Defining Transaction and Transaction Costs

In writing about A. Allan Schmid and his ideas, I've run into a few common themes. One of them is the key idea of human interdependence (as written about in this blog post), but another is the economists' handling and discussion of transaction costs (also other econ buzz words like free market, externality, etc., but those are topics for other posts). Throughout my reading and writing, I've compiled several notable authors' definitions of transaction costs. A few key differences stand out.

The definition, in economics literature, of a transaction is often separate from the definition of transaction cost. This seems important to note, since it is clear to me that economists can mean very different things when they refer to a transaction (not that we always agree on what is considered a cost either). In the 1937 paper, The Nature of the Firm, by Ronald Coase, he does not use the term "transaction cost" but refers to "the cost of using the price mechanism". He later adopts the terminology, suggesting (1988, 1994) that one should "pay attention to the world of positive transaction costs", focusing on the role of different legal structures and how they shape how resources are used and thus how the economy grows. He wrote that without a concept of transaction costs, it is near impossible to understand and analyze how our economic system works, much less understand its problems and effects on growth.

This later definition is markedly different from his 1937 "cost of using the price mechanism". yet he is nonetheless often credited with coining "transaction cost". His later definition has much more in common with the definition used by Douglas North, who in 1984 defined transaction costs as "the costs of specifying and enforcing the contracts that underlie exchange and therefore comprise all the costs of political and economic organization that permit economies to capture the gains from trade." This definition had much in common with the foundations laid by Institutional Economist John R. Commons.

Commons is credited with introducing the Transaction as the basic unit of economic analysis (1931). He wrote,

"These individual actions are really trans-actions instead of either individual behavior or the "exchange" of commodities. It is this shift from commodities and individuals to transactions and working rules of collective action that marks the transition from the classical and hedonic schools to the institutional schools of economic thinking...because it is society that controls access to the forces of nature, and transactions are, not the "exchange of commodities," but the alienation and acquisition, between individuals, of the rights of property and liberty created by society, which must therefore be negotiated between the parties concerned before labor can produce, or consumers can consume, or commodities be physically exchanged".

— John R. Commons, Institutional Economics, American Economic Review, Vol.21, pp.648-657, 1931

With this idea of the transaction in mind, the transaction cost now seems much more inextricable from legal structures set by institutions. In Conflict and Cooperation (2004), Schmid defines TCs as "Costs inherent to the exchange of the rights to a good or service." He builds on this throughout the book, offering categories of determinants or varieties of TC's, before ultimately settling for North's definition, if slightly modified into his own words: "TCs consist of the costs of defining and measuring resources or claims, plus the costs of utilizing and enforcing the rights specified."

Most interesting to me throughout reading about TCs and observing the differences in definitions and word choice is what these differences mean. Coase's "the cost of using the price mechanism" says nothing of the legal underpinnings that determine them, though his later work makes it much more clear that transaction costs are often (always?) institutionally defined. The language used by North, Commons, and Schmid certainly makes the legal-economic intersection clearer. When we talk about or think about transactions or transaction costs, we are also talking about institutions, or legal structures.

Douglas W. Allen, in his critical 1999 assessment of the history of the concept of transaction costs (I highly recommend reading this if you're interested in learning more about the history of the conceptual definition specifically), concludes that this institutional definition is wholly different, if connected to the more basic neoclassical definition:

"Given its long history and prevalence, it is ironic that the definition of transaction costs would be so difficult to agree on. This paper has argued that two definitions prevail in the literatures: one that defines transaction costs as only occurring when a market transaction takes place; the other defining transaction costs as occurring whenever any property right is established or requires protection. I have called these the neoclassical and property rights definitions and have argued that which definition is useful depends on what question is being examined. Recognizing the distinction, though, is important for removing ambiguity and animosity"

I just wonder: wouldn't the work of legal-economics scholars suggest that a "market transaction" is the establishment or change of some property right (or other legal relationship)? Does ignoring this (or not making this clear) to the point where these definitions seem wholly separate benefit the discourse?

The onus is on the writer to prove whether their definition or use is in fact useful, and without a clear understanding of the concepts we're using, how would we be sure we weren't missing crucial details or variables? If every economist that included transaction costs in their model were queried, would they give definitions that were consistent with the way they used, measured, or discussed them in their research?

Schmid's definition recognizes these two concepts of transaction costs as inseparable. "TCs consist of the costs of defining and measuring resources or claims, plus the costs of utilizing and enforcing the rights specified." Though it may seem less wieldy and require more work to use, it seems more complete after my initial forays into their literature.

Coase, R. H. (1937). The Nature of the Firm. Economica. https://doi.org/10.2307/2626876

Coase, R. (1998). The New Institutional Economics. American Economic Review. https://doi.org/10.1080/14719030000000027

North, D. C. (1984). Government and the Cost of Exchange in History. The Journal of Economic History. https://doi.org/10.1017/S0022050700031855

Schmid, A. A. (2008). Conflict and Cooperation: Institutional and Behavioral Economics. In Conflict and Cooperation: Institutional and Behavioral Economics. https://doi.org/10.1002/9780470773833