In competitive market economies, prices and profit opportunities signal scarcity and valuable production, and together, they coordinate efficiently the plans of millions of individuals in a decentralized fashion. But ironically, free markets have given rise to the modern corporation, microcosms of command and control. Famed economist Ronald Coase solved the apparent paradox of the modern corporation by highlighting the importance of transaction costs. If a product has many inputs, negotiating each individual transaction and coordinating them across multiple parties can be extremely costly. Firms emerge to economize on these and other transaction costs, with competitive pressure leading to an optimal mix of outsourcing and insourcing.
The nature of the firm is a useful starting point for thinking about the distinction between government and governance. Both the state and the firm partake in governance by setting and enforcing rules, monitoring compliance, and engaging in rational planning to solve coordination problems in light of transaction costs. Likewise, when a state or a firm fails to practice good governance in the long run it either reforms or it ceases to exist. Reform and ruin occurs most often when the broader institutional setting somehow changes and, in turn, the nature of transaction costs also change. When transaction costs are falling, for example, governance can unbundle, which is what happened in the 1990s when firms began widely outsourcing customer support services to foreign call centers following lower trade barriers and innovations in communication technology. In addition, it is no coincidence that many countries undertook, in tandem, so-called “neoliberal reforms” during the same period. From deregulation to a greater reliance on subcontracting, public governance may be slower and clumsier, but it too is shaped by transaction costs.
Consider the battle raging between Uber and the global taxi industry. Although the current taxi licensing schemes in North America cities are conducive to rent seeking, I believe they reflect genuine efforts at good governance. Licenses are simply a blunt and easily-abused tool that gives customers some expectation of a minimum standard for quality and safety, and regulated prices eliminate the need to haggle with drivers. Uber’s innovation was in developing a multisided platform (MSP) technology that reduces transaction costs for both sides of the market. This platform features a driver and customer rating system and a responsive pricing algorithm that combines with preauthorized payments to remove any need for haggling. And by controlling a bottleneck to market access, Uber acts as a de facto private licensing authority.
To see why MSPs make for agents of good governance consider the market itself. Contract law, property titling, and a system of arbitration represent platform technologies for reducing transaction costs to the benefit of both buyers and sellers. And much like Uber, markets are subject to network externalities. The more sellers in a market, for instance, the more likely that buyers will agree to participate and vice-versa. But as long as there is the possibility of exit, market “regulators” will be driven to maintain a balance between the interests of buyers and sellers that is roughly consistent with minimizing social cost, even if their network effects tend them toward natural monopoly. Therefore, it should be no surprise that some of the earliest modern MSP technologies include marketplaces like eBay and Amazon, neither of which is primarily a retailer. Instead, they represent platforms that help connect independent buyers and sellers from around the world. Technologies like PayPal and services for dispute resolution are all ways to reduce transaction costs and to engage in genuine governance.
Similar to how Uber is disrupting traditional taxi governance, ecommerce is displacing conventional commercial governance. One could even imagine all rental units to eventually list on something akin to AirBnB, effectively rendering local Residential Tenancy Acts as obsolete and archaic as taxi industry regulations. Existing rental markets, for example, often dramatically favour tenant rights over landlord rights or vice-versa, depending on who had the greatest historical influence on the local council. But as Coase famously argued, the dual-sided nature of externalities makes the assignment of rights ambiguous in the abstract. While noise pollution has a social cost, for instance, forcing tenants to quiet themselves imposes a cost as well. If the loud tenant is having an amazing party, he may be more than willing to fully compensate the landlord or the sleepless neighbors. But more often than not, anger and ego are the ultimate barriers to a transaction and such a bargain rarely unfolds. Thus, good and effective laws are ones that approximate the assignment of rights that will minimize social cost on average; however, this attempt often fails because of special interest groups who capture the legislative process.
MSPs are adept at assigning these rights efficiently. Credit card networks, for example, make sellers bear the full cost of processing payments, while customers are often cross-subsidized through rewards and promotions. The only way to supplant an incumbent platform is to adjust the governance structure in such a way that social costs are better compensated by maximizing the bargaining surplus. In other words, MSP technologies are not just a bit better at governance. They potentially meet the economic definition of an ideal “public interest” regulator. Whether this technological revolution translates from local to national governments is not a question of if but when.
Much like the liberalizations of the 1990s, changes to the very nature of transactions have brought all forms of public administration and regulation to the precipice of a new way of reform. Critics will dub it an era of massive deregulation, yet that will be wrong. Less government does not imply less governance. Indeed, there will be exactly as much governance as you can bargain for.
Samuel Hammond is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Carleton University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies