Public Organizations and Transaction Costs

Ronald Coase asks himself in "The Nature of the Firm" why firms emerge in specialized exchange economies.

The laureate of Nobel Prize in Economics in 1991 understands that companies are profitable because of temporary high costs related to open market price mechanisms.

Within their firms, entrepreneurs are able to reduce the costs of information organization, trade negotiation, and market uncertainty; and as a result, firms can grow as more transactions are controlled.

Transaction costs, however, mark also the limitation of indefinite growth. Costs to organize additional transactions rise and thus hectic entrepreneurs can no longer allocate resources as efficiently.

The break-even point happens when “costs of organizing extra transaction within the firm equal the costs of carrying out the same transactions in open market”.

This is the moment when entrepreneurs decide that firms should stop growing and the supply of products and services should derive from price mechanisms in open markets.

The point raised by Coase is also relevant for public sectors. Public administrators are expected to constantly ask themselves the following questions:

i) How can public organizations control more transaction costs and increase their size?

ii) How can public organizations reduce the costs of each transaction while increasing size and providing better services?

iii) When and how should public organizations start shrinking and contracting out?

Given the importance of providing collective essential services and the high costs involving the expansion of public organizations, Coase’s following-up questions greatly help public administrators reflect on how institutions operate and bureaucratic tasks performed in terms of resource allocation aiming size and efficiency.