Transaction Costs and the Progress of Humanity

Anything that enables us to exchange more easily will help to make us wealthier.

The progress of humanity is the story of the ongoing reduction of transaction costs.

Increases in wealth simply mean that people are getting more of the things they value.

For me, that sentence captures the essence of humanity’s climb out of centuries of poverty and ignorance to the more enlightened and materially comfortable world of the 21st century. It’s a simple sentence, but the ideas behind it need to be unpacked to see how powerful its argument really is.

Human Progress and Getting What We Want

To understand that argument, we need to step back and understand how economists look at wealth. For good economists anyway, wealth refers to the things we value, and increases in wealth simply mean that people are getting more of the things they value. Consistent with the subjectivism of modern economics, this definition does not specify what it is that people do, or should, value. What we value is up to us, whether those are material goods or things like peace and quiet, love, meaningful employment, or anything else that we prefer more of to less.

So how do we acquire the things that we value? The vast majority of things we acquire through exchange. Certainly, that is the way we get most of the material goods we value. But things like peace and quiet can be bought by paying for living quarters in a quiet neighborhood, or through non-monetary exchange with the people we live with. Meaningful employment comes through exchange. Whether love does is a matter of interpretation, but at the very least we must interact with other humans to come to love them as either friends or romantic partners. Such interactions are a form of exchange as well, even though they normally don’t involve money.

If it is through exchange that we are able to acquire the things that we value, and thereby become wealthier, we should be looking for ways to make it easier for people to exchange. This is where transaction costs come in. For economists, that term refers to “the costs of arranging contracts and agreements – trades in general – among interested parties.” This can mean the costs of anything from finding someone to trade with, to negotiating the terms of trade, to enforcing those terms. The higher are transaction costs, the more difficult it is to engage in the exchanges that create wealth. The progress of humanity has been the result of the ongoing reduction of transaction costs.

It is in this sense that the progress of humanity has been the result of the ongoing reduction of transaction costs. Anything that enables us to exchange more easily, in the broadest sense of the word “exchange,” will help to make us wealthier. In the long historical perspective, consider the development of spoken and written language and the printing press as transaction costs reducers. The ability to communicate with other humans makes it much easier for us to interact and gain from verbal and written exchanges.

Or consider the great economic transaction cost reducer, money. When we say that the problem with barter is that we cannot find someone who both has what we want and wants what we have, we are making a claim about high transaction costs. By being a generally accepted medium of exchange, money assures buyers that the seller will always want what they have and assures sellers that the other party will have what they want. It dramatically reduces the transaction costs of economic exchange, promoting more trade and greater wealth.

One can also point to a whole variety of other economic and social institutions that reduce the costs of engaging in exchange. The major institutions of a liberal society that do so are clearly defined and well-enforced property rights, the rule of law, and stable money. The market as a whole, and especially market prices, reduce transactions costs as well.

Social Norms, Tech, and L.O.V.E

Any number of social norms reduce transaction costs by facilitating smoother, more predictable social interaction. One can even see the adoption of what Deirdre McCloskey calls the “bourgeois virtues” as a way of making trade easier and therefore more common by reducing our ethical condemnation of trade and profit seeking.

Reduce the transaction costs of finding the right partner and you’re more likely to do so.

Of course the biggest transaction costs reducer of the last 25 years has been the Internet and its related technology, especially smartphones. The examples are endless. At the more mundane level, there are those of us who remember how hard it was in college 35 years ago to coordinate lunch plans among a group of friends. It took multiple phone calls or walks to another dorm with messages left on whiteboards to make it happen. Today, one group text makes this all much more simple. The technology reduces the transaction costs of human interaction and exchange.

And if you think this doesn’t matter for love, consider how sites like eharmony.com or match.com, not to mention apps like Tinder, have reduced the transaction costs of finding all sorts of companionship, from exclusively sexual encounters to romantic relationships that evolve into life-long partnerships. Even as early as 2010, couples who “met online” were second only to couples who met “through friends.” It’s not out of the question that this change in the way people meet is at least partially responsible for the slowly declining divorce rate. Reduce the transaction costs of finding the right partner and you’re more likely to do so.

Beyond romance, the Internet has given us the opportunity to make new friends around the globe through general interest sites like Facebook to more narrow online communities that allow us to use a shared interest or hobby as a way to globalize our friendships. I have no doubt that, thanks to Facebook, if I were ever stranded in almost any country on the planet, I could find a libertarian or fan of the band Rush who I know online who could help me out. That is an amazing human accomplishment, and it, like these other examples, adds to our wealth.

Throw on top of all of this the more material examples – such as online shopping, Uber, AirBnB, and the rest of the “sharing economy,” Google’s ability to give us information immediately, and our ability to access it through a device that fits in our pocket – and the power of Internet-driven cost reduction becomes clear.

Problem Solving

Consider how all of these pieces came together for me this week. My in-house Wi-Fi (itself a huge transaction cost reducer) was not effectively reaching my Internet-connected TV in the basement. I went on Facebook and asked for suggestions to solve the problem, including recommendations for particular devices. I also did some web searching myself to learn more about my options. I received a couple of dozen responses including a friend’s specific product suggestion. I clicked his Amazon link, ordered the device, and paid with another click. That took two minutes. The device was delivered to my door within 24 hours and my problem was solved.

Humans live at a level of wealth and comfort unimaginable by even our recent ancestors.

The ability to draw upon specialized knowledge and experience through Facebook is wealth created by falling transaction costs. The ability to find and purchase the needed device in minutes is the result of falling transaction costs. Overnight delivery is too, as is the ability to research my options on the web.

It’s very easy to take all of this for granted when our smartphones connect us to all of our friends and family and the libraries of the world (not to mention endless cat videos), so we should pause from time to time to realize just how amazing it all is. This is particularly true for “digital natives” who are young enough to not know a world that didn’t have all of these things.

Indulging our sense of wonder at, paraphrasing Hayek, the marvel of modernity is also good for the souls at a time when the news is full of human suffering at the hands of both nature and other humans. Humans continue to engage in evil and, despite our best efforts, we still cannot control nature’s wrath (though our wealth enables us to minimize its damage). In the bigger picture though, more and more humans live at a level of wealth and comfort unimaginable by even our recent ancestors. Our ability to create ways of reducing transaction costs has been perhaps the key contributor to that progress.

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