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II. Transaction Costs And Planning (6)

Conventional explanations of planning in welfare economic terms explicitly or implicitly associate planning with government intervention and state action, juxtaposing the (planned) public sector with the "free" market. Other discussions of planning and markets reveal the same dichotomy, contrasting "market-" and "plan-rationality" or comparing synoptic planning to an incremental political market.

But more advanced theory and observation suggest that this dichotomy is no longer correct, and if it was it has outlived its usefulness. Many definitions of planning (e.g. as rational choice, as anticipatory coordination, or as the attempt to control future actions) are so general (perhaps too universal) as to transcend this dichotomy. Political economists have been debating the respective merits of markets and various alternative forms of organization, and in the policy arena exploration of organizational structures and service delivery systems has ranged from markets through various mixed forms to pure bureaucracies.

Increasing complexity has also blurred the boundary between the elements of the original duality: the public sector and the market. Partial privatization and "third party governance" (Palumbo, 1987: 97-99) have diluted the public sector, which is no longer the exclusive domain of sovereign state agencies (if it ever was). Defense illustrates the interdependence and interaction between the public and private sectors, as arms manufacture and procurement exhibit various types of integration between government and private corporations in different countries and over time, consistent with their cultures and circumstances.

In the U.S. a complex symbiosis has emerged between the Pentagon and major defense contractors. This combines formal separation in market-like contracts and competitive procurement with the actual close cooperation necessitated by the imperatives of technical expertise supported by the continuities of personal and institutional relationships. Other countries, like France, openly recognize this interdependency, with government a major shareholder in defense industries. Elsewhere, again (e.g. in Brazil and Israel) national arms industries integrate R&D, production and procurement from private subcontractors. This example shows how artificial the public-private sector distinction is, even for national defense, surely a public good par excellence.

The private market, too, is rarely the "perfect" market beloved of classic economists, but has evolved into a variety of hybrid market forms, which include large integrated corporations with many of the attributes of (public) bureaucracies (Williamson, 1975). Consequently (as I will explain below), planning is not limited to the public sector. Firms and corporations plan their own activities, formally applied in corporate strategic planning (Lorange, 1982).

Private sector firms, as expert planners, also do most of the planning that is actually done today. They are the outsourced providers of governments' comprehensive forward land-use and development plans which back up their statutory planning and development control, and they do almost all the sectoral planning (7), e.g. for infrastructure and strategic facilities, land development and improvement, industrial production, and telecommunications. Planners, then, are as ubiquitous in the private sector as in government: they may be independent expert consultant firms, or they may be an in-house unit of sectoral private firms and corporations.

But the conventional rationale for planning, as a societal undertaking, has been based on the old public-market dichotomy. It has been associated with the basic functions of government, and explained in welfare-economic terms as public intervention in response to market failures. These include negative externalities (e.g. pollution), positive externalities demanding some public-private goods (e.g. education) and pure public goods that the market cannot supply (e.g. defense).

We find, however, that planning is not only a property of the public sector, but is widespread in the market as well. Should not an adequate theory be able to account for planning in a way that can explain planning in the market itself, and not only as something external or complementary to markets? The "Transaction cost theory of planning" does this, but first a brief introduction to integrated transaction cost theory (TCT) is necessary.

Transaction cost theory

Transaction cost economics was developed to explain economic institutions. Extended from the market into the public realm, an integrated transaction cost theory (TCT) can be applied to institutional analysis in the public sector. This has been done, for example, in reviewing the development of U.S. economic policy (Dixit, 1996) and in exploring alternative forms of governance for the U.S. State Department (Williamson, 1999).

Modifying classic economics to focus on transaction costs, TCT explains institutional adaptations of the perfect economic market. The basic unit of analysis is the transaction: any exchange between parties, from simple exchanges of goods and services for money, to other transactions involving the promise of action of value by one party in exchange for money, goods, services or other valued resources, or for the promise of reciprocal action of economic or other value. Though TCT originally focused on economic exchanges, it can now cover all transactions, in the public and private sectors and the political and economic markets alike.

In institutional analysis, TCT applies the principle of remediability, i.e. it compares alternative feasible forms of governance, rather than referring to some hypothetical ideal. TCT prescribes discriminating alignment: matching the transactions involved and their specific attributes, with alternative governance structures, to see which offers the lowest transaction costs for all participating actors. The counterpart of this analysis, fitting appropriate governance structures to a market's transactions and their characteristics, is institutional design.

Critical transaction attributes include interdependence (often focusing on, but not limited to, asset specificity), uncertainty (which may be the result of limited or asymmetric information), and duration: a transaction that is repetitive or extended over time. To the degree that a transaction has these characteristics, the actors may be exposed to various hazards: opportunism, e.g. one party to a contract exploiting the other's dependence or his own superior information; or moral hazard: an agent's accepting unwarranted risks that are divorced from responsibility, such as questionable bank loans in government guaranteed programs. In response to such hazards, transactions with various combinations of these transaction characteristics are associated with different forms of governance.

The completely independent transaction, a unique exchange with predictable results (like a simple purchase) is highly compatible with the perfect market. "Mixed" transactions, more interdependent, more uncertain or more ongoing, evoke market adaptations into hybrid forms of governance. These include voluntary arbitration, relational contracting (e.g. industrywide bargaining), and bilateral governance regulating markets; e.g. stock exchanges in the economic market, and campaign financing legislation in the political market. "Idiosyncratic" transactions, with high interdependence and asset specificity, uncertainty and information-impactedness, and which are repetitive or long lasting, stimulate the parties' integration into a single organization: the public bureau or the corporate firm.

A transaction cost theory of planning

In "perfect" markets, transactions are unplanned. This is true in both economic and political markets. The participants are all small, simple units: firms (as producers and consumers of goods and services and price setters), households and individuals (as suppliers of labor, consumers of economic and public goods and services, and voters), legislators, simple political units and unitary public agencies.

Decisions in these transactions are spontaneous in light of circumstances and available information, guided only by some basic deliberation and mutual adjustment. This is quite informal and may be largely intuitive, involving information processing and evaluating alternative courses of action in the light of possible contingencies. This is the kind and level of planning that goes into deciding upon and drafting a simple enforceable contract or agreement in the economic or public arenas.

Collective outcomes here are unplanned: they are the aggregations of all the individual decisions and spontaneous mutual adjustments in these political and economic markets. The perfect market, then, is associated with nonplanning. In the economic market, outcomes are the systemic results of free competition and supply and demand. In the political market, collective decisions emerge in an incremental process of partisan mutual adjustment.

Markets do not need planning to make collective decisions; organizations do. Single unitary organizations need strategic planning to articulate their objectives and design and evaluate future courses of action to meet possible contingencies. They also engage in routine advance planning of prospective operations, essentially a future extension of management.

Simple organizations can limit themselves to these kinds of planning. But few organizations are that simple. As they increase in scope, size, and complexity, hierarchical control becomes inadequate to identify and implement common purposes. Planning becomes more interactive, to bring the divergent objectives of different units into concert by creating agreed upon frames of reference for future decisions and actions.

This is coordinative planning (8). If a firm is not a mom-and-pop business, but a large corporation, it cannot set marketing objectives without consultation between its marketing and production divisions. Once a marketing strategy has been adopted, its implementation also needs planning, assigning to each unit - marketing, finance, production, franchisees - its essential tasks. Similarly, in contrast to a small town Public Works Department, a regional transportation agency needs coordinative planning to determine its traffic management strategy, and planning its execution in detail involves interaction with local governments, employers, and other interests.

Another aspect of coordinative planning, then, is devising strategies for deploying the relevant organizational units and ensuring the commitment of each to its assigned role. In this way we can recognize coordinative planning as the "missing link" between planning and implementation. Ultimately, such coordinative planning leads to organizational and institutional design.

As organizations grow and differentiate, the interdependence of internal and external stakeholders also increases, making the distinction between the organization and its environment ever more tenuous. At this scale, coordinative planning in an organization transmutes into coordinating interorganizational systems. Much of what we observe as planning is anticipatory coordination of this kind.

The global corporation's strategic planning is basically aimed at coordinating the strategies and operations of its subsidiaries, focusing on internalizing transactions that would be too costly if left to the market or devising artificial market frameworks for exchanges between subsidiary units. Economic transaction cost theory accounts for the emergence of large firms and complex corporations that are essentially interorganizational systems, and the consequent transformation of what classic economics envisaged as the simple "perfect" market. Here, then, is also an explanation for planning in the market.

In the same way, the local government's master plan is meant to be a framework for coordinating its own units' and its residents' and firms' investment and location decisions in a way the market cannot. A mandatory regulatory system usually supplements such plans. TCT offers a parsimonious explanation (perhaps not the only possible one) for why this quasi-hierarchical system of public agencies, households, firms, developers and other interests, and the planning that goes with it, have come into existence. This is presented in more detail below.

    To summarize the transaction cost theory of planning:
  • Transaction costs, especially those involved in idiosyncratic transactions, are incentives for developing nonmarket linkages that generate hierarchical organizations and interorganizational systems.

  • Collective market outcomes, economic or political, are aggregations of multiple self-interested decisions and partisan adjustments through systemic market interactions: perfect markets do not need planning.

  • Planning, therefore, is part of the response to high market transaction costs, and is a property of nonmarket forms of organization. In particular, planning is associated with formal organization (9), which appears in various structures ranging from unitary hierarchical organizations to complex interorganizational systems.

  • These organizations exist in the public and private sectors alike, the consequence of market adaptations to minimize transaction costs. Since it is associated with organization, therefore, planning is not only government intervention in the market, but occurs in the market too.

In this way, TCT provides a theory refuting the "planning vs. market" dichotomy, which confirms empirical observation of private sector planning and of the vanishing public-private divide. The transaction theory of planning goes beyond conventional rationales for planning, to account for planning in the market as well as planning as public intervention.

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