Theory

Apart from comparative advantages in production, transaction costs are the main determinant of (international) trade flows. Similarly, differences in transaction costs are crucial for the location and investment decisions of firms on where to produce, and on where to organize and orchestrate production. So knowledge on transaction costs, and on how to manage these transactions, is vital for these trade and investment decisions. Reducing transaction costs will make existing trade more profitable and will lead to more trade. It strengthens the competitive position of individual firms, and through spill-over effects it will enhance the welfare of the whole nation. Simply put, a reduction of transaction costs creates value for both firms and society.

'A major skill in transaction management is to be a competent player in the game of trust'

Transaction costs are associated with formal and informal trade barriers. Formal trade barriers (like tariffs and transport costs) are gradually disappearing. It implies that the (relative) importance of informal trade barriers increases. Examples are cultural differences, legal infrastructure, government rules and regulations, trust between trading partners, information asymmetry and incompleteness of contracts, relation specificity, etc. A further reduction of these informal transaction costs will enhance trade and worldwide economic welfare considerably.

Amsterdam

The Netherlands, having been a trading nation for centuries, is a perfect example of a country which has proved to avail of good skills in keeping transaction costs low. However, the last decades have witnessed an increased momentum in specialization and fragmentation of production and in the resulting trade flows and investment decisions (outsourcing, global sourcing, and foreign direct investments). The shifting of the production of goods and services to countries with lower production costs brings about a sense of urgency on how the Netherlands, like other developed open economies, can keep its position in value creation through trade. A viable solution for this is to grow from a production economy to one of the world's leading production-orchestrating economies. This can be achieved by further reducing the transaction costs of exchange. It requires innovative changes in the management of transactions and in the way international trade relationships are established.

Sailboat 

A country that has better abilities to reduce transaction costs than its competitors will acquire a relatively strong position in trade. The Dutch case may indeed be explained by the trading culture of being able to trade at low transaction costs. An example of this evidence is the large share in world trade, which cannot solely be explained by natural factors such as a favourable geographical position. Adam Smith already noted that the Netherlands has been an outstanding trading nation and earns a large part of its welfare by means of trade. The amount of trade can be enhanced when a further reduction of transaction costs can be managed. Lower transaction costs lead to more trade, and hence, to more welfare. Such welfare increases are obtained both by making existing trade less expensive and by expanding trade. As a matter of fact, trade and division of labour are directly related. The division of labour and specialization, which allows the use of technological advanced equipment, are a basic source of productivity growth. Yet, the division of labour and the subsequent fragmentation of production has its limits. More division of labour increases the need for coordination, which leads to more transaction costs. Promoting innovations that make coordination and transaction less expensive, foster the division of labour and enhance productivity further. The welfare gained by reducing coordination costs can be acquired in the production chain both within firms (intra-firm trade) as well as between firms (inter-firm trade).

'Transaction costs amount to 50% of the costs of value creation in an economy'

Background
Transaction costs at macro-level


                                                                           RITM 2
                 Knowledge on value creation through transactions in the era of globalization