The Provenance of an Economics of Adaptation in Long-term Relationships

Abstract

Since at least the early nineteenth century, much of “political economy” had become occupied with “resource allocation”. It became occupied with understanding the relative merits of economic systems coordinated by decentralized processes (market-mediated exchange) or by centralized processes invested in an hypothesized administrative state. Debate ultimately inspired advances in theories of system design at the microeconomic level. These advances folded incentive constraints and informational constraints into a formidable theory of the second-best. The theory, however, yet corresponds to Vernon Smith’s “institution-free core” of economic theory. The question remained about whether the core encompassed all of the important action or if the analysis of ex post governance in economic relations would require further theoretical developments. Specifically, problems of adapting relationships to contingencies, programmable or unprogrammable, remained outside of the purview of the theory. The addition of incomplete contracting and friction (as in “haggling costs”) makes adaptation an interesting economic problem.

Keywords: incomplete contracting, adaptation, renegotiation, flexibility, long-term relationships

JEL Classification: D02, D23, D74, L14, P21