Describe The Interdependent Relationships Within Networks Economics Essay

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This alternative approach within the network literature has as its central concern the interdependent relationships within networks (e.g., Johanson and Mattson 1988). Rejecting transaction cost minimisation as an explanation for networks, this approach emphasises the web of interactions or relationships amongst a number of players (including customers, suppliers, competitors, and public and private support agencies) through which activities and resources are exchanged and shared. Rather than analysing transnational expansion purely in economic or transaction cost terms, this network approach acknowledges that firms do not operate in isolation of other firms and that transactions arise from embeddedness within broader patterns of network/stakeholder relations.

Perhaps the most prominent critic who argues along these lines is Mark Granovetter. Writing from a sociological perspective, Granovetter asserted that economic institutions can only be explained as social constructions (Granovetter 1992). Since much of the Chinese Capitalism literature that has become so influential has its theoretical roots in this sociological approach, a close look at its key concepts will be taken.

Granovetter's main critique of the transaction cost approach is that it explains institutions such as business networks as "the efficient solution to certain economic problems" (Granovetter 1985: 488). Whereas transaction cost theorists suggest that specific organisational forms are able to solve certain market failures which result from bounded rationality and opportunism, Granovetter points out "that most behavior is closely embedded in networks of interpersonal relations" which blurs the boundaries between organisations on the one hand and the market on the other (Granovetter 1985: 504). Since under both modes of governance the economic actors are tied into networks of social relations, the actual behaviour of individuals might differ from the one expected from an efficiency point of view. Therefore, only "pressures" exist toward a particular mode of governance, and there is no guarantee that the "most efficient one will be the one observed" (Granovetter 1985: 503).

Zukin and DiMaggio distinguish between four types of embeddedness: cognitive, cultural, political, and structural embeddedness (Zukin and DiMaggio 1990). Cognitive embeddedness refers to the limits to economic rationality imposed by the structures of mental processes. To some extent, Williamson takes into account this form of embeddedness via his concept of "bounded rationality," though sociologists argue that he underestimates its impact (Zukin and DiMaggio 1990). Economic behaviour is also culturally embedded in the sense that certain socially agreed values, assumptions, and beliefs can impede transactions that otherwise might appear as economically rational. This form of embeddedness is a useful analytical concept in cross-cultural comparison, though it is of lesser importance the more actors are part of the same cultural framework. Political embeddedness refers to the restrictions imposed by those economic institutions that are not the result of economic decision-making in the sense of cost-minimisation or profit-maximisation, but evolve through inequalities in power among economic and social actors.

The fourth form of embeddedness-structural embeddedness-takes into account the dyadic relations of actors as well as the structure of the overall network of relations (Grabher 1993a). In other words, actors "do not behave as atoms outside a social context… Their attempts at purposive action are instead embedded in concrete, ongoing systems of social relations" (Granovetter 1985: 487). Structural embeddedness pays attention to the history and future of relations, thus explaining behaviour that - considered in isolation - may seem irrational. However, it also suggests that institutions such as networks may have downsides. As an example, Granovetter mentioned entrepreneurial networks based on ethnic ties, which are therefore not open to outsiders (Granovetter 1992). Another problem he highlighted was crimes against the organisation, such as embezzlement, which may arise once actors come to greatly rely on trustworthy behaviour by their partners: "The more complete the trust, the greater the potential gain for malfeasance" (Granovetter 1985: 491). Furthermore, given the perspective that economic institutions are primarily based on existing social ties, there is an inherent risk that non-economic goals may take priority. Granovetter gave an example of cases where "the welfare of the local community is put ahead of that of the business as such" (Granovetter 1992: 7). Another important danger is that institutions based on social relationships may become "locked into" actions that once conferred success but have now "turned into stubborn obstacles to innovation" due to the strength of the established ties (Grabher 1993b: 256, also another ref). Thus, Granovetter does not view the overlapping of social and economic networks as necessarily positive. In this sense, his conception of embeddedness rejects the functionalist view of institutions usually found in transaction cost theories and, more generally, in the New Institutional Economics.

In summary, there are three major ways in which Granovetter's embeddedness approach differs from the transaction cost approach:

1) Since all economic actors exist within a concrete network of social relations, the dichotomy of atomised individuals in the market versus actors tied together in a hierarchical organisation with a uniform set of objectives is misleading (since market relations overlap with social relations and interpersonal ties link individuals inside the organisation with actors outside). Therefore, the assumption of a continuum from market to hierarchies does not reflect reality. (ref)

2) In contrast to the "overly deterministic" predictions of transaction cost economics, Granovetter stressed the importance of contingent factors in influencing the actual outcome of any situation. He therefore argued that the specific economic conditions in any situation only restrict the range of possibilities, while the existing social structure determines the actual outcome. Therefore, under similar economic conditions, different solutions are possible. (ref)

3) Lastly, since the social embeddedness of economic relations does not necessarily serve the purpose of economic efficiency, the embeddedness approach rejects the functionalism implied in transaction cost analysis. (ref)

Thus, in viewing the firm as a social entity as much as an economic institution, Granovetter's sociological critique contradicts economic theories of inter-firm cooperation in which the business network is conceptualised as a transaction cost economizing institution. This argument does not, however, preclude the role of economic benefits in the calculus of decisions to cooperate. Rather, it views economic "factors" as necessarily contingent historically, geographically, and socially because the same set of economic "advantages" are not always replicated elsewhere (ref). In other words, although particular cases of successful networks may exhibit significant reductions in transaction costs between members of the network, transaction cost analysis in itself cannot completely explain why any particular case of networking is organised as it is. In line with this argument, Grabher (1993a) identified four basic features inherent in all networks: reciprocity, interdependence, loose coupling, and power relations.

A crucial element in any cooperative relationship is the concept of trust (Parkhe 1993). Unfortunately for the taxonomist, however, this concept has been explored by social scientists in many disciplines, including economics (e.g., Dasgupta 1988; Williamson 1985, 1991), and management (e.g. Gulati 1995), and each of these of bodies of literature has provided unique insights into the nature and processes of trust (ref). There have been few attempts to integrate the various perspectives.

One of the first problems encountered is defining this fuzzy concept. Though definitions of trust vary, the following two definitions provide a good flavour of how trust is generally treated in the literature. First, it has been defined as a willingness to rely on another party and to take action in circumstances where such action makes one vulnerable to the other party (Doney 1998). A second, complementary view is that it is the expectation of regular, honest, and cooperative behavior based on commonly shared norms and values (Fukuyama 1995). In inter-firm relationships, trust is credited with lowering transaction costs in more uncertain environments, thereby providing firms with a source of competitive advantage (Barney and Hansen 1994). Trust is also held to facilitate long-term relationships between firms (Ganesan 1994) and is an important component in the success of strategic alliances (ref). Within organisations, trust contributes to more effective implementation of strategy, greater managerial coordination, and more effective work teams (Doney 1998).

The concept of trust that is most associated with the economics literature (e.g., Buckley and Casson 1988; Dasgupta 1988; Williamson 1985) suggests that the development of trust involves a calculative process: it is the outcome of a process whereby one party calculates the costs and/or rewards of another party cheating or cooperating in a relationship (ref). When the benefits of cheating do not exceed the costs of being caught (factoring in the likelihood of being caught), the trustor can infer that it would be contrary to the other party's best interest to cheat, so that party can be trusted (Akerlof 1970). Buckley and Casson (1988) suggested that an assessment of costs and benefits leads to forbearance (refraining from cheating), which leads to trust. Dasgupta concluded that trusting another party "implicitly mean[s] that the probability that he will perform an action that is beneficial or at least not detrimental to us is high enough for us to consider engaging in some form of coordination with him" (Dasgupta 1988: 217). Trust is sustained over time in direct proportion to the degree to which some sort of deterrent to cheating is clear, possible, and likely to occur if the trust is violated. In other words, the economic calculus used to establish whether another party is "trustworthy" is based on the behavioural assumption that, given the chance, most people act opportunistically and in their own self-interest (Williamson 1985, also other ref). Given this assumption, Doney (1998) pointed out that in the case of long-term joint ventures, incentives to engage in opportunistic behavior are minimized by shared profits, joint decision making, and reward and control systems that allow parties to pursue self-interest without a need to resort to guile (ref).

According to the sociological critique posed by Granovetter, trust is not only based in social institutions such as "generalized morality," but is developed in personal relations (Granovetter 1985: 489). Whereas "under-socialised" transaction cost theory considers opportunistic behaviour to be checked by contracts between actors or potential damage to the reputation of the culprit, Granovetter argues that personal trust is the normal and more efficient way to prevent deceptive behaviour. And he asserts that the concept of reputation used in transaction cost theory makes it little more than a "generalised commodity," which is traded against economically promising opportunities for malfeasance (Granovetter 1985: 490). To the contrary, Granovetter points out that empirical observations show that actors usually prefer to deal with partners they know or who are at least known to trusted informants. Trust among partners then increases as more transactions are successfully conducted between them. Thus, personal relations - not only of dyadic but also of triadic nature - play a crucial role in the production of trust. Even if originally both actors were not linked by social ties, "continuing economic relations often become overlaid with social content that carries strong expectations of trust and abstention from opportunism" (Granovetter 1985: 490).

One additional perspective worth noting is that of international business studies. A key emphasis in this literature is that levels of trust are assumed to vary not only between individuals but between cultures (Hofstede 1991; Shane 1994; Steensma et al. 2000). Hofstede was among the first to explore the ways in which the societal norms and values that guide people's behaviour and beliefs impact whether and how trust is established (Hofstede 1980). Since each culture's "collective programming" results in different norms and values, the ways in which people decide whether and whom to trust may be heavily dependent upon a society's culture (ref). This perspective is frequently stressed in the Chinese Capitalism literature, through its frequently allusions to xinyong, or trust. For example, Hamilton stated "…these networks [guanxi networks of family firms] rest on trust and reciprocation" (Hamilton 1996a: 17).