Chapter 5

ABSTRACT

Social and economic transactions provide the impetus for the production and exchange of information. Transactions, however, entail effort and incur costs and are thus subject to attempts at economizing through institutional arrangements. In the l-space, we distinguish between four basic types of transactional structures:

1Markets, in which transactionally relevant information is well codified, abstract, and widely diffused.

2Bureaucracies, in which transactionally relevant information is well codified and abstract, but whose diffusion is under strict central control.

3Clans, in which transactionally relevant information is uncodified, concrete, and only diffused to small groups.

4Fiefs, in which transactionally relevant information is uncodified, concrete, and undiffused.

These transactional structures are both the products and shapers of information flows. Where such flows are stable and recurrent, such structures will metamorphose into institutions.

Institutions impart a certain facticity to their knowledge base and are treated as stores of potential intelligence. Since such stores help to economize on data processing, transactions tend to gravitate towards those regions of the l-space well endowed with prior institutional investments. Institutions, however, not only enjoy a limited reach in the l-space, but also are prone to obsolescence on account of the effects of new information flows.

As pointed out in the preceding chapter, economics, although acknowledging the importance of information in economic exchange, has tended to concern itself primarily with information asymmetries and hence with the diffusion dimension of the I-space. By largely ignoring the influence of codification and abstraction on the distribution of information, it has been led to an essentially static form of institutional analysis that greatly underestimates the creative scope for learning in an economic system.

5.1: INTRODUCTION

Investing in the I-space

Whether movement in the I-space occurs cyclically, as we have hypothesized that it does when new knowledge is created, or whether it is random, it entails efforts and incurs costs in time, effort, resources and so on. What specific activities are associated with these costs? Essentially, those of problem-solving and of learning by doing in the case of vertical movement along C and back, those of repetition and testing along ĀA, and those of transmitting and receiving information in the case of horizontal movement along D. For the larger part of our waking moments, many of these costs might be considered trivial and may not even be reckoned such. A mother reading a bedtime story to her child (transmitting information) or a schoolboy mastering a computer game on his father's PC (absorption) may not think of themselves as particularly burdened; indeed, they may actively enjoy what they are doing. From a more analytical perspective, however, this is just another way of saying that what they get out of their respective activities justifies the effort that they put into them so that each is willing to invest time while their satisfaction lasts.

The willingness of the mother to invest time in bedtime reading may not be simply a question of immediate enjoyment, much as this may also be present. She may have more complex investment criteria involving the need to give her offspring a good start in life, the desire to develop a strong parental bond, and so on. Even if she is tired and not particularly inclined to read, she may still pull herself together and make the necessary effort if she takes a longer-term view of the benefits that accrue from this activity. The schoolboy's interest in his computer game, however, is likely to be more volatile. His father may rejoice at the idea that he is acquiring sophisticated technical skills, but at the point that the game bores him, he will drop it without a further thought and move on to his Spiderman comic or his Lego set.

The cost-benefit calculations performed by the mother and the schoolboy are likely to be unconscious or at best intuitive and informal. The mother does not sit down with pencil and paper to compute how many increments of career progression for her child an extra five minutes of bedtime reading will yield. Yet certain types of movements in the I-space require such levels of effort that they will only be undertaken following a fairly searching analysis. The problem-solving activities that make up a major research and development project, for example, may call for several hundred man-years of highly skilled and painstaking effort; or again the advertising campaign required to educate a market to the use of a radically new technical product – a diffusion cost – may run into tens of millions of dollars, and so on.

An important distinction should be drawn between the example of the mother and that of the schoolboy. Since the mother is communicating with her child, there is a sense in which the movement of information in the data field is visible; the child smiles, laughs, gasps, and generally provides feedback. By watching for this feedback we know whether or not data has effectively been transmitted. In the case of the schoolboy, by contrast, everything is hidden or impacted; whatever skill he has absorbed sitting alone in front of his father's PC remains his unique possession until, through some form of social interaction, he is led to show what he knows. Indeed, it may be in anticipation of such a future interaction that he is striving for mastery. He may, for example, be practising for a casual game with friends, or even for a tournament. In the latter case, the expected benefits of his efforts will run beyond the enjoyment of the moment and he may become willing to invest a correspondingly higher level of effort in practising his game. Indeed, he might now try to calculate informally what such a level should be in terms of other activities forgone that he would have preferred to pursue – i.e., hanging out with the gang, going to a movie, etc. But now, as in the case of the mother and her child, movement in the I-space is prompted by the prospects of a future return, a form of exchange with the schoolboy's physical or social environment whose consummation is spread out in space and in time.

Transactions

The use of information may be central to a physical or a social exchange or may be quite peripheral to it; for our purposes it matters not. In either case information ends up as support for a transaction between an agent and its environment, steering it towards desired outcomes and triggering adjustments on the way. In this chapter, we shall take transactions as the driving force behind the creation and use of information, giving a purpose and a logic to its flow and evolution in the data field. Transactions, past, present, and prospective, energize the field and endow it with a characteristic structure, accessible through the I-space.

Clearly, we are here using the term transaction in a broader sense than is common in economics where it has been taken as the ultimate unit of microeconomic analysis.¹ Simplifying somewhat, we might say that if money drives economic transactions, information drives transactions in general. Yet what is money if not a physical store of information? Like money, codified information can be a store of value, a measure of value, as well as a means of exchange; at certain times, one of these functions will predominate, at others another one will. And just as making money and exchanging it productively for goods and services require an intelligent expenditure of effort over time, and, usually, well ahead of a transaction, so do the production and exchange of information. In short, effective transacting requires prior investment.

At times, the creation of information may appear to be only loosely related to the transactions in which it might be used. The schoolboy playing around with a game on his microcomputer, for example, may only decide that he is of ‘tournament class’ after he has already achieved a measure of proficiency and this may have been quite casually acquired. He may not initially have thought of consciously investing time and effort to achieve a particular skill level. Yet looking back, he discovers that intentionally or not he has effectively invested himself and that his ‘learning by doing’ has moved him down the I-space from C, where he possessed no more than basic knowledge of the rules of the game, towards , where he had implicitly internalized strategies and a feel for promising patterns of play.² He can now transact from a position in the space which was possibly inaccessible to him six months before.

To summarize, the production of information and its use in transactions both incur costs and are thus subject to economizing. In the 1970s, there occurred a revival of interest among economists in the economics of transaction, and Oliver Williamson in particular, building on the earlier work of Ronald Coase and John Commons, has explored the different institutional arrangements which govern transactional choices.³ In this chapter, we shall also concern ourselves with the institutional order built up from transactions, but our focus will be less narrowly economic than the one adopted by Williamson. Like him, we shall argue that institutional structures aim partly at achieving transactional efficiencies and that where such efficiencies are effectively achieved they act somewhat like a magnetic field – a mathematician would call them ‘attractors’ – drawing the uncommitted transaction into a given institutional orbit. Yet in contrast to Williamson's, our concept of transactions is underpinned by an explicit rather than an implicit theory of information production and exchange which yields a different way of classifying them as well as a distinctive approach to their governance. We find ourselves in consequence in the realm of political economy rather than of economics tout court.

In the next chapter, we shall show how the institutions that crystallize out of transactional structures mediate a cultural order; a powerful link between institutional economics and cultural analysis is thus established. Attempts to build such a link have been made before, notably by William Ouchi;⁴ yet Ouchi, I feel, had underestimated the role that must be played by information in such an analysis. By treating, as we intend to do, transactional structures and institutions as emergent phenomena in a data field, we are placing the information environment in which a transaction occurs at the heart of our analysis.

5.2: TYPES OF TRANSACTIONS

Structures and processes

In what way might an individual's or a group's access to information influence the terms on which they enter into different forms of social exchange? Cast in the language of the I-space, the question becomes ‘What roles do the codification, abstraction, and diffusion of information play in the way that an individual or a group construct and enact their social world?’ We share Mary Douglas's ambition to go beyond the assertion put out by social phenomenology that the individual's life-world (Umwelt) is socially constructed.⁵ Like her, we would like to know what kinds of worlds are likely to be constructed when social relations take on this or that form. Yet we could equally well run the lines of causal influence in reverse and ask what kinds of social relationships are brought forth by a given way of constructing the world. A materialist position sees the life-world as all superstructure, an emanation from the social and economic relationships which it expresses with modest, if any, causal powers of its own. An idealist position, conversely, subordinates the creation of social and economic structures to the imperatives of a particular cosmology or world view. It argues, so to speak, either from design or from an all-embracing universal concept.⁶ The flow of information in the data field can effectively accommodate both approaches, since it is both channelled by structures – social, physical, cognitive, etc. -and in turn serves to build these up. Structures are zones of stability in a dynamic process that reach out into the field to modify its configuration. Structure and process here mutually determine each other. The resulting patterns can be exceedingly complex and no description of these will be attempted here. Our aim, more modestly, is to identify the type of structure that is likely to crystallize out of information flows in certain regions of the data field – what Max Weber, in another discourse, would have labelled ideal types – and briefly to investigate both its intrinsic social attributes and how these might be modified by the action of the SLC over time. Our approach remains consistent with the connectionist metaphor discussed in Chapter 2. Transactions activate complex patterns of information exchange within a network of agents in potential interaction with each other. The patterns themselves are the product of excitatory or inhibitory links between individual transactions that compete or collaborate with each other. The analogy with the behaviour of neural nets should need no further elaboration.

A transactional typology

It is the SLC itself which brings forth transactional structures in the I-space; articulations of distinct phases in its trajectory. In this chapter we identify four such structures. There may be more in practice but we believe these will be hybrids and thus not amenable to analysis as ideal types. The location of our four structures is shown in Figure 5.1. We have labelled them markets, bureaucracies, clans, and fiefs, the first three in deference to existing transactional typologies, and the last one on account of its provocative connotations.⁷

The fact that existing transactional typologies such as those of Williamson and Ouchi might be made to fit into the I-space amounts to a quick and dirty test for the plausibility of our claim that transactional structures can be viewed as an emergent property of information flows. What then needs to be established in the sections that follow is how far the social patterns of behaviour associated with each structure could reasonably be predicted from the characteristics of the information environment in which they occur. More challengingly, one would expect to discern some systematic relationship between the dynamic evolution of the data field brought about by information flows themselves and shifts of emphasis in the building up and maintenance of institutions away from one type of structure and towards one better adapted to new constraints imposed by the changing nature of the data. At a macroscopic scale, that at which the aggregation of transactional populations in the SLC yields discernible institutional patterns, one could then reasonably expect any shift that occurs between structures to tell us something about the nature of social evolution. This will be the subject of Chapter 6.

Figure 5.1 A transactional typology

We next examine our transactional structures individually.

5.3: MARKETS

Information characteristics

In the case of pure markets we are dealing with transactions the effectiveness of which depends on the provision of two items of well-codified, abstract information being available to all members in a given population: quantities and prices. Yet if such information is so available it will be because it is abstract and well codified. Of course, much non-codified and concrete information is also often widely distributed in a population and is therefore collaterally available in market transactions, but since it tends to diffuse only slowly and mostly in face-to-face situations, it is subject to lags, leakages, and distortions. Given that with respect to this second type of information, one can hardly argue that everyone is in possession of the same transactional information as required by the theory of efficient markets,⁸ it has tended until recently to be either underemphasized or ignored.

Codified, abstract information can be acquired and transmitted by impersonal means. Although impersonality is usually associated with large distances and in our day with modern communications technology, it is also quite viable in many face-to-face relationships. The key point is that in an impersonal social exchange, one is not essentially concerned with the identity of the other party even if this happens to be knowable. It would be unusual, for example, to enquire into the family background, personality, or value system of a street newspaper vendor before deciding to purchase an evening paper. If both the price and the type of contents of the paper are known beforehand, the transaction will be brief and to the point – indeed, in the typical case, it may even be wordless. Both parties will be concerned to minimize the time taken up by the transaction and get on with other business – if, say, it takes place during the evening rush hour when the vendor expects to make his/her best sales to large volumes of people hurrying home, personalizing the relationship with any one buyer will be bad business. Anyone, such as an out-of-town tourist, who starts asking for transactional information on the newspaper's price or its contents, may receive a pretty curt reply to his/her questions. The purchaser is in fact expected to know the paper's price and its contents.

On the other hand, transpose this hapless tourist to a Saudi Arabian souk where codified information on the goods displayed is neither much available nor much diffused, and the transaction acquires quite a different character. Here, personalizing the relationship will become the central requirement of a bargaining process which proceeds, like Walras's auctioneer, by tâtonnement.⁹ Yet Walras's auctioneer strives for impersonal outcomes since these help to speed up the process. The auctioneer is helped in this by the fact that he/she finds himself in a multilateral bargaining situation in which buyers and sometimes sellers are anxious not to reveal their respective identities. In the souk, however, bargaining will be bilateral in nature. Since everyone does not possess the same information as to price, quality, or the level of demand, it pays both parties to find out more about each other. The seller, for instance, might wish to discriminate pricewise between buyers who are ‘wised-up’ and those who are not. The buyer may wish to know more about the product's quality and the seller's honesty in describing it. Both sides will therefore be attentive to nuance and context, looking for clues, and ‘sizing up’ the other.¹⁰

Although buying a newspaper from a street vendor and buying an article in a Saudi Arabian souk are both characterized as market exchanges, the key difference between the two kinds of transaction is that the ready availability of relevant codified information to both parties in the first case places the buyer and the seller on an equal footing. In contrast to the case in the Saudi souk, the cost of haggling is eliminated for both parties. The newspaper seller knows that she will not get a purchaser to pay more and the latter will not expect to pay less than the going rate for an evening paper.

Efficient versus real markets

This first kind of transaction is therefore somewhat closer to what economists refer to as efficient markets. Only somewhat, however, since the price of an evening paper does not respond to every fluctuation in supply and demand conditions but is set in anticipation of future market trends. Thus a knowledge of price by the parties avoids haggling and reduces transaction costs, but it only affects the price itself with a lag.

Depending as they do on the speedy and extensive diffusion of abstract codified information, efficient markets have become the paradigm case of economic exchange. In the real world, however, they are also extremely rare and, for the most part, represent something one aspires to rather than expects. Why? There are many possible reasons for this. Here we shall give only two. Firstly, as markets increase in efficiency, the larger the number of players that are made to compete on an equal footing. This requires the freedom to enter or exit markets in response to price movements. In reality, however, and for practical reasons, most markets are limited in size so that over time some players may acquire a disproportionate weight relative to others. They are then in a position to influence price-volume relationships and become price makers rather than price takers. In fact, it has only been with the advent of information technologies that allow continuous trading across space and time that certain types of markets have been able to approximate the economist's definition of efficiency. In earlier times markets were intermittent affairs that found it hard to bring together would-be buyers and sellers in one place. The Champagne fairs of the thirteenth century, for example, took place on certain fixed dates only – usually five or six times a year – and involved such high transaction costs for the parties that for the most part only luxury goods could justifiably be traded there.¹¹

Secondly, and more problematically, a market only achieves efficiency where the prices at which trading occurs embody all the transactionally relevant information available to buyers and sellers. Thus not only does price behaviour reflect current trading conditions, but everything that is currently known about future trading conditions as well. This ‘rational expectations’ view of markets in effect amounts to a requirement that all such transactional information be fully codified, abstracted, and diffused.¹²

The workings of the SLC itself should alert us to the near impossibility of ever fully satisfying this requirement. A price that is the outcome of bilateral bargaining between economic agents (a priori, therefore, this excludes our newspaper vendor) is a local affair that has the character of a hypothesis to be tested both against knowledge of ‘local circumstances of time and place’¹³and against non-local, abstract knowledge of prices practised elsewhere. Much of the local knowledge that goes to make up the price in fact stays local, but the price struck only effectively captures it as transactionally relevant information if the hypothesis is a good one, i.e., if exchange actually takes place at that price¹⁴ and if that price effectively has implications for exchange practised non-locally.

Defenders of the rational expectation view will argue that it is not essential to start with good hypotheses concerning prices providing that subsequent hypotheses are corrigible and can be improved by learning. In other words, local prices are tested against the market price and all other available information and adjusted accordingly.¹⁵ Learning so defined contributes to the movement of prices towards equilibrium, that unique price at which the market is cleared.

Markets and learning processes

Some light upon this issue can be shed by Ross Ashby's ‘law of requisite variety’.¹⁶ The law states that learning, to be effective, must operate at a rate that matches that of changes occurring in the organism's environment. The law does not guarantee that such learning, even if effective, will necessarily also be epistemologically correct: it may, after all, be built on a faulty hypothesis.¹⁷ The rational expectations hypothesis ignores this feature of the law of requisite variety and takes market learning to be epistemologically unproblematic. Systematic errors are sooner or later weeded out and random errors do not impede the learning process.¹⁸ It is thus, by assumption, that market learning contributes to an equilibrating process and movement towards a single equilibrium price. And if, as one approaches equilibrium, the rate of change in the market environment decreases, the rate of learning by economic agents is, so to speak, allowed to ‘catch up’.

Yet our SLC points to the possibility that a move away from equilibrium is itself the fruit of a learning process – i.e., knowledge absorption – which impacts what might otherwise be available knowledge in the heads of a few well-situated individuals capable of using it opportunistically and in novel ways. It thus becomes once more concrete and local – i.e., undiffused. To present this disequilibrating process merely as an interlude between two equilibrium points, as rational expectation theorists are prone to do on the argument that disequilibrium will sooner or later be followed by equilibrium, is to miss the essence of the phenomenon.

Clearly, any breach of the two conditions mentioned above – namely, that market entry and exit should be unimpeded and that market price should capture all available information – will tend to push transactions out of the market region and towards other parts of the I-space. The smaller the number of players, for example, the more likely it is that their identity as well as their relative size will begin to matter and that their behaviour will in fact embody local information known to them but not to others. They can then behave ‘strategically’¹⁹ with respect to other agents in the market who are less well informed. Strategic behaviour, of course, shows up in price movements and is thus sooner or later communicated. But it usually does so too late to matter, particularly where early learning has been successfully impacted and has allowed strategic actors to move away from equilibrium in opportunistic ways. In the absence of equilibrium, therefore, a market sometimes becomes the location in the I-space where ‘suckers’ are to be found, and these are unlikely to gain much consolation from the knowledge that others will one day learn from their mistakes.

One way of avoiding the ‘small numbers’ condition, as we have seen, is to make entry and exit into the market unrestricted. Any profit resulting from monopolistic positions would then immediately attract new entrants. The small-numbers condition itself, of course, if persistent, moves one either towards bureaucracies or towards clans in the I-space as the transactionally relevant population shrinks. Where market-relevant information has not been fully abstracted, codified, and captured by the price, transactions are more likely to migrate towards clans than towards bureaucracies. Some of the more local uncodified information relevant to transactions will then only be transmitted face to face and will therefore no longer be available to all would-be participants. It will only be passed on to those close at hand: to colleagues, friends, and relatives who may consequently enjoy an information advantage with respect to ‘outsiders’.

It is worth noting that the two impediments to market efficiency just described – i.e., barriers to entry and an inadequate codification and abstraction of transactionally relevant information – tend to mutually reinforce each other. Transacting among small numbers, for example, will tend to stabilize relationships and increase the opportunities for personalizing them and thus for transmitting uncodified information face to face. Yet transacting with uncodified and concrete information is an uncertain, time-consuming business that will automatically tend to limit the number of participants that can be involved.

Moving in the I-space towards clans and moving towards bureaucracies, however, involve quite different responses to the workings of SLC. In the first case, one follows the cycle out of the market region in a way that might almost be called ‘natural’ since the move away from equilibrium and towards small numbers in effect reflects a form of market learning (absorption) and impacting. In the second case one moves against the cycle by explicitly setting up barriers to the diffusion of codified abstract knowledge (see next section).

The markets which today are considered to come closest to achieving the efficiency ideal are financial markets in industrialized economies. Not only do they now benefit from a telecommunications technology that ensures a rapid diffusion of codified information – a price movement on Wall Street, for example, will be registered in a matter of seconds in both London and Hong Kong – but with the growing integration of national financial markets into a single global one, they have increased severalfold the number of players who can freely participate in their operations.

Yet, as the ‘insider trading’ scandals of recent years amply demonstrate, even in so-called efficient markets, information is never fully codified, abstracted, or diffused. Market prices continue to conceal as much as they reveal and small numbers lurk opportunistically within the large numbers required for transactional efficiency.

Markets and social values

Economists will continue to debate whether the asymmetric distribution of market-relevant information constitutes an insuperable barrier to the attainment of transactional efficiency as technically defined. Yet efficiency can also be impaired by how the presence of information asymmetries is perceived by participants themselves. Why else would insider trading scandals ‘rock’ Wall Street? Why should a few winks and nods between eminent and established figures of the financial community land them with four- or five-year jail sentences? There is little mystery here: by their behaviour such people may not have posed any great threat to market efficiency as technically defined by rational expectation theorists; but in being perceived to benefit unfairly from an information advantage they were challenging the value system of the market as an institution. It is this value system that keeps a market working as close to its ideal as is feasible under given circumstances and, in the absence of its lubricating effects, both confidence in the fairness of the institution and a willingness to use it for transactional purposes will be undermined. If too many people leave the market in search of more equitable alternatives, large numbers will once more give way to small numbers and the market's efficiency will be further compromised.²⁰

Can components of this value system be identified? Perhaps the two core values that underpin market transactions are a belief in individual rationality and a belief in competition as a regulating mechanism.

A belief in individual rationality received its most powerful formulation in the philosophies of the Enlightenment as systemized by d'Holbach²¹ and, in economics, its most popular articulation in the writings of Adam Smith. Simply stated, it holds that individuals are quite capable of deciding for themselves what constitute their real interests and of then going about satisfying these in sensible ways, always providing that they are adequately informed as to what their real options are. Individual rationality, to be effective, thus presupposes access to transactionally relevant information.

Individual rationality per se, however, does not necessarily yield socially desirable outcomes, and it would never by itself have commanded the attention it has done had not another important insight also been available. For if individuals can be shown to be rational in the pusuit of their own goals what is to guarantee that such goals, when aggregated across a large number of individuals, are in any way compatible with each other or that if they are not, social harmony can ever be preserved?

Adam Smith was certainly not the only one to see how the market might resolve this dilemma in the eighteenth century, but he gave the solution its most broadly intelligible formulation. He did not argue, as many have taken him to, that the selfish pursuit of individual interests was ethical,²² but merely that it was reasonable. Smith held that if self-interested individuals could be put into regulated competition with each other in pursuit of their respective goals, then, from a social point of view, there was no need to pass judgement on the ethical worth of these goals; they were in effect a matter for the individual and his conscience. Socially efficient outcomes could be secured in spite of the selfish pursuit of individuals, providing the latter could be made to compete fully and fairly with each other. Under such circumstances individual rationality would be productive of social rationality and the information generated by countless local transactions would be used by the market to regulate itself.²³

Social welfare will only be maximized in this self-regulating scheme, however, when competitors are numerous and small, when no transaction is of such a size as to produce distorting effects, when no barriers exist to prevent people from entering or leaving the market, and finally when competitors cannot collude to form powerful subgroups. It is, of course, this last condition that ‘insider trading’ violates, thereby demonstrating how difficult it is to satisfy these requirements in practice even in the most sophisticated and best-functioning markets.

Linked to these core values are other values that are not always made explicit but are none the less implied by markets as an equitable institutional order. For example, freedom to choose goes hand in hand with a belief in personal responsibility for one's own fate, which in turn translates into a social value stressing equality of opportunity rather than equality of outcome.²⁴ Put more harshly, rational men are equally free to make choices -some will be good, some will be poor; in all cases, though, they must bear the consequences. The doctrine of personal responsibility promotes both tolerance and impersonality. Tolerance, because if each individual is free to pursue personal objectives according to his own lights, then he must not be unduly constrained in doing so through the moral judgement of others – in this sense, markets are pluralistic as well as individualistic. Impersonality, because any concern with the identity and welfare of the other party to a transaction beyond that minimum required by civility and the preservation of the social order can act as a brake on one's own maximization objectives and hence to the detriment of a properly competitive relationship. Thus collusion between free economic agents, that is, those not bound by blood relationships or those of employment, translates into the pursuit of a group welfare function which threatens the atomism of the market, and by implication its efficiency as an allocator of social resources.²⁵

Perhaps the most fundamental social value underpinning the institution of markets remains the belief that an individual must be left free to pursue his life chances as he sees them. Possibly originating in the medieval doctrine of the sanctity of the individual soul, the acknowledged primacy of individual over collective goals, coupled with a growing understanding of how the latter could be served by the former through the mechanism of self-regulation, gradually came to erode the perceived legitimacy of the mercantile state in the eighteenth and nineteenth centuries. Markets have existed in some form or other in most cultures and in most historical periods but nearly always in a subordinate role to other institutions. Only in western liberal doctrine were they later to be elevated into a dominant component of the social order, albeit one maintained by the regulatory power of the state – the latter exercised through a form of bilateral governance in which markets retain the leading role.

Markets as a social order

The automatic self-regulatory nature of efficient market processes, however, largely does away with the need for state direction in those regions where markets rule. Inspired by the politically as well as the economically liberating implications of ideas of self-regulation, ‘He governs best who governs least’ then became the slogan of laissez-faire capitalism in the nineteenth century, some of whose protagonists held that much of social life could be reduced to market processes supervised by a ‘nightwatchman state’. What had initially evolved as a governance structure for certain classes of transactions then for true believers became elevated to the status of an ideology which could reign over the social order as a whole – indeed, by appropriating Darwin's theory of natural selection for its own purposes after the theory's publication in 1859, market ideology could expand hegemonistically to claim dominion over organic life itself.²⁶

Although these hegemonistic impulses of market ideology have since been somewhat reined in, market processes still remain the dominant paradigm for economic transactions in those countries where free market institutions were allowed to flourish.²⁷ They increasingly came to be perceived as an integral part of the natural order with market equilibrium expressing an underlying tendency of the social system as a whole towards stability when this is unimpeded by external ‘disturbances’.²⁸ The whole arrangement is magnificently Newtonian since once the metaphysics of equilibrium has been suitably established – this could only be done mathematically, not empirically – any move away from the equilibrium point became by definition an ‘external’ disturbance and hence of no threat to the metaphysical core of the doctrine. As Williamson puts it in Markets and Hierarchies, ‘in the beginning there were markets’,²⁹ and the economist's concept of ‘market failure’ is a normative presumption in favour of market transactions which implicitly casts alternative forms of governance as second best.

As we have seen above, where ‘market failure’ occurs on information grounds, it will move transactions towards those regions of the I-space occupied by bureaucracies or clans, in the first case pushing against the flow of the SLC, in the second, moving along with it and allowing it to run its course. We consider bureaucracies next.

5.4: BUREAUCRACIES

The informational characteristics of bureaucracies

Like market transactions, bureaucratic ones depend on the use of well-codified and mostly abstract information – financial budgets, monthly reports, economic assessments, statistical surveys, etc. But now this information is no longer available to all agents as it might be in a market. It is the authorized possession of a limited number of individuals who thereby stand to gain a legitimate transactional advantage from it.

The theory of the SLC is built upon the premise that information has a natural tendency to diffuse when it is codified and abstract so that in effect it has little inherent stability in that region of the I-space where bureaucracies are to be found. If information is to remain there, as it must if bureaucratic institutions are to emerge at all, barriers to its diffusion must be erected. And it is the very presence of such barriers that gives bureaucratic transactions their particular flavour.

Barriers are not necessarily designed to block the diffusion of information as such, but simply to make it controllable by designated individuals. In contrast to the market case, in bureaucracies diffusion ceases to be a random process with receivers colliding haphazardly into messages that are somehow ‘out there’ for the taking. Messages are now distributed discreetly on a point-to-point basis with further redistribution also taking place selectively. If the appropriate metaphor for the diffusion of information in a market is that of an Alka-Seltzer tablet dissolving in water, the one that best conveys bureaucratic information processing is that of the central nervous system, a hierarchically structured communication network. Of course, if we consider that knowledge is power, then the differential possession of transactional information confers considerable advantage to individuals who operate the barriers to its diffusion. The information resources under their control put them in a position of strength in many forms of social exchange, and the institutionalization of transactions in this region of the I-space is therefore designed to ensure that the circumstances in which such individuals come to possess valued information, and the use to which it is then put, are both perceived to be socially legitimate. A confidential report, for example, transmitted by a government's intelligence services to a head of state is not expected to be widely diffused; its restricted circulation will usually be granted a high degree of legitimacy by the country's citizens given the threat to their security posed by any leaks. A publicly quoted industrial corporation, on the other hand, which sought to prevent the publication of its financial accounts in order to avoid answering embarrassing questions at a shareholders’ meeting might quickly provoke an outcry. The first type of transaction therefore is a plausible candidate for bureaucratic governance whereas the second should properly be assigned to market governance.

But how are individuals effectively selected for the privilege of operating barriers to information diffusion? What criteria are used? In the real world, these are numerous and they are applied with varying degrees of rigour. In the case of the pure bureaucratic transaction, however – the ideal type – we need only retain two: competence and accountability.

Competence and accountability

The competence criterion ensures that only those who know how to use the information they receive do in fact get it, and that those who do not are kept out of the distribution channel. The decision-maker has to be capable of evaluating and interpreting transactional information received prior to deciding how it should be used and to whom it should be further distributed. For this he/she needs a knowledge of context to guide his/her analysis. What the decision-maker then decides to retransmit up or down the communication hierarchy is always the product of an act of selection; i.e., an abstraction and a codification. Competence, therefore, has to extend beyond the identification of appropriate nodes in the communication network with which to interact, and cover as well an ability to formulate appropriate messages in an intelligible code in order to overcome Shannon's three communication problems.³⁰ The consummate bureaucrat is, above all, a consummate communicator.

The accountability criterion is required to ensure that the privileged possession of information does not lead to abuse. In a bureaucracy, individuals are no longer free to pursue their own personal objectives as they are in a market. Objectives are now hierarchically imposed from above. Individuals are granted power and authority in a bureaucracy to the extent that they accept as their own objectives that are handed down. They are not required to subscribe to these personally, merely to act as if they did. Yet it is sometimes easy for individuals holding such power privileges to exploit them for ends that have little or no institutional legitimacy. They must therefore be constrained in their behaviour either by the presence of external control systems designed to render their behaviour visible, or through the gradual development of a personal value system that can act as an internalized control system. Where transactions are well codified and based on abstract principles and can therefore be recorded and made visible, the first kind of control system might be preferred. Where the information used in transactions is concrete and cannot be so codified, however, only those who have been socialized to the required value system and can demonstrate a credible commitment to it will be entrusted with its possession. The latter case, however, ceases to describe a purely bureaucratic transaction; it properly belongs to the fief region of the I-space and will be further discussed in section 5.6. Yet in both instances the differential possession of information creates a hierarchical transactional structure; in bureaucracies this becomes a formal and specialized communication network based on impersonal authority. In contrast to fiefs, therefore, power in bureaucracies is constrained by structure.

Roles and routines

A formal communication hierarchy possesses distinctive properties. For a start, the authority relations it describes are built largely upon expertise. Eligibility for a particular position is determined by meritocratic criteria that stress both competence and accountability. Then, since such a hierarchy deals with codified information, its transactional style tends to remain largely impersonal. Roles – i.e., the codification and standardization of behaviour patterns – rather than the vagaries of personalities and of individual identities are what matter. Roles express behavioural clusters of specialized knowledge and expertise that serve to mutually orient both the senders and receivers of codified abstract information. Roles also allow transactions themselves to be standardized and subsequently routinized so that larger volumes of information can then be processed by the hierarchy. But since roles reflect the logic of standardized transactional requirements rather than individual idiosyncrasies, they also demand impersonality. Just as in a pure market transaction at a given price, one customer is as good as another, so in a pure bureaucratic transaction, providing that each party possesses the required competence and sense of accountability, one role incumbent is as good as another.³¹

Bureaucracies typically, but not always,³² involve smaller numbers than markets do, although they tend to deal in more varied and more complex information than markets can properly handle. A market is designed to process large volumes of abstract data coded as prices and quantities. Bureaucracies also deal with abstract codified data, which can therefore be written down on paper, but it is often of a kind that cannot so easily be standardized. Disparate kinds of written data – on personnel records, legislation, budgets, etc., – have to be reconciled in ways that often call for a knowledge of context and the exercise of personal judgement. Of course, bureaucratic routines that integrate and structure transactional information into more manageable wholes are constantly being sought; yet since such routines cannot deal with every unforeseen contingency – remember that codification involves selection from a limited set of alternative possibilities -a certain number of transactions will inevitably fall outside their scope. These will be ‘referred upwards’ and thus travel up the hierarchy until they find a procedure – which may or may not be routinized – for dealing with them.

This upward drift of transactions for which no suitable code exists at a lower hierarchical level suggests that, whatever the nature of the organization, not all transactions in a hierarchy can be purely bureaucratic, and that as a consequence fuzzy, unanalysable, non-routine decisions must inevitably gravitate towards the top. As we shall see in section 5.6, such transactions belong in fiefs. The point that we wish to make here, however, is that since, in contrast to what prices are meant to do in markets, codes cannot completely capture all the information relevant to bureaucratic transactions, these occupy a position somewhat lower down the codification dimension than markets do in the I-space and remain somewhat less abstract (see Figure 5.1).

Bureaucratic values

How does the value system that underpins bureaucratic transactions compare with that of markets? Certain values the two institutional orders will share; in other respects they are totally different.

Take, for example, rationality. Both markets and bureaucracies aim at the rational integration of means and ends and both make use of codified and abstract information for achieving this. But here the resemblance ends. Defenders of markets believe that each individual exercises rationality in the pursuit of his own personal goals and that, providing that enough of the relevant information is available to all, this atomistic collection of goal-seeking individuals achieves optimum social outcomes through a process of self-regulation. Individual rationality under efficient market governance thus generates social rationality with little or no leakage. Defenders of bureaucracy, by contrast, challenge this automatic transposition of rationality from the individual to the collective level. Not only might self-regulating processes not function properly, but even if they did they might still fail to bring about socially desirable outcomes. These must then be secured by hierarchical means. Certain carefully chosen individuals will therefore be legally empowered to represent the collective interest and to pursue it through a process of hierarchical coordination.³³ Relations between different levels of the hierarchy will then be based on the exercise of authority, legitimated by expertise rather than by market power. As Max Weber has defined them, bureaucratic relations are based on a belief in rational-legal order.³⁴

Those in authority, then, are deemed to know more than their subordinates and this gives them the power to coordinate the allocation of resources; the use of that power will be considered legitimate by those who submit to it as long as it is applied to social rather than personal ends. By assuming at the outset an asymmetric distribution of information among social and economic agents, bureaucracy may be thought to require less heroic assumptions than markets. In practice this may be so, but a bureaucratic ideology, by positing the existence of the all-seeing professional administrator working selflessly in the service of society, strains our credulity in other ways.³⁵ The synoptic abstract rationality of markets has not been done away with, but merely monopolized by those who, now calling themselves ‘central planners’, sit atop the administrative hierarchy.

Bureaucracies also share with markets a concern for stability and a Newtonian world view that sees change as the externally generated disturbance of a system wanting to move towards equilibrium. Yet in bureaucracies, the system does not move towards equilibrium unaided: the invisible hand of the market is replaced by the visible hand of an all-knowing administration drawing on information that is for the most part codified, abstract, but not diffused.

The stability of a hierarchical order is in fact incompatible with the widespread and uncontrolled diffusion of the transactional information on which it rests; the non-sharing of information consequently becomes a deeply entrenched bureaucratic value among those who cherish such stability. If market institutions struggle against insider trading and the exploitation of information asymmetries, bureaucratic ones by contrast strive to prevent ‘leaks’ of valuable transactional information: self-regulation requires information sharing; hierarchical coordination requires information hoarding. Interestingly enough, in both cases, institutional transgressions take the form of an uncodified and concrete transaction – a social exchange whose transient face-to-face nature remains hidden to all but the few involved in it and which subsequently leaves no trace.

A third important bureaucratic value briefly touched on above and irrelevant to the functioning of efficient markets is that of professionalism, which harnesses the privileged possession of specialized knowledge and competence to an ethic of service. Professionalism in fact operates in two modes:

1It serves to legitimize the non-diffusion of diffusible information by arguing that such information ‘getting into the wrong hands’ would not serve the public interest. The implication here is that the ‘right hands’ do serve the public interest and are prepared to subordinate private goals to public ones. A professional bureaucrat or ‘public servant’, for example, is someone who not only has the technical competence to select the means once the ends have been decided, but, within certain politically definable limits, gives himself the moral right to select the ends themselves. The bureaucrat's commitment to an ethic of service qualifies him/her to specify social goals, whether this be done selectively (i.e., in situations where collective choice finds no coherent expression either in markets or through the ballot box³⁶ – in other words, where markets fail) or more comprehensively, as in command economies, where individual choice is granted from the outset a low level of legitimacy. The social counterpart to the technical and moral authority of the professional bureaucrat, of course, is obedience from subordinates and compliance or at least acquiescence from clients.

2It serves to bolster the exercise of highly personal idiosyncratic skills in ill-defined situations where a high degree of interpersonal trust between the parties is required if a transaction is to take place at all. A doctor-patient relationship or a lawyer with his client typify this kind of social exchange. As in the first mode described above, there is information asymmetry between the transacting parties, but here such information is intrinsically hard to codify and thus does not transmit easily between a professional and her client. The latter, therefore, not only has to take on trust that the former has the requisite ability to perform the service that is being solicited for, but also that she is willing to use it exclusively in the client's own interest.³⁷

As we shall see in section 5.5, the second mode in which professionalism operates properly belongs to the clan region of the I-space and is not in fact representative of the bureaucratic transaction as such. It is more personalized and involves smaller numbers than the latter, since in bureaucracies professional competence and accountability can be effectively achieved, and on a larger scale, by more impersonal means.³⁸

Bureaucratic competition

Bureaucratic transactions, no less than market ones, involve competition between participants, and in both cases individual success involves moving from a position on the right in the I-space, where one is a net recipient of knowledge, towards a position on the left along the diffusion curve, where one becomes a net contributor.

But surely, it might be objected, on the right we do not find bureaucracies but markets. Was this not after all the burden of section 5.3? What would a bureaucrat be doing on the right anyway unless he had lost control of his stock of information? The answer is that transactional structures compete with each other throughout the I-space but are better positioned to survive in some parts of the space than in others on account of the fit that obtains between their information requirements and the characteristics of their local information environment. Thus, for example, a market represents a limiting case of hierarchical decentralization, the point at which information parity between all actors in an organization effectively allows self-regulating processes to take over from hierarchical coordination. Yet until one reaches the top right-hand corner of the I-space, some measure of hierarchical coordination remains possible. Where transactional possibilities overlap in this way, we may either view the situation as one in which bureaucracies extend themselves to the right along the diffusion scale reaching into markets to impose a measure of hierarchical structure – such would be the case, for example, where natural monopolies are regulated by the state – or, conversely, we may see market processes moving leftward along the diffusion scale and penetrating bureaucracies in the form of internal organizational competition – between divisions, functional units, individuals, etc. How does such competition work in practice?

Both Adam Smith and later Joseph Schumpeter realized that no player actually enjoys the rigours of pure competition and that players will do what they can to escape it by attempting to secure for themselves some monopolistic advantage – today the term used is ‘competitive advantage’: it sounds less offensive while retaining essentially the same meaning.³⁹ Smith saw the phenomenon somewhat statically as a source of economic inefficiency to be deplored, whereas Schumpeter thought of it in more dynamic terms as a stimulus to innovation.⁴⁰ He understood that the quest for competitive advantage and the flight from pure competition themselves constituted competitive processes that brought but temporary relief. Either way, a monopolistic control of markets resting on an information advantage amounts to a leftward move in the I-space and away from the purely competitive case.

The quest for competitive advantage characterizes a bureaucracy no less than a market. A move up an organizational hierarchy where there are fewer players confers an information advantage that is monopolistic in nature and that also translates into a leftward movement in the I-space: information has to be shared with a smaller percentage of the transactionally relevant population. Yet a leftward move in a bureaucracy remains in principle meritocratic and rests on competence and accountability rather than on raw market power. Nevertheless, both bureaucratic and market moves towards the left share a common aspiration to overcome the barriers to entry that will inevitably be found there in order to escape the turbulence of competition on the right. When these barriers have been crossed, transactions can then navigate in calmer waters; thoughtful people can now see where they are going and appropriate courses of action can be chartered. Competition has not of course been completely eliminated on the left of the diffusion scale, but it becomes a more leisurely, more gentlemanly affair involving but a few players.⁴¹

The bureaucratic order

If individual freedom in a self-regulating cosmos remains the dominant value underpinning market transactions, the necessity of subordinating individuals to collective interests and a belief in the power of orderly and rational planning characterize the bureaucratic outlooks. The ‘blindness’ of markets, with no competent hand to guide them, is abhorred and considered to be a social aberration. If, as Williamson claims, in the beginning there were only markets, then it must surely follow that in a progressive society the move away from a Hobbesian ‘war of all against all’ and towards the security and serenity of hierarchy must count as a desirable outcome. The regression towards markets, the drift towards the right in the I-space, must then amount to a form of ‘bureaucratic failure’.

Many liberals would argue, however, that societal evolution actually requires bureaucratic failure. When citizens all enjoy high levels of education, then information asymmetries can no longer be justified on welfare grounds. The absolutist state of the seventeenth and eighteenth centuries, the paradigm case of a bureaucratic order,⁴² was only possible while the coding skills conferred by education remained in the hands of an administrative elite. With industrialization and the spread of mass education this asymmetry ceased to be tenable. It was maintained in place on a large scale by the Marxist-Leninist state – a twentieth-century attempt at state absolutism – in those countries where mass education had not yet emerged: the USSR, China. Where mass education is available, however, it gradually erodes a pure bureaucratic order from within – witness Eastern Europe in 1989, and in 1991 the Soviet Union itself.⁴³

In the People's Republic of China, on the other hand, where mass education is not yet widely available above – or even at – primary school level,⁴⁴ the bureaucracy, whilst failing to deliver, has not in fact ‘failed’ in favour of markets. An examination of the SLC reveals that markets are in fact not the only resting place for failed bureaucracies. Like markets themselves moving towards bureaucracies, the latter can also move against the cycle: towards fiefs. As we shall see in section 5.6 and illustrate in Chapter 7, this is a move towards feudalism. Before considering this alternative form of bureaucratic failure, however, let us first examine the second way that markets themselves can fail, when, allowing the SLC to follow its natural course, they move into clans.

5.5: CLANS

The information characteristics of clans

Markets fail when information asymmetries between transacting parties create a small-numbers condition and the self-regulating nature of the exchange process can no longer be assumed. A hierarchical governance structure might then emerge either to complement or to replace market processes. Is hierarchy the only option?

Information asymmetries, as we have seen, can arise in a number of ways. Those codifying new knowledge on the left of the I-space, for example, may choose to be selective in what they diffuse – such is often the case with patent disclosures: enough is revealed to secure the patent but not enough to allow imitation by would-be competitors. Alternatively, creators of new knowledge may actually be unable to fully codify or abstract from certain areas of their experience which must consequently remain concrete and personal to them. In both these cases the clockwise progress of the SLC itself is slowed down, thus maintaining existing information asymmetries.

Moving against the cycle in an anti-clockwise direction in the upper region of the I-space, on the other hand, is another way of either maintaining or creating information asymmetries. It can mean developing proprietary coding skills for oneself, and then using them to make one's own discoveries or using them to gain privileged access to newly codified, abstract, but as yet undiffused knowledge. Bureaucratic competition pursues information asymmetries through either option; it consists of a regulated manoeuvring for position as far to the left as possible along the diffusion scale.

Yet information asymmetries can also result from following the SLC rather than either slowing it down or moving against it, from an absorption of codified, abstract knowledge that is subsequently impacted in idiosyncratic and possibly creative – but now uncodified – ways. Put another way, markets also fail when the learning-by-doing opportunities that they offer are skewed in favour of a small number of individuals who thereby gain a ‘first mover’ advantage from knowledge that is hard to articulate or to disclose.⁴⁵

The small-numbers condition

The communication constraints imposed by uncodified and concrete information tend by themselves to generate a small-numbers condition since the number of agents that one can maintain a worthwhile face-to-face relationship with remains of necessity limited. We shall label small face-to-face groups that operate on the basis of shared but largely uncodified and concrete, i.e., local, information, clans. They represent a case of limited information diffusion in which a group of ‘insiders’ collectively enjoys an information advantage with respect to ‘outsiders’.

Some of the authors who have studied the dynamics of transactions in clans tend to see many of them essentially as the outcome of instabilities in political and economic markets. Both Michels in Political Parties⁴⁶ and Olson in The Logic of Collective Action⁴⁷ call into question the self-regulating character of market transactions. And Axelrod in The Evolution of Cooperation⁴⁸ further demonstrates that the payoff to small-group collaboration in recurrent conditions will always be higher than to competition involving large numbers. The implication seems to be that institutional attempts to keep small groups of regularly transacting parties in a purely competitive arm's-length exchange relationship will often be subverted by the interest they have in banding together and in personalizing their dealings with each other.

Oliver Williamson and Alfred Chandler, by contrast, both see small-numbers clan transactions as being themselves unstable and subject to erosion by the logic of markets. Chandler, for example, in his study of the repeated attempts by many US industries to cartelize their operations at the turn of the century, found them to be short-lived and plagued by defections. Relations between cartel members were characterized by a lack of trust and a lack of any durably effective policing devices that could compensate for the lack of trust.⁴⁹

Clearly, interpersonal trust must be counted an important ingredient in bringing about stability in clan transactions. Yet this quality of personal relationships, so important to information sharing behaviour when transactional data is uncodified and local, is subsumed by Williamson under the catch-all label of ‘atmosphere’ and is thus not perceived by him as extending the range of transactional options beyond those that he originally identified; i.e., those of markets (the large-numbers condition) and hierarchies (what we have termed bureaucracies) which usually regroup larger numbers than clans (although not always) yet smaller numbers than efficient markets, these being in theory open to everyone.⁵⁰ William Ouchi, one of Williamson's collaborators, has analysed the concept of the clan as a governance structure in its own right⁵¹ and others have at various times referred to communes⁵² or federations⁵³ as equally viable transactional possibilities. Yet none of these authors have conceptualized clans as anything other than a transactional form located in an intermediate position along the diffusion scale between markets and hierarchies.

Clans, however, are assignable to the lower region of the I-space. They deal essentially in fuzzy information which is diffusible enough to be shared by clan members in a given time period but not by the population as a whole. Should we characterize the data used by clans as tending towards the abstract or the concrete? Given the location of clan transactions on the SLC, we are tempted to answer ‘the concrete’ and in most cases this is likely to be right. Clans will treat as critical the local, particularistic data that affects the day-to-day working of clan life. Yet one can conceive of groupings whose essential concerns and ultimate effectiveness might well require a shared base of abstract knowledge. This might be truer, though, of a purely scientific community than, say, of a professional association whose primary mission might be to defend the interests of its members in the wider society – even if it does this while proclaiming its adherence to abstract values.

Exceptions such as the scientific community apart, clans exemplify the distinction drawn by the cultural anthropologist Edward Hall⁵⁴ between ‘high context’ and ‘low context’ cultures. The distinction is almost directly derivable from differences in their respective information environments: high context cultures deal with rich, concrete, uncodified data in face-to-face situations that are complex, multidimensional and subtle, whereas low context cultures orient their transactions towards the selective use of codified abstract data in clear, simple, impersonal settings.

As with Williamson's typology, Hall's also turns out to be only half the story. If in the first case markets and hierarchies as institutionalized information processing structures can only be located along the diffusion dimension of the I-space on account of Williamson's almost exclusive theoretical focus on information asymmetries, Hall's high context and low context cultures can only be placed in the E-space. Hall is in fact aware that context affects information-sharing behaviour but his observations do not lead to any theoretical analysis of this phenomenon that might cause him to refine or extend his typology. The phenomenon of information diffusion is left out of the picture.

The issue of trust

Clan transactions are inherently uncertain. Markets can handle risk where the possible range of outcomes and their likelihood of occurrence can be specified sufficiently to shape expectations. They are less well equipped to handle uncertainty.⁵⁵ How does transactional uncertainty arise? When neither the range of external contingencies faced by transacting parties, nor their possible responses, can be identified and assigned probabilities in advance; when, for example, it is impossible to be sure that someone faced with overwhelming opportunities or threats will remain steadfast in honouring earlier commitments which turn out subsequently to be vague or leaky. Market contracting then becomes an unreliable device for securing such commitment since it acknowledges as legitimate any self-seeking behaviour not specifically constrained by enforceable contract clauses or external legislation. Caveat emptor is as much of a comment on the informational deficiencies of markets where complete contacts cannot be written as it is on human nature as we know it.

Clan transactions assume information parity among clan members and for this reason they partly escape the ‘moral hazard’ issue that arises when one party possesses transactionally relevant information that the other does not. I say ‘partly’ because one information asymmetry remains; namely, a transacting individual's knowledge of her own intentions. She may choose to disclose these or she may not. In markets characterized by spot contracting, such disclosure is hard to elicit; the parties meet, exchange, and go their own ways. They owe each other nothing beyond civility. In more continuous interactions, however, intentions may gradually be discerned. The extensive socialization efforts associated with effective clan governance are specifically designed to keep such intentions mutually aligned.⁵⁶

The elimination of moral hazard through a shared pattern of socialization is best achieved with small numbers. In any dealings between clan and outsiders, the moral hazard issue is likely to retain its full force. Within the clan structure itself, participants develop implicit forms of communication which simultaneously affirm and reinforce their ‘apartness’ from non-members; i.e., their exclusive access to a collectively apprehended reality that is either opaque or possibly invisible to outsiders. Apartness bolsters a group's identity and creates ‘barriers to entry’ which can be as varied as the initiation rites to which novices must submit on entering a religious community and the screening that applicants are put through before being admitted as members of an exclusive golf club.

Moral hazard is extensively discussed by Williamson who comes very close to the concept of information absorption, the move towards , in his analysis of information impactedness – a condition in which information sharing is perceived to be too costly to undertake on account of a transaction's lack of codifiability. Yet impacted information in Williamson's analysis simply moves one along D further to the left and towards hierarchies tout court; by leaving to one side issues of codification and abstraction, it can yield no further transactional options.

Uncertain and complex transactions pose the problem of trust in an acute way and the greater the uncertainty, the greater the amount of trust between the parties needed to overcome it. As we shall see in section 5.6, the need for interpersonal trust grows greater as one moves towards Ās in the I-space. Yet trust effectively turns out to be a required ingredient of all transactions in the lower region of the space – i.e., in Ā – where transactional contingencies can never be fully specified and catered for.

Trust relationships cannot be decreed. They either evolve or they do not. An understanding of the circumstances in which trust flourishes can be helpful in building it up, but it will remain a hit or miss affair dependent on a wide range of factors such as personality, cognition, prior familiarity with issues and agents, and so on. Prior familiarity seems to be a particularly important requirement in fostering attitudes of trust towards expected outcomes. Is there in fact any difference between the paratrooper who trusts that his parachute will open when he tumbles out of the aircraft thus saving him from a certain death, and the wounded infantryman who trusts his ‘buddies’ not to abandon him to the enemy as they pull back under attack? The former ‘knows’ his equipment and the latter ‘knows’ his buddies.

Trust is primarily a matter of prior familiarity and grounded expectations: the attribution by those who possess it of a higher probability to ostensibly uncertain outcomes or events than those lacking such familiarity would be willing to grant. Yet since familiarity requires time to build up, trust cannot be given freely beyond the boundaries within which familiarity has had time to evolve. These boundaries may gradually be pushed outwards but since one cannot be familiar with everything, whatever stock of trust is available must of necessity either get spread more thinly across people and events or it must be more selectively invested. One is then moved by degrees to trust classes of events rather than events themselves, and categories of people rather than specific individuals. What is gained in extension by codifying and abstracting in this way, however, is lost in intensity so that trust becomes a form of taken for granted knowledge subject to revision.

Of course, the process cuts both ways: a loss of trust in an individual can rapidly contaminate the social categories he is placed in. One of the major purposes of professional codes of conduct, for example, is to maintain a high degree of public trust in a group of people who exercise uncodified skills on a fiduciary basis. Professions stand to lose a great deal should that trust disappear, which is why they are often allowed to police themselves. In attempting to do so, however, they face a paradox in that the built-in disposition to trust colleagues in clan organization creates a bias in favour of the insider at the expense of the outsider – in this case the client or the public at large⁵⁷ – so that self-policing tends to become self-serving.

Clans and shared values

How does one minimize the risks involved in the granting of interpersonal trust? One looks for clues: background, reputation, affiliations, etc. But what constitutes a promising clue in a given situation will itself be the fruit of prior familiarity, of ‘learning by doing’, of a downward and horizontal move towards Ā in which information is absorbed and impacted in intangible ways. In clans such learning is a collective process. For this reason, people who share a common background, a shared system of values, will be quicker to trust each other than those who do not. The process of transmitting transactionally relevant information will be more efficient since much of it can be done implicitly – the old school tie, a certain accent or choice of words, a particular way of dressing, etc. A would-be ‘con-man’ has to, master a host of implicit codes before he is in a position to abuse people's trust. And it is precisely when the con-man fails to to ‘absorb’ the necessary codes – that is, when he has gained access to them as an outsider rather than as an insider, and thus leaves them in their unadapted, codified form – that he is unmasked. He treats them as stereotypes whose nuances escape him. He rings false for reasons that those who do possess the codes may not themselves be able to articulate. Is this not precisely the problem that ‘new wealth’ faces in passing itself off for ‘old wealth’? Does not the hurried effort at mastering the appropriate codes show through? Not always as clumsiness, but sometimes as a kind of technical virtuosity that smacks of overachievement?

The scope for the effective exercise of interpersonal trust is limited either by the number of people that can be known personally – i.e., that can be the focus of prior uncodified transactional investments – or by the number of implicit or explicit categories available to an individual for deriving reliable behavioural predictions. The weakness of stereotyping in addressing such limitations is that it so easily achieves false data processing economies. It amounts to a hurried construction of explicit categories based on traits or features that more often than not offer poor predictive value. Stereotyping leads to false generalizations about individuals that one has had no time to know better; it becomes in effect a substitute for trust, one that is sometimes imposed by cognitive overload. It is primarily the need for trust that confines clans, in contrast to markets, to comparatively small numbers and in particular to that number with whom values can be shared and expectations made to converge.

Note that convergent expectations and values do not imply that transacting parties actually have to like each other or that they must necessarily share the same goals. They must, however, be able to anticipate each other and get on to ‘the same wavelength’ in a process of mutual adjustment. They must also be united by some superordinate values or goals, however remote, that are capable of maintaining the relationship in spite of divergencies in individual interest – some of these, indeed, might actually form the focus of the transaction. For unlike market transactions, which in their pure form are quite transient and disembodied, clan transactions are deeply embedded in, and shape, long-term social relationships.⁵⁸

Consider, by way of illustration, the price fixing behaviour of a cartel. Much of the information used to reach a decision is not traded outside the group and much of it is exchanged informally in a face-to-face situation – the proverbial smoke-filled room. Since in most circumstances in a free market economy, a cartel is considered illegal, agreements must remain uncodified and must not be leaked to any party outside the group. A copious economic literature on the ‘signalling’ practices of cartels, the corporate winks and nods by which their members adjust their behaviours and align their expectations, bears witness to the uncodified and highly local nature of this communication process.⁵⁹

And yet cartels, as Chandler and others have shown, tend to be unstable structures.⁶⁰ They tend to break down when eroded by the opportunistic behaviour of their members. After all, these remain competitors at least as much as they might be collaborators. As in the Prisoner's Dilemma, the payoff to defection tends to be higher in many cases than the rewards of conformity to group discipline.⁶¹ In the face of such persistent divergencies of interests should we consider cartels to be viable clan structures?

When it comes to pure cartels, probably not. They only exist to serve a narrowly overlapping set of membership interests and no superordinate goal structure exists to make the payoff to adherence more attractive than that to defection where this can be practised either undetected or without penalty. Yet many structures economically organized as cartels successfully manage to survive by endowing themselves with a broader purpose, one which not only gives their members a collective identity that they can live with but one which also bestows upon the group a high degree of social legitimacy – in short, they find ways of increasing the degree of overlap in their members ‘ individual interests.

Medieval guilds and corporations offer one example of such a structure.⁶² To be sure, their demise from the end of the Middle Ages onward can be attributed to the gradual defections of their members lured away by the more attractive economic opportunities offered by nascent market relationships. Yet this only happened when the credibility of the superordinate goals guilds had been proclaiming had already eroded and they came to be perceived by both insiders and outsiders as pure cartels with no socially legitimate interests beyond narrowly sectional ones. Today many professions are confronted with a similar development: the ethic of disinterested professional service is increasingly viewed by the public and its representatives as a veil drawn over less altruistic economic motives.⁶³

The scope of clan governance

The term ‘clan’ as used here will refer to a non-hierarchical group of limited size transacting on the basis of shared intangible knowledge and values. In theory, at least, tacit knowledge and values can be diffused to much larger groupings than clans since their inter-generational transmission from parents to children can often compensate for the spatial and other obstacles that exist to the intra-generational transmission of uncodified knowledge. In this way, much uncodified knowledge reaches populations in D beyond the reach of transactional structures such as clans, and certainly well beyond what appears to be indicated by the diffusion curve itself. Such knowledge, however, not only diffuses extremely slowly but is distorted by heavy information losses. The ‘high context’ in which various categories of receivers make use of such knowledge becomes ever more diverse and leads to a form of cultural ‘speciation’⁶⁴ in which values and understanding get differentiated to create new and distinct groupings.

Yet, for all that, it still remains true that socialization mechanisms can be effective in larger groupings than clans. The shared sense of belonging to a single nation, or sometimes to a single species, diffuses beyond small numbers and works to mutually align the behaviour of even perfect strangers in ways that go beyond what is required for market exchange. Where does this shared sense of belonging come from?

Theories exist that purport to account for the coherency of such diffusion mechanisms. Carl Jung, as we have already seen, argued that we all share in the possession of primordial images, archetypes which as a species we have inherited from the earliest times.⁶⁵ These form what he called our collective unconscious. Yet if primordial uncodified knowledge can be universally shared in this way, on what grounds can we then argue that the use of uncodified knowledge will tend to confine transacting to small numbers? Are we not in fact capable of attuning ourselves with anyone with whom we are able to share some common elements of socialization?

Up to a point. Pushed to extremes, a Jungian definition of shared uncodified knowledge can easily become a reductio ad absurdum of our transactional categories. Whatever the personal and cultural variations in the way we choose to interpret events, there remains a sense in which we all ‘know’ that the sun will rise tomorrow and that nasty things tend to happen to people who jump off cliffs. This knowledge may be implicit but it is nonlocal. Thus to categorize someone as human is at the outset to set brackets around the range of experiences and behaviours that might be expected of him/her.

Yet categorization becomes trivial if it does not help to discriminate between prospective transactional partners. In a market the discrimination required may not run beyond a brief assessment of ability to pay – and even then enforceable contract law often keeps this requirement to a minimum. Personal considerations, therefore, need not be involved. The key requirement that sets a limit to the number of potential participants in any transaction, then, is the common possession of transactionally relevant knowledge. The fact that a banker and client both know that water does not run uphill in no way helps the first to decide whether the second will pay back the loan she is requesting. For that, a detailed knowledge of the applicant's background and what she is about is likely to be more helpful to the banker than a nodding acquaintance with hydraulics or geophysics. Some of the banker's knowledge concerning the applicant may be well codified -her university diploma, military or medical records, etc. But the banker's confidence will be greatly increased if the applicant has been recommended by a long-standing mutual friend, or, better still, if she has already been known to the banker for a number of years.

It is this interpersonal investment that creates transactionally relevant uncodified knowledge, a process limited by time and the availability of agents – what Hayek has termed local knowledge⁶⁶ and what in Chapter 2 we have defined as concrete knowledge. Small numbers merely reflect the spatiotemporal constraints that limit such interpersonal investments. We call them clans because they operate on the basis of exclusion, distinguishing between those who by dint of personal effort or good fortune possess the relevant knowledge and those who do not. Only the former are then admitted into the transactional arena.

Clans create in-groups and they create out-groups. In-groups are bound together by feelings of loyalty and mutual obligations and sometimes by feelings of hostility towards out-groups.⁶⁷ The polarization of such relationships is itself the product of information asymmetries and uncertainty since the former are known and hence understood and trusted, while the latter are often the target of ignorant speculation and prejudice.

The amount of knowledge deemed to be transactionally relevant varies considerably from one grouping to the next. We might hypothesize that the smaller the informational requirements of the typical transaction, the larger the feasible size of the clan that can handle it is likely to be. A team of research scientists working on an advanced basic research project, for example, has sophisticated and complex information requirements, much of the information being uncodified; it might therefore not run to more than a dozen colleagues.⁶⁸ A Chinese family clan in Fujian province, by contrast, may draw on little common knowledge beyond a rudimentary awareness of the clan's origins and subsequent history and for this reason could run to 6,000 or more members.

5.6: FIEFS

The information characteristics of fiefs

In transactional terms, fiefs are the antithesis of markets. If the latter are characterized by the rapid impersonal diffusion of abstract codified information (CAD) that works to achieve a self-regulating outcome, the former describe a transactional structure that deals in uncodified, concrete data (Ā) that is hard to transmit – even face to face – and that leads to highly personalized hierarchical relationships, usually of limited reach, and expressive of cumulative information asymmetries between transacting parties.

Fiefs can either emerge spontaneously from interpersonal processes already occurring in Ā, or more gradually from bureaucratic or clan failures. The first type of failure results from an inability of the bureaucratic rule to adequately encode transactional complexities. The second type of failure reflects information-sharing problems and the presence of durable information asymmetries between transacting parties. Both kinds of failures, each in its own way, end up placing hard to codify – and hence diffuse -transactionally relevant information in one or a few hands, thereby endowing them with considerable personal power.

One example of the fief type of transaction will be found in the patriarchal family units of pre-industrial societies, units which vest paternal authority with a primordial wisdom designed to inspire a feeling of awe and submission. Although such authority is deemed to be benevolent, it is also absolute and brooks no restraint within the immediate family unit. The father figure is sometimes charismatic; that is, endowed with special powers that guide its actions and confer on them an aura of infallibility.

Charismatic authority is, of course, not the only source of paternal power. Douglas⁶⁹ and Bernstein,⁷⁰ for example, distinguish between personal families in which parental authority rests on the manipulation of thoughts and feelings, and positional families in which a child grows into a set of unchallenged categories. Only in the first case, if authority is invoked, is it likely to be charismatic; in the second it will be traditional. Charismatic and traditional authority constitute two of Weber's three basic categories of authority – the third being bureaucratic.⁷¹ Traditional authority, in effect, can be thought of as a halfway house between totally uncodified and personal charismatic authority on the one hand, and codified and impersonal bureaucratic authority on the other. To be sure, rules are involved in the exercise of traditional authority, but their interpretation and application remain more personalized and less rationally grounded in universal principles than in the case of bureaucratic authority.

In personal families authority need not be centralized; with the modern American middle-class family, a charismatic structure often gives way to something more akin to a clan. Relationships between family members remain highly personalized and a measure of decentralized social control can be achieved through an appeal to internalized family values. The process becomes consensual rather than authoritarian so that ‘Dad’ ceases to be a god and instead becomes a ‘buddy’.

The highly personalized forms of knowledge that are a major source of power in fiefs are most effectively applied when there is little or no codified or abstract information to counterbalance it: the wisdom of the elders is always vulnerable to challenges originating in the growth of structured abstract knowledge visible to all and open to rational criticism. Yet, paradoxically, the reach of such personal power also remains limited unless it can be amplified by complementary transactional structures operating at a more codified and abstract level – a point we shall have occasion to discuss further in the next chapter. Within its own transactional orbit, however, the power available in fiefs can be absolute and offers its possessor considerable discretion as to how it is exercised.

The origins of the term

But why the label ‘fief’?

Taken in its Eurocentric historical sense, a fief describes a territory and its inhabitants over which a vassal was empowered to rule by his liege lord. The granting of fiefs and, below them through a process of subinfeudation,⁷² of subfiefs created a personalized hierarchy of authority in which protection and rights were granted by a superior in return for loyalty and the performance of certain obligations by a subordinate. The resulting social order went by the name of feudalism; it emerged in Europe in the ninth and tenth centuries in a decentralized form to fill the institutional vacuum created by the collapse of the Roman Empire in the fifth century.⁷³ The feudal economy was essentially manorial and was built around non-monetary exchanges that were highly local in nature.⁷⁴ Following the barbarian invasions, and in Southern Europe the Islamic invasions of the eighth century, the Roman transport infrastructure that had linked different parts of Europe to each other had fallen into disuse, fragmenting the economic space and offering little opportunity for large-scale specialization prior to the re-emergence of cities as centres of industry and commerce from the tenth to the twelfth centuries.⁷⁵

Although feudalism as a form of economic organization has existed in many parts of the world – in China, unlike in Europe and Japan, it remained centralized⁷⁶ – it is no longer considered compatible with the needs of industrialization so that in many cultures it has become a term of abuse. Indeed, even Karl Marx, his devastating critique of nineteenth-century capitalism notwithstanding, credited capitalism with clearing away the cobwebs of feudalism and the forms of human bondage historically associated with it ⁷⁷However, even today what might loosely be called feudal relations linger on or are deliberately maintained in a wide variety of social organizations. It follows that fiefs, although not necessarily institutionalized as a legitimate transactional form in their own right, may still constitute an effective driving force in many different types of social exchange.

Clearly, we are not using the word ‘fief here to describe the possession and control of a physical stretch of territory. Prior to industrialization, control over land was effectively control over resources. With industrialization, however, resources became more mobile and could therefore be owned independently of territory. And with the information revolution, resources have become more mobile still. Have fiefs therefore disappeared? In the institutional sense of a chunk of real property handed down by a territorial magnate to his vassal together with a bundle of personal rights and obligations attached to it, perhaps. But fiefs, taken as the exercise of personal power over highly localized people and things and based on the monopolistic possession of a scarce resource, live on.

In this section, therefore, we shall be discussing the fief as a transactional structure that crystallizes around the tacit and personal possession of potentially useful knowledge as a scarce resource. Under suitable circumstances such knowledge, in spite of its inherent lack of diffusibility, can be selectively imparted to others – albeit slowly and usually interpersonally -and hence can be traded for the loyalty and obedience of a privileged group of recipients. A successful entrepreneur or the head of a family business may both often operate in fiefs used in this wider sense no less than fudai daimyo or a tozama daimyo did under the Tokugawa Shogunate.⁷⁸

Fief values

What kinds of values and beliefs bestow on fiefs their legitimacy as a transactional order?

Perhaps the most crucial is a social acceptance of the exercise of personal power by those deemed to possess certain gifts and, by implication, of a duty of loyalty and obedience by those who do not. These gifts need not necessarily reduce to the simple possession of knowledge as such – they could for example alloy such possession with military prowess, the display of outstanding virtue, or a demonstration of magical powers⁷⁹ – but in all cases, and this is what concerns us here, the knowledge in question is likely to take the form of divine inspiration, of extraordinary insight, and will generally be deemed beyond the reach of the common run of mortals. Such knowledge may not be of the conceptual or intellectual kind and in certain cases it will only find expression in a display of physical or technical virtuosity. A world-class tennis player, for example, possesses this kind of knowledge, as do in their own way concert pianists, orchestra conductors, and painters. In all these cases, the gift is not transmissible other than by the force of example, and the knowledge and insights it embodies cannot be properly articulated in words. It can therefore only be conveyed very gradually, and with considerable risks of failure and misunderstanding, to disciples or followers willing to accept the authority of a ‘master’ on trust.⁸⁰

Transmitting personal knowledge in this way requires the co-presence of communicating parties and, above all, time. Spatial proximity and a hefty time commitment are essential ingredients for the effective transmission of tacit knowledge. Given such constraints, a master may be able without too many difficulties to secure the devoted following of, say, twelve disciples;⁸¹ but if he then wishes to extend his following to 1,200, the way that he transmits what he knows will necessarily undergo some subtle changes. With larger numbers, face-to-face communication will lose its nuance and some coding conventions will have to be introduced. It may even be that parts of the transmission process will have to be entrusted to others now acting as relays. The master's charisma will now run the risk of becoming routinized, to use Weber's term,⁸² and his personal authority will be under a constant threat of challenge from the impersonal rule underpinning such routinization.

Like clan transactions, fief transactions of necessity involve small numbers and operate on the principle of exclusion. To personally serve a charismatic leader is a privilege available to only a few, a privilege that must be won by continued demonstrations of loyalty and devotion. Although charismatic authority can at times be exercised in a diffuse manner over very large numbers – witness the ability of a Napoleon or a Mao to win, at least temporarily, the affection of millions of followers – it only effectively commands absolute and unconditional obedience from small numbers and even there poses problems of transmission to successors. Fiefs, therefore, tackle the problem of agency by keeping numbers down to a minimum and imposing unusually rigorous selection requirements on potential followers.⁸³ In many cases, the criterion of eligibility to be considered a follower or a potential successor is often itself the possession of some charismatic power. In this way a charismatic community is created.

The power of fiefs

The exercise of purely personal power cannot easily be constrained by rules of accountability. Individuals may in time come to lose their charisma, but while they possess it, usually no direct causal links bind them in the use of their powers to the realization of specific outcomes or performances to which they are committed. Following floods or a famine, for example, the Chinese emperor might conceivably be deemed to have lost the mandate of heaven; yet natural catastrophes could usually only be loosely related to his conduct so that such a contingency was in fact extremely unlikely. Ambiguity is a solvent that allows personal power to remain capricious if it wishes to be, and hence always potentially dangerous. Its acceptance by followers therefore requires a high degree of trust on their part that it will be applied to ends that they consider legitimate and that it will not be exercised at their expense. Followers of a charismatic leader are always vulnerable. They therefore need to be reassured. The ‘Son of Heaven’, for example, kept his mandate in a good state of repair by a continuous display of benevolence just as the medieval lord and his vassal were bound to each other by a chivalrous code of honour that affirmed a broader set of principles.⁸⁴ In the patriarchal family, paternal wisdom is assumed to have only the welfare of children and the future security and prosperity of the household at heart.

The most egregious abuses of personal power will in fact often be tolerated as long as they can be veiled by a credible appeal to higher values.⁸⁵ Even as destructive a paranoia as Stalin's could be sustained while he was able to project himself to a sufficient number of immediate followers as an avuncular figure concerned only with the welfare of his people.⁸⁶

The fragility of fiefs

Fiefs, dependent as they are on the judicious use of individual personal power, usually perish with it and perhaps for this reason constitute the least stable of our transactional categories. The way that such perishable powers are preserved for transmission to successors provides some clue as to how fiefs fail.

Followers seeking to maintain their prior transactional investment in a leader who has disappeared may attempt to routinize his charisma by embodying it in practices or rules over which they will exercise custody. Thus we have the Mosaic laws, the rule of St Benedict, the ancestral code, etc. In a first phase, we might move towards a form of traditionalism in which personal authority continues to be exercised by designated successors but where the scope for discretion is now restricted by precedent and customary practice. In a second phase, as the number of followers expands inter-generationally, rule-based authority, now rationally determined and impersonally applied, may gradually come to replace the exercise of personal power, and the uniquely gifted individual, acting on prior experience and intuition alone, gives way to the technically trained official applying an abstract rule according to purely rational and impersonal criteria. This move from fiefs into bureaucracy follows the SLC in the I-space and is consistent with a gradual articulation and structuring of the transactionally pertinent knowledge base. Here the fief fails where no mechanism is available either for the preservation of charisma or for its faithful transmission from one generation to the next. Religious leaders sworn to celibacy, for example, may be forced to designate their successors and thereby split their following. Where transmission mechanisms are available – as in the case of a royal blood line – charismatic authority may in fact be preserved for a considerable time across generations unless openly challenged or abused.⁸⁷

Fiefs also fail when personal power is fragmented among followers. Hereditary charisma might be preserved intact through the institution of primogeniture, or it could gradually diffuse through all descendants of a particular blood line. In the second case, it might rapidly be dissipated through a competitive struggle for dominance among contenders. Yet it might also be successfully preserved as a communal possession through a collegial exercise of power – keeping it in the family, so to speak. Either way, the move towards the right in the I-space is one from fiefs to clans – albeit with possibly more stability in the latter instance – one that amounts to a successful move against the flow of the SLC.

In sum, as with the other institutional structures described in this chapter, fiefs can fail either by following the SLC or by moving against it. It is the specific configuration of information flows in the I-space that channels transactions towards or away from particular institutional structures and hence determines how these will evolve over time.

5.7: TRANSACTIONAL EVOLUTION

Transactions in the SLC

The main features of our transactional typology are given in Table 5.1. It is far from exhaustive since many forms of social exchange overlap or shade into each other to create new subcategories. Its significance derives from the fact that it is more than just a classification of empirically observed transactional behaviour – for all its magnificent erudition, this, in effect, is what Max Weber's Economy and Society amounts to;⁸⁸ it is the analytical fruit of a theory of information flows. Although we cannot specify here in any great detail the causal relationships that link particular transactional behaviour patterns and given information environments, we can offer the refutable hypothesis that they are related, and that any failure of a particular transactional order will be associated with changes in the underlying distribution of information available in the data field resulting from the dynamic action of the SLC.⁸⁹

Table 5.1 Profile of transactions in the I-space

Bureaucracies		Markets		Fiefs		Clans
Information is abstract, codified, but undiffused -i.e., its diffusion-i.e., under central control. Example: the monthly financial report		Information is abstract, codified, and diffused. Example: prices		Information is concrete, uncodified and undiffused. Example personal childhood memories; expertise		Information is concrete, uncodified, but enjoys limited diffusion - i.e., to groups, rather than the target population as a whole. Example: myths, oral traditions, etc.
Relationships are impersonal, identity does not matter		Relationships are impersonal, identity does not matter		Relationships are personal, identity does matter		Relationships are personal, identity does matter
Control is external, shared values and trust are not necessary		Control is external, shared values and trust are not necessary		Control is internalized, shared values and trust are necessary		Control is internalized, shared values and trust are necessary
Coordination is hierarchical and formal		Coordination is horizontal and self-regulating (the invisible hand)		Coordination is hierarchical and informal		Coordination is horizontal and carried out through mutual adjustments
Goals are imposed from above		Each player is free to pursue his/her own goals		Goals are imposed from above		Goals are negotiated between players
Core institutional value: obedience to the rule		Core institutional value: transactional freedom		Core institutional value: loyalty and submission to a leader		Core institutional value: loyalty to the group

Transactions may either follow shifts in the distribution of knowledge in the data field or they may provoke them. To illustrate: a small firm manufacturing a complex technical product but relying essentially on the uncodified know-how of a skilled and experienced workforce may well be forced to codify and diffuse a part of its proprietary know-how in order to stimulate customer demand, particularly if the product is quite new and prospective buyers lack the information that would allow them to evaluate it. In so doing, the firm may open the door to potential customers mastering the procedures necessary to enter the business themselves. From what had originally been a strong monopolistic position in Ā, the firm may be forced by degrees to shift to a more vulnerable one in CAD – a move along the SLC from fiefs to markets.⁹⁰ The move, although initiated by the firm itself, was prompted by the need for a stronger market orientation and the consequent need to relax its monopolistic grip upon its proprietary knowledge base. In this particular example, the transactional shift, although provoked by the firm's own actions, followed the SLC; but, as has been indicated in the previous sections, countercyclical shifts are also possible.⁹¹

Grid and group: Mary Douglas's typology

One way of bringing out the theoretical distinctiveness of our transactional typology is to compare it with one that shares its cognitive orientation but is less grounded in a specific theory. Recall from Chapter 2 that Mary Douglas in her book Natural Symbols⁹² has analysed the relationship between the value systems and cosmologies held by different social groupings on the one hand, and their cognitive and power orientation on the other. Using a conceptual tool that she labels grid and group, Douglas has produced a provocative analysis of belief systems and their associated forms of social organization in a variety of cultural settings. An illustration of her approach is given in Figure 5.2 which uses a modified version of grid and group to produce a typology of family values.

The vertical axis, grid, describes the communication style among group members as a function of the cognitive elaboration of categories and concepts used. Thus at the top of the scale, interpersonal discourse uses what Basil Bernstein has termed a ‘restricted code’, in which much content is left implicit, and shared and familiar experiences are left to fill in the gaps. At the lower end of the scale, by contrast, communications between family members draw upon an ‘elaborated code’⁹³ which is much richer and conceptually explicit. Clearly, we have here a distinction similar to the one Edward Hall has made between ‘high context’ and ‘low context’ cultures⁹⁴ and that we ourselves have established between uncodified and codified communications.

Figure 5.2 Grid and group: a typology of family values

Turning now to the horizontal scale, group, Douglas analyses power distribution within a group, with individual freedom to pursue one's own goals being located on the right of the scale, and the necessity to submit to hierarchically imposed goals on the left. Commenting on her typology, Douglas observes:

The area of maximum structuring of the family is on the left: the area of maximum openness and freedom from structuring is on the right. In the bottom right, the individual emerges as free as possible from a system of socially structured controls ... The people who have been freed most completely from structured personal relations are among those most involved in the complexity of modern industrial structure.⁹⁵

In effect, we would argue, they are involved in market transactions as one can immediately see by inverting the vertical scale and superimposing our recently derived transactional categories on to Douglas's value typology (Figure 5.3). To those who have followed the transactional analysis presented in this chapter, the resemblance between Douglas's typology and our own should appear quite striking.

The key difference, of course, is that our own analysis is built upon a theory of information-based production and exchange whereas Douglas's classification is derived from observed attributes of thought and behaviour in different cultural settings. We might say, following Simon, that Douglas's typology is data driven whereas our own is theory driven.⁹⁶ That the two should be so close is encouraging but it should not obscure the fact that the scope of Douglas's approach remains somewhat circumscribed by its lack of grounding in a general theory. Our scheme offers her such a theory.

Figure 5.3 A transactional typology located in grid and group (vertical scale inverted)

Douglas's work is certainly closer than our own to what Robert Merton has described as ‘theories of the middle range’.⁹⁷ Yet by focusing on observed behaviour rather than on the information environment that supports it, Douglas has no way of explaining the evolution of structures and belief systems over time, or the possible shift from one structure to the other. Power and cognition in grid and group can yield a classification, and, to be sure, a useful and illuminating one at that, but they remain theoretically disjoint. We know that they interact and mutually influence each other, but the mechanisms are not articulated sufficiently to be theoretically relevant. In the absence of a dynamic theory of information processing and flows, Douglas has no way of moving from one part of the space she has created to another. Intriguing and suggestive as it is in many respects, her scheme is more of a taxonomy – a classification based on observed traits and only modestly guided by an underlying theory – than anything else, and for this reason it enjoys relatively modest predictive power.

It is, then, the derivation of our transactional typology from a dynamic theory of information behaviour that endows it with the power potentially to predict not only what belief and value systems might be associated with a given transactional structure – to some extent, Douglas's grid and group does this as well – but also how these are likely to evolve over time and under what circumstances. This claim will be further discussed in the next chapter and illustrated in Chapter 7. Here we shall confine ourselves to a couple of observations.

Transactional competition and collaboration

Transactions may originate in one region of the I-space alone but not necessarily.⁹⁸ A large project, for instance, may trigger off a complex pattern of exchanges which draw upon several different transactional structures simultaneously. When transactions occur in such clusters, there is no reason to suppose that they all exert their effects independently of each other, or that they are all drawn from neighbouring regions of the I-space. Indeed, transactions located in different regions of the space may well act so as to mutually reinforce each other, so that one is not necessarily led to make exclusive choices between markets and hierarchies, fiefs or clans; it may therefore be possible to operate with several transactional types concurrently and then subsequently to integrate them.

An example may help to make this clear. It is a commonplace that in the real world, the self-regulating character required of efficient markets is not sufficiently developed or pervasive to ensure socially equitable outcomes for all would-be participants.⁹⁹ The very act of codifying market knowledge such as prices, of course, opens the door to some possibility of control by reducing the degrees of freedom inherent in transactional knowledge. Yet the locus of such control along the diffusion dimension of the I-space remains as yet unspecified. Self-regulation, for instance, would embed it within each self-seeking participant in the market itself. Where transactional data is insufficient, however, much of the control process may still be left to self-regulation, but now judiciously augmented by some measure of hierarchical control. The market may be policed and would-be participants might therefore be required to register with some external authority prior to or subsequent to any exchange – a move away from the anonymity that results from absolute freedom of entry and exit in impersonal atomistic markets, and towards a hierarchically determined eligibility to participate. Bureaucratic and market transactions operate synergistically in such circumstances: the greater the potential volume of market transactions, the greater the pressure from potential entrants to achieve transactional eligibility, and the more rationally and fairly this can be achieved – even if through bureaucratic means – the greater the general willingness to transact and hence to increase the volume of market transactions.

North holds the rational-legal apparatus of the state bureaucracy to be an essential complement to market processes if transaction costs are to be brought down to the point where a sufficient number of players are willing to use markets in efficiency-promoting ways.¹⁰⁰ Yet as he himself points out, a political element is rarely absent in such transactions. To take our example one step further, the rationality or fairness of the regulatory bureaucratic transaction itself might on occasion be open to challenge and may need to be bolstered by the legitimating presence of a charismatic figure located in fiefs but sitting atop the bureaucratic structure itself. In Great Britain, the Monarch, with his or her reserve powers, performs the function of a charismatic backstop should a failure of the political or bureaucratic apparatus – here taken to include the military hierarchy – occur. In Spain, the effectiveness of this reserve charismatic power of a modern monarchy was demonstrated in February 1981 when an attempt was made to seize the state apparatus in a coup, a pronunciamiento, mounted by a group of military officers nostalgic for dictatorship. Yet with a single televised speech, King Juan Carlos was able to rally popular support against the coup which then fizzled out. In another context, the chairman of the Federal Reserve Board also requires a certain charisma if he is to keep the trust of financial markets at times when the regulatory mechanisms under his control are put under strain. In Britain, a few calming words by the Governor of the Bank of England can have a miraculous effect on the psychology of financial markets – another instance of collaboration between fiefs and bureaucracies.

Transactional pathologies

The trick in many situations, then, may be to find the right transactional mix rather than making exclusive choices between competing transactional structures. Put in too much bureaucracy and self-regulating market processes get crowded out. On the other hand, build up too charismatic a leadership at the top of a hierarchy and the rational-legal foundations of a well-functioning bureaucracy begin to erode. One might usefully frame the issue in terms of countervailing transactional power, an even-handed distribution of transactions in the I-space that works against the emergence of transactional pathologies – a situation in which all transactions are channelled through one type of structure to the exclusion of others, no matter how ill-adapted that structure turns out to be to the diversity of requirements placed upon it.

As an instance of such a pathology, consider the case of pure hierarchy in which no information is ever allowed to flow horizontally between agents (as it would in, say, a market or a clan) and all relationships are vertically ordered. The creation of such a pathological structure was in fact attempted by Stalin. It operated on the basis of absolute authority unmitigated by any trace of countervailing power. Polanyi explains how such a ‘divide and conquer’ strategy can be made to create absolute hierarchy:

It is commonly assumed that power cannot be assumed without some voluntary support, as for example, by a faithful praetorian guard. I do not think this is true, for it seems that some dictators were feared by everybody, for example, toward the end of his rule, everybody feared Stalin ... If in a group of men, each believes that all the others will obey the commands of their claimed superiors, each will obey.¹⁰¹

Other examples that at times got close to becoming transactional pathologies were furnished in the 1980s by attempts in the US and in Britain to force large tracts of social exchange best handled by other means exclusively through market processes. That the market should be ever present as a competitive transactional alternative is not disputed, but in their more extreme forms, Reaganomics in the US and Thatcherism in Britain amounted to an unbridled pursuit of individual self-interest, unmitigated by any feelings of fellowship or common sentiment. The alienating effects of markets on individuals had been the burden of the Marxist critique of capitalism in the nineteenth century, although it should not be forgotten that the Marxist-Leninist alternative to treating labour as a commodity that could be impersonally bought or sold was to treat it as a commodity that could be impersonally ordered about. As transactional pathologies, pure markets and pure hierarchies rival each other, and it should not be supposed that pure clans or pure fiefs offer any improvement.

The issue of transactional mix will be taken up again in the next chapter. We conclude this section by noting that transactions, as forms of social action, incur costs measured in terms of time, space, energy, and information. Where they occur in large volumes and on a recurring basis, some thought may be given to minimizing these costs for a given transactional effect. A structure might then be created to channel transactional energies more efficiently. Such a social investment in transactional infrastructure creates specific institutional forms that express the scope for economizing in different parts of the I-space. The economizing perspective on institutions is developed in the next section.

5.8: INSTITUTIONALIZATION

Characteristics of institutions

Institutions are stores of established social practices, structures through which we externalize collective memories, representations, values, norms, rules, etc., in order that they should outlast us. Giddens calls them ‘chronically reproduced rules and resources’.¹⁰² Only transactions that are unusually salient in their consequences for social life, or that are recurrent, will normally justify the costs of a specific effort at institutionalization; that is, of creating a structure tailor-made for their governance. The less salient or more transient interactions that form the stuff of everyday life are usually accommodated within existing institutional structures, and these may be only roughly adapted to their individual governance needs.

North argues that an organization stands somewhere between the evanescent transaction and the more permanent institutional order, a particular concretization of a given set of institutional practices.¹⁰³ The commercial firm, for example, expresses specific property and employment relations, forms of rationality embodied in particular accounting and managerial practices, and a set of economic values that originate in the tradition of possessive individualism.¹⁰⁴ The typical firm, then, constructs its internal organization from a pre-extant and available institutional repertoire; it does not start from scratch.

Transactions involve an exchange in which some knowledge and information is transmitted from one party to the other. Where transactions are regular in character and recurring, the knowledge they build on may come to acquire an absolute and objective quality that subsequently locates it in that part of our experience that Schultz calls the life-world (Umwelt) and that we take as ‘given’.¹⁰⁵ The processes of abstraction described in Chapter 2 by degrees transform the concrete and local knowledge of individual transactions, provisional and uncertain as it might be, into a universal knowledge embedded in institutions and consequently perceived as forming an unalterable part of the natural order. Such knowledge may or may not satisfy strong requirements of epistemological validity. Yet whether or not it can be adequately corroborated according to specifiable universal criteria, for some identifiable social groups it becomes, through a process of absorption and impacting, part of the socially taken-for-granted stock of knowledge that is implicitly held, and hence comes to acquire a legitimacy and an inertia of its own.

Institutions as potential intelligence

Institutional knowledge of this kind can be thought of as a form of potential intelligence in the sense used by Gregory and discussed in Chapter 4. Gregory distinguished potential and kinetic intelligence as follows:

We live off intelligence stored in artefacts designed by our ancestors. These solutions are of enormous potential use for our problem solving. We no longer have to invent roofs or scissors when we know about these things. So education increases our ‘internal’ potential intelligence, through giving knowledge of what problem solvers or aids are available.

... Kinetic intelligence is on this account mainly gap filling, necessary where solutions are not adequate as stored potential intelligence ... To the extent that problem solving follows established rules, it draws upon potential intelligence in discharging a kinetic function’.¹⁰⁶

Of course, the potential intelligence of institutions is embedded in individual minds as well as in physical objects such as books, physical structures and so on. In Popper's terminology, then, institutions must be considered World 3 objects that are stored partly in World 2 and partly in World 1.

Potential and kinetic intelligence can be viewed as substitutes for each other: the more of the one is available to solve a given problem, the less the need to draw on the other. Yet in so far as potential intelligence is also a sunk cost borne by earlier generations, and hence not recoverable, the bias will inevitably be towards letting bygones be bygones and economizing primarily on kinetic intelligence, the cost of which is directly borne by an existing generation. In an economic sense, therefore, a predisposition to be bound by the past and inherited traditions is often a rational solution to a cognitive investment problem that requires a marginal cost approach. This remains so even though a marginal cost approach sometimes imparts a considerable inertia in the face of needed changes to the institutions that perpetrate such traditions.

Transacting at the margin in the institutional order

The foregoing observations lead us to a simple proposition: if we incorporate the intangible costs of aligning values and attitudes with choices made into our definition of transaction costs, alongside more tangible ones such as physical effort or search, then a concern with transactional efficiency will assign transactions to those parts of the I-space in which prior transactional investments – i.e., the ready availability of potential intelligence – will offer the greatest marginal returns; that is, to those parts in which institutionalization either has already occurred or is under way.¹⁰⁷

Another way of saying the same thing is that prior institution building serves to lower the marginal cost of transacting and thus helps to channel the uncommitted transaction into those regions of the I-space where institutional structures are to some extent already available.

At this point, an objection might be raised. Surely, once the process of institution building has got under way, based on some initial cost advantage one institutional form will sooner or later come to predominate and all others must of necessity wither away for lack of competitiveness. After a while, therefore, genuine institutional choice will effectively disappear. Once a marginal cost advantage has been achieved, a vicious circle is set in motion in which the more transactions are drawn to a given part of the I-space, the greater the scope for institution building there and the further the marginal cost of transacting drops, hence attracting further uncommitted transactions, and so on. The institution becomes in effect what mathematicians call an attractor and what speaking somewhat more metaphorically we might call a transactional black hole: it draws into its orbit transactions that might initially be floating in quite remote parts of the data field and keeps them there, forbidding all escape.

Joseph Schumpeter conceived of the passage from a capitalist to a socialist order to be of this nature, with the giant industrial firm conferring an initial economic advantage on internal bureaucratic transactions which, as they grew in volume and scope, would gradually drain market institutions of their transactional content. Once the transition to a hierarchical order was complete, the state would only need to take over a few giant corporations to usher in a command economy.¹⁰⁸

This ‘winner takes all’ objection elicits four counterarguments. The first is a purely economic one, namely, that the marginal costs of transacting beyond a certain point will cease to fall when scale and learning effects have been exhausted and will gradually start to rise again. Without major modifications to the institutional structure that will increase its transactional capacity beyond the limits that have now been reached, at some point it will begin to lose its attractions. Such a modification, however, represents a major investment the viability of which is by no means guaranteed when ranked against alternatives, themselves competing on the basis of incremental costs.

The second counterargument is linked to the first in that the psychological component of the cost of transacting – the values and beliefs that facilitate or constrain a transaction – frequently looms large and for the most part remains hidden. The comment ‘he would sell his own grandmother’, for example, points to implicit limits beyond which the market transaction would be in violation of deeply held social norms, and would be considered pathological in the sense discussed in the previous section. And just as not all forms of social exchange will be allowed to pass through markets, so too bureaucratic, clan, or fief transactions will discover limits to their dominion. For all its ideological ardour the communist leadership in China did not succeed in replacing the peasant family with the work brigade. The psychic costs to individuals proved too high, no matter how attractive such a form of social organization might be on other grounds.¹⁰⁹

If the psychological costs of transacting through institutions in ways that are at odds with social values and norms is taken into account in any economic evaluation of competing alternatives, then one would expect to see these costs rise as an institution reaches out into the I-space to capture transactions far removed from its own natural information environment.

A third counterargument is that to rising marginal costs and psychic costs must be added the transaction costs of choosing between transactional options.¹¹⁰ Options have to be discovered and evaluated and in the absence of full information the switch from one to the other is not frictionless. Suboptimal choices may thus allow competing transactional options to co-exist under a ‘satisficing’ regime.¹¹¹

A final counterargument would point to the static nature of the information environment assumed by the objection. The knowledge underpinning the institutionalization of transactions, like all phenomena that rest on a physical substratum, is prey to the ravages of time.¹¹²

Firstly, it is subject to obsolescence which appears when prior institutional investments no longer meet current transactional needs. The inductive procedures that gave situation-specific and concrete transactional knowledge its objective and universal character break down, and taken-for-granted transactional arrangements are suddenly found wanting in corroboration. As the contingent nature of the assumed transactional order suddenly becomes discernible through the smooth and seamless surface of events, confidence in the solidity of the institutions that had underlain it gets eroded. At this point alternatives are sought.

Secondly, the action of the SLC itself is constantly redistributing knowledge throughout the data field so that, for example, information which might have been appropriable for the exercise of hierarchical control at a given point in the cycle ceases to be so as it diffuses to ever-wider populations: as they get hold of transactionally relevant knowledge these may begin to impose a market style on the marginal transaction that better reflects the emerging exchange possibilities offered by the new information environment. Attempts at a bureaucratic solution under such circumstances will prove to no avail.

The operation of black markets illustrates this last point: a central authority that lacks the appropriate administrative mechanisms for imposing a total hierarchical control upon a given class of economic transactions must resign itself to tolerating a parallel and competing transactional structure that is market oriented and that draws its strength from the wide availability of leaked information.

Or again, taking an example from further along the SLC, what may start out initially as an efficient market gradually gives way to clan transactions as locally recurring encounters reveal the identities of certain parties to each other and help to personalize their relationship. An in-group may then slowly crystallize in cases where participants prefer to do business with each other. Criteria of group membership can vary: ethnic background, a common education, religious affiliations, and so on. As with all clan transactions, however, personal identity matters, and in this example identity is built up by the SLC itself upon reaching a certain region of the I-space. There, the intangible experiences that transacting parties come to acquire of each other through ostensibly impersonal and arm's-length market transactions reflect the cumulative effects of learning by doing. Transactions, of course, may then move on further along the SLC – possibly towards fiefs.

Institutions as entropy-reducing devices

In sum, stored knowledge at any one location in the I-space depreciates over time and if institutions are the expression of a cumulative social learning process, they are also subject to forgetting - i.e., information losses that reflect either the disorganizing effects of entropy, or the onset of atrophy and a consequent loss of utility, with both working in harness most of the time. For this reason, the institutional order can never be static. Where it appears to be so, it is because a state of dynamic equilibrium has been reached in which for some unspecified period, the rate of transactional investment in the maintenance or development of a given institutional structure exceeds the rate at which it depreciates.

The consequences of this last point bear spelling out. Considered as a moment in the progress of the SLC, for example, market equilibrium would appear to be a much more precarious phenomenon than neoclassical economists – and indeed some neo-Austrians¹¹³ – would have us believe. Their faith in the potential stability of market processes stems from an assumption that all transactionally relevant knowledge sooner or later finds its way into the market region of the I-space and stays there. It may start life as local knowledge, as Hayek maintains, but it gradually gets abstracted from its concrete particulars, becoming universal and available to all. In the neoclassical perspective, social learning is never a disequilibrating process; in the Austrian perspective, on the other hand, it is equilibrating in that phase of the SLC that precedes an entry into the market region and disequilibrating when it moves transactions out of that region and towards clans – a phase of the SLC that in a political context Roberto Michels has labelled ‘the iron law of oligarchy’.¹¹⁴

Let us further elaborate the point. Those institutions with the greatest depth of prior investments will be the slowest to ‘forget’ through the disorganizing influence of entropy. In the language of Chapter 2, they will have the greatest capacity to minimize entropy production. Good for the institutions perhaps, but not necessarily for the system as a whole since they may then become vulnerable to obsolescence and atrophy.

The problem arises as an inevitable consequence of codification itself. Knowledge that has been codified, as we have already seen, is knowledge that can be stored – on stone tablets, on microfiche, on paper, on computer tape, etc. It loses the transience of knowledge stored in the neural cells of a living brain. Its durability can be impressive: the Hammurabi code has been preserved for nearly 6,000 years since it was first set out on stone tablets in the Mesopotamian basin. In one sense, we are not about to forget the Hammurabi code; it forms part of our archaeological heritage. But in another sense, that is effectively all that the code has become for us today: archaeology. It has little to offer by way of practical guidance to twentieth-century man; as knowledge it is obsolete.

As well as being stockable, codified and abstract knowledge can travel faster and further than the uncodified sort; it can thus diffuse rapidly across space to contemporaries as well as durably over time to descendants. Yet the more it roams the I-space, the further such knowledge moves from a given institutional base that it was feeding and sustaining and into institutional alternatives that over time may come to constitute competing transactional modes. It is the SLC that works this effect: slowly in the lower regions of the I-space (in Ā) and quite rapidly in the upper regions (in AC).

Dealing with institutional obsolescence

Obsolescence expresses the impact of unforeseeable future events upon the viability of a given transactional structure. No amount of past investment can protect an institution from obsolescence when changing circumstances bring it about. A saddle might be designed to last a thousand years, yet it could still never compete against the motor car when it arrived on the scene. The onset of institutional obsolescence thus restores a certain viability to competing institutional alternatives as they crystallize out of the operation of the SLC, and this quite independently of whatever accumulated investments might have been channelled into existing institutions to prolong their existence. Codification and abstraction accelerate the process of obsolescence since knowledge having reached AC in the I-space will move faster about the space, cross-pollinating these competing alternatives. The action of the SLC, then, ensures that the forces of renewal in the I-space sooner or later triumph over those of preservation.

Perhaps another way of approaching the trade-off between institutional memory and obsolescence is to look at what happens when one invests in uncodified knowledge. Here the storage of information is a difficult business, for the commodity itself is highly perishable; oral traditions, for example, are notorious for the unreliability of their transmissions.¹¹⁵ Yet paradoxically their very lack of structure gives them a resilience and a power of adaptation which are often not available in the case of more rigidly codified practices. They survive by a process of incremental and informal adjustment to changing circumstances that is often quite unconscious. Myths, for instance, gain much of their power from their plasticity; they are constantly being modified and reinterpreted to serve the needs of the present. Where myths are transmitted by word of mouth, this plasticity is enhanced.

The recording and storing of codified knowledge, by contrast, creates an institutional commitment, an inertia that is frequently highly resistant to change; not only are the chances of obsolescence increased by the rigidity of knowledge-preserving structures themselves, but its consequences are made more damaging by the social legitimacy that the very existence of such structures may bestow upon past practices.

Codification, however, is only one of the variables that affects the obsolescence of the knowledge base. Its degree of abstraction is another. The more concrete the circumstances that have been codified into a given rule, the greater the tensions that arise when circumstances change but the rule remains in force. Conversely, the more general and abstract the scope of the rule, the easier it will be to adapt or interpret it to suit new circumstances. Recall from Chapter 3 that abstract knowledge gains in utility in proportion to the number of concrete instances in which it finds application. This would seem to suggest that the further up the U-space towards A we locate the knowledge base, the larger the region in the space that obsolescence has to capture before such knowledge effectively atrophies.

In sum, we might say that institutional obsolescence can be fought in two ways. The first is by keeping institutionalized transactions sufficiently vague and uncodified that they can be adapted unconsciously to new circumstances as they arise. The second is by codifying their governing principles at a sufficient level of generality and abstraction that broad classes of present and future contingencies might still be accommodated without undue strain.

These two ways of combating institutional obsolescence work within different time-frames and are often complementary. While both involve codification as a critical transactional variable, the first is primarily interested in preserving the social integrity of a transaction in the diffusion process – a problem for the C-space – whereas the second is mostly concerned with the epistemological robustness of a transaction's information base and hence with its degree of generality. It therefore looks to the E-space.

Style versus governance

The C- and the E-spaces are two of the three planes – the third being the U-space – that make up the I-space, the conceptual tool through which we apprehend the data field. The C-space orients us towards the communicative aspects of a transaction, the way that actors hoard or share information with each other. How these choose to respond to the constraints and opportunities in which their information environment places them, how far they avail themselves of the institutional structures at hand, tells us something of their transactional style.

In transacting with each other, actors pursue their own interests, albeit constrained by their adopted principles. Loosely speaking, we might think of principles as expressive of a broader, more universalistic class of interests -what Rousseau called the volonté générale to distinguish it from the more particularistic and atomized volonté de tous.¹¹⁶ Principles and interests can be ranked along ĀA in the E-space according to the degree of generality and abstraction they can demonstrate. It is reasonable to assume that the more general or universalistic a given principle or interest proves to be, the larger the transactional population whose interests it can claim to serve. The E-space therefore helps us to focus on the nature and extent of the interests served by a particular transaction and on the effectiveness of a given set of institutional arrangements for protecting and promoting these¹¹⁷ – in short, to concentrate on its governance.

These two aspects of a transaction, its style and its governance, are intimately intertwined and for this reason have not always been adequately distinguished from each other. We therefore discuss governance in the next section.

5.9: GOVERNANCE

The scope of a transaction

The distinction we are making between the style and governance of a transaction is potentially, as we shall presently see, an important one and it has been overlooked by the existing literature on transaction costs.¹¹⁸ Governance – the process of identifying and reconciling the different interests to be served through a given transaction – is one of the two variables that affect the scope of a transaction, the other being the range and diversity of activities that it can accommodate. We can effectively describe transactional scope by means of a diagram (Figure 5.4) in which the number of different interests to be served by a given governance structure are positioned on a vertical axis and the range of activities that can serve such interests are positioned on the horizontal axis. This allows us to distinguish between governance structures that are focused on a narrow range of activities but that serve a broad range of potential interests (for example, social security agencies), and those that display the opposite characteristics, namely, of serving a narrow range of interests but of doing so through a wide range of different activities (for example, a closely held conglomerate firm).

The range of interests to be served and the range of activities that serve these can reciprocally determine each other. One could, for instance, start with a given activity and ask whose interests might be served by pursuing it, or, reversing the sequence, one could start with a specific set of interests and ask what types of activity best serve these. Either way we end up transacting at a specific location in the two-dimensional space just described; whether in fact a transaction can feasibly be accommodated by a particular governance structure at that location will be given by its transaction possibility frontier (Figure 5.5), the boundary within which a transaction can be coordinated from inside the structure at an acceptable cost, and beyond which some other form of governance will be needed. In many regions of the space, the frontier is a blur rather than a line, a situation that gives rise to border disputes between competing forms of governance.

Figure 5.4 Transactional scope

Figure 5.5 The transaction possibility frontier

An increase in transactional capacity brought about either by an organization's growth or an increase in its resource base has the effect of pushing its transaction possibility frontier outward and away from the origin, and of increasing the volume of transactions that can be internalized by its chosen governance structure, whatever that might be.

Transactional style then describes how that capacity is utilized: is a given transaction, for example, most effectively handled by completely decentralizing it – as in a market – or should some impersonal form of hierarchical control be maintained – i.e., as in a bureaucracy? Should highly personalized methods of coordination be sought – in which case we approximate fiefs or clans – or is the information involved sufficiently codified or diffused not to require these?

Three points should be made about this way of approaching the issue. Firstly, transaction costs associated with the process of governance itself – the identification and reconciliation of divergent interests or levels of interest -are to be distinguished from those associated with the technical coordination of a diverse range of activities. In much of the transaction cost and agency literature, the interests to be served by a governance structure tend to be taken as given rather than as problematic, with ‘higher’ level corporate interests then appearing as somehow more legitimate than lower level ones. In most instances discussed it turns out to be the agent, not the principal, who is considered a source of potential problems and therefore has to be monitored and controlled. Where he acts on interests that diverge from those of boss, his behaviour gets labelled ‘opportunistic’, and the governance challenge naturally becomes one of keeping his opportunism in check. The interests of the firm then reduce to those of the principal. These, in effect, become the ‘higher’ purposes that the governance structure is designed to protect.¹¹⁹ By taking interests as given and unitary – i.e., as well-codified profit maximization rather than as more fuzzy and diffuse social responsibility – it becomes possible to de-politicize transactions and concentrate instead on their efficiency characteristics.¹²⁰

Secondly, a decision to internalize a transaction, to bring it within the transaction possibility frontier of a given governance structure, is partly a response to governance constraints – the activity so internalized must demonstrably serve a defined set of interests – but it is in no way reducible to a choice of transactional style – that is, to a choice between markets, bureaucracies, fiefs, and clans, since these are equally available outside the chosen governance structure. The implicit association of internal transactions with bureaucracies and of external ones with markets is a dangerous simplification first performed by Coase (1937) and subsequently kept alive by Williamson himself.¹²¹

To illustrate: in a command economy, the only legitimate type of external transaction available to the typical state-owned firm is a bureaucratic one, not a market one. In a market economy, by contrast, many large firms choose to conduct even intra-firm transactions – the allocation of capital between competing divisions, buying and selling between divisions, the allocation of employees to jobs, etc. – through largely self-regulating internal markets.

Thirdly, reconciling diverging interests on the one hand and integrating and coordinating the diverse activities required to serve them on the other, and all within a single transactional structure, both call for abstraction but of different kinds. The first type of abstraction acts on the motivational structure of transactional actors, aligning their preferences and values with each other by means of a unifying vision;¹²² the second acts on their disposition to achieve mutual coordination through the creation of a coherent strategy. Vision and strategy can either reinforce each other or they can work against each other. Effective governance partitions the I-space along the abstraction dimension into internal transacting populations, those that can be reached and made to share a unifying vision, and external populations that cannot. The larger and more diverse the internal transacting population, the more abstract the vision must be. External transacting populations are then parametrized and pushed further out along the abstraction dimension. Strategy then effectively drives the SLC of the newly created internal population – whether it be a firm or another type of organization – through a judicious mix of transactional styles some of which will connect it at various points along the abstraction dimension to external populations. Figure 5.6 indicates how our transactional categories, activated by the SLC, give rise both to elements of internal organization and to external transactional structures.

Figure 5.6 Internal and external organization in the l-space

An example

A concrete example will help to illustrate the difference between governance and style.

The local branch of a large international firm is located at some distance out of town. Until recently, its employees were obliged to come into the city at lunchtime for lack of adequate catering facilities provided at the workplace, a procedure that was both costly and time consuming and a source of grumbling and dissatisfaction throughout the local organization.

The firm, mindful of its image and the need to retain staff, then decided to establish a canteen on the premises in order to resolve the issue. As a purely financial proposition, a catering facility was of dubious attraction given that it would probably only serve one meal at midday, and this only to a limited number of people. The question for the firm's management was whether to have the organization itself provide the catering service in-house or to have an outside firm bid for the catering contract. That management was prepared to address the issue at all implied that it was willing to extend the firm's transactional scope, if only by accommodating an expanded set of interests: those of employees. But how far should such scope be extended?

Were the firm to opt for the second course and go for external contracting, the situation would be fairly straightforward and would leave its organizational structure unaffected. Part of the firm's own premises might be let to the successful bidder on an arm's-length basis and employees would be charged a market price for their meals that reflected the convenience to them of not having to travel into town. On the other hand, opting for the first course by providing an in-house catering facility, whether on a purely commercial or a partly subsidized basis, would amount to a further extension of the firm's transactional scope, an internalization of activities that it was not originally designed to undertake, but which, through its effects on staff morale, might have a beneficial long-term impact on its strategy.

The extension of scope brought about by the first option, however, occurs along both the activity axis of Figure 5.4 and its governance axis. We can approach the governance issue by asking whose interests are being served by the provision of a canteen on the premises. The short answer seems to be ‘the employees’. Obviously they stand to benefit most directly from such an arrangement since they are spared the time, cost, and effort of going into town for their midday meal. But do not the firm's shareholders and its other stakeholders also benefit? Fewer lunchtime delays might occur, staff morale might improve, and, by allowing employees more flexibility in their choice of mealtime, overall productivity might go up, and with it, the firm's profits.

To the extent that the interests of employees have to be accommodated by the firm if it is not to be penalized, it is led to extend the range of interests to which it is willing to respond as well as the range of activities through which it does so. Employees, in effect, become acknowledged as stakeholders with a legitimate impact on governance. Indeed, if they ever became the most powerful stakeholder in the organization so that all other interests were subordinated to their own, then the organization would become indistinguishable from the Yugoslav labour-managed firm.¹²³

Now assuming that the firm accepts to extend its activities in this way -and by implication the range of interests that it serves – it then has to decide how the canteen will be managed. And if, as is sometimes the case with large international firms, this one tends to be ponderous and bureaucratic, it may feel that its current way of managing things will have to be modified in the case of the canteen if it is ever to become financially viable. Perhaps it will have to decentralize day-to-day control over catering decisions – purchasing, the choice of menu, etc. – to an extent that would be quite unacceptable in other parts of its organization. Alternatively, it may feel that if this new undertaking is to have the required impact on staff morale, employees should be actively involved in its management through a committee structure and regular consultations. Hard upon the heels of a decision concerning its transactional scope, then – should this kind of organization be getting into the catering business at all, whether directly or through subcontracting? – the firm confronts a choice of transactional style.

Governance, strategy, and style

Questions of scope tend to be dealt with at that level in an organization responsible for governance – the board of directors in an enterprise, the council of bishops, the cabinet, etc. The key issues to be decided at this level are what range of interests should legitimately be served by the transactional structure – the problem of governance – and what range of activities best serve these – the choice of an appropriate strategy. Governance and strategy choices are strongly interlinked: changes in the one are likely to entail changes in the other with the causal lines of influence moving in both directions. Problems of transactional style, on the other hand, are usually left to executive discretion: change the people in charge of implementing a chosen strategy and they will often wish to modify the style in which the relevant transactions are conducted in a direction that they personally feel more comfortable with.

Governance and strategy on the one hand, and style on the other, allow a transacting group to forge its own identity over time. Strategy, to be effective, must navigate between the constraints set by governance considerations on the legitimacy of organized action, and those set by the transactional styles available on the capacity for such action. In short, interests must be reconciled using the resources available. Where governance has a broad focus, and must accommodate a wide variety of diverse or divergent interests, it will seek to work to a set of abstract values and universal principles that all transacting parties can subscribe to.¹²⁴ Since these can never be fully realized in practice, the organization's perceived effectiveness – up to a point at least – will be linked more to the integrity of its chosen procedures than to any specific outcomes. Where, on the other hand, governance has a narrow focus and only one or a few interests to serve, it will be oriented to concrete goals, to specific outcomes, and to efficiency considerations. Abstract values and principles might then appear to take a back seat and a more pragmatic cost-benefit approach will predominate.

The problem of organizational growth

Economic organizations work to a narrower governance focus than, say, political or religious organizations. Paradoxically, however, as they grow, they often come to exceed the transactional capacity of those styles associated with a narrow focus, such as fiefs and clans. They then seek out transactional styles – bureaucracies and markets – that promise greater efficiency, but in doing so are inevitably led to broaden the range of stakeholder interests to which they must respond. Not all these stakeholders, however, are internal to the organization when it is narrowly construed as a firm, in spite of the influence they are able to exert on its transactional structure.

The character of economic organizations can thus be transformed and at the same time subtly undermined by a quest for transactional efficiencies, which, by provoking a change in transactional style, increase capacity by imperceptibly bringing about a shift from narrow to broad governance. The consequence of the shift is either a politicization of the governance structure which becomes an arena for bargaining between an expanded set of competing interests, or an increasing emphasis on process rather than performance – the plague of many a state bureaucracy.¹²⁵

Only rarely can firms escape this dilemma as they grow. If they do so it is because they have been able to infuse into their situation a coherent and energizing vision behind which ostensibly competing interests can align themselves with no loss of transactional efficiency. Such a strategic vision helps to articulate the interests to be served by a given transactional structure in a non-conflictual way, to specify the range of activities through which they will be served, and to identify the transactional styles most appropriate for pursuing such activities. Whether we choose to label it a founding myth, a tradition, a Utopia, or whatever, a well-crafted vision exerts a strong influence on the evolution of a culture whether at the level of a small group, an organization, or a nation-state. It becomes a solvent that keeps the process congruent with the requirements of effective performance.

Culture itself, the pattern created by institutionalized transactions as they evolve in the I-space, is the subject of the next chapter.

5.10: CONCLUSION

Recapitulation

The contribution of this chapter to the book's general theme will now be briefly summarized. Information moves through the SLC largely in anticipation of or in giving effect to social exchanges. Movement in the data field has a cost that is best contained by creating structures for the accommodation of recurrent exchanges where efficiency matters. Social exchanges constrained by efficiency considerations we call transactions, and the general purpose structures that they inhabit we call institutions. Organizations are concrete embodiments of institutional arrangements adapted to particular cases.¹²⁶

To be viable as transactional structures, institutions must adequately reflect the information environment in which the exchanges they claim to govern might take place. This chapter has identified four ideal-typical transactional structures amenable to institutionalization. Each is listed and briefly described in Table 5.1.

The action of the SLC is continuously redistributing information in the I-space and hence affecting the viability of each of these structures. The assignment of transactions will therefore shift between them partly as a passive response to the influence of the SLC itself and partly in more active attempts to forestall the erosive action of the cycle through investments in institutionalization.

The SLC, by continuously modifying their information environment, acts directly on transactional options in the I-space. It also acts on them indirectly by extending or contracting the range of interests along the abstraction dimension that a given transactional structure can coherently serve. The issue of governance, therefore, is to be distinguished from that of transactional choice although the two remain intimately related through the action of the SLC.

Governance issues effectively partition the I-space along the abstraction dimension into a transacting population that subscribes to a given set of objectives and others that do not. Governance in a sense motivates the creation of organization. Organization, in turn, operates through interlinked transactional structures, reconfiguring them as circumstances in the data field dictate. For this reason, the decision to internalize a transaction – i.e., to bring it within a given framework of governance – is not reducible to a choice of transaction structure as such.

Limitations of institutional economics

Differences between the transaction cost and the neoclassical approach to economizing are by now well documented¹²⁷ and will not be dealt with further here. Of more importance to our discussion perhaps is that the differences between the approach to transactions outlined in this chapter and that adopted by the new institutional economists such as Oliver Williamson are numerous and potentially significant. We shall deal with three.

Firstly, although the New Institutional Economics acknowledges the important role played by information in the choice of transactional arrangements, by focusing primarily on the information asymmetries that might exist between parties – i.e., on the diffusion characteristics of a transaction -rather than on the degree of codification or abstraction of relevant transactional data, it has been led to concentrate its attention on effects rather than on causes. Codification and abstraction are, of course, referred to, but in essentially atheoretical terms. They are dealt with under the general categories of ‘uncertainty’ and ‘atmosphere’; beyond occasional references to the tacit nature of certain kinds of knowledge, an appreciation of their crucial link to communicability and hence to the social possibilities of information sharing remains generally undeveloped.

The consequence of this neglect is that transactional choices have been framed purely in terms of their centralization characteristics, at first by concentrating on the end points of a centralization-decentralization continuum – i.e., on hierarchies and markets – and then later on intermediate forms.¹²⁸ Much transactional richness related to codification or abstraction phenomena escapes such a formulation so that even when an intermediate transactional form is introduced – Ouchi talks of clans, Butler of federations – it is perceived to be little more than an infill between markets and hierarchies.¹²⁹ The whole exercise thus remains strictly one-dimensional. Only information diffusion is brought into play.

Secondly, the markets and hierarchies paradigm implies, but does not develop, a dynamic theory of information flows. Expressions such as ‘information impacting’, ‘opportunism’, and ‘strategic behaviour’ are highly suggestive and, in my view, somewhat Schumpeterian in flavour. But they are pressed into the service of an essentially static theory of transactional assignment. A mechanistic rather than an evolutionary perspective still informs too much of the analysis.¹³⁰ The SLC shows that creative destruction is at work in the I-space, and applies no less to transactional structures than to other economic goods. Information flows activate new structures and cause older ones to atrophy. Some institutional investment helps to reinforce existing structures and to slow the process down, some merely helps to accelerate it. In this view, markets attain moments of stability – i.e., equilibrium – but in historical time: not only is the attainment of equilibrium path dependent so that the specific trajectory of the SLC as it approaches the market region of the I-space matters, but transactional activity, even once it has reached the market region and pace equilibrium theorists, has no built-in tendency to remain there. The learning that occurs in markets is as likely to move it away from equilibrium as towards it in a ‘logic of collective action’ that was first described by Michels and then by Olson.¹³¹

Finally, in the absence of a conceptual scheme that could factor out governance issues from transactional ones, the new institutional economists have tended to conflate the two: hierarchies are treated as a matter of course as internal to firms, and markets as institutions that are external to firms. Hybrid forms, to be sure, exist between these polar alternatives, and in such cases one talks of bilateral governance.¹³²

None of this is wrong as such, but it paints an incomplete picture: all transactional forms may exist inside or outside particular governance structures such as firms and in each case they are amenable to varying degrees of institutionalization. Governance objectives may be served by either internal or external transactions, and any particular mix or transaction style will reflect, on the one hand, efficiency considerations and the availability of internal and external structures, and on the other, the distribution of power among stakeholders within the governance framework. The simple dichotomy created by the markets and hierarchies paradigm between internal and external transactions may turn out in fact to have but a limited institutional application; namely, to the joint-stock firm. Indeed, the boundary that separates the inside from the outside of such an organization already presupposes a highly codified transactional environment. Inject a measure of fuzziness and ambiguity into that environment, however, and the boundary may well dissolve or appear as nothing more than a gradient.¹³³ We discuss this further in the context of the case presented in Chapter 7.

Institutional economics: the way forward

In spite of such limitations, the New Institutional Economics research programme, given its willingness to acknowledge the central role played by information in the economic process, constitutes a marked advance over what is on offer from the neoclassical orthodoxy. There, information retains the status of the luminiferous ether of classical physics before Einstein: a ubiquitous medium that admitted of a mechanical account of action at a distance and kept the world conveniently Newtonian.

Institutional economics, however, needs a more explicit and dynamic theory of information flows if it is to make more than a dent in the neoclassical defences. Having established that there exist credible institutional alternatives to markets, it needs to show how information production and exchange underpins them all, shaping their internal evolution as well as how they collaborate and compete. In effect, what is needed is a theory of social learning that extends beyond the individual or the organization¹³⁴ to encompass more complex institutional settings. Such a theory, I believe, is foreshadowed in Douglass North's historical studies of institutions. It now needs further development.

The SLC takes a step in the direction of such a theory, one that encompasses neoclassical forms of learning – moves towards equilibrium – as a special case. The kind of learning promoted by the SLC we might call meta-learning;¹³⁵ it is quite at odds with the Pavlovian kind of learning associated with efficient markets. This, to be sure, occurs, but it gradually gives way to experience-based reflection (absorption and impacting) and to an accumulation of insights (scanning) that move well-positioned individuals away from a mindless equilibrium passively endured and towards new opportunities opened up by creative data processing strategies.

Only in one phase of the SLC – the diffusion phase – can information gradually come to acquire the characteristics required by efficient markets, and that phase is temporary. Elsewhere, understanding the exchange process requires an appreciation of the specific circumstances under which information is structured (codified and abstracted from data) and shared (diffused) among social agents. A structural approach to the information problem leads us to the kind of institutional analysis presented in this chapter. It is distinguishable from a structuralist approach by its contingent and constructivist operation.¹³⁶ A process approach, by contrast, would lead us to a cultural analysis; culture, under most definitions, having something to do with the way that experience is structured and shared within and between groups. Structure and process are not exclusive perspectives. We turn to process next.