Transaction Costs, Market Efficiency and Economic Development

Economic activity is defined by transaction costs. There are a world of “hidden” costs involved in any exchange of goods or services. It is widely known in economic theory that these “transaction costs” explain the way in which our economies operate. In the developed world, we have markets, firms, and technologies that all exist to reduce the cost of doing business. However, many developing countries are plagued with high transaction costs that lower income, investment and economic growth. 

Over the last decade, we have experienced an explosion in technology platforms like Amazon, Uber and Airbnb that effortlessly connect millions of people to a virtual market. By allowing you to easily search for goods, compare prices, and engage in transactions, these technologies have significantly reduced transaction costs and bolstered economic activity.

Despite the rapid growth of these technologies around the world, many markets in developing countries still struggle to overcome the problem of high transaction costs. In Nepal, for example, many people rely on goats as source of income and nutrition. But high transaction costs make it difficult for producers to make a profit, and market demand often goes unmet.

This problem arises because it is difficult for producers and intermediaries to communicate and negotiate. Prices are often determined through one-on-one bargaining, where producers receive low prices and intermediaries have to repeatedly travel to each producer in order to complete a sale.

It is easy to imagine that these problems seemed unsolvable even a decade ago. Prior to widespread cellphone and internet access there were few ways to make it easier for goat traders in Nepal to access and negotiate with producers. But the recent increase in access to technology throughout the developing world has created an avenue to solve some of these difficult problems. What if we were able to simply adapt the technologies that reduce transaction costs in the developed world for markets in low-income countries? Could these same concepts be used to relax the constraints on economic activity in a place like Nepal?

I am currently working on a research project that attempts to answer those questions. In this study, a randomly assigned group of goat-producing cooperatives in Nepal will receive access to an app that allows them to update inventory, negotiate prices and coordinate sales from their mobile phones. By comparing the success of these cooperatives to a control group that does not receive the app, we will be able to determine the causal effect of introducing this technology. If the intervention proves to be successful, this study could provide evidence for a means of significantly reducing transaction costs in an efficient, scalable way.

Transaction costs provide a perfect example of a way that (seemingly subtle) market problems can act as a hinderance to economic activity. By identifying emergent solutions to fundamental economic problems, we can work to chip away at the constraints to economic growth.

  1. Coase, R. (1937). “The Nature of the Firm”. Economica. Blackwell Publishing. 4 (16): 386–405.

Published by Scott Miller

Scott is currently earning his PhD in development economics at the University of Florida. He has worked for various non-profits and international organizations, including USAID. Scott has worked on a number of research projects around the world, including projects in Haiti, Nepal and Brazil.

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