How Low Participation Costs Make Peer Production Inevitable

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the text below is also one of the main theses of Yochai Benkler's book on the Wealth of Networks, as well as the essay Coase's Penguin.

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when costs of participation are low enough, any motivation may be sufficient to lead to a contribution.

- Michael Feldstein [1]

"It turns out (cfr. the above citation) that this is the key to understanding both Coase and Benkler, both capitalist firms and open source communities.

Despite a reputation for practicing the “dismal science,” Adam Smith and many of his intellectual progeny are fundamentally optimists. You have to be optimistic to believe, as Smith did, that the cumulative effect of individuals pursuing their self-interest in a free market would result in the collective good via the “invisible hand” of the markets. The genius of economist Ronald Coase is that he was able to articulate the force behind this invisible hand—and its limits—in a clear, sensible formula with predictive power. Think of him as the Isaac Newton of economics.

Coase claimed that, in a perfect world, the invisible hand would always prevail. For example, given a farmer and a cattle rancher who both need the same land, the two will always work out a mutually advantageous agreement. One will always offer to compensate the other in return for giving up access to the land such that they both benefit. Importantly, Coase argued that this would be true regardless of who owned the land. In that perfect world, property rights—which many of us have come to understand as a cornerstone of capitalism—are completely superfluous to a properly functioning market. People would trade to mutual benefit without the need for property or companies. Think of this as the economic equivalent of Newton’s First Law of Motion: economic transactions in motion tend to stay in motion.

The trouble, of course, is that friction exists. Friction (and gravity) are why baseballs don’t fly forever when you throw them on Planet Earth. The economic equivalent of friction, according to Coase, is something called transaction cost. Transaction costs are anything that contribute to the cost of something being purchased other than the cost of the production. If you pay your broker a commission on a stock, that’s a transaction cost. If you invest time researching and bargaining for your new car before you buy it, that investment is a transaction cost. If you have to pay a lawyer to write up a legally binding contract so that you have clear title to the house you are buying, that’s a transaction cost. When transaction costs are high enough, they make some economic deals too costly. In response to this problem, humans created property and companies. For example, nobody would start a car company by going out and buying all the car components on the open market and then going to yet somebody else (again, on the open market) to have them assemble the cars. The costs would be prohibitive. Instead, somebody hires workers to make the parts and assemble the cars. The automobile workers don’t have the transaction cost of constantly looking for somebody to buy the parts that they are making while the factory owner doesn’t have the transaction costs of searching to find every single part and negotiate for it separately on the open market. In return for providing a steady income to all the producers, the factory owner gets to own their work product.

Of course, there are costs to running a company too. Anyone who has ever worked in a large organization (or even a small one) knows that they are not exactly frictionless either. There is a cost to centralization. Managers don’t always know everything they need to know in order to make optimal decisions. According to Coase, this is the limiting factor on the size of companies. As long as the costs of a centralized organization are lower than the transaction costs on the open market, firms will grow. But as they grow, their internal inefficiencies grow with them. When the internal costs equal the market costs, the firms will reach their growth limits.

In the world that Coase imagined, the choice is binary. There are firms and there are markets. These are the only two means by which economies get things done. And that all makes sense on Planet Earth, where there are gravity and friction to counterbalance the force of inertia. But what about in space? What happens when we radically reduce the amount of friction in the system? According to Benkler, this is exactly the puzzle that the Twenty-first Century information economy poses. Today, an increasingly large percentage of our economy is dedicated to creating goods that are not automobiles and other industrial goods but ideas. They are software code and gene sequences and art. They are goods that have near-zero cost to reproduce and distribute (a characteristic that economists call non-rival). And they don’t require expensive machines and real estate to produce. I help design software for a living, but I work out of my home on a relatively cheap computer. Everything I produce can be reproduced as simply as selecting “Save As…” from a pull-down menu.

In this world, Benkler argues, dramatically reduced friction makes practical certain organizational structures that we simply wouldn’t see in an industrial economy. The less resistance there is to overcome in a system, the less formal structure is required for transactions to happen. I didn’t have to lead an organized movement for my practical joke or the Wikipedia page to succeed. If I did, then neither would ever have happened. But because the costs of participation and coordination were so low, a wide range of people were able to find a wide range of reasons that were sufficient to motivate their useful participation.

And we don’t have to assume only non-financial motives such as the ones in my first two examples. To the contrary, the low transaction costs make a wide range of new business models feasible. For example, we know that that upwards of 50% of the total cost of big enterprise software systems are support and maintenance costs. If a company can invest a small fraction of the total resources required to develop a content management system by contributing to an open source project but sell support and maintenance to their customers, then they may be able to beat their proprietary competition on costs while still making a good profit. This economic model has been particularly successful for a little company called IBM. When business analysts say that IBM has transformed itself into a services company, part of what they mean is that it now makes less of its income selling licenses for its proprietary software and more of its income selling support for open source software such as linux and apache." (http://blog.worldcampus.psu.edu/index.php/2007/10/31/coases-university/)


Source

Coase’s University: Open Source, Economics, and Higher Education. Michael Feldstein

URL = http://blog.worldcampus.psu.edu/index.php/2007/10/31/coases-university/