I’ve been thinking about a couple classic papers by Ronald Coase (Nobel Prize in Economics, 1991) lately. Here are some ideas that I think are important.
There are transaction costs associated with participation in markets. Firms (companies) provide a way to reduce those transaction costs, but at the cost of higher inefficiencies that come with non-market solutions. Lowering transaction costs and creating more efficient markets reduces the need for firms, and will lead to changes in how people exchange goods and services.
At one time there were very high transaction costs associated with connecting people who needed rides with people who could drive them around. If I needed a ride, I could call a bunch of people I knew, find out who was closest to me, who was able to pick me up, and give them my address. The transaction costs (knowing people, calling around) were high.
Taxi companies came along to reduce those transaction costs. In a world with taxi companies, I call one taxi company and that call is broadcast simultaneously by a dispatcher to all of the company’s taxi drivers. The closest available driver will respond and pick me up.
Today, thanks to the internet and GPS, marketplaces have been created (e.g., Uber) that drastically lower the transaction costs of participating in the passenger/driver market. Anyone can easily and quickly find a ride or a passenger without the need for the dispatching company.
This is a very powerful trend: as transaction costs are lowered, the exchanges of goods and services that were once controlled end-to-end by large companies can now be facilitated more efficiently by smaller, market-making companies.
Coase discussed the relationship between transaction costs and firms in his 1937 paper ‘The Nature of the Firm’.
Governments are firms. One of their primary roles is allocating goods and services with high related transaction costs (e.g., infrastructure, welfare, schooling). Many people think that only very large firms with unique powers (governments) are suitable for that task. However, as transaction costs fall, more efficient markets could change how these high-transaction-cost goods and services are exchanged as well.
At one time there were very high transaction costs associated with connecting people who drove cars with roads on which they could drive them. If I wanted to get somewhere, I would have to find out which roads I would be allowed to drive on, and I would have to stop and pay a fee to the owner of each road on my route. The transaction costs (knowing which roads were open for business, stopping, paying) were high.
Many people were driving cars and needed roads to drive them on, so we got governments involved to reduce those transactions costs. In a world of government-controlled roads, I can drive on almost any road without worrying about who to pay.
Today, online maps, transponders, and licence plate cameras have drastically lowered the transaction costs of participating in a private driver/road market. Anyone with an internet connection and a transponder (or even just a license plate) can identify private roads on their route and efficiently pay for the use of those roads without going through their government.
This is a very powerful trend: when transaction costs are lowered, the exchange of goods and services that we once required governments to oversee can be done more efficiently between private corporations and individuals.
Coase briefly discussed the idea of governments-as-firms in his 1960 paper ‘The Problem of Social Cost’.
Hopefully these examples get you thinking about what is possible in a world of low transaction costs. There are many advantages to allocating goods and services through markets as opposed to firms, and we should be looking for opportunities to do just that: not only with corporations, but with governments as well.