Transaction Costs and Regulation

David Larrabee: It's all beginning to make sense. Mr Tyson owns the sugar cane. You own the formula for the plastics. And I'm offered as a sacrifice on the altar of industrial progress.
Linus Larrabee: You make it sound as if the son of the hotdog dynasty had to marry the daughter of the mustard king.
--Sabrina

Oliver Williamson passed away last week. Professor Williamson was a giant in the field of transaction cost economics. Building on the pioneering work of the late Ronald Coase, Williamson sought to explain why we see different organizational forms in the marketplace.

On one extreme we find granular trade between small independent contractors producing narrow ranges of output and trading with each other with little or no organizational overhead. Lots of 'outsourcing.' On the other extreme we find huge corporate hierarchies that do much of production and exchange internally rather than on the market. Lots of 'insourcing.'

What factors drive markets versus hierarchy?

Williamson theorized that a primary factor was contracting cost--i.e., the costs associated with governing transactions between parties. When contracting costs are low, then trade tends to happen between granular entities on the market as portrayed in many introductory economics textbooks. As contracting costs increase, more organizational hierarchy becomes necessary to govern trade. At some point, the bureaucratic costs of governing exchange become so high that firms will look to take those transactions off the market and manage them internally.

One source of transaction costs is regulation. For instance, if traders are required to pay a tariff, or meet mandated product or process requirements before a market transaction can be consummated, then entities will consider alternatives such as engaging in production themselves if regulatory costs can be reduced. Of course, these efficiency gains must be weighed against efficiency losses from less specialized/more diversified production.

Currently, regulatory burdens imposed by COVID-19 'regulators' are certain to drive transactions off the market. For example, if goods and the transportation modes that move them must be sanitized before they change hands, then that increased cost of trade will reduce volume associated with contracting out.

Consumers will behave similarly. For instance, if masks are required to go to a gym, restaurant, or sporting event, then that increased cost of trade will motivate some consumers to stay at home and become more self-sufficient.

If regulatory burdens do not lift, then Oliver Williamson would likely agree that motivation for outsourcing will continue to decline, and motivation for insourcing will continue to rise.