Specificity of resources and the danger of extortion - Institutional Economics

Specificity of resources and the danger of extortion

The economic agent, who has invested in specific assets, is in a vulnerable position. Outside of this transaction, his specific investments lose their value, for other economic agents they do not represent the same value. If the transaction is not executed, then the party that has made specific investments, loses its investments. In a similar situation, when a party carrying out specific investments appears to be "locked" ( locked-in ) into a deal with your partner, there is a danger of opportunistic behavior on the part of the counterparty, which is called "extortion" ( hold-up ). Dependence is often two-sided. Before the deal, the economic agent faces a large number of sellers, and he has the option of choosing a counterparty, but after the contract is concluded, competitive relations are replaced by the bilateral monopoly relationship if investments are made in transaction-specific investments in physical or human assets. What is happening is what Williamson called a fundamental transformation.

An example of such a fundamental transformation is contained in the case of Alaska Packers 'Association v . Domenico (1902). The captain of a fishing vessel in California signed a contract with the team, according to which he promised to pay each member of the team at $ 50-60 per season and 2 cents for each salmon, in the capture of which he took part. On board the ship, the team arrived at Pyramid Harbor in Alaska, where the captain invested in salmon conservation equipment in the amount of $ 150,000. A few days after arrival, the team stopped working and stated that it would not resume it and return to San Francisco if Each of the team members will not be paid $ 100 per season. The place was remote, the salmon fishing season was short, and the captain could not find other workers, so he agreed to change the contract. On his return to San Francisco, the team demanded a remuneration in accordance with the amended contract, but the captain refused to pay a surcharge, citing the fact that the deal was committed under duress. The team sued, but the court found the second contract invalid.

When the captain in San Francisco picked up the team and made deals with employees before the start of the voyage, he had a choice among a large number of competing sellers of standard labor. However, when the captain's team was in Alaska, it was no longer threatened by competition. The captain made specific investments designed for the deal concluded with the team: he bought fuel, food and equipment for preserving salmon. All this (lack of competition and specific investments) and led to a fundamental transformation - the relationship of competition in the labor market was replaced by the captain's dependence on the team he had recruited. The lack of competition and the captain's specific investments increased the negotiating power of the team, which tried to reconsider its remuneration fixed in the contract.

In the court case examined, the opportunistic behavior of the team was obvious and it could be proved in court, but often breaches of the contract are so obvious, they are not observable by a third party that must decide the dispute, therefore, the party carrying out specific investments should think over the means protect these investments and provide for them in the contract itself.

Why do economic agents carry out specific investments? Specific investments can lead to lower production costs and provide additional income. It is this additional income that arises from the pooling of specific resources and is called "quasi-rent", and is the target of extortion. A partner of a party that has made specific investments has the opportunity to "extort" most of the surplus created by a particular resource, through the threat of termination.

So, we can define extortion as follows:

Extortion is a kind of opportunistic behavior that occurs after the conclusion of a transaction and the essence of which is the redistribution of quasi-rent, in which the interests of the party that carried out specific investments are infringed.

By combining resources specialized to each other, a super-loan effect arises, which is the source of quasi-rent. This quasi rent is divided among the owners of specific resources.

When an economic agent decides to enter the industry, he compares the income that he receives with the investments that he needs to make. That part of the income that exceeds the minimum amount necessary to attract a firm to this industry is rent. Rent usually arises on a limited resource (the restrictions can be both natural and artificial, for example, customs barriers).

However, when the investments are already made, the revenues may be lower than anticipated. They may not even pay back those investments that the economic agent has made. That part of the income that exceeds the minimum amount necessary to keep the producer in the industry and will be quasi-rent.

Quasi-rent is the difference between the income of a production factor when it is used at a given location and the income of that production factor with its alternative best use case.

As an example, a steel plant located near a power company and investing, depending on whether the plant can buy energy at a certain price, can be cited here. After making investments that are irrevocable, an energy company can raise the price of energy, and the steel mill will still work, since marginal benefits, even at a higher energy price, will exceed marginal costs, despite the fact that irrecoverable investments in this case will not pay off.

Rent is a surplus compared to average total costs. Quasi-rent is a surplus in comparison with average variable costs. In a competitive economy, rent is a transient phenomenon, and quasi-rent is a fairly common phenomenon. It is always created when non-recurring, specific investments are made. Therefore, quasi-rent is more common than rent. Quasi-rent in its magnitude can be either equal to or less than rent, but it can not exceed the rent. In order to keep the firm in the industry, a lower income is enough compared to what is needed to attract it to the industry. The difference between them arises from the presence of costs that the firm (or employee) carries when entering the industry, and which it can not return if it leaves this market.

The payment for the quasi-rent brought is the increased risk of specialized investments, the need to search for additional guarantees against the partner violating his obligations. Quasi-rent can be expropriated, and the owner will not extract a factor from this sphere of use.

Let's consider an example. The owner of the printing machine A receives a fee from the publisher B for using the machine

in the amount of $ 5,500 per day. Operating costs are $ 1,500 per day, and its residual value is $ 1,000 per day. The machine will be operated until the payment for using it reaches a minimum of $ 1,500 per day (average variable costs). The quasirent, which falls on the machine, is:

5500 - 1500 - 1000 = 3000 ($ per day).

The amount of $ 3,000 per day is the difference between the income brought by the printing press at a given place of use ($ 4,000 per day) and the income for its best alternative use ($ 1,000 per day). We assume first that B - is the only buyer of the owner of the printing machine, so he has the opportunity to assign all quasi-rent in the amount of $ 3,000 per day. But if in addition to the publisher, there is also a publisher C, ready to pay $ 3,500 a day to the owner of the machine A , then the publisher В can only assign $ 2000 per day if he manages to reduce the price of printed works to $ 3,500,000 a day. In this case, $ 2,000 per day is a quasi-rent that can be assigned ( appropriable quasi -rent ). The owner of the machine can also assign a portion of the publisher's income if the seller does not have another seller, or if the price of the services of another seller is higher.

How can quasi-rent be appropriated? In particular, by illegal means, for example, by gangsters through racket, or expropriated by lawful means. The danger of expropriation exists when a particular resource depends on another resource, which is in some way unique. When the owner of this unique resource withdraws its resource, and the substitutes are either very expensive or of a lower quality, then the quasi-rent that is attributable to other specific resources is withdrawn. For example, the decision of the Nobel Prize laureate to leave a small private college for a large university means a decrease in quasi-rent received by the owners of the college. Another example is the termination of the lease agreement, as a result of which the retail store, which has become habitual in some locality, is forced to leave the local market. In this case, the quasi-rent is being expropriated, which the store received from its location.

There is another type of dependency that is associated with the asymmetry of information. Expropriation of quasi-rent can occur in this case if the results of activities are difficult to measure and it is difficult to prevent unfair work, while close substitutes can be quite accessible. An unskilled worker at a beverage factory that is easy to find a replacement, does not check dirty bottles badly and jeopardizes the company's reputation and its specialized investment in the brand.

Expropriation of quasi-rent of one of the parties to the deal is just a redistribution of wealth. That is why it would be wrong to use antimonopoly legislation in situations that are characterized by the specificity of resources, despite the emergence of a bilateral monopoly relationship after a contract is concluded and investments are made in specific resources. The antimonopoly legislation is aimed at protecting consumers from high prices and a limited supply caused by the monopoly position of the producer. And the expropriation of quasi-rent does not lead to an increase in prices for consumers. It deals with the redistribution of income between the parties to the transaction and does not affect market prices, since quasi-rent is a return on non-returnable capital.

Does the potential for expropriation of quasi-rent affect the wealth of society, and what are the dangers of extortion from the point of view of economic efficiency? Assignment of quasi-rent is associated with the costs of resources and does not create any value, but only redistributes it. The threat of extortion from a partner is a serious obstacle to the implementation of specialized investments. If there is no way to prevent the expropriation of quasi-rent, then economic agents will not invest in specific resources. This can be illustrated with the help of the mathematical example presented in Table. 4.2.

Table 4.2

Specific investment and threat of extortion

Firm In

Assign

Do not Assign

Firm A

Assign

-1; -1

3; -2

Do not Assign

-2; 3

2; 2

Two firms, A and B, join forces to implement a joint project. Each of them must implement specific investments, the value of which beyond the limits of this transaction is zero. Let each firm make investments at a rate of 2. The total profit that these investments bring is 8, and if the profit is divided equally according to the initial agreement, each firm will receive 4. However, the distribution of profits between firms carries the danger of extortion from the side each of the partners. Assigning profits is not a free activity. To assign the most part of the profit, each of the firms must incur costs in the amount of 3. A reliable contract that would manage the profit distribution process is impossible to conclude in our example.

Each of the players must choose one of two strategies: to assign the greater part of the profit or not to assign. If none of the firms makes a profit, then it is divided in half and the players' winnings are

(8 - 4): 2 = 2.

If both try to allocate most of the profits, then the total winnings are divided in half:

[(8-4): 2] -3 = -1.

If, for example, firm A assigns, and firm B does not, then A receives all the profits, and δ does not receive anything and the player's winnings will be for A

8 - 2 - 3 = 3,

and for B - its investment costs, i.e. (-2).

Here we are dealing with a situation such as the "prisoner's dilemma". Players come to ineffective equilibrium, choosing the strategy assign & quot ;, and getting the winnings (-1; -1). In a similar situation, firms will not even start the game. When making a decision about investments, firms take into account possible winnings, and it is these incentives that influence decisions about investing. In our situation, the threat of opportunistic behavior in the form of extortion completely destroys the incentives to invest. If firms do not have reliable guarantees that their partner will not demand more than its share in profits, then no one will invest funds. As a result of the refusal of specific investments, the costs of providing goods and services will increase, and this will already be the social cost of extortion. To solve this problem of insufficient investment in specific resources, economic agents seek and find a form of contract that reliably guarantees them income for their specific investments.

Why does not the problem of extortion arise in the standard theory of markets? In the standard economic theory, it is assumed that the contracts concluded are complete and provide for all possible random events. The parties can protect themselves from various kinds of problems by stipulating them specifically in the contract. Standard economic theory assumes that the market is competitive and prices are set on the market, so breach of obligations and deception are impossible. In the classical market, there is a disruption in supply, because it always has a large number of suppliers of an identical resource. You should not worry if the consumer refuses purchases, because there are many alternative ways to use the resource.

In the economic theory of transaction costs ( transaction costs economics), developed by O. Williamson, awarded for his studies of the Nobel Prize in 2009, the problem of extortion and its prevention is central. It arises from a combination of the specificity of resources, the incompleteness of the contract and the desire of economic agents to obtain benefits in any way, even by appropriating the wealth created by the investments of the other party. Concern about these problems leads to inefficient use of resources: firms, fearing that the investments made will make them vulnerable to extortion, refuse to invest in specific resources. Solve problems arising from the danger of extortion, helping to choose the right type of contract and how to organize the transaction.

In the example given by us with a printing press, publishers usually have printing machines in their possession, rather than renting them. In America, many railways, which were segments of a single through transport line and were in separate ownership, were integrated at the end of the 19th century. Until then, separate ownership of certain segments of the through railway led to constant battles for the share of companies in the total cost of transportation, if it went beyond a single section of the railway. Integration eliminates the danger of expropriation of income, which the party that made specific investments expects to receive from these investments. But other solutions are possible, which we will consider in the next paragraph.

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