Transaction Cost Economics

By Scott E. Masten

Transaction cost economics (TCE) and the New Institutional Economics (NIE) have been virtually synonymous since the 1975 publication of Oliver Williamson’s Markets and Hierarchies, with its first chapter titled “Toward a New Institutional Economics.” Pretty much anyone working on organizational or institutional issues will be familiar with aspects of the transaction cost framework. The number who would regard themselves as “transaction cost economists,” however, is considerably smaller. How small? Right around the time that Ronald Coase, Douglass North, and Oliver Williamson were inaugurating the International Society for New Institutional Economics, Deirdre McCloskey quipped that only a handful, “a bare half-dozen,” economists truly understood the Coase theorem. By that reckoning, the number with a reliable grasp of transaction cost economics, given that the former is prerequisite to the latter, was tiny indeed — hardly a promising base on which to build an academic society!

Although the club of TCE cognoscenti is not quite that exclusive, full assimilation of transaction cost principles is hardly the norm. To some, especially in business and management areas, transaction cost economics consists almost entirely of the relation-specific investment hypothesis. Others regard TCE as a pre-formal contribution to the analysis of organizations that, while important, has largely been superseded by more modern approaches. For its proponents, however, transaction cost economics represents a distinct orientation or “lens,” as Williamson often describes it, for viewing organizational problems. The seminal focal adjustment comes from the “true” Coase theorem, specifically, the insight that any and all gains from cooperation will be realized, in the absence of any impediments to doing so, regardless of organizational form or institutional arrangements. Although a truism, Coase’s insight has two immediate implications. First, it focuses our attention on the impediments to cooperation, what we have come to call transaction costs. Second, it means that organizational and institutional arrangements matter only to the extent that transactional frictions differ among them. Williamson’s work beginning in the 1970’s (with important early contributions by Victor Goldberg and Benjamin Klein, among others) to “operationalize” Coase’s crucial discernment traced the primary sources of transactional frictions to bounded rationality and opportunism, characterized the distinguishing features of internal organization and contractual exchange, and identified attributes of transactions, notably asset specificity and complexity/uncertainty, that differentially affect the incidence of frictions under each. [...]

This post is the abbreviated version of an article written for the "Our field" section of, which can be fully read here.