Abstract
In neither in advanced economies, nor in developing countries are economic transactions without cost. But the lower these costs are, the more exchange is possible, and the greater are a society’s gains from trade and specialisation. It is well known since the early days of classical economics that a major cause for the wealth of nations is the ability of both countries and firms to exploit comparative advantages through specialisation and the division of labour. However, the division of labour requires that everyone can exchange his specialised output for other products. Although the importance of the exchange economy is well recognised, it has long been assumed to operate at no cost. Accordingly, economic development was conventionally attributed to changes in production factors and technology alone.
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Notes
- 1.
See Sect. 8.2 for a more detailed discussion of the theoretical foundations of the New Institutional Economics and its application to development problems.
- 2.
Within this branch of institutional theory, the economics of property rights deal with the part of the institutional environment that is concerned with the rules that govern economic activity in the private sector. Correspondingly, the public choice literature has developed from research on the rules and mechanisms that determine the performance of public institutions.
- 3.
Williamson (1979) refers to mode of exchange as the governance structure under which a transaction is executed, i.e., the institutional arrangement within which the integrity of a transaction is decided. The idea that transactions and governance modes are aligned in a way to economise transaction costs was later formulated in Williamson (1996) as the discriminating alignment hypothesis.
- 4.
In these cases, transaction costs are low because, for instance, the verification of a product’s price and quality parameters is easy, or because exchanges are executed with reference to standard terms and conditions which help to keep contracting costs low.
- 5.
See Chap. 4 for a discussion of the forms and functions of privately governed exchange arrangements that have evolved in contexts of low-income countries.
- 6.
Expressed in technical terms, transaction cost economies that result from aligning specific types of transactions with their most economical governance structure could be interpreted as movements towards a given production possibility frontier (PPF), whereas institutional change that results in a lower overall level of transaction costs in an economy has the effect of shifting the PPF outwards, implying a more productive use of available resources. Expressed in the terms of constitutional economics, the distinction between attaining transaction cost economies through optimising the institutional form of exchange, or through a deliberate change of the institutional environment would correspond to making choices within constraints, as opposed to the choice of constraints.
- 7.
It is important to understand that in the context of low-income countries, reforms that only affect the formal institutional environment are likely to remain ineffective as large parts of population of these countries operate outside the official economy. This point is further developed in Sect. 5.3.1 on policy options for formalising informal economic activity as well as in Sects. 8.2.2 and 13.2.1 on the role of informal norms and values in the process of (formal) institutional change.
- 8.
This applies to unskilled labour whereas the availability of skilled labour (human capital) and entrepreneurial talent often represents an investment constraint. This explains why investments in human capital through education can enhance productivity as much as physical capital investments do. Both categories thus warrant analogous treatment.
- 9.
In lack of the latter, a major rational for international development aid has long been to supply the capital necessary for filling a country’s domestic savings gap. For development theories that support this proposition see Chap. 6.
- 10.
Features of the institutional environment that are of particular relevance for the diffusion and acquisition of new technologies include the available stock of knowledge and the physical infrastructure, but also behavioural attributes, formal regulations and production standards. On the interactions between technological and institutional change, see North and Wallis (1994) and North (1997).
- 11.
See, for instance, the findings from the World Bank Group’s World Business Environment Surveys (WBES), which are presented, among others, in Batra et al. (2003), as well as the International Finance Corporation’s Investment Climate Assessments which represent comprehensive country reports that draw upon the results of World Bank’s business environment surveys and other available diagnostic tools.
- 12.
In economic analysis, the possibility that contracts are incomplete and may thus require ex post realignments is a consequence of assuming that individuals experience limits in foreseeing and processing all relevant information and future contingencies when formulating and solving complex problems. These limits unavoidably place bounds on the rationality of individual actions. For a more detailed discussion of bounded rationality and related behavioural implications, see Sects. 10.3 and 13.1.4.
- 13.
Note that the interpretation of transaction costs from the point of view of a country’s institutional environment just describes another approach of defining the cost of transacting in an economy. Whereas the perception of transaction costs from the point of view of different modes of organising economic activity breaks down transactions costs according to different types of transaction activities, the institutional environment view defines transaction costs in terms of their distinct origins. For instance, the cost of obtaining a credit is a component of transaction costs that are determined by the institutional environment (in this case by the performance characteristics of financial institutions), but at the same time these costs can also be interpreted as the sum of information and negotiation costs involved in signing a credit agreement.
- 14.
As a source of cross-country comparative data on the outcomes of different forms and approaches to business regulations, the Doing Business Project is of great value for private investors, policymakers and academic researchers. But the data are also increasingly used to benchmark regulatory practices and outcomes across countries and as such function as a motivating device for national policymakers who are competing for foreign capital and investors. But giving priority to a particular reform on the basis a country occupying a low rank in terms of regulatory outcomes may be an unsound method of making choices about policy reforms in developing countries. The reason is that choosing reforms based on international benchmarking hides from the view the possibility for context-specific arrangements that are hardly susceptible to international best practice. For further elaborations on the context-specific nature of development problems and outcomes see Sect. 9.2.
- 15.
According to the World Bank’s Investment Climate Surveys carried out since 2001 among senior managers in 53 developing countries, more than 70% of respondents in Latvia, Georgia, Russia, Belarus and Moldova disagreed with the statement that the interpretation of regulations by officials was predictable in their country. The lowest percentage of managers who disagreed with the statement was surveyed in Bangladesh (21.4%) and China (33.7%) (World Bank 2004).
- 16.
For instance, the public posting of price schedules for legal fees required to register a company has helped to fight administrative corruption in India (World Bank and IFC 2004).
- 17.
The inclusion of the infrastructure services in a definition of transaction costs is conceptually disputed. Some (e.g. North and Wallis 1986) argue that their cost should actually be regarded as part of the electricity, telecommunications or transportation industries’ respective costs of sales (thus belonging to the class of “transformation costs”). This view is justified to the extent in which transportation, communication and distribution services represent individual input factors for other commodities. Similar arguments apply to the value of national taxes and custom duties. They determine a country’s relative cost structure, but do so primarily through their effect on the price of productive inputs. Nevertheless, transaction costs are also affected as dealing with tax authorities or clearing customs for imports and exports represent resource-consuming transaction-related activities.
- 18.
The unavailability or poor quality of Africa’s transport infrastructure may actually surprise given the considerable efforts undertaken by most colonial powers to improve the situation through the construction of railways and roads. They had indeed been quite aware of the effects of infrastructure investments on lowering transaction costs and fostering trade and development. However, as Boserup (1981) notes, these infrastructure investments were heavily biased towards external commerce. Most of the African railways network built in the colonial period actually connected interiorly located mines and extraction fields to a coastal harbour. The transportation infrastructure inherited from the colonial powers thus contributed little to improve intra-African trade as it failed to interlink the various regions of the African continent.
- 19.
The consequences of a poor transport infrastructure in countries with a low population density are well illustrated, for instance, by the difficulties that the United Nations experienced in assisting the preparations for the Democratic Republic of Congo’s referendum about its new constitution, which laid the groundwork for the country’s first democratic elections since independence in 1960. The country, which makes up two-thirds the size of Western Europe, has scarcely any decent roads. Consequently, material for the referendum had to be air-lifted by helicopters, ferried by dug-out canoes and carried through the jungle on people’s heads (The Economist 2006). The referendum was made even more difficult by the lack of a communication infrastructure necessary to inform people about the purpose and consequences of their vote.
- 20.
See Chap. 4 for an illustration of how informal norms can support business transactions, Sect. 8.2.2 for a discussion on the role of informal norms and values in the process of institutional change, and Sect. 13.2.1 for the effects of cultural influences on economic processes and outcomes.
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Altmann, M.P. (2011). Transaction Costs. In: Contextual Development Economics. The European Heritage in Economics and the Social Sciences, vol 8. Springer, New York, NY. https://doi.org/10.1007/978-1-4419-7231-6_3
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