Article

Transaction Cost

Writer: Muhamad Husni Mubarok

 

Have you ever wondered, why do goods, merchandises, even services from foreign countries flood your country?  How come they become cheaper than your country’s products? Is it good or bad to your country’s economy? Maybe you will hear people say that it is because of globalization. After hearing that answer maybe you will be wondering again, how does globalization actually work? Well, to make someone understand about globalization, usually they will start with definition.

The problem with defining globalization is, it will take more pages than I allowed. So, let me start with transaction cost. According to Douglass C. North, “one can think of transaction costs as all those costs incurred in operating an economic system”.[1] In high school, we often taught that when we try to sell something, the price should be higher than the production cost. Let say, you want to sell a pen. The price of the pen you would sell depends on how much you have to pay to get a pen. You will calculate the fix and the variable cost to make a pen. The fix cost would be something that independent of the output. No matter how many pens you produce, it will cost the same. Variable cost depends on the output. It changes following your amount of production. Add both and you will get the production cost.If you want to get profit, sell your pen higher than the cost you have paid. Unfortunately, to make a transaction happens and profitable, you cannot merely calculate the production cost. You should also calculate the transaction cost.

 

Transaction cost is hard to calculate. Coase, in 1960, wrote that discovering who it is that one wishes to deal with, informing people that one wishes to deal and on what terms, conducting negotiations leading up to a bargain, drawing up the contract, undertaking the inspection needed to make sure that the terms of the contract are being observed are counted as the cost of market transaction.[2] Collins and Fabozi, somehow, had been trying to measure transaction cost in stock market. Just like production cost, they divided transaction cost into fix and variable cost. Commissions, transfer fees, and taxes are including in fixed costs. While variable costs are more complicated like price impact, timing costs, and opportunity costs.[3] Transaction costs are extremely high and higher when you try to conduct an international trade. In order to make trade smoother, economists and world leaders has been trying to create some institutions to eradicate those transaction costs. The old European chartered companies, GATT, WTO, EU, FTA that conducted bilaterally, regionally, and multilaterally are the examples of that institutions. Technological development keeps reducing production costs while trade institution are making transaction costs lower. Combinations of the two are driving globalization. The world economic are slowly integrated, goods and services are getting cheaper, international trade are getting smoother. World trade volume is increasing in an unexpected amount.

According to Federico and Tena-Junguito, the rate of growth of world trade from 1800 to 1913 (the first wave of globalization) is 3215.9% in total. While through the second wave of globalization, the rate of growth from 1950-2007 alone accounted to 1823.6%.[4] Yet, the next question is “who is benefitted from this remarkable growing of world trade?” The first wave of globalization benefitted more the advanced country. But, the second wave benefitted both advanced and developing nation.[5] Even sometimes, the advanced countries feel insecure with this integrated economic situation. Take UK and US as an example. Brexit happened because freer market brings not only freer movement of goods but also freer movement of people. UK citizens are afraid that the immigrants will takeover the jobs from the locals and, politically, they create a populist backlash against Europe's political elite. Recently, US also chose the identical way by leaving the Trans-Pacific Partnership retaining its isolationism policy. On the other hand, new emerging economies such as China, India, South Korea, and ASEAN, are eager to integrate their economies more to the world. But, if some of the old-established economies are turning their back to the freer trade, how come these newbie can survive in the fierce world economic competition?

 

 

Reference:

[1] Douglass C. North, “Institutions, Institutional Change and Economic Performance”, International Center for Economic Growth, 1992: 6

[2] R.H. Coase, “The Problem of Social Cost”, in Journal of Law and Economics, Vol. 3, Oct., 1960: 15

[3] For a further detail about this study see Bruce M. Collins and Frank I. Fabozzi, “A Methodology for Measuring Transaction Costs”, in Financial Analysts Journal, Mar/Apr, 1991: 47 [4] Giovanni Federico and Antonio Tena-Junguito, “A tale of two globalizations: gains from trade and openness 1800-2010”, in IFCS - Working Papers in Economic History, 2016: 11-12 [5] Ibid., p. 21

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