Evolution and economic organization

1. THE VARIETY OF THEORETICAL APPROACHES

Over the last ten to twenty years, institutional change has proceeded at a rapid pace in many countries. The wholesale collapse of the organisational structures of the planned economies of Eastern Europe is of obvious importance, but even in Western countries, which could loosely be described as ‘market-oriented’ and ‘capitalist’, changes have occurred which few would have predicted in the 1970s. The privatisation of industry; the experiment with new contractual methods in the public sector; attempts to stimulate competition and liberalise entry in certain industries; the setting up of new regulatory agencies; an upsurge in takeovers, manage­ment buy-outs and buy-ins; unprecedented interest in different models of corporate governance – all these features have been characteristic of recent years.

An introductory appraisal of some of these developments and of public policy in the sphere of economic organisation can be found in Part 3. It is clear that the economic analysis of institutional structure cannot be regarded as a somewhat peripheral or secondary part of economics. On the contrary, it is central to our understanding of how economic systems actu­ally operate. In spite of this pivotal role, a fully developed theory of eco­nomic organisation has yet to emerge. As we have seen in earlier chapters, there exist many different strands of thinking which can be observed woven together in varying combinations. Two very broad approaches can be dis­tinguished, however, and the tension between them can be found running through much of the economic writing about economic organisation. For simplicity, they are referred to below as the neoclassical and the radical approaches respectively.

1.1. Neoclassical Analysis of Organisations

In Chapter 1, the impossibility of a theory of organisational structure built upon the assumptions of full information and costlessly enforced contracts was demonstrated. A world with these characteristics – the ‘general equi­librium’ world of Arrow and Debreu – would be free of organisational structures, although there is an implied assumption that a perfectly effec­tive state acts as a costless enforcer of contracts. Recognising that the world is one of imperfect information and imperfectly enforceable property rights does not mean that the neoclassical research programme becomes obsolete and that a ‘paradigm change’ is inevitable, for neoclassical microeconom­ics is built, not on any particular assumptions about the costlessness of information or the economic environment of transactors, but on the tech­nique of constrained maximisation. Applying this technique to situations in which information is distributed asymmetrically between contracting parties, in which the environment is risky, in which people will behave opportunistically if that proves to be in their own interests, and in which enforcement is part of the problem of optimal contract design, has ensured an ample supply of new contributions to economics journals in the neoclas­sical tradition. The archetypal form of this analysis is the theory of princi­pal and agent, which was reviewed in Chapter 5 and applied in many different contexts throughout Part 2.

A major problem with neoclassical analysis of this type is that it suffers from several of the weaknesses which motivated the development of insti­tutional economics in the first place. Transactors may not have full infor­mation, but in calculating the optimal response to particular circumstances they seem to have access to vast quantities, nevertheless. If the principal cannot observe the agent with perfect reliability and at zero cost, both parties know the characteristics of the monitoring technology, the prob­ability distribution of states of the world, the influence of the agent’s effort on this probability distribution, the degree of risk aversion associated with each contractor and so forth. Where agents differ from each other and the adverse selection problem arises, further contractual problems are con­fronted. The existence of transaction-specific capital (either human or physical) complicates the issue further.

In spite of this complexity, the theory has been used extensively to explain institutional structures. Again, in Chapters 6 and 7 we saw how asset spec­ificity combined with opportunism influenced hierarchical incentive struc­tures within the firm and relationships with suppliers. Principal-agent models were also used to cast light on management incentives (Chapter 8), the financial structure of the corporation (Chapter 9) and on other types of enterprise (Chapters 10 and 11). On the other hand, application of the theory to particular circumstances confronts substantial methodological problems. Unless concepts such as asset specificity, risk aversion and mon­itoring costs can be objectively identified there is a danger of rationalising all observed institutional structures as an efficient response to transactional problems. Economists’ efforts in this area then call to mind Tristram Shandy’s father who ‘like all systematic reasoners . . . would move heaven and earth, and twist and torture everything in nature, to support his hypoth­esis’.² Simon (1991, p. 27) expresses this point when he comments that while the New Institutional Economics is ‘compatible with and conservative of neoclassical theory, it does greatly multiply the number of auxiliary exoge­nous assumptions that are needed for the theory to work’.

1.2. Radical Approaches to Organisations

Critics of the neoclassical paradigm argue that the approach is flawed at a very fundamental level. It provides a theory of contracts but not of organ­isation. In neoclassical theory, people choose optimal contractual arrange­ments in stochastic environments where information can be generated by monitoring or search using a known technology. Differing circumstances will produce differing optimal solutions for the contractors. The contracts chosen will not be ‘first best’. Indeed, from the point of view of traditional theory there may be many ‘inefficiencies’ associated with the contractual outcome. In Chapter 6, we saw how the payment of ‘efficiency wages’ might lead to unemployment and, in general, how effort incentives could lead to ‘bond-posting’ or the taking of ‘hostages’. These contractual devices pro­duced dependency on the firm and implied that payment was in part a rent on resources sunk in the relationship – an enforcement rent. However, although such contracts may be far from ‘first best’, it is not clear that they must necessarily be ‘incomplete’. For the critics, though, organisations are inextricably linked to contractual incompleteness.

Radical schools of institutional economics all have as their basic start­ing point the idea that organisations exist in order better to handle change and uncertainty. This includes adaptation to events outside the organisa­tion, and the devising and initiating of new developments within. As explained at length in Chapter 6, contracts in the face of continual change and uncertainty are ‘relational’ rather than ‘classical’. They are loosely specified and operate within the context of some ‘governance structure’. Although Williamson falls within the neoclassical camp with his great emphasis on the problems posed by opportunism and asset specificity (and hence contract enforcement), the plain problem of coordinating resources and establishing valuable information flows in a world of continual change is enough to require some form of ‘organisation’.

Indeed, for the radical critics, the firm as a means of generating and using information is a more significant concept than the firm as a means of con­tract enforcement. The primary purpose of economic organisation, in the radical view, is to provide a vehicle for entrepreneurship and a system capable of generating, coordinating and using new knowledge. The focus of attention, in other words, is less on the contractual necessity of intro­ducing enforcement rents and more on the creation of entrepreneurial rents; a distinction which has been emphasised at several points throughout the text, especially in Chapter 7 and the first sections of Chapter 8.

The neoclassical and radical research programmes both contribute to the study of economic organisation, and individual scholars often appear to be looking for a place in both schools. Williamson’s work, for example, some­times has a neoclassical flavour in its emphasis on the problem of contract enforcement in the presence of opportunism, but the underlying accep­tance of bounded rationality means that the firm as a device for coping with change and uncertainty is perhaps more central to Williamson’s overall scheme. The problem with taking this idea seriously, however, is that a different analytical framework from the one that most economists find familiar is required. People cannot be seen as constrained maximisers in a world where there is true uncertainty (as defined by Knight)³, where infor­mation about constraints has to be discovered, and where the ability of the human mind to see the possible implications of a piece of information is bounded. It is for this reason that theorists wishing to develop the more radical research programme in economic organisation have found it useful to adopt a more evolutionary perspective.

2. THE RESOURCES OF THE FIRM

Use of the term ‘radical’ to describe the evolutionary research programme should not be taken to imply that the ideas are extremely recent. It is true that neoclassical theory has dominated the discipline for many years, but the founders of modern economics such as Marshall and Menger were well aware of the tensions that we have been discussing. The rhetoric of Marshall’s Principles of Economics has a strong evolutionary bias which reflects a clear recognition of the importance of the growth of knowledge in economic development.

Capital consists in a great part of knowledge and organisation . .. Organisation aids knowledge; it has many forms, e.g. that of a single business, that of various businesses in the same trade, that of various trades relatively to one another, and that of the State . . . The distinction between private and public property in knowledge and organisation is of great and growing importance: in some respects of more importance than that between public and private property in material things; and partly for that reason it seems best sometimes to reckon Organisation apart as a distinct agent of production.⁴

For Marshall, therefore, as for many more recent scholars of economic organisation, the main resource possessed by a firm is knowledge. Further, this resource was not conceived of as limited to technical knowledge pos­sessed by employees, but also encompassed tacit knowledge, and knowl­edge concerning the wants of customers and the reliability and flexibility of suppliers. ‘External economies are constantly growing in importance rela­tively to Internal in all matters of Trade-knowledge.’⁵ Loasby (1991) draws attention particularly to Marshall’s treatment of the external relations of the firm. ‘By his use of the term “external organisation” to describe a firm’s network of contacts, Marshall had defined the management of this network as a normal business activity’ (p. 84). The notion of a network as an intermediate form of organisation between the firm and the entirely arm’s-length market transaction has become of great interest and concern to business analysts recently, but it has a very long pedigree.⁶

The special knowledge embodied in each firm’s resources, procedures, contacts, team relationships and so forth, produces what Chandler (1990, 1992) calls ‘organizational capabilities’. The relationships established by each firm enable it to do things which other firms cannot do, or cannot do so well, or so quickly or so cheaply. Organisational capabilities take time to replicate. They permit the firm to be ‘more than the sum of its parts’ (1992, p.86). Other writers use slightly different terminology, but usually they are driving at the same basic point. Porter (1990) uses the notion of ‘competi­tive advantage’ which can derive from a variety of possible strategies, such as the search for cost-reducing methods, greater product variety, high product quality and so forth. Which strategy a firm will pursue, however, is determined by the capabilities of its resources. Teams that are used to con­centrating on improving product quality will find their routines, proce­dures, contacts and technical knowledge inappropriate for the search for cost reductions or entirely new products. Kay (1992, p.119) sees the distinc­tive capability of a firm as determined by its ‘architecture’.

Architecture is the most subtle and elusive source of competitive advantage. It is a feature of the set of contracts taken as a whole, and it emphasises the rela­tional rather than the classical aspects of these contracts; by its nature, a classi­cal contract can be written down, and what can be written down can be replicated.

If organisations create competitive advantage from the generation of knowledge, the link between entrepreneurship and organisational structure is a close one. In Chapter 3, we saw how Kirzner interpreted the entrepre­neurial function entirely in terms of intermediation in the market. The modern conception of the firm as the creator of competitive advantage implies that entrepreneurs gain from working in groups, and that Wu’s idea of the firm as a group of cooperating entrepreneurs is closer than Kirzner’s to recent work in business strategy. On the other hand, Kirzner’s view of the entrepreneur as gradually uncovering the possibilities latent in a given set of circumstances does have close affinities with that of Marshall and does lend itself to evolutionary analysis. By looking at the firm as a coalition of Kirznerian entrepreneurs, an evolutionary theory of the firm can be devel­oped which does not draw on neoclassical principles of maximisation. Shackle’s world of boundless possibilities and ‘the anarchy of history’ pre­cludes analysis. Kirzner’s conception of a world of continual but marginal discoveries might at least be compatible with historical evolution – a process which may be seen as neither totally anarchic nor totally predictable.

3. EVOLUTION IN ECONOMICS

3.1. Biological Analogies

Biological analogies have a long history in Economics. Marshall (1925, p. 240) specifically mentions the influence that Malthus’s writing on popula­tion is said to have had on the development of Darwin’s thinking.⁷ Most of Marshall’s analysis of economic organisation is couched in the language of evolution and the ‘struggle for survival’. The most famous of his biological analogies concerns the life cycle of firms which he compares to the trees in a forest (pp. 315-16). As saplings, the trees compete for light and air against their larger neighbours and many fail to develop and die. Later, the more successful ones grow rapidly until they dominate the environment. The years of this domination are numbered, however, and they eventually atrophy and are replaced by younger more vigorous trees. Modern scien­tific understanding of genetics and ecology has advanced greatly since Marshall’s time so that the analogy now seems extremely loose. Where in a joint-stock company, for example, is the genetic material which condemns it to inevitable decline? Penrose (1952, p. 804) was induced to complain that ‘biological analogies contribute little either to the theory of price or to the theory of growth and development of firms’. The analogies are descriptive rather than exact.

One may sympathise with Penrose’s irritation with loose descriptive con­nections between the natural and economic worlds, but the problem of pro­viding a coherent intellectual framework capable of explaining the behaviour of the firm as a generator and interpreter of information remained. It was Alchian (1950) who suggested a systematic incorporation of the ideas of evolution and natural selection into economics. The eco­nomic system, he argued, could be interpreted as ‘an adoptive mechanism which chooses among exploratory actions generated by the adaptive pursuit of “success” or “profits’’’ (p. 16). People are not maximisers. They merely wish to survive and, in the economic context, this implies making positive profits. Those who do not make positive profits are selected out by the economic environment. Survival invites imitation by others, who use those procedures that are thought to ensure it.

Penrose argued that if conscious imitation in pursuit of survival qualities is admitted, the analogy with biology breaks down. Firms might then attempt not merely to adapt to a given environment but to change the envi­ronment in their favour. This might be accomplished, for example, through political pressure or by some startling innovation. In terms of the analysis of Chapter 3, we might see a Kirznerian firm as adapting to a given envi­ronment but a Schumpeterian firm as actively creating the conditions nec­essary for its future progress. Whatever their formal relationship to biological models of evolution, however, economic models have been devel­oped in recent years by Boulding (1981) and most notably by Nelson and Winter (1982).

3.2. The Evolution of the Firm

At the heart of Nelson and Winters’ approach is the assumption that the firm has, at any given time, a set of ‘decision rules’ and ‘routines’. These ‘routines’ might be regarded as the genetic material of the organisation. As in the system proposed by Alchian, routines and decision rules which produce profits lead the firms which have adopted them to grow relative to other firms experiencing lower profits. Nelson and Winter simulate evolu­tionary change by linking profits to investment in the firm and hence to its rate of growth. In addition to the mere use of existing routines, search takes place within the firm for new or adjusted routines. ‘Our concept of search obviously is the counterpart of that of mutation in biological evolutionary theory’ (p. 18). Search and selection then results in an evolutionary time path.

It is an interesting aspect of Nelson and Winters’ approach that ‘search’ and the implied entrepreneurial activity is itself seen as bound up with ‘rou­tines’. ‘Problem solving efforts that are initiated with the existing routine as a target may lead to innovation instead’ (p. 130). Kirzner would be sure to point out that no routine can produce innovation automatically. A machine-repair person who notices, while applying a routine procedure, that a cheap alternative to this procedure would be possible, is alert in Kirzner’s sense. Noticing such improvements requires the exercise of a human faculty quite distinct from following routines. However, what Nelson and Winter emphasise is that the established routines may condi­tion the scope for successful search by determining the likely information sources that people will encounter. Routines which acquaint people with different activities within the firm, for example, may be more likely to produce ideas for improvement than routines which confine people within a more limited sphere.⁸

Successful routines, argue Nelson and Winter (p. 119), will lead the firm to expand into areas where the success can be replicated. ‘A firm that is already successful in a given activity is a particularly good candidate for being successful with new capacity of the same sort.’ Chandler (1992, p.93) strongly supports this view and suggests that it was precisely these advan­tages of experience and learning which led to the growth of many of the major firms who were ‘first movers’ in chemicals, electrical engineering, motor cars, telephony and office machinery after the First World War. ‘Such growth was driven much less by the desire to reduce transaction, agency and other information costs and much more by a wish to utilize the competitive advantages created by the coordinated learned routines in pro­duction, distribution, marketing, and improving existing products and pro­cesses.’ His argument supports the view of the firm as a means of making use of information – not simply of the technical variety, but of the accu­mulated experience of the resources of the firm which become embodied in its routines. Further, it is not simply access to particular pieces of informa­tion that confers competitive advantage on the firm, but the ability to gen­erate such information. The entrepreneurial function of the firm is thus central to this conception.⁹

3.3. Market Relationships and Evolution

Evolutionary forces can be seen as of wider-ranging influence than the establishment of routines within the firm, however. Relationships with sup­pliers, customers and workforce may also be affected by perceptions of reli­ability, reputation, trust, expertise, and so forth which have evolved over a long period of time.

3.4. Trust

At many points in earlier chapters the importance of establishing trust between trading partners has been emphasised. Firms that were trusted by their workers could institute hierarchical incentive systems involving bond-posting which would be unavailable to other firms (Chapter 6). Trust in suppliers could result in a less vertically integrated industrial structure (Chapter 7). Firms with a good financial record and close contacts with their financiers would find it cheaper to raise finance for further expansion (Chapter 9). In other words, a reputable history is a valuable asset that cannot be wished into existence. Creating a reputation requires a degree of continuity over time and continual reinforcement in repeated deals. Marshall (1925, p. 198) noted the potentially disruptive consequences of lack of continuity in exchange relationships, when he wrote ‘change may be carried to excess; and when population shifts so rapidly, that a man is always shaking himself loose from his reputation, he loses some of the best external aids to the formation of a high moral character’. Our ability to transact with others profitably in the present thus depends to some extent upon the history of our relationship with them.

Modern treatments of the process of innovation emphasise the impor­tance of collaboration between firms. Collaborative ventures grew in importance during the 1980s in areas such as biotechnology, microelectron­ics and information technology. In the United States, the Microelectronics Computer Corporation (formed jointly by 19 firms) played a part in per­suading Congress to exempt joint research ventures from antitrust legisla­tion such as the Sherman Act. In Europe, the European Computer Research Centre also represented an attempt to share the costs and results of research between a group of member firms. These cooperative associa­tions require the development of trust and experience over time. Metcalf (1992, p.226), in a review of types of collaboration in the innovation process, emphasises that ‘collaborations involve more than contracts; they involve interactions between the organisations to alter the behaviour of at least one of the parties’. Firms, by their collaborative associations become part of an evolutionary process of ‘group selection’. Survival depends not merely upon the existing capabilities of a firm and selection in the market (the first level of competition), but also on the ability to generate new capa­bilities (the second level of competition). This type of competition can involve the formation of collaborative associations with other firms in a group. ‘Collaborative R and D is a prime example of group selection at the second level of competition’ (p. 223).

3.5. Codes of conduct

Market transactions rely on the existence of codes of conduct which limit uncooperative behaviour. As was seen in Chapter 1, it is possible to con­struct repeated games in which self-interested responses on the part of indi­viduals produce cooperative outcomes. These games rely on a high probability of repetition of a transaction or on the ability to recognise char­acteristics likely to correlate with a transactors’s trustworthiness. Again, biological analogies can be used. The Hawk-Dove game¹⁰ indicated how, over time, the equilibrium proportion of those playing an aggressive non­cooperative strategy might be determined. Where a Hawk can be identified in advance, the payoff to the Hawk strategy will be reduced. Hawk strate­gies will be met with Hawk strategies, and the resulting conflict will be dis­advantageous. Aggressive non-cooperation is only a good survival strategy in a world in which most other individuals are cooperative and cannot modify their strategy according to the characteristics of their opponents.

Once we admit the possibility of informative signals about the reliability of transactors in a market, conventions and codes of conduct supportive of cooperation can evolve.¹¹ Conventions are rules of behaviour which are self-enforcing in that it is in each person’s individual interests to recognise them and comply with them. Sugden (1986, p.8) argues that these conven­tions may take on a moral dimension. When people fail to meet our expec­tations and breech some time-honoured convention, we complain of injustice. ‘Some of our ideas of rights, entitlements and justice may be rooted in conventions that have never been consciously designed by anyone. They have merely evolved.’

These conventions have the added advantage of economising on deci­sion-making costs. Bounded rationality implies that our decisions will often be made on the basis of ‘rules of thumb’ or historical precedents. Following conventions and adopting behavioural patterns that other trans­actors see as reliable and honest have the advantage of making no demands on a person’s decision-making powers. It is perhaps not sufficiently empha­sised in the recent economics literature that bounded rationality places limits on opportunistic behaviour. ‘Plotting covetousness and deliberate contrivance in order to compass a selfish end, are nowhere abundant but in the world of the dramatist; they demand too intense a mental action for many of our fellow-parishioners to be guilty of them.’¹² Covetousness and contrivance play an abundant role in the world of the institutional econo­mist, as we have seen, but it is interesting that, even in a social world small enough for its inhabitants still to be called ‘parishioners’, George Eliot emphasises not the peer pressure leading to cooperative behaviour but the plain mental effort required in planning anything else. Once social evolu­tion has produced a functioning set of conventions or norms, therefore, inertia can protect them from systematic challenge over long periods of time.

3.6. An Ecology of Institutions

Interdependencies between institutional structures provide another analogy with the natural world. At several points in earlier chapters, the consequences for one organisational structure of the existence of another have been commented upon. Absence of firms with sufficient information about new methods to act as reliable suppliers leads to vertical integration at one time followed by disintegration as the new structures are developed (Chapter 7); competition from the proprietary firm constrains the manag­ers in a dispersed joint-stock firm through competition in the product market (Chapter 8); the takeover threat and hence the viability of the dis­persed joint-stock enterprise depends upon the existence of concentrations of private wealth capable of intervening in the market for corporate control (Chapter 9); the managerial labour market which gradually develops to serve the large dispersed corporations may later be used by worker-owned firms to recruit managers (Chapter 10); the performance of public enter­prises may be assessed and incentive packages constructed using compara­tive information generated in other sectors (Chapter 11). Although analytical tractability often requires it, a given institutional form cannot, therefore, be seen as entirely independent of the environment of other exist­ing institutions or of the time path followed by their development.

4. EVOLUTION AND EFFICIENCY

According to the radical evolutionary thinking set out in section 3, the organisational structures that exist at any one point in time cannot be explained entirely by reference to conditions prevailing at that time. Instead, they must be seen in the context of the evolutionary time path that has produced the search routines, networks of contacts, cultural norms, conventions, and informal enforcement mechanisms that accompany insti­tutional developments. Institutional structures are path dependent. Further, it is not clear that the path is leading anywhere in particular.

Again, it is possible to discern two different views about the direction of the evolutionary path. Some theorists such as Demsetz and Williamson, being closer to the neoclassical world of optimisation than many others, tend to take an optimistic view. In Chapter 4, Demsetz’s view that property rights tend to develop in a way conducive to the realisation of efficiency gains was discussed. Similarly, Williamson (1993, p. 107) takes the view that evolutionary processes will produce institutions which economise on trans­actions costs. ‘I hold only that the institutions emerging from the competi­tive process will be comparatively efficient; and I eschew reference to minimising and maximising.’ The path may not always be ideal, and it may not lead to a land of perfect efficiency, but on the whole there are social ben­efits attached to moving on.

Others are more sceptical. At the purely theoretical level, it is easy enough to construct game-theoretic models which are consistent with the evolution of inefficient self-enforcing conventions.¹³ Further, all are agreed that the ‘survival of the fittest’ in no way implies that those that survive are perfectly suited to their environmental niche.¹⁴ Some historians of eco­nomic development take a notably pessimistic view of the evolutionary process. North (1991, p.98) argues that most economic history concerns the failure of economies to develop a beneficial evolutionary time path. ‘When economies do evolve, therefore, nothing about that process assures economic growth.’ He contrasts the history of the English colonies in America with those of Spain. The centralised structures imposed by six­teenth-century Spain at the time of Philip II led to a time path of evolu­tion which was inimical to economic development. By contrast, those established by seventeenth-century England at the time of the Civil War and the struggle between Crown and Parliament permitted the evolution of more secure property rights and the ability to experiment with new ideas on the part of economic agents. The initial conditions proved to be far more favourable.¹⁵

It is interesting to note, however, that the liberating forces which under­lay economic development in the United Kingdom and the United States have recently become the subject of suspicion. The fluidity and individual­ity which permitted experiments to be undertaken and new deals to be struck has been seen as now fatally undermining cooperative efforts. Marshall (1925, p. 197) was well aware of the tensions involved. ‘Changes in work, of scene, and of personal associations bring new thoughts, call attention to the imperfections of old methods, stimulate a “divine discon­tent”, and in every way develop creative energy.’ Yet, as we have already noted, such continual changes of personal association ‘shake a person loose’ from their reputation. Some things require trust to accomplish rather than mere energy.

A study of the United States by Dertouzos, Lester and Solow (1989) draws particular attention to what it sees as lack of training for the work­force, poor coordination of research effort, an inability to foster teamwork, and failure to agree upon common technical standards. British students of their domestic economic situation have been reading similar lists for years. The point is simply that each of these areas is thought to play a vital role in modern economic development but each confronts the decentralised market with substantial difficulties. If human capital is more significant than physical capital for economic growth; and if new knowledge is a more influential determinant of ‘competitive advantage’ than ‘factor endow­ments’, it is sobering to reflect that these areas are precisely those in which transactional hazards abound. Markets in human capital and information are, to a greater extent than most others, prone to information asymmetry, vulnerable to opportunism, and dependent for their effective operation on suitable ‘organisation’.

The view is widely held that countries such as the United Kingdom and the United States with their decentralised and individualistic traditions are at a disadvantage in matters of economic organisation. As Adam Smith predicted, the United States evolved into the world’s richest country, yet now, according to some commentators, it faces the consequences of being a ‘low trust economy’.¹⁶ The ability of individuals to escape from the coer­cive influence of conservative social interests that see all innovation as a threat, so necessary to the initial stimulation of new methods, carries with it disadvantages which become evident only as time advances. Sen (1987, p. 18) remarks, for example, that ‘in the case of Japan, there is strong empiri­cal evidence to suggest that systematic departures from self-interested behaviour in the direction of duty, loyalty and goodwill have played a sub­stantial part in industrial success’. Japan, in other words, has a competitive advantage in ‘organisation’, an advantage which cannot be replicated easily by other countries because it rests upon an evolutionary time path which happens to have produced favourable results in the post-war era. Even for Japan, however, advantageous factors at one point in time may become dis­advantageous at another. Opportunity costs are attached to strong and durable contractual bonds. Such bonds involve sacrificing the flexibility and fluidity of weaker, less durable, associations.

Source: Ricketts Martin (2002), The Economics of Business Enterprise: An Introduction to Economic Organisation and the Theory of the Firm, Edward Elgar Pub; 3rd edition.