The Knowledge Encapsulation Phenomenon and Its Role in The Construction of a Knowledge Trasnfer Cost Theory

The paper offers a general foundation for the currently fragmented economic studies on knowledge. We argue that such a foundation can be found in the frequently ignored phenomenon of knowledge encapsulation, coined by Harold Demsetz. Knowledge encapsulation refers to a situation under which economic agents are incentivized to compress the costly full knowledge it into incomplete knowledge algorithms. To prove the potential of placing such a phenomenon at the core of a general theory of knowledge, we identify the full knowledge elements and analyze the cost minimizing effects that encapsulation has on them. We then study a wide spectrum of knowledge encapsulation mechanisms, from instructions and superstitions to institutions and outsourcing. We demonstrate that each of these mechanisms can substantially decrease the full knowledge costs without causing a corresponding increase in costs of using incomplete knowledge. These results confirm the universality and the broad scope of knowledge encapsulation phenomenon and allow us to tentatively recommend its application in the general economic theory of knowledge. We further note that the Demsetzian approach may re-orientate the focus of knowledge studies in economics from the process of knowledge creation to its transfer.