The Competitiveness of Nations
in a Global Knowledge-Based Economy
October 200
3Brian J. Loasby
Cognition and Markets
CRIC
Workshop on Market Relations and the Competitive Process
Centre
for Research on Innovation and Competition
Economic
& Social Research Council
4-5
May 2000
Index
Cognition
and the Growth of Knowledge
Whether as an explanation of decision
making or as a guide to making decisions, rational choice theory is not very
interesting. What is called a decision
is merely the logical precipitate of the premises; everything that might be
regarded as a determinant of choice is already in place, and assumed to be
known (if only as a probability distribution) to the chooser, and so it is the
explanation of these determinants – and why they, and only they, are
determinants – that deserves attention. Now
this should not be a source of complaint, for, paradoxical as it may seem,
choice theory is not about decisions. Its
purpose is to provide an essential element in constructing theories of
equilibrium, and equilibrium in economics is routinely defined as a state of
affairs in which there are no choices to be made. In models of multi-period equilibrium, such as
two-stage games, the conditional choices in later periods have to be fixed in
the process of proving the existence of an equilibrium set; and if there are
multiple equilibria, choice theory provides no criteria by which agents may
choose between them. Within choice
theory agents make no choices.
When choices are deduced, only premises matter; and it is standard
practice to explain differences in behaviour, including changes in behaviour
over time, by differences in the premises from which behaviour is deduced –
usually differences in opportunity sets, and often with specific emphasis on
incentive structures. One might
therefore have expected economists to have shared Herbert Simon’s view that the
premise should be the unit of analysis. The
reason that they do not is that decision premises are assumed to reflect
precisely the fundamentals of economic analysis; they are therefore innocuous. (There are a few exceptions, such as the
theory of speculative bubbles.) It is
therefore not accidental that few economists pay specific attention to
organisational forms, because in equilibrium models any organisational
structure must be transparent to the basic data; and it is notable that
orthodox and quasi-orthodox economists who have tried to explain why firms, as
organisations, exist have taken care to isolate their explanation from the
theory of production, which continues to be directly based on the supposedly
fundamental data of the economy. As
Coase (1991, p. 65) has pointed out, this has led economists “to neglect the
main activity of a firm, running a business”. In a rational choice equilibrium, running a
business is a trivial activity.
What prompted Simon’s proposal to focus on decision premises was his
belief that they are problematic and yet capable of investigation by
observation and experiment, and in particular his belief that organisational
design is a significant influence on the premises that are used in various
parts of an organisation. To understand
organisational behaviour, therefore, it is not sufficient to postulate
rationality in the peculiarly restricted sense that is used in much economic
theory (though it is normally appropriate to postulate intelligent and
purposeful behaviour); one needs to investigate the procedures by which
occasions for decision are identified, options are sought and examined, and
choices made; and this investigation should pay particular attention to the
premises which guide these procedures.
In this paper my primary concern is not the firm but the individual,
though we shall need to consider to the activities of firms. But our brief excursion into organisational
design
2
was not
irrelevant, because in considering the individual as decision maker we shall
pay particular attention to the ways in which individual knowledge is
organised, and to the decision premises which shape both the development and
use of that individual knowledge. In
accordance with the title, we shall give some emphasis to the influence of
markets on the growth and use of individual knowledge and also note how
knowledge within firms may benefit from market relationships. We begin by identifying some basic elements of
human cognition – not in order to produce a psychological theory, but to
provide a credible psychological basis for our economic reasoning.
Cognition and the Growth of Knowledge
The principle of biological evolution is that of genetic selection for
features which contribute to the fitness of each organism. These features include both physical and
behavioural characteristics, in a sorting process which necessarily extends
over very many generations. The standard
biological model therefore assumes a stable selection environment, and implies
the possibility of extinction if there is an unfavourable environmental change;
we should not therefore be surprised that only a very small proportion of the
species which have appeared on earth have survived, or that species are
disappearing at a high rate in the present era of environmental change, much of
it the result, sometimes intended and sometimes not, of human activity. Our own species, of course, is not exempt from
the possibility of extinction; but it does have a biological advantage in our
evolved, and quite exceptional, capability to recognise significant change and
to develop new behaviours in response. This
potential for learning may itself be interpreted as a biological adaptation to
environments in which change is too rapid or too transitory to allow adequate
genetic response through mutation and selection (Schlicht 2000); it provides
real options to cope with uncertainty.
Though this capability might seem to be represented by the economic
concept of rationality, it is much more than that, and much of the rationality
involved is procedural rather than substantive (as Simon has pointed out),
relying not on system-wide optimisation or strategies in the game-theoretic
sense of conditional actions, but on the deployment of cognitive potential in
the creation of localised structures. The
possibility of individual adaptation does not arise from the evolution of a
general purpose programme within the brain which can be applied to all
situations – which seems to be the conception implicitly underlying rational
choice theory, especially when extended to rational expectations – but by the
evolution of an architecture which is appropriate for distributed programming;
this allows sensory inputs to be assembled into distinctive patterns, each of
which triggers effective actions, in the process of interaction with specific
environments.
There are two linked evolutionary reasons for this architecture. The first reason is that genetic evolution
proceeds by successive adaptations, each step of which has to be compatible
with (even if it does not positively favour) survival, and the step by step
construction of a general problem-solving programme would entail many stages in
which the use of the incomplete system would be likely to lead to disastrous
mistakes. The second reason is that
brain tissue has particularly high energy requirements. The
3
emergence of homo sapiens has been marked by a very
substantial increase in brain size, and therefore by an increasing need to
economise on energy demands. We should
not therefore be surprised that multiple cognitive systems, each adapted to a
limited function, and switched on only when required, proved to be the
successful pathway to improved cognition, rather than a central processing
system which would need to be permanently engaged. The division of labour is a fundamental
principle of development, in the brain as well as in society; and the network
architecture of the brain made such a division possible.
These capabilities for adaptation were well advanced before the
development of consciousness; and consciousness appears to have emerged, as one
might expect, from this architecture and the functions that it supported. If the unconscious brain collects impressions
into categories, and associates each category with a particular action, it is
natural that consciousness should begin with awareness of some of these
categories, and in particular with a perception that one of the categories
presently employed is not appropriately defined, or is linked to actions which
are not particularly effective.
(The resemblance to the Carnegie language of aspirations and
achievements is not accidental.) The
response to dissatisfaction would then be a search for better ways of ordering
sensory impressions or for better connections between impressions and actions. It has been quite frequently observed that we
consciously seek to make sense of our environment by imposing patterns upon it,
thus aiming deliberately to improve upon tacit skills by codification, or
sometimes by giving a conscious direction to a process which remains beyond any
detailed conscious control; and it is one of the most remarkable features of
modern formal economics that its models of human behaviour make no reference to
this characteristic activity of pattern-making, both conscious and unconscious
– even though modern formal economics is itself an impressive example of the
drive to impose patterns. Consequently
what is called ‘rationality’ within modern economics is a rather small, if
important, part of human cognition, and makes a limited, if important,
contribution to the explanation of human behaviour.
The two stages of development of human cognition which have just been
outlined were presented as an evolutionary hypothesis in a paper written by
Alfred Marshall (1994) as a young Fellow of St John’s College for a Cambridge
discussion group. The significance of
this paper for both the content and method of Marshall’s subsequent work as an
economist was identified by Tiziano Raffaelli; and it has been suggested
(Butler 1991) that the motivation for writing it was supplied by a double
crisis of religious and mathematical faith, the common feature of which was the
perceived failure of axiomatic reasoning to guarantee empirical truth. The mathematical crisis was precipitated by
the invention of non-Euclidean geometry; the point was not that Euclidean
reasoning was wrong, or even inapplicable, but that its applicability was a
distinct issue, which could not be settled by appeal to the quality of
reasoning; as Ziman (1978, p. 99) warns us, ‘scientific knowledge cannot be
justified or validated by logic alone’. (This
was also the lesson of Marshall’s later encounter with Cournot’s argument that
falling costs entailed monopoly – a lesson that was entirely lost amid the
reinvention of Cournot’s logic in the 1930s, although Dennis Robertson seemed
to have a sense that there was something wrong about the assumed relationship
between logical and empirical truth.) Marshall’s
response,
4
like Hume’s
response to his own argument that it is impossible to prove any general
empirical proposition, was to turn to the question of how people acquired what
we call knowledge, and Marshall did so by drawing on Darwin’s principles of
evolution to sketch an evolutionary psychology. Caution in applying the patterns of axiomatic
reasoning which had proved inadequate, and use of the evolutionary principles
of the organisation of knowledge are persistent themes of his work as an
economist.
Marshall appears to have been unaware of Hume’s work, or of Adam
Smith’s (1980) remarkable development of it in his psychological theory of the
growth of science. As we have observed,
the basic, and very powerful, human cognitive skill is the creation and
application of patterns (of which logical reasoning is a special case); and
Smith characterises scientific activity as the invention of ‘connecting
principles’ which provide a credible account of relationships between
phenomena. For this cognitive skill to
be put to effective use it is important that people should be both sensitive to
patterns and motivated to seek out or manufacture patterns. Not the least of the merits of Smith’s
analysis is the attention that he gives to motivation, and what that motivation
is. The driving force is the link
between cognition and emotion.
Smith begins by identifying three human emotions: surprise, wonder
(what we might now call perplexity) and admiration. An event or impression which does not conform
to our expectations is surprising, and surprise causes discomfort; if we can
find no way of accommodating it to our cognitive categories we are conscious of
a failure to understand, which is at least disconcerting and may be dangerous;
we therefore feel an urgent need to find a new way of making sense of our
environment. “Wonder, therefore, and not
any expectation of advantage from its discoveries, is the first principle which
prompts mankind to the study of Philosophy, of that science which pretends to lay
open the concealed connections that unite the various appearances of nature”
(Smith 1980, p. 51). From an
evolutionary perspective, we can easily see that the emotive power of ‘wonder’,
in Smith’s sense, might sometimes be much more effective than ‘an expectation
of advantage’ in promoting fitness-enhancing cognitive activity and thus
improving adaptation to novel circumstances.
As we have already noted, sense-making is achieved through the
invention of patterns, or new cognitive structures, which Smith carefully
distinguishes from the perception of empirical truth; and if we are successful,
either through our own efforts or by discovering a means which is already being
used by someone else, then our sense of relief produces admiration in
proportion to the discomfort, thus, in psychologists’ terms, providing
reinforcement to our new cognitive skill. Thus “the repose and tranquillity of the
imagination is the ultimate end of Philosophy” (Smith 1980, p. 61); and because
this repose and tranquillity rests on human inventions, rather than revelations
of the principles that are actually in operation, it is always liable to
further disturbance, which stimulates further invention. Hayek (1952) was later to note that the
categories that we use to order sensory impressions may differ substantially
from the categories which have been developed to accommodate the development of
corresponding scientific knowledge, and suggested an evolutionary explanation
which is compatible with the argument of this section.
5
In a very recent paper, Ekkehard Schlicht (2000) has associated both
the motivation to resolve difficulties by inventing new patterns, and the
criteria by which possible new patterns are assessed, with an aesthetic sense
which, he suggests, often seems to take priority over more strictly
instrumental concerns; as in Smith’s analysis, an emotive drive may be more
powerful than the prospect of practical benefits. Indeed, when people are consciously searching
for a theory which will account for some puzzling phenomenon, or for an
effective product design, they often work on the principle that ‘if it looks
right, it is right’. Schlicht provides
some examples from modern science; and Smith’s detailed account of the
succession of cosmological theories incorporates repeated attention to the
significance of aesthetic criteria, for example in the motivation of Copernicus
to incorporate the heavenly bodies within “a new system, that these, the
noblest works of nature, might no longer appear devoid of that harmony and proportion
which discover themselves in her meanest productions” (Smith 1980, p. 71). In explaining the triumph of Newtonian
physics, Smith (1980, p. 105) recognises the rhetorical power of its supreme
aesthetic appeal; and in his Lectures on
Rhetoric he uses this appeal in recommending that, in giving an account of
some system, one should “lay down certain principles… from which we account for
the several phenomena, connecting all together by the same chain” because “the
Newtonian method is undoubtedly the more philosophical, and in every science… is
vastly more ingenious and engaging” (Smith 1983, p. 146). The incentives to which both Smith and
Schlicht appeal do not coincide with the incentives to which economists
typically give priority, though the latter may complement them; but they still
appear to be important incentives to scientific investigation. In this, as in other aspects of its practice,
science is still an art.
Smith went on to observe that as science progresses, it tends to divide
into specialisms, and these specialisms encourage attention to details which
would otherwise not be noticed. This
closer observation increases the chances of perceiving anomalies which then
provoke efforts to modify or replace patterns that would be acceptable to the
non-expert; thus the division of labour within science leads to increases in
scientific knowledge. As we know, Smith
(1976b) was later to found his theory of economic development on this
principle, in an exemplary demonstration of “the Newtonian method”. We can now see that what underlies the unique
potential of the division of labour within human society, in comparison with
specialisation within any other species, is the architecture of the evolved
human brain, which is capable in principle of forming any of an enormous
variety of networks, far more than any single brain can actually sustain. By appropriate specialisation, therefore, a
human community can generate far more knowledge than any single person is
capable of. Marshall added to Smith’s
principle of the division of labour Darwin’s principle of variation in response
to environmental differences, which had already been incorporated in Marshall’s
evolutionary hypothesis (noted earlier) and underlay his insistence on the
importance of variety among the firms in each industry. Economic development is therefore the result
of the division of labour, supplemented by variation within each field of
knowledge, both acting through the capacity of the human brain to develop new
cognitive networks and motivated by the human desire to make sense (and not
just money) by imposing patterns.
6
A necessary consequence of this process is the increasing
interdependence of human society. Most
of the knowledge and the skills that each of us need are held by other people;
and although knowledge and skills are non-rival in a narrow sense, because of
the basic facts of human cognition they are rarely reusable without cost by
those who do not already possess them. The
lowest costs are typically incurred in acquiring knowledge within familiar
fields from those who seem to be better informed, or in improving performance
skills, mental as well as physical, by adopting the practices of those who seem
to perform better, because we can usually assume that we are already organising
our knowledge in similar ways to those whom we are seeking to emulate. Willingness to borrow ideas and methods from
others who appear to be relevant models is a familiar human characteristic,
explicable by its survival value (Schlicht 2000). Nor is it difficult to understand why we
should so often converge on a few models, as Smith realised; his psychological
theory of science gives due attention to the factors affecting the diffusion of
each cosmological system. Our cognitive
limitations provide the incentives to borrow; the cognitive limitations of
others, by impelling them to make and use patterns rather than attempting to
optimise using information that we cannot observe, makes it easier to
understand their rules of behaviour, as Heiner (1983) argued; and our shared
characteristics make it easier to imagine ourselves in someone else’s
situation, and to tailor actions and communications to their perceptions, as
Smith showed in both his Theory of Moral
Sentiments (1976a) and Lectures on Rhetoric
(1983).
When we do so converge on rules for deciding how to behave, the shared
conventions and procedures may be called institutions; and our understanding of
institutions is enhanced if we begin with an appreciation of human cognition,
and the consequent advantages of adopting other people’s procedures for good
reason – that they seem to work for them – even when our actions have no effect
on anyone else (Choi 1993), rather than by postulating games between people
without cognitive limitations – and often with no acknowledged limits on their
information either, although the specification of the game often imposes
artificial limits on the players’ possibility sets. Schlicht’s focus is on the conventions that
facilitate interaction, and in particular on the criteria for a good rule, and
this leads him to emphasise the importance of “evaluation of an aesthetic kind,
relating to formal features like symmetry, analogy, or good continuity”
(Schlicht 2000, p. 3). Such evaluations
are also important in choosing good rules for our private procedural
rationality. As Schlicht points out,
these features are not relevant to anyone who is deemed capable of optimising
everything except the use of scarce cognitive resources, but in a changing
environment optimisation on each separate occasion is not a sensible objective,
even by the criterion of overall optimisation. We may recall Schumpeter’s (1943, p. 83)
proposition that “[a] system… that at every
given point of time fully utilizes its possibilities to the best advantage may
yet in the long run be inferior to a system that does so at no given point of time, because the
latter’s failure to do so may be a condition for the level or speed of long-run
performance”. Schumpeter applied this
proposition to “any system, economic or other”; it is a proposition about
uncertainty and
7
discovery,
which is as applicable to the individual as to the economy; indeed it is its
applicability to the individual that underlies its application to the economy.
Schlicht identifies imitation (which is rarely a precise copy) as an
effective mechanism for coping with changes which do not last long enough to
permit adaptation at the genetic level, but long enough for knowledge which has
been acquired by individual pattern-making to be reusable by others at
relatively moderate cost. Sometimes this
reuse may be formally organised. Frank
Knight (1921), having defined uncertainty as a situation in which no existing
pattern or procedure is sufficient, and the entrepreneur as someone who is willing
to impose an interpretative framework on that situation, then suggests that
this entrepreneur may find it quite easy to persuade people to accept his offer
of employment rather than attempt to cope with uncertainty on their own. (Their motivation may well correspond to that
on which Smith based his theory of scientific development.) The entrepreneur therefore exercises authority
within his firm precisely in Barnard’s (1938, p. 163) sense, which locates the
decision about what is authoritative with the recipient, not the source.
However, our analysis should indicate that, as Barnard’s definition
permits, authority is by no means restricted to hierarchical relationships, or
even to relationships within formal organisations. Anyone whose instructions, advice, or example
we accept in any particular context is a figure of authority within that
context; and we would find it very hard to manage our lives without many such
figures. It is important to recognise
the source of both institutions and authority in individual efforts to take
advantage of the range of human potential in coping with individual cognitive
problems and the urge to make sense of the complexity of our environment,
because it provides a basis for understanding why the emergence of institutions
which serve to co-ordinate interactions is often much easier than would be
suggested by the multiplicity of equilibria in many game-theoretic models, and
why people should be much readier to accept subordinate roles in organisations
than might be expected from a model populated by cognitively self-sufficient
agents. It also explains the
effectiveness of marketing institutions which match cognitive needs.
A great deal of effort has been devoted by economists to examining the
efficiency of exchange. However, it is
not often that this examination begins by posing the question in an
appropriately cognitive form: to what extent can the problems of differentiated
knowledge be resolved through the exchange of knowledge which is embodied in
goods and services? To do so immediately
raises questions about the design of goods and services and also about the
arrangements for exchange – or, in other words, about the working of markets. These are not necessarily distinct questions,
for as Marshall (1919, p. 181) observed, “[p]roduction and marketing are parts
of the single process of adjustment of supply to demand. The division between them is on lines which
are seldom sharply defined: the lines vary from one class of business to
another, and each is liable to modification by any large change in the
resources of production, transport or the communication of intelligence.” New products may require the creation of new
market institutions, and the possibility of creating new market institutions
may suggest product
8
redesign. We are about to consider the working of
markets, each of which will be treated as “a specific institutional arrangement
consisting of rules or conventions that make possible a large number of
voluntary transfers of property rights on a regular basis” (Ménard 1995, p. 170);
and we shall focus on the ways that these rules or conventions reduce the costs
of transactions by simplifying cognitive tasks. But before doing so we should recognise the
importance of transfers of knowledge which is not embodied in goods or
services, and of arrangements for the development of knowledge, for these
aspects of co-ordination are also often dependent on the working of markets. The markets to be considered are not, of
course, the unanalysed markets of so much microeconomic – and of almost all
macroeconomic – theory.
The failure to analyse markets as institutional arrangements which
structure processes is a natural, and almost inevitable, consequence of
choosing to start the analysis of exchange with perfect competition, for
competition cannot be perfect unless every potential buyer has equal and
costless access to every seller, and vice versa. The moment that one provides any structure to
these market relationships competition is no longer perfect. The methodological necessity of avoiding
structure accounts for the extraordinary status of the ‘auctioneer’ as the
organiser of the perfect market (for whom Walras has received undeserved
blame): the auctioneer has neither preferences nor motivation, consumes no
resources, is able to communicate with everyone without ever establishing any
kind of personal contact and without cost to either party, and never makes a
mistake; most extraordinary of all, the auctioneer is a monopolist who is
trusted by everyone never to exploit his position, and always justifies this
trust. Exactly the same characteristics
are attributed to the ‘social planner’, who is subject to the same
methodological necessity.
Since these perfect markets deliver efficient allocations without cost,
it is not surprising that economists found some difficulty in explaining the
existence of firms, which used resources in doing what the auctioneer did for
nothing; nor is it surprising that Coase found it necessary to assume that
economic agents, if not the auctioneer, incurred some costs in using markets. If Coase had been better trained in economic
theory, he might have realised that costs of using markets would be difficult
to reconcile with perfect competition, and responded by following Joan Robinson
(1933) into her world of monopolies; if, however, he had been less well
trained, or alternatively had been more familiar with the work of earlier
economists, he might have addressed to markets the question that he posed about
firms: if they cost something to operate, why are people willing to incur these
costs? Markets should be explained, not
assumed.
The route to an explanation was provided by Carl Menger ([1871] 1976),
who set out to analyse the structure of an economy as an increasingly complex system
for meeting human needs. Beginning with
goods which can be directly applied to their owners’ needs, he introduced what
was to become a characteristically Austrian concern with indirect ways of
meeting these needs, such as making machines to make tools for growing crops
which can then be turned into food. In
this analytical system, the exchange of what one already possesses for
something which can be used in the production chain is itself an indirect way
of meeting needs. It is therefore not
surprising, though it is significant, that Menger introduces exchange at the
opposite end of the range from what has become the
9
standard
practice, with simple bilateral deals, and that he also recognised that making
a deal incurs costs. We now have
isolated exchanges but no market, and so have the possibility of explaining
markets as a means for reducing the costs of exchange, if there is a demand for
multiple exchanges.
It is the next step that is crucial. Rather than exchanging what they already have,
some people may begin to use what they already have in the production of goods
which are intended to be exchanged with others; and if this plan is successful,
it may be worth while acquiring additional goods, not for use, but as inputs
into regular production. Exchange now
becomes an essential part of the business of improving one’s condition, and the
efficiency of the exchange process itself becomes a constraint on this
improvement, and therefore a matter for attention. If the creation of a market can improve the
efficiency of exchange, it is, in Menger’s terms, a good of higher order, and
its value is derived, in the first instance, from the value of the exchanges
that it makes possible through this improvement in efficiency – and ultimately
by the value of the indirect contribution that it makes to satisfying human
needs.
The most obvious means of improving the efficiency of exchange is
through the development of a generally-accepted medium of exchange, which
removes the need to match the goods that are included in each transaction. Menger concentrates on money, because it
exemplifies the emergence of a pervasive institution as a result of individual
initiative and the readiness (not necessarily immediate) of people to copy
behaviour that seems to work effectively for others. In the course of developing this argument, he
does, however, point out that goods differ substantially in their marketability
– that is, in the costs which must be incurred in the process of exchange. Unless the producer has some special
advantage, commodity production will be concentrated on goods with relatively
high marketability, though, in accordance with
The obstacles to trade discussed by Casson are primarily the result of
deficiencies of knowledge; and so are the costs invoked by Coase (1937) to
explain the creation of firms – though Coase did not see that firms make
markets as well as goods. Both require
knowledge to be organised; this is a cognitive issue, to be handled by
procedural, not
10
substantive,
rationality. Costs per transaction are
reduced by the development of a set of conventions about the way in which it is
to be carried out, including, for example, the location, the provision of
information, opportunities to inspect or try out the product, standards for
product characteristics, methods of payment, provision for servicing, and the
commitments that are implicit in the deal. Because of the standard use of preference
functions in consumer theory, it is important to mention that the use of money
not only makes payment straightforward; the use of money prices also simplifies
the assessment of each potential purchase. The ‘measuring rod of money’ is among the most
important of conventions. The effect of
these institutions is to ease the cognitive task of making a satisfactory
purchase (and also the cognitive task of making a satisfactory sale). This cannot be achieved without a cognitive
investment, and though the cost of this may fall mainly on the producer,
customers must develop their own new routines. Everyone has to learn how to shop in a
supermarket, how to buy through mail order, how to buy PEPs or ISAs, and know
how to use the internet effectively. This
learning produces potentially reusable knowledge; consequently everyone who
makes this cognitive investment experiences the equivalent of what Penrose
(1959) called “the receding managerial limit” as their new capabilities become
embedded in new patterns of behaviour and therefore release cognitive resources
for other tasks, and especially tasks which can incorporate the new routines. On the other hand, significant changes in
institutional arrangements, such as the replacement of PEPs by ISAs and, on a
much larger scale, the development of internet markets, impose new cognitive
burdens.
The importance of simplifying the customer’s cognitive task is illustrated
by considering those markets in which many customers are willing to go to a
good deal of trouble to get what they want, and where the common practice of
supplier-fixed price does not apply. Three
outstanding examples are the markets for houses, cars and collectables. Here there are two powerful incentives for the
customer to incur substantial transaction costs: purchases typically involve a
substantial outlay, and they have substantial implications for the customer’s
style of living, and even for self-image. Such cognitive structures as life-style and
self-image are a natural consequence of the pattern-making characteristics of
the human brain which have been considered earlier, and the maintenance of
these structures will normally be a major objective. It is therefore worth taking a good deal of
trouble to ensure that any major purchase is compatible with the relevant
patterns – or, occasionally, that an available purchase has sufficient appeal
to justify some modification of those patterns. Rules for making such decisions have a
substantial aesthetic component, even when the opinions of family, friends,
colleagues, or neighbours are not of direct concern.
When there is substantial diversity among customers, the greatest
reduction in transaction costs for a particular group may be achieved by the
creation of sub-markets in which the rules and conventions, as well as the
products, are precisely adapted to that group. This is yet another instance of the effects of
the division of labour, which as always is limited by the extent of the market;
but the extent of the market is influenced by the incremental cost of
transacting in it. Firms, like
individuals, differ in their capabilities, including their capabilities in
devising institutional arrangements for reducing particular kinds of
transaction costs for particular groups of potential customers, and these
differences are
11
reflected in
what they attempt and (even more) in what they achieve. But thinking of the ways in which firms can
develop arrangements that enable them to sell more easily should not distract
our attention from the contribution of these arrangements to the firm’s
knowledge about its business. They are
an important part of what
However, the emphasis in this paper is on consumers. Market institutions are an important part of
consumers’ external organisation; the rules and conventions form part of their
interpretative system and their framework for decision making. How we decide is not without influence on what
we decide; and the power of market-making firms to shape the way that we decide
seems to be well appreciated in many businesses, as is manifest in a brief
observation of marketing strategy. This
power is often attenuated by the efforts of rivals; as Hayek (1948, p. 106)
pointed out, competition is a “process of formation of opinion”, or in language
used earlier, a means of deciding whose communications will be provisionally
accepted as authoritative. There is no
choice without a framework, and as in Penrose’s theory, the routinisation of
procedures makes possible the acquisition or creation of new knowledge and new
skills. If the process of transacting is
easy, we can concentrate on what to transact, and how to develop new skills as
consumers – or indeed as humans. Our
cognitive resources, like the productive and managerial resources of the Penrosian
firm, are capable of development, and when developed may deliver new productive
services; we have therefore an incentive to learn about the possibilities and
the opportunities (Penrose 1959, p. 77) or what we might call their option
value. We may be encouraged to do so by
the recognition that the array of markets which we can use without much effort
also have an option value for us; they allow us relatively easy access to a
wide range of other people’s capabilities.
We should not forget that the greater part of the value of transactions
within a modern economy has no direct reference to customers at all; and the
same incentive to reduce the costs of individual transactions by substantial
investment in developing appropriate institutions applies here. Business customers may have stronger
incentives than their suppliers to simplify the process of transacting, and
this may not merely be a matter for the purchasing department; for production
is closely linked with purchasing as well as marketing. Arrangements with suppliers may reduce the
costs associated with production, and modifications to product and process may
simplify relationships with suppliers. Amid
the flurry of excitement about e-commerce, there have been several predictions
that its impact may be greater on relations between businesses than on
retailing; if this is so, it will be because of changes not only in the
handling of transactions but because of associated changes in the internal
operations of firms.
We make sense of our situation by constructing order; the quality and
applicability of our knowledge capital, as of physical capital, depends on its
structure. But even in our private lives
we are not dependent on our own resources; our common mental architecture makes
it possible to connect to external knowledge capital, though by no means to all
of it.
12
Market
relationships provide links which make possible the construction of additional
knowledge, and by allowing many activities to be guided by rules and
conventions, provide scope for imagination. Co-ordination by institutional arrangements
define boundaries, which should lightly be assumed to match the fundamental
data – which is not known anyway; but from a cognitive perspective it also
defines a space to think within those boundaries – and even to make selective
forays across them. The history of human
development (which is only part of human history) is one of discovering ways of
circumventing the limits apparently imposed by the cognitive capacity of each
individual, by an increasing division of cognitive labour and by developing
procedures which enable us to make new combinations from the results of that
division.
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The Competitiveness of Nations
in a Global Knowledge-Based Economy
October 200
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