The Secret Life of Mundane Transaction Costs

Transaction costs, one often hears, are ‘the economic equivalent of friction in physical systems’. Like physicists, economists can sometimes neglect friction in formulating theories; but like engineers, they can never neglect friction in studying how the system actually does — let alone should — work. Interestingly, however, the present-day economics of organization also ignores friction. That is, almost single-mindedly, the literature analyzes transactions from the point of view of misaligned incentives and (especially) transaction-specific assets. The costs involved are certainly costs of running the economic system in some sense, but they are not obviously ‘frictions’. Stories about frictions in trade are not nearly as intriguing as stories about guileful trading partners and expensive assets placed at risk. But I will argue that these seemingly dull categories of cost — what Baldwin and Clark call mundane transaction costs — actually have a secret life. They are at least as important as, and quite probably far more important than, the more glamorous costs of asset specificity in explaining the partition between firm and market. These costs also have a secret life in another sense: they have a secret life cycle. I will argue that these mundane transaction costs provide much better material for helping us understand how the boundaries among firms, markets, and hybrid forms change over time.