Oliver Williamson: Early Life, Academic Career, Impact

Oliver Williamson (1932 to 2020) was a U.S. economist, Nobel Prize laureate, and academic, best known as one of the leaders of New Institutional Economics (NIE) and the founder of Transaction Cost Economics (TCE), novel economic frameworks that moved traditional theory beyond an exclusive focus on markets and price theory—and permanently changed how economists, governments, and corporations view non-market institutions and transactions outside the market.

As the founder of Transaction Cost Economics (TCE), Williamson opened up the inner workings of firms (the “black boxes”) that traditional economists had considered inconsequential—and pioneered a new way for business enterprises to be analyzed. For example, by shifting the focus to the inner workings of transactions, Williamson explained the existence, the function, and the characteristics of business firms. By accurately predicting how real-world markets operate, he also disproved neoclassical price theory’s perfect competition model, a theoretical market structure in which there are no monopolies.

A multi-disciplinary scholar with a strong background in organization theory and contract law as well as economics, Williamson is also known as an economist who made a significant impact on many areas outside economics, including anti-trust policy, regulation/deregulation, and the law.

Williamson was the author of several books, including an economics classic, Markets and Hierarchies: Analysis and Antitrust Implications (1975), and one of the most frequently cited works in social science research, The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting (1985).

Education and Early Career

Oliver E. Williamson (1932 to 2020) was born in Superior, Wis., a small town he described as “the most democratic community (he) ever lived in.” Both his parents were former high school teachers; his father left teaching to join Williamson’s grandfather in the family real estate business; his mother was required to retire from teaching when she married.

As a child in Superior’s “very egalitarian” school system, Williamson wanted to become a lawyer. By the time he was a high school student, he decided that his keen interest in math and science made engineering the ideal career. On his mother's advice, he enrolled at Ripon College, which had a joint-degree program (in management and engineering) with the Massachusetts Institute of Technology (MIT).

After earning a B.S. from the MIT Sloan School of Management in 1955, Williamson’s first job as a project engineer at General Electric was followed quickly by a stint in the U.S. Federal Government, at the Central Intelligence Agency (CIA) in Washington, D.C. Looking back later in his career, Williamson said these roles gave him the opportunity to learn how big government, big business, and big bureaucracy functioned.

During these early years, Williamson began to develop his trademark multi-disciplinary perspective across economics, business, and law—and even engineering. For example, in 1958, when he was accepted into the M.B.A. program at Stanford University’s Graduate School of Business, he was struck by the fact that two completely different disciplines—economics and engineering—used surprisingly similar analytical methodology. As he noted in his Nobel biography, he “discovered that…(his) engineering training in mathematics, statistics, and model building gave (him) a much more grounded foundation (in economics) than would…any of the social sciences.”

Once he completed his M.B.A., Williamson acted on advice from mentors at Stanford (James Howell and Kenneth Arrow) and made the move from business to economics. In 1960, he was awarded a three-year fellowship by the Ford Foundation to pursue a Ph.D. in Economics at Carnegie-Mellon University in Pittsburgh—where he “found (his) niche” in the multi-disciplinary approach to economics and organization theory as taught by the faculty of the Graduate School of Industrial Administration. In 1963, Williamson’s Ph.D. dissertation, “The Economics of Discretionary Behavior: Managerial Objectives in a Theory of the Firm,” won the Ford Foundation dissertation competition.

Academic Career (1963 to 2004)

In the fall of 1963, Williamson took his first faculty position: Assistant Professor of Economics at the University of California, Berkeley (UC Berkeley). Over the next 40 years, as he developed the groundbreaking theories that ultimately earned him the Nobel Prize, he also served on the faculties of the University of Pennsylvania and Yale University and held numerous visiting professorships outside the U.S.

After two years at UC Berkeley (1963 to 1965), Williamson was recruited to the University of Pennsylvania (UPenn), where he spent 18 years (1965 to 1983), as Associate Professor (1965 to 1968) and Professor (1968 to 1983), including appointments as Professor of Economics and Social Science (1977 to 1983) and Chair of Economics (1971 to 1972; 1976 to 1977).

Of note, in the late 1960s, in addition to serving on the Economics faculty at UPenn, Williamson was appointed to the faculty of the Law School and the School of Public and Urban Policy—another multi-disciplinary role that he found highly productive.

In that spirit, in 1983, he accepted an “even more productive” position at Yale University in a multi-disciplinary appointment in the School of Organization and Management, the Law School, and the Economics Department. As Professor in three departments, he spent five years (1983 to 1988) leading workshops on law and organization at Yale Law and on economics and organization in the School of Organization and Management. He also served as Founding Editor of the Journal of the Law, Economics, and Organization.

In 1988, Williamson was recruited back to UC Berkeley, where he spent the rest of his academic career in a dual role in the Haas School of Business and the Economics Department, with an auxiliary appointment to the faculty of the UC Berkeley Law School.

Over the next 16 years, from 1988 until his retirement from active teaching in 2004, Williamson’s accomplishments at UC Berkeley included creating a new field in the Economics Department—the Economics of Institutions—and reshaping the Business and Public Policy curriculum in the Haas School. Post retirement, Williamson kept an office at UC Berkeley to continue his research and remained active in workshops as well as recruiting and fund raising.

Industrial Organization and Vertical Integration

Williamson’s specialty for his Ph.D. in Economics at Carnegie, Industrial Organization (IO) (sometimes called Industrial Economy), is the study of how industries operate in the economy, including regulatory policy, antitrust policy, and market competition. (The word “industrial" in industrial organization means all large-scale business activities, including agriculture and the tourism industry—not just manufacturing.)

Antitrust Division of U.S. Department of Justice (1966 to 1967)

Although Industrial Organization (IO) was out of favor with economists in the 1960s, Williamson did not hesitate to challenge the prevailing anti-IO orthodoxy of the time wherever he encountered it. For example, during his tenure at the University of Pennsylvania, Williamson spent a year (1966 to 1967) as Special Economic Assistant to the Head of the Antitrust Division at the U.S. Department of Justice (DOJ)—an experience that he described as “the defining event” in the development of his work in industrial organization (IO) and vertical integration.

In the Antitrust Division, Williamson noticed that the economists and the DOJ experts, who were preoccupied with how to prevent monopolies, completed overlooked the internal workings of companies as they were deciding policy. As he put it, they thought of the firm as no more than “a black box that transfers inputs into outputs,” so they never looked inside to understand how decisions were made.

As soon as he recognized this basic oversight, Williamson realized that the entrenched anti-IO orthodoxy that refused to even consider (much less analyze) economic activity inside organizations was leading to major mistakes in antitrust policy. For example, the DOJ at the time suspected all contracts that were not simple market exchanges of fostering monopoly power and hurting the public. What Williamson objected to in this policy was that the DOJ automatically labeled as anti-competitive any strategy that takes transactions out of the marketplace—including vertical integration, the streamlining of business operations by taking direct ownership of various stages of production (suppliers, manufacturers, distributors) rather than outsourcing them.

Williamson also realized that another premise of the anti-IO argument—that markets were always places of perfect competition where transactions could happen much more efficiently than inside firms—was faulty as well. Although he did acknowledge that—when markets are competitive—they work well to resolve disputes (because buyers and sellers can turn to other trading partners), his research proved that—when market competition is limited—the dynamics inside firms handle conflict resolution much better than markets.

Williamson took this groundbreaking insight from his antitrust work at the DOJ back to his team at UPenn, where he focused on research that proved that many economic decisions that mainstream theory said would be handled more efficiently in the marketplace were actually handled much more efficiently within firms.

New Institutional Economics (NIE)

In 1975, Williamson published a landmark text in the New Institutional Economics (NIE) movement, The Economic Institutions of Capitalism, which presented his case that the analysis of transactions and contracts could explain the structure and boundaries of companies, effectively refuting the theory of firms as no more than profit-making machines.

Economic Governance

The broad category cited by the Nobel Committee when Williamson won in 2009 was economic governance—a term for all the regulatory policies, procedures, and processes (both formal and informal) to resolve conflicts that governments and hierarchical organizations (including firms) carry out within institutions—in other words, outside the marketplace.

Williamson’s theories about economic governance are integral to a new branch of economic thought that he co-created—New Institutional Economics (NIE)—which is based on the common-sense premise that the driving force behind the decision to choose one governance option over another is the desire to economize on total costs. The fact that total costs for goods and services necessarily includes all the costs associated with writing, monitoring, and enforcing contracts—and addressing contractual hazards inherent in transactions (i.e., incomplete contracts)—Williamson’s NIE/TCE approach begins with analyzing the characteristics of each transaction (his basic unit of analysis) to determine which governance option is the best match.

Nobel Prize in Economic Sciences (2009)

In 2009, Williamson was one of two recipients of the Nobel Prize in Economic Sciences for his analysis of economic governance, “especially the boundaries of the firm.” His co-laureate, Elinor Ostrom, also won for her analysis of economic governance, “especially the commons.” (Commons means finite common-pool resources within a community, e.g., water, forests, and fisheries.)

When the Nobel Committee selected him that year, he was 45 years into his career as a multi-disciplinary academic with significant accomplishments in several economic disciplines, political science, and the law, including groundbreaking work on antitrust policy and the study of institutions. The fact that—of all his achievements—the Nobel Committee cited “his analysis of economic governance, especially the boundaries of the firm” at the height of the global financial crisis—was considered evidence of a desire to look outside the traditional pool of market economists in that difficult year.

A Nobel for Institutional Economics

When Williamson won the Nobel in 2009, it came as a surprise to many. Although he had been discussed as a possible recipient for several years before he won, he was always considered a long shot. Only two years earlier (2007), in an article about likely winners, Forbes had mentioned him as a “left-field” and “non-mainstream” possibility.

The timeliness of Williamson's Nobel was less surprising. The Associated Press noted that, although the 2009 Nobel Committee did not cite the global financial crisis, their choice of two nontraditional economists, Williamson and his fellow laureate, Elinor Ostrom—both cited for economic governance in the wake of a market crash attributed by many observers to an absence of regulatory oversight—was clearly an acknowledgement of the essential role of institutions.

In contrast, the frontrunner that year, Eugene Fama, a University of Chicago professor, is best known as the father of the efficient market hypothesis, which holds that the price of a traded asset (a share or a bond) accurately reflects its true value—a theory that had just been discredited by the global market meltdown.

In response to the Nobel winners in 2009, fellow economist Paul Krugman noted that “Williamson’s work underlies a tremendous amount of modern economic thinking”—and said it was “an award for…New Institutional Economics”—a field that had been making a “quiet comeback” for decades under the leadership of economists like Williamson and Ostrom.

Transaction Cost Economics (TCE)

As the founder of Transaction Cost Economics (TCE), Williamson had two primary objectives: 1) to understand how variations in the characteristics of transactions lead to all the different kinds of organizations that govern trade in a market economy; 2) to create economic models that predict real-world phenomena.

Challenging the Logic of Zero Transaction Costs

In his Nobel address, Williamson explained that his first insight into Transaction Cost Economics (TCE) was simply that he challenged the logic of a core assumption made by orthodox economists: zero transaction costs in a perfect market.

He argued that TCE is not concerned with simple contracts with zero transaction (or governance) costs—for example, bartering “nuts for berries on the edge of the forest.” Instead, Williamson started with the more reasonable premise that—because TCE is concerned with complex contracts in complex organizations in the real world—transaction (and governance) costs for economic activity would always be positive (more than zero).

The fact that Williamson did not accept that there could ever be zero transaction costs—and he knew that business decisions were driven by the desire to maximize profit and minimize costs—led to his realization that the analysis of these transactional costs was the ideal lens through which to map organizational structure. In other words, transaction costs (which are always positive) drive the structure of organizations—and that is the reason that complex organizational and institutional structures (especially firms) were essential to functioning markets.

Williamson’s arguments for TCE were so effective—and his research was so thorough and replicable—that his transaction cost perspective on the inner workings of firms replaced the neoclassical emphasis on prices and markets.

Transaction Costs Economics (TCE): Outsourcing

Williamson’s pioneering research on Transaction Costs Economics (TCE) transformed the way economists, corporate leaders, and governments evaluate strategy in several core areas with significant impact in the real world. For example, Steven Tadelis, an economist at UC Berkeley, gave an outsourcing decision at Boeing as a real-world example of how Williamson’s TCE theory accurately predicted the factors determining when it is more efficient for a firm to produce a component in-house rather than in the market.

Outsourcing Decision: When Boeing was building a new plane, they had “make-or-buy” decisions about an enormous number of separate aircraft components—some simple and some complex—for example, the screws and the fuselage. In the case of the screws, Boeing could easily find what they needed on the market—there was no need to produce their own. However, that was not the case with the fuselage, the main body of the aircraft into which many other parts have to fit. Williamson accurately predicted that, if Boeing decided to outsource the design and production of the fuselage, they would run into two problems: asset specificity and incomplete contracts.

Asset Specificity: Any company that accepted the outsourcing contract would invest considerable time, training, and resources in Boeing’s fuselage—and it was unlikely that any of those asset-specific investments in machinery or knowledge would ever be deployed to any of the company’s other products. Asset specificity meant that the company would become locked into working with Boeing.

Incomplete Contracts: Williamson predicted that the second problem that Boeing and their outsourcing partner would encounter is that the complexity of the design of something like a fuselage makes this a highly complex transaction as well. Unlike a simple transaction (“nuts for berries on the edge of a forest”), it is impossible to write a contract that covers every possible modification to the design and manufacture of a Boeing fuselage from start to finish. No matter how carefully the contract is written, it will always be incomplete, which means it will have to be renegotiated—haggled over—every time a change is needed.

Application of TCE: Williamson argued that: 1) in complex cases like Boeing’s fuselage, transactions handled in the marketplace would always be plagued by haggling over changes (incomplete contracts); 2) the fact that both parties are locked in (asset specificity) meant that the haggling would be prolonged and acrimonious. In this example of TCE in action, after four years of delays, Boeing did take the fuselage production back in-house—where extensive investments in machinery and knowledge were no longer exclusively for a solitary project (resolution of asset specificity) and the haggling was replaced by managerial control (resolution of incomplete contracts).

Williamson's Impact Beyond Economics

When Williamson began his career, mainstream economists were focused almost exclusively on transactions that happened in the market—with prices as the standard unit of analysis in economic research—and completely discounted transactions that happened inside firms and between firms. To counter the entrenched view that firms were no more than “black boxes of production,” the research Williamson pioneered was based on a novel unit of analysis: transactions.

With this revolutionary switch of focus to transactions, Williamson made a range of players (from economists and business leaders to government officials) understand that—to maintain efficiency in a capitalist world—it is essential to “open up the black box” to analyze the inner workings of firms and other institutions, especially how governance and incentives within and between firms drives decision-making.

In addition to advancing knowledge of how decisions are made inside firms in the real world, Williamson's transaction approach has made his work highly influential outside economics as well. In his Nobel announcement, The Wall Street Journal called him “the economist most cited by non-economists.”

As an academic conducting his own TCE research, Williamson launched a new generation of economists who continued to build an increasingly influential body of theoretical and empirical work that has led to the application of the TCE beyond the industrial organization of firms and markets. Since his original research at UCBerkeley, Williamson’s TCE framework has been deployed to understand the structure and performance of organizations as diverse as government bureaucracies, political and legal institutions, and non-profits.

Antitrust Policy

Notable praise from the legal profession includes an academic paper by Herbert Hovenkamp, a law professor considered “the dean of American antitrust law,” who credited Williamson and his TCE approach with an important role in antitrust—avoiding the “extreme” positions of two previous schools of antitrust policy, i.e., the Harvard-based structural school, which unilaterally blamed monopolies in the market structure for poor performance, and the Chicago School, which denied that monopolies caused power imbalances in the market.

Unlike the two polar-opposite positions, Hovenkamp praised Williamson’s TCE as a more analytical, situation-specific approach that demands close scrutiny of any scenario where significant market power is in play. Hovenkamp also gave credit to Williamson’s TCE for the fact that, since the 1970s, both of these “extreme” antitrust schools have slowly moved toward the center.

Public and Private Bureaucracies

In his 1999 article, Public and Private Bureaucracies: A Transaction Cost Economics Perspectives, Williamson challenged the dominant view that public bureaucracy, a widely used organizational form, is always and everywhere assumed to be inefficient compared to private bureaucracy. When he brought a TCE lens to the analysis, he determined that “public bureaucracy, like other alternative modes of governance, is well suited to some transactions and poorly suited to others.” Just like any modes of governance (markets, firms, regulation), public and private bureaucracies should be objectively analyzed for their efficacy and then “kept in their place.”

The Bottom Line

When Williamson began his career, mainstream economic research was fixated on transactions that happened in the market—and completely discounted transactions that happened inside and between firms. As the founder of Transaction Costs Economics (TCE), he introduced a completely new unit of analysis into economic research—transaction costs—and it transformed the way economists, corporate leaders, and governments evaluate strategy in several core areas with significant impact in the real world—including many areas outside economics, from outsourcing to antitrust policy, regulation/deregulation, and the law.

By shifting the focus to the inner workings of firms, Williamson's TCE research not only pioneered a new way for business enterprises to be analyzed, but it also highlighted areas where standard economic approaches fail to explain what actually occurs. For example, his accurate predictions of how real-world markets operate—with imperfect competition and positive transaction costs—continue to serve as a potent counterargument to the perfect competition model—a theoretical market structure with perfect competition, zero transaction costs, and no monopolies.