Toward a Demsetzian Knowledge Theory

The paper attempts to outline a general theory of knowledge in economics based on the work of Harold Demsetz. We identify that “knowledge encapsulation” is a key Demsetzian idea that could unite the otherwise fragmented or narrow research on knowledge in economics. The knowledge encapsulation concept holds that mobilizing cognitive resources and acting under full knowledge is costly. This creates an incentive to compress knowledge into an algorithmic form, which can then be transferred in a cost-efficient manner between a multitude of agents. From this idea of Demsetz, we create a simple theoretical model. To prove its generalizability, we extrapolate it onto a wide range of cases, from traditions and superstitions to institutions and division of knowledge. We conclude that knowledge encapsulation applies to an extensive array of phenomena. However, such encapsulation must also be supplemented by adequate enforcement and mechanisms of coping with ex-post consequences of its use. If our analysis is correct, then the Demsetzian theory could be a strong contender for becoming a fruitful alternative research paradigm on knowledge in economics.