The Science of Demand (46) - Unofficial Translation of Steven Cheung's 经济解释 - 科学说需求

Section 3.  Constraints in Transactions

We have repeatedly touched upon constraints when we analyzed the issue of demand. But constraints in demand are different from constraints in transactions. We may wish to think in terms of Crusoe’s one-man economy first when analyzing transactions. Crusoe’s economy had demands, had constraints, but could not have transactions. Constraints in transactions only exist in a society.

From the viewpoint of rights delineation, property rights do not exist in a one-man economy. Property right is a constraint set up for society. From the viewpoint of costs, transaction costs do not exist in a one-man economy, therefore such costs only exist because society exists. The definition of society is the existence of more than one person. In Volume III, I will give transaction costs a broader definition termed institution costs, which refers to all the costs that exist only in a society. Even without market transactions, institution costs, which are non-existent in a one-man economy, still exist in a society. Also in Volume III, I will explain institutional costs (including the costs of market transactions) which can be viewed as costs in restraining competition among people. These concepts come from the thirty years of my following China’s development. I will go into the details later.

The paradigm of the new institutional economics includes the relationship between property rights and transaction costs, and the impact of their constraints on institutional arrangements and human behavior. I was fortunate enough to be around when the new institutional economics was incubated, and started participating in its cultivation as a graduate. Counting back, I have been pondering unrelentingly over this field for forty-eight years. Unfortunately, in the past thirty years, the road I have chosen diverges from my teachers’ and friends’. Some of them have turned to developing the game theory; some have chosen to approach from non-observable viewpoints resembling the game theory’s shirking, threatening or opportunism. In fact, “shirking” was first advocated by me in 1969. Soon afterward, realizing that such jargon implied non-observable behavior with which no testable hypotheses could be generated, I therefore abandoned such a viewpoint. Some colleagues say it was the “shirking” I advocated that led to the revival of the game theory. If so, undesirable influence that is, regrettably.

The significance of property rights and transaction costs is evident. Imagining in a one-man economy, we will not have banks, lawyers, nor police, civil servants, councilors, clerks, accountants, brokers, merchants … these professions emerged all because of the existence of transaction costs in a society. The reason for my focus on applying changes in these cost constraints to explain behavior is not only due to these costs are common, but also changes in these constraints are real and in principle observable. They are neither easy to measure nor easy to handle, but these can be accomplished both in principle and in practice.

Thus far, economic explanation is centered on two major topics: resource (factors of production) allocation and income distribution, while a blind eye is turned to far more amazing phenomena. The latter include the establishment of institutions, the organization of structures, the choice of contracts, pricing arrangements, etc. These phenomena are brought about by the existence of transaction or institutional costs. Continuing disregard of these phenomena amounts to a crucial missing link in economics, resulting in economists providing merely rudimentary explanation on resource allocation and income distribution.

Let’s revert to the aforementioned. The equilibrium point (i.e., when the marginal use value of every demander for a particular good equals its market price) may display myriad changes given the existence of transaction costs. A major difficulty is we cannot assume no transaction costs in this perfect market – even though most economists say so. The problem is, market itself is an institution, and institution arises due to the existence of transaction costs. If transaction costs equal zero, why would market exist?

One thing is certain – market exists to reduce certain transaction or institutional costs. But what exactly are these reduced costs? A big conundrum indeed. We will defer its exploration until Volume III.

The Coase theorem, having a profound influence on me, suffers the same problem. In a nutshell, this theorem says if there are no private property rights, there will be no market transactions. This viewpoint is correct. However, Coase in his monumental work added another condition: transaction costs equal zero. This is problematic. Private property rights is a system arising due to the existence of transaction costs. If there are no transaction costs, why would the system of property rights come into existence? The Coase theorem is inconsistent in its constraint assumption and contradictory in its logic. This will also be subsequently expounded.