What are transaction costs?

What are transaction costs?

Transaction costs are all costs made in trade transactions, either as an exchange of property rights in a market transaction, or as an exchange of responsibilities in a hierarchical situation. In other words, transaction costs can be associated with the fuss and ado that occurs when purchasing or selling goods and services, when changing the location of production and splitting up the supply chain. An entrepreneur who is able to keep his transaction costs low, will be more successful to offer an attractive product to the market, as this type of costs plays a considerable role in international trade. In principle two types of transaction costs can be distinguished: the “hard” transaction costs and the “soft” transaction costs (see also figure 1). The hard transaction costs relate to costs that are readily perceptible and quantifiable, such as transport charges, import levies and customs authorities tariffs. The soft transaction costs are much more difficult to observe and measure. One can think of all kinds of costs of making and checking contracts, information costs, costs because of cultural differences and communication failures, tacit knowledge on legal procedures, formation of trust and reputation, network building, costs associated with rules and regulation in order to reduce risks, security requirements etc. Now that the hard costs decrease because of trade liberalisation and lowered transport charges, the soft costs become more important. Good entrepreneurship in trade is needed to valuate these soft transaction costsand to reduce them with the help of transaction management.

Types of transaction costs

Figure 1

For that reason this research programme aims at excellence in both practical and academic knowledge on how to create value in trade transactions through a reduction of transaction costs. Positioning itself within this niche, the programme underlines and enhances the position of the Netherlands as a leading trading nation.

The research programme purports to study to what extent a reduction of transaction costs and knowledge investments that foster reduction of transaction costs yield welfare gains. These knowledge investments may relate to the use of new technologies, cultural knowledge and networks in trade relationships. More specifically, promoting the use of uniform standards can contribute considerably to a reduction of transaction costs. Part of these effects may be external and imply a role for the government. Insight into these externalities may give a hint for the kind of innovation policy needed to foster the transaction sector. It must be mentioned that in a globalizing world, where the growth of world trade is structurally larger than real production growth, the transaction sector also becomes increasingly important in countries which are not specific trading nations. 


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'

Transactioncosts at macro-level

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