The Functions of Transaction Costs: Rethinking Transaction Cost Minimization in a World of Friction

Abstract

This article critically examines the goal of minimizing transaction costs, including the costs of legal decision-making. This goal permeates the law and economics literature and has profoundly influenced public policy. While most transaction cost scholarship has focused upon private law, the minimization goal has strongly influenced public law, where it has contributed to a variety of legal changes aimed at reducing public transaction costs, often through privatization. We argue that transaction costs purchase corollary benefits. They frequently enable those engaging in transactions to obtain information needed to correct for information asymmetries or inadequate information. They perform the functions of facilitating efficient transactions, allowing the avoidance of bad transactions, and serving important equitable goals. It follows that lawmakers must take transaction cost functions into account when deciding whether eliminating them is desirable. We discuss how to identify transaction cost functions and how to take these functions into account in choosing legal rules. In so doing, we extend the transaction cost debate, which has focused predominantly on private law, into the public law arena, or, more precisely, into the debate about the role of private markets in achieving public values. While some transaction costs deserve elimination, we conclude that maintaining or even increasing transaction costs sometimes makes sense. We show that viewing each transaction cost as a simple deadweight loss skews legal theory in both the public and private realms. This article uses the teachings of the Supreme Court's procedural due process jurisprudence, institutional economics, and theories focusing on information to inform analysis of transaction costs. It examines transaction costs' role in both the legal theory and policy-making in a wide variety of areas, including nuisance law, environmental law, intellectual property, corporate law, contract and the privatization of social services.