Capabilities and Governance : The Rebirth of Production in the Theory of Economic Organization

In the last 25 years, the economics of organization has emerged as a thriving branch of economics. In spite of some variety among the contributions to this field, it is fair to say that the literature is in agreement on the fundamentals. The basic insight is this: in addition to production costs of the usual sort, one must also consider transaction costs in explaining institutions like the firm. Whether called transaction-cost economics (Williamson 1975, 1985) or the economics of organization more broadly (Milgrom and Roberts 1992), the field has indeed focused precisely on the comparative transaction costs of alternative organizational structures, including, paradigmatically, the choice between firms and markets. Firms and other institutions are alternative bundles of contracts, understood as efficient mechanisms for creating and realigning incentives. Transacting is fraught with hazards, and the problem of organization is one of creating governance structures to constrain the unproductive rent-seeking behavior that imperfect information permits. In fact, the basic heuristic driving this literature is to reduce literally all problems of economic organization to problems of incentive-conflicts attendant on imperfect information