
convenient to decrease the agency costs of occupational skills through
the attribution of occupational rights
Rigidity and Flexibility
American Capitalism:
organizational and occupational flexibility.
Japanese Capitalism:
organizational flexibility and occupational rigidity
German Capitalism:
organizational rigidity and occupational flexibility
Occupational rigidity Organizational flexibility
Organizational rigidity Occupational flexibility
Changes in the Biodiversity of
Capitalism
Different rights ----------->
Different agency costs----->
Different factor prices------>
Different Institutional Comparative Advantage
-------- (Because of Globalization)--------->
Increased specialization in the sectors where the country has an
Institutional Comparative Advantage ------------------->
Institutional Specialization ---------->
------> Increase in inter-country Institutional Biodiversity
------> Decrease in intra-country Institutional Biodiversity
Globalization may increase the
Biodiversity of Capitalism
Thus, as a result of Globalization, the variety of models of
capitalism should not tend to decrease.
For instance, the U. S. should specialize even more its institutions
in goods and processes requiring top-down co-ordination and
innovation while Germany and Japan should specialize its
institutions in different goods and processes requiring bottom-up
co-ordination and innovation.
All models could co-exist increasing and exploiting their
institutional differences according to the well-know principles of
comparative advantage.
The commodification of intellectual
capital: a global revenge of Taylorism?
Increasing biodiversity: good picture of the eighties?
Even then: American attempt to imitate Japan.
In the nineties: the situation got completely reversed and America
seems to be the model that everyone should imitate. What
happened?
Here, we should consider Globalization not simply as
cultural and economic integration but as a new set of political
conditions that has allowed the global definition and enforcement
of property rights and, in particular, of intellectual property rights.
Intellectual property rights are
global rights.
Intellectual property rights cannot be locally defined and enforced
like the rights on physical assets.
For a physical asset the existence in a given location implies
that it is not used in other locations.
For intellectual assets non-rivalry in use implies that the
enforcement of property rights should be global.
In nineties the downfall of the Soviet Union made it possible a
much stronger definition and enforcement of Intellectual Private
Property Rights.
When there is weak enforcement of
IPR (80'):
a) More technologically advanced countries give free knowledge
to less advanced countries. Catch-up is possible.
b) Top down co-ordination and innovations systems, based on
the transmission of precise and formalised knowledge, are easily
exploitable by bottom-up co-ordination systems based on
informal and tacit knowledge. The knowledge developed by the
former can be appropriated by the latter while the opposite is not
possible.
When there is strong enforcement of
IPR (90’):
a') More advanced countries can exploit with monopoly prices
less advanced countries. A widening gap is possible.
b') Top-down co-ordination and innovation systems, based on
the transmission of precise and formalised knowledge, are
better suited for the production of IPRs than bottom-up systems
that produce informal and tacit knowledge.
Thus, the global enforcement of IPR favoured the U. S. in both
respects. This may explain the change from the eighties to the
nineties.
A revenge of Taylorism?
There is pressure to adopt this new version of Taylorism
where commodified knowledge (or reified intellectual) capital
separates conception from execution.
Fundamental difference between private property of
intellectual and physical assets:
- The exclusion from access to a physical asset is a local
exclusion: access to other similar assets in different locations
is usually possible.
- The exclusion from access to an intellectual asset is a
global exclusion: access to other similar assets in other
locations is not usually possible.
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