transaction cost measurement for evaluating environmental policies

www.elsevier.com/locate/ecolecon

Ecological Economics 5

ANALYSIS

Transaction cost measurement for evaluating

environmental policies

Laura McCanna,*, Bonnie Colbyb, K. William Easterc,

Alexander Kasterined, K.V. Kuperane

aDepartment of Agricultural Economics, University of Missouri, 214B Mumford Hall, Columbia, MO 65211-6200, United StatesbAgricultural and Resource Economics, University of Arizona, Arizona, United States

cDepartment of Applied Economics, University of Minnesota, United StatesdAgra CEAS Consulting Ltd., Imperial College, Wye, University of London, England

eWorld Fish Center, Dhaka, Bangladesh

Accepted 4 August 2004

Abstract

Policy choice and policy design need to take account of transaction costs in order to increase the efficiency and sustainability

of policies. However, transaction costs must first be measured to be included in the evaluation of alternative environmental or

natural resource policies. While a number of studies measure transaction costs, there has been no systematic treatment of the

fundamental issues involved. This article examines the issues involved in transaction cost measurement and makes

recommendations regarding a typology of costs as well as the measurement methodologies themselves. In particular, methods

used for nonmarket valuation of environmental goods may have potential for the measurement of transaction costs.

D 2004 Elsevier B.V. All rights reserved.

Keywords: Transaction costs; Environmental policy; Measurement methodologies

1. Introduction

bWhat gets measured gets managedQ is an axiom in

the business world. Analyses of public policies need

to include transaction costs, as well as transformation

0921-8009/$ - see front matter D 2004 Elsevier B.V. All rights reserved.

doi:10.1016/j.ecolecon.2004.08.002

* Corresponding author. Tel.: +1 573 882 1304; fax: +1 573 882

3958.

E-mail address: [email protected] (L. McCann).

costs, and to be included, they must be measured.

Transaction costs can be substantial; measured mag-

nitudes have ranged from 8% of water purchase cost

for the California Water Bank (Howitt, 1994) to 38%

of total costs for an agricultural technical assistance

program (McCann and Easter, 2000). Nontrivial

magnitudes mean that transaction costs will affect

the optimal choice and design of policy instruments.

Yet another reason for incorporating transaction costs

in our empirical analysis of public policies is that, by

2 (2005) 527–542

L. McCann et al. / Ecological Economics 52 (2005) 527–542528

ignoring important costs, which are obvious to the

agencies involved, the economics profession is less

credible. The profession has not been able to

incorporate these costs in our analyses because of

inconsistent definitions and frameworks, and difficul-

ties in measurement—a dilemma that this article seeks

to address. While the specific context and examples

relate to natural resource and environmental policies,

the issues raised and recommendations are relevant for

the analysis of other types of public policies such as

food safety, education, and monetary policy, and may

be useful for measurement of transaction costs in the

private sector as well.

A large literature, following Williamson (1985)

and Coase (1937), has empirically demonstrated that

transaction cost minimization can help explain indus-

try structure and decision making by economic agents

in the context of market transactions (Globerman and

Schwindt, 1986; Pittman, 1991; Leffler and Rucker,

1991; Lyons, 1994; Moss et al., 2001). This literature

is relevant to, but distinct from, our focus on

measurement issues associated with public policies.

Coase (1937) wrote pioneering works on transaction

costs as related to the firm, as well as public policy

issues (Coase, 1960). In bThe Problem of Social

Cost,Q Coase (1960) compares bargaining, court

decisions, and regulation to resolve externalities.

There is also a relevant literature concerned with

factors that influence the magnitude of transaction

costs (Coase, 1960; Williamson, 1985; Oates, 1986;

North, 1990; Griffin, 1991; Milgrom and Roberts,

1992; Easter, 1993; Vatn and Bromley, 1994; Stavins,

1995; Challen, 2000; Vatn, 1998, 2001). In order to

focus on measurement, we are not addressing factors

affecting the magnitude of transaction costs or sources

of institutional change (Libecap, 1989; Feeny, 1993;

Zhang, 2001) in this article.

While much of the research in new institutional

economics (NIE) is empirical in nature, Masten et al.

(1991) indicate that this research could be improved

by measuring transaction costs. Although the magni-

tudes of transaction costs associated with environ-

mental and natural resource policies are

demonstrably important (Kuperan et al., 1998;

McCann and Easter, 1999, 2000; Falconer et al.,

2001), few studies to date have attempted to actually

quantify transaction costs. This may be because,

despite the pressing need, bthe measurement of

transaction costs poses formidable difficultiesQ (Wil-

liamson, 1996, p. 5).

Transaction costs have in the past been viewed as

wasteful and as something to be minimized. Randall

(1981) argues that bThese costs are not dmoney

down a ratholeT but are expended in exchange for

transactions services.Q Nevertheless, there are likely

to be efficient versus inefficient types and magni-

tudes of transaction costs, analogous to efficient and

inefficient combinations of inputs in a production

process.

In practice, transaction costs are not usually

included in empirical evaluations of alternative

environmental or natural resource policies, although

they are recognized in some theoretical work (Stavins,

1995; Fullerton, 2001). However, to fully compare

alternatives, policy choice and policy design should

take account of the transaction (including adminis-

trative) costs involved, as well as production costs and

abatement costs. In particular, an emphasis on trans-

action costs may serve to moderate government

failure (Falconer and Whitby, 1999; McCann and

Easter, 1999). More specifically, accounting for

transaction costs can:

1) improve preliminary comparison and screening

across alternative policy instruments;

2) enhance effective design and implementation of

policies to achieve particular objectives;

3) evaluate current policies in order to improve their

effectiveness; and

4) assess the budgetary impacts of policies over their

life cycle.

The goal of this article is to improve our

profession’s collective ability to incorporate trans-

action costs in our research models and policy

analyses, and to measure transaction costs in a

consistent and meaningful way. It advances this

effort by summarizing the foundational issues that

need to be resolved, proposing a typology and

chronology of transaction costs, reviewing how

transaction costs have been measured and the

strengths and weaknesses of the various method-

ologies, proposing measurement methodologies and

protocols, and suggesting new avenues of research in

order to improve transaction cost measurement theory

and techniques.

L. McCann et al. / Ecological Economics 52 (2005) 527–542 529

2. Fundamental issues

There are a number of fundamental issues relating

to transaction cost measurement, which underlie the

subsequent discussions of typology, chronology, and

measurement methodologies. These can be grouped

as: (1) integrating transaction costs in policy analysis;

(2) defining transaction costs; (3) the effect of time on

transaction costs; and (4) the tradeoff between

precision and measurement cost.

2.1. Integrating transaction costs in policy analysis

Transaction costs need to be measured within a

larger framework of the overall costs and benefits of a

proposed policy. Many transaction cost measurement

studies have implicitly or explicitly assumed that the

benefits provided by different policies are similar so

that a cost-effectiveness framework is sufficient. This

may not always be the case. For some policies, there

is a much broader range of benefits than the other

policies examined. For example, a land retirement

program has wildlife and aesthetic benefits, in

addition to reducing phosphorous runoff, while a tax

on phosphorous would only affect the latter (McCann

and Easter, 1999). It is rarely the case that the types

and levels of benefits are the same for all the options,

so a full cost–benefit analysis is desirable.1

It is essential to make a distinction between

decreasing transaction costs and increasing efficiency

for a number of reasons. A policy should not be

rejected due to high transaction costs alone since there

may be tradeoffs between transaction costs and other

types of costs. Some policies with low abatement

costs may have higher transaction costs. Transaction

costs also need to be viewed in the context of what

costs would be incurred in the absence of the policy

being evaluated. For example, a policy to reduce catch

in a declining fishery may be costly but the alternative

may be the eventual loss of an industry or the

extinction of a species.

1 While recognizing that benefits of policies and their types and

incidence are important, the issues involved in benefit estimation are

the subject of a voluminous literature and are beyond the scope of

this article. The partial focus on costs here mirrors the environ-

mental economics literature’s partial focus on benefit estimation.

Coase (1960) and Demsetz (1969) advocated

comparing policies based on the extent to which they

improve upon the current situation, not compared to

some ideal. Some studies of environmental and

natural resource policies inappropriately compare a

totally inflexible command and control approach to an

optimal tax. Comparing the transaction costs of a

poorly designed policy (existing or hypothetical) to an

optimally designed one may similarly bias the

evaluation of the transaction cost characteristics of

alternative instruments. It is probably the case that

many current policies are not optimally designed

(Falconer et al., 2001).

While detailed analysis is beyond the scope of this

paper, it may be that NIE concepts and methods need

to be broadened for evaluation of public policy issues.

The models based on the Williamson framework do

not account for government failure or public choice

issues. Observed policy choice is affected by property

rights and politics, and a policy outcome will probably

not have efficiency as its main goal (Colby, 2000).

Therefore, one does not necessarily observe policy

choices that minimize transaction costs in a manner

analogous to the choice of organizational form in the

private sector. A related issue is that the factors that

are assumed to affect transaction costs, and thus

decision making in the private sector (frequency,

uncertainty, and asset specificity) may not be the most

important factor for environmental and natural

resource policy. Other factors, such as monitoring

technologies (Fullerton, 2001), property rights (De

Alessi, 1983; Allen, 1991), and other institutions

(North, 1990), may be paramount.

2.2. Defining transaction costs

Empirical work causes researchers to confront

details in a way that theoretical work does not and

motivates the issues discussed in this section. Meas-

urement of transaction costs forces examination of

what is and is not a transaction cost. Transaction cost

measurement also requires researchers to look at the

reality of how policy is made and implemented.

Kuperan et al. (1998) demonstrate the importance of

detailed knowledge of the political and natural

resource system to ensure that all costs are accounted

for. Such knowledge allowed them to recognize that

the government is involved at many different stages

Fig. 1. Boundary issues relating to transaction costs.


with respect to both central management and co-

management of a fishery.

There are numerous definitions of transaction costs

and inconsistencies among them that confound the

development of consistent transaction cost measures.

A very narrow definition was used by Demsetz (1968,

p. 35), bTransaction cost may be defined as the cost of

exchanging ownership titles,Q while Barzel (1985,

p. 4) used the somewhat broader bcosts of effecting

exchange.Q Gordon (1994) defines transaction costs as

the expenses of organizing and participating in a

market or implementing a government policy. In his

article on externalities, Coase (1960) uses the phrase

bthe cost of carrying out market transactionsQ to refer

to interactions between firms or between individuals

and firms. Coase refers to administrative costs when

the resolution of the externality comes about within a

firm or by government regulation. Some authors treat

transaction costs and administrative costs as essen-

tially interchangeable terms (Stiglitz, 1986). When

evaluating alternative policies to achieve environ-

mental or natural resource objectives, distinguishing

between transaction costs and administrative costs can

confuse the issue, particularly if both market and

nonmarket policies are being evaluated (Stavins,

1995); therefore, we define the term transaction costs

as including administrative costs.

Allen (1991, p. 3) presents a definition that, while

designed to be generally applicable, is particularly

well suited to environmental and natural resource

policies since many market failure issues stem from

incomplete property rights: bTransaction costs are the

resources used to establish and maintain property

rights. They include the resources used to protect and

capture (appropriate without permission) property

rights, plus any deadweight costs that result from

potential or real protecting and capturing.Q Some of

these costs may represent lost opportunities for

productive innovations since human competence is

scarce (Eliasson, 1996). However, Allen (1991)

explicitly excludes many of the information costs that

are key components of the NIE literature such as costs

of finding a trading partner, decision costs, and search

costs. In addition, for many environmental problems,

the bgoodQ (in addition to the rights regarding it) is not

well defined so resources will be expended to define

the bpropertyQ under dispute. North (1984) indicates

that measuring valued attributes embodied in a good,

such as an orange, is costly. Therefore, a broader

definition is used in this paper: transaction costs are

the resources used to define, establish, maintain, and

transfer property rights.

There are a number of issues that relate to the

boundaries of transaction costs and their measure-

ment, which are illustrated in Fig. 1. Several

distinctions have been developed in the literature that

are not as clear-cut as they first appear. The dichotomy

between policy (associated with the implementation

of policies) versus nonpolicy costs (incurred by

parties to voluntary transactions) (OECD, 2001) is

not readily applicable. Simply analyzing the costs

involved with market transactions (area A in Fig. 1)

will underestimate total transaction costs of market-

based instruments. Government is involved in any

definition or reallocation of property rights that

enables private trade. Furthermore, public agencies

record, monitor, and enforce trades, so the full cost is

area A plus area B. In market failure issues such as

pollution (overfishing), government establishes the

total amount of pollution (catch) allowed and thus the

number of tradable permits (fishing licenses) issued.

In the case of water markets, questions of who has

rights to how much water must be addressed prior to

water trading (Colby, 2000). Furthermore, transaction

costs will depend on the broader institutional environ-

ment, such as the legal system (Easter et al., 1998;

Saleth and Dinar, 2003). If changes in the institutional

environment are required, total costs would include

areas A, B, and C, as illustrated in Fig. 1.

Another distinction has been made between pro-

duction or abatement costs (or transformation costs),

and transaction costs. The distinction is less clear

when one examines actual cost data. For technical

2 Part of the increase in transaction costs from the early 20th

century demonstrated by Wallis and North (1986) might be due to

implicit costs becoming explicit.


assistance programs, some costs incurred by govern-

ment agencies, such as design costs related to abate-

ment technologies, could be categorized as either

transaction costs or abatement costs (McCann and

Easter, 2000). The distinction matters when compar-

ing the magnitude of abatement costs versus trans-

action costs, but is less of a problem if the analytic

goal is simply to account for all costs related to a

policy instrument.

There are other unresolved boundary issues related

to transaction cost measurement. For example, should

basic research on the cause of a problem, such as

nitrates in groundwater, be included in policy analysis

as a transaction cost? What about research on the

effectiveness of various technical solutions to the

problem? Should we incorporate social science

research on the effectiveness of alternative policy

instruments? What about costs of social conflict

before the issue is resolved by the legislature or the

courts? Should we incorporate enactment costs of a

legislative process? Or, should we only count the

costs of the policy from the time a policy instrument

has been formally selected? In general, researchers

should follow the with/without principal to determine

whether it is appropriate to allocate a cost to a

particular policy. Transaction cost measurement

should be explicit about what costs have been

included and excluded and why. This paper presents

a broad typology, which may be adapted by other

researchers for specific purposes.

Another problematic issue is implicit versus

explicit costs. For instance, in evaluating agricultural

policies, certain costs, such as family labor and

opportunity cost of capital, are not out-of-pocket

expenses. Determining the hours spent and then

attaching an appropriate value to that time is a

standard technique to deal with family labor. Still,

there are problems involved with valuing the cost of

farmers’ time since they may enjoy extension meet-

ings or have a low opportunity cost of time at some

periods of the year (Berkes, 1992; Abdullah et al.,

1998; McCann, 2001). Time that farmers spend

talking to government officials or reading documents

relating to environmental programs is an implicit cost,

whereas paying a consultant to evaluate the program

is an explicit cost. In the public sector, reallocation of

agency staff time is an implicit cost, while allocation

of additional staff and monies is an explicit cost. Both

types of cost need to be accounted for and implicit

costs pose greater difficulties. Policy changes

designed to reduce transaction costs may merely

move costs from one party, where they are an explicit

cost, to another party, where they are an implicit cost.2

This may, in fact, be strategic in some cases.

2.3. The effect of time on transaction costs

Transaction costs consist of both ex ante and ex

post costs—those occurring before and after the actual

transaction. Yet, defining the transaction with respect

to an environmental or natural resource policy is not

straightforward. Ramstad (1996) points out the differ-

ences in the definition of a transaction between

Commons (1934) (ba transaction is a transfer of

property rightsQ) and Williamson (1985) (ba trans-

action is a transfer of a good or service across a

technologically separable interfaceQ). Coase’s (1960)

discussion of transaction costs seems to be consistent

with Commons’ definition and is the more appropriate

definition to use with respect to the problem of

externalities or high exclusion cost goods. The

btransactionQ could be thought of as the enactment

of legislation or a court ruling. However, there may be

a number of transactions prior to and subsequent to

the primary one. For instance, a policy that establishes

tradable permits will entail transactions for years after

the policy is established. It may be appropriate, in the

case of public policies, to focus on stages of

development of policy instruments, rather than trying

to define specific transactions. We explore this further

in Section 3 (Table 2).

In the context of policy evaluation presented here,

a distinction should be made between measurement ex

ante and measurement ex post, before or after a policy

decision is made (Hicks, 1946), although one could

also make a distinction between before and after

implementation. If several policies are being eval-

uated prior to making a decision, ex ante measure-

ment is what is both feasible and useful. Ex post

measurement is feasible only for the alternative that

was actually chosen. Many of the studies measuring


transaction costs have been ex post, so some cost data

were available (Falconer and Saunders, 2000;

McCann and Easter, 2000; Falconer et al., 2001).

Falconer et al. (2001) have pointed out that

transaction costs vary over the life cycle of a program.

They may decrease with time due to learning, similar

to the literature on learning by doing in manufacturing

(Arrow, 1962), and to the presence of fixed or sunk

costs, which are incurred primarily at the beginning of

a program. Fang et al. (2005) found that 65% of the

transaction costs of a point–nonpoint source trading

program were incurred before any trades took place.

In some cases, costs may also change with changes in

monitoring technologies, abatement technologies,

related legislation, or changes in implicit property

rights, and these changes may themselves be induced

by adoption of the policy. Many of these changes

could be expected to reduce transaction costs, but

increasing scarcity may increase transaction costs

(Libecap, 1989). McCann and Easter (1999, 2000)

have also identified the issue of fixed costs associated

with agri-environmental programs, while Abdullah et

al. (1998) discuss it in terms of dynamic and static

costs. It is analogous to construction costs versus

operating costs of an irrigation system. The issue of

learning and sunk costs is important when the costs of

a new program are being compared with one that has

existed for some time (Falconer and Saunders, 2000).

Existing institutional arrangements and policies may

lower the costs of one program relative to another

(OECD, 2001). History matters, in that an efficient

new policy may appear to be more costly than a less

efficient program that was set up long ago. Typically,

the status quo is used as a baseline for a with/without

comparison; however, this baseline tends to bias the

analysis against new policies that entail start-up costs

(McCann and Easter, 1999). In another setting, where

there is no existing policy, it may be less costly to

adopt the more efficient policy. Regardless of the

baseline chosen, researchers need to be explicit

regarding how costs may be affected by pre-existing

policies.

There are tradeoffs among costs over time. There-

fore, the time period covered by the analysis and the

discount rate used become important. For instance, a

policy/program might incur high initial transaction

costs as part of a broad stakeholder outreach and

consensus-building process and have lower litigation

and noncompliance costs later (Egdell, 1998; Colby

and Pearson d’Estree, 2000a,b). Kuperan et al. (1998)

found that while overall costs were similar for central

management versus comanagement of a fishery, the

latter had higher costs associated with decision

making, while central management had higher

ongoing enforcement costs. Another example of

tradeoffs among types of costs are the arguments

made for the efficiency of targeting (i.e., treating

different agents differently), but this increases trans-

action costs (Gordon, 1989; Milgrom and Roberts,

1992; Kozloff et al., 1992).

2.4. Precision versus measurement cost

For the differing purposes of transaction cost

measurement, how precise do our estimates need to

be? As an initial screening across policy instruments,

rough borders of magnitudeQ may be good enough and

would represent an improvement over current prac-

tice. If these types of costs are to be used as evidence

in court, as with nonmarket valuations of natural

resource damages, a much higher standard will be

required. However, collecting detailed data on trans-

action costs is difficult and costly. Different method-

ologies may be required for these different uses. It is

also important to be aware of the distinction between

accuracy and precision so researchers do not fall into

the trap of having precise, inaccurate measurements

(Mayer, 1993). For example, if researchers only

measured types of costs for which there is abundant,

reliable data and ignored other types of costs, the

measured values would be biased.

3. Transaction cost typologies/framework for

transaction cost measurement

Separating transaction costs into categories is

important for measurement and policy design. A

typology can help compare empirical studies since

some studies incorporate a wider range of transaction

costs than others. It may also help to ensure that all

relevant types of costs have been accounted for, and

facilitate the collection of data on transaction costs.

Different types of costs may be borne by different

agencies or at different points in the life cycle of a

policy. Meaningful categories can also be used to

Table 1

Typology of transaction costs associated with public policies and

who incurs costs

Type of transaction cost Incurred by

Legislature/

courts

Agencies Stakeholders

Research and information + ++ +

Enactment or litigation ++ + ++

Design and implementation ++ +

Support and administration ++ +

Contracting + ++

Monitoring/detection ++ +

Prosecution/enforcement + ++ +

( ) Negligible transaction costs; (+) low transaction costs; (++) high

transaction costs.

3 Rosegrant and Binswanger (1994) indicate that the incidence of

the costs of moving to a new water allocation system will affect the

magnitude of transaction costs. Fang et al. (2005) found that a

government agency bore 81% of the cost of a point/nonpoint source

trading program.


improve policy design. Some costs may be positively

(complements) or negatively (substitutes) correlated

with other types of costs. Again, costs associated with

stakeholder participation at an early stage may

decrease monitoring and enforcement costs later

(Egdell, 1998). Also, different types of policy instru-

ments may entail a different mix of costs or a

difference in the costs’ relative importance. Attention

to such differences will help to identify the funda-

mental determinants of transaction costs.

A number of typologies exist (Dahlman, 1979;

Stiglitz, 1986; Foster and Hahn, 1993), but that of

Thompson (1999) seems to subsume most other

recent typologies and is used as our starting point.

Thompson develops an institutional transaction cost

(ITC) framework, which incorporates enactment costs

as well as implementation and monitoring/enforce-

ment costs. His focus on enactment costs can be seen

as reflecting an emphasis on the transaction as the unit

of analysis. The primary btransactionQ occurs when

property rights are implicitly or explicitly defined or

redefined. Creating a market for tradable permits

requires decisions regarding the initial allocation, and

therefore subsequent trades involve second-order

transaction costs. We have added a contracting

category to reflect these second-order costs and to

emphasize the fact that much of the NIE literature

concerns this component of transaction costs. We have

also modified Thompson’s model by including initial

research and information costs as they are important

for the full life cycle of a policy (and thus for

choosing the optimal level of abatement), but are not

explicitly incorporated in the ITC framework

(McCann and Easter, 1999). Within each category,

costs may consist of supplies, travel, labor, etc., with

labor usually being the most important component.

It is important that any framework be general

enough to include both market and nonmarket policy

instruments since both alternatives may be under

consideration (Coase, 1960). Table 1 presents a

typology of transaction costs for environmental and

natural resource policies including an indication of who

might incur the costs. As indicated above, this table

represents modifications of the models developed and

used by Thompson (1999) and McCann and Easter

(1999). Transaction costs associated with public

policies thus include: (1) research, information gather-

ing, and analysis associated with defining the problem;

(2) enactment of enabling legislation, including lobby-

ing and public participation costs, or, alternatively, the

costs of changing laws through the courts or modifying

existing regulations; (3) design and implementation of

the policy, which may include costs of regulatory

delay; (4) support and administration of the ongoing

program; (5) contracting costs, which may include

additional information costs, bargaining costs, and

decision costs, which are relevant when a market has

been set up for a pollutant, or natural resource; (6)

monitoring/detection, which may include both the

monitoring of the environmental outcome, or the level

of compliance with the regulation, tax/subsidy scheme,

or private contract, as well as the development of

monitoring technologies; and (7) prosecution/induce-

ment/conflict resolution costs incurred if lack of

compliance is found. Most measurement studies are

not comprehensive, in that they have focused on some

subset of these costs, either regarding the type of cost or

who bears them.

Who bears the transaction costs is a fundamental and

relatively unexamined issue.3 In addition, identifying

who pays the costs, which enables their measurement,

is distinct from the question of who ultimately bears

the costs. For example, while costs are incurred by the

legislature, the courts, or a government agency,

taxpayers ultimately pay. For purposes of transaction


cost measurement, we focus on the parties who

initially incur the costs. Given the paucity of data in

this area, the incidence and magnitudes presented in

Table 1 require empirical verification.

The categories are listed roughly in the order of the

life cycle of a policy. While other ways of organizing

costs may exist, this framework facilitates transaction

cost measurement. Colby (2000) discusses stages in

the implementation of cap and trade policies. We

present a chronology for environmental and natural

resource policies based on her work and combine it

with the associated transaction costs (Table 2). When

costs are incurred is an important question for

transaction cost measurement, but another issue is

when transaction costs should be measured. With

respect to the best points in time to measure trans-

action costs, many of the categories can be assessed at

several points in time over the life cycle of a policy.

The first stage is the baseline period when there is

growing awareness of the need for policy action but

before a new policy is proposed or implemented.

Research on the technical and social aspects of the

problem may be funded and stakeholder groups may

incur costs to raise the visibility of the issue.

Estimating research costs enables bdoing somethingQto be compared with bdoing nothing,Q even though

Table 2

Chronology of when transaction costs occur and when they should be me

Shaded areas indicate that the type of transaction cost is incurred during

this research may be relevant for several policy

options. Ex ante evaluation of the costs of alternative

policies is necessary to provide information for the

policy instrument selection and design process (the

second, or development stage).

In the development stage, policies are proposed,

debated, negotiated, lobbied for and against, defined

and redefined, formally considered by Congress or

state legislatures, and ultimately adopted. Alterna-

tively, there may be an analogous process occurring

through the legal system in which case evidence is

gathered and the case is argued in court. Executive

branch policy decisions can also set policy and change

property rights. Formal adoption of a particular

policy, or a court ruling, represents the first-order

btransaction.Q The types of costs incurred can be

classified as enactment/lobbying or litigation costs. In

addition, there are information and design costs

occurring during this process. Data could be collected

in this stage and subsequent stages in order to develop

accurate ex post estimates of transaction costs for the

policy instrument that is chosen.

The third stage is early implementation. Admin-

istrative rules are designed and adopted, agency staff

are hired to administer the program, public notices

and hearings are conducted, short-term adjustment

asured

this stage.


occurs as the affected population reacts to the new

policy, the agency responds to litigation and resolves

conflicts, and implementation details are worked out.

The costs incurred are primarily design and imple-

mentation costs, although information costs continue

to be important.

In the fourth stage, full implementation, policies

are actually put into effect. Depending on the actual

policy instrument selected, bids are taken for land

retirement programs, tradable permit markets are

established and trades begin to occur, taxes are

collected or subsidies are paid, land use plans are

developed, or educational programs are conducted.

The btransactionsQ at this stage are what we have

termed second-order transactions. The working out of

implementation details is necessarily an iterative

process since some issues will only become apparent

during full-scale implementation (e.g., the approval

process for trades or bids may need to be adjusted).

There will be a learning curve for both the agency

staff and the stakeholders so information costs will be

high compared to the subsequent stage. Lobbying and

court challenges by negatively affected parties may

continue for the life of the policy. Those benefited will

seek to maintain the new status quo. Costs incurred

during this stage include implementation costs, sup-

port and administration costs, and contracting costs.

After the new policy has been in place long enough to

have measurable effects on transaction costs, prelimi-

nary ex post estimates could be developed, recogniz-

ing that there will be ongoing costs during the next

stage, which will necessarily be ex ante.

In the fifth and final stage, established program, the

policy instrument has become well-established, fully

implemented, and is part of the routine for the affected

population. Permit trading becomes routine and

brokers may appear as in the case of SO2 permits,

compliance with land retirement or conservation

tillage programs is routinely monitored, payments

are made, and, if necessary, prosecution and enforce-

ment occur. In the case of trading, price information

and rules for trades are well known so transaction

costs for implementing trades are lower. For both

agency staff and stakeholders, information costs

decrease. Other costs incurred during this stage,

which is ongoing, include support and administration

costs, contracting costs, monitoring and detection

costs, and prosecution and enforcement costs.

Because this stage is ongoing, the discount rate used

will affect the magnitude of transaction costs. As soon

as the policy is fully established, finalized ex post

transaction cost measurements can be developed. If

transaction cost measurement stopped at the end of

stage 4, this would seriously disadvantage new

policies as compared to established ones (see Section

2.1). These finalized estimates can then be used to

develop better ex ante measurements of policy

instruments in the future.

4. Methods for transaction cost measurement

In Section 3, we discussed the stages at which

transaction costs occur in the policy process and when

we would ideally develop estimates of transaction

costs. This section addresses transaction cost measure-

ment methodologies. A number of methods have been

used to measure transaction costs. Incorporation of

transaction costs in a neoclassical framework is the

perspective that seems to underlie most of the trans-

action cost measurement work to date. Williamson

(1993) suggests that researchers may be able to

measure a lower bound of transaction costs indirectly.

For instance, the difference between buying and

selling price for SO2 permits has been used as a

measure of transaction costs although it does not

include time spent within the firm, nor monitoring and

enforcement costs borne by the government (Stavins,

1995). It also does not include enactment or design

costs, which we have argued are part of the full costs

of any policy instrument. There are some empirical

studies that have tried to measure transaction costs

more directly. Wallis and North (1986) tried to

estimate the transaction bsectorQ for the United States

using public data. They classified certain jobs in firms

(shipping clerk) and certain industries (real estate) as

being primarily associated with transactions. They did

not attempt to measure information costs by consum-

ers, etc. They estimated that public and private sector

transaction costs increased from one-fourth to one-

half of GNP in this century.

There have been a number of transaction cost

measurement studies related to water markets. Nunn

(unpublished) looked at transaction costs involved

with water markets in New Mexico. She directly

surveyed water users who had recently been involved


in a water transaction to determine their transaction

costs. Colby (1990) measured policy-induced trans-

action costs in western water markets through surveys

of buyers, sellers, and agency staff. She suggested that

these costs may indirectly serve a useful role in

signalling the external effects on third parties of water

transfers. Colby compared actual transaction costs

among various western states (measured through

surveys of water purchasers and state agency staff)

and found that transaction costs averaged 6% of the

price paid by the applicant to transfer water, with

Colorado having higher costs than the other states.

Howitt (1994) reported that the overhead costs

incurred by the State Department of Water Resources

for the California Water Bank were about 8% of the

water purchase cost. Hearne and Easter (1995)

surveyed farmers and found that the transaction costs

involved with water transfers in Chile represented 7–

23% of the transaction price.

In the area of agri-environmental policy, govern-

ment figures have been used by a number of

researchers (Falconer and Whitby, 1999; McCann

and Easter, 2000; Falconer et al., 2001). Publicly

available financial data would seem favorable from the

point of view of accuracy and ease of measurement.

They represent actual expenditures and do not require

surveys or interviews on the part of the researchers.

There are, however, a number of disadvantages

including: (1) incomplete coverage of types of costs;

(2) not well-organized data for research purposes in

that it may be difficult to separate out transaction costs

for different policies, or to clearly separate transaction

costs from abatement costs; (3) requirement for

cooperative agency contacts willing to pull together

information; (4) confidentiality issues; and (5) can

only be used for ex post studies. Access to the

necessary data is a major problem faced by researchers

examining transaction costs. Private and public sector

managers are understandably suspicious about the

collection of information that may reflect unfavorably

on them or their programs, but this information is

necessary to make programs more efficient. This

problem may become more acute as more transaction

cost measurement studies are published. For example,

Whitby says that not long after they completed their

study on countryside stewardship policies using

government data, the government stopped reporting

the data (personal communication, July 2001).

Government documents can be used to develop

estimates of transaction costs of public policies.

Falconer and Saunders (2000) examined documents

such as correspondence, invoices, legal agreements,

and information on phone calls, meetings, site visits,

etc., to estimate costs for the formal negotiation

process involved with agri-environmental manage-

ment agreements in a region of Britain. In-depth case

studies allowed them to estimate standard costs for

various types of documents. This method required

them to make a number of assumptions regarding the

value of time for various stakeholders, homogeneity

among the agreements in a given program, etc.

Systematically collecting information while the

policy is being planned and implemented would be

ideal. Governments should be encouraged to collect

this type of information and economists could help

develop useful data collection frameworks. In Victo-

ria, Australia, a pilot project evaluating the potential

of environmental management agreements includes

measuring transaction costs as part of the evaluation

(Strappazzon, personal communication, April 2001).

Other options would be to examine budgets in

proposals for new programs (McCann, 2001), assum-

ing that these costs have been accurately projected.

Other researchers looking at environmental and

natural resource policies have used either surveys or

interviews to estimate agency transaction costs, which

is time-consuming and costly. If we assume that, prior

to the policy, staff time allocation was such that the

marginal benefits from their activities were at least as

high as the marginal cost, a new activity would displace

other valuable activities, which are no longer being

carried out. This opportunity cost, an implicit cost,

could be estimated by taking the hours spent on the

new activity and multiplying by the salary and fringe

benefits rate. McCann and Easter (1999) interviewed

government staff regarding time spent on various

activities within their organization and then used a

standard value of time for various categories of staff.

This strategy has been used by a number of researchers

(Egdell, 1998; Kuperan et al., 1998; Fang et al., 2005).

Surveys and interviews usually require people to

either remember information about a time in the

(possibly distant) past, or to predict costs for a

hypothetical scenario. The closer in time the survey

takes place to when activities occurred, the better. If it

is an ex ante study, the interviews have the potential

Table 3

Type of cost and recommended measurement methods

Type of cost Ex ante Ex post

Implicit Explicit Implicit Explicit

Research and information 1, 2 5 1 1, 3, 4, 5

Enactment or litigation 1, 2 1 1, 3, 4, 5

Design and implementation 1, 2 5 1 1, 3, 4, 5

Support and administration 1, 2 1 1, 3, 4, 5

Contracting 1, 2 5 1 1, 3, 4, 5

Monitoring/detection/

conflict resolution

1, 2 5 1 1, 3, 4, 5

Prosecution/enforcement 1, 2 5 1 1, 3, 4, 5

(1) Surveys or interviews of government personnel and stake-

holders; ex post results from other studies; (3) government reports;

(4) financial accounts; (5) proposed budgets.


for interviewer, information, strategic, and hypothet-

ical bias, similar to nonmarket valuation studies. On

the other hand, staff in government agencies are used

to estimating human resource needs for projects and

developing budgets, so it is a more familiar task than

asking consumers how much they value a wetland.

Surveys or interviews are usually the only way to

obtain estimates for implicit costs or for an ex ante

evaluation of policies. It also allows researchers to

collect information on the types of costs that are of

interest for the study. If a very similar policy has been

implemented in the past in a similar institutional

environment, it may be possible to extrapolate data

obtained on the previous program.

Recent research has estimated the size of public

agency transaction (administration) costs in the

provision of environmental public goods in the

European Union (Falconer and Whitby, 2000). In

contrast, there is little work estimating the size or

importance of costs that fall on farmers or other

stakeholders who must comply with new policies.

Recent studies include an estimation of farmers’

transaction costs of participating in agri-environ-

mental schemes by Falconer (2000) and Kasterine et

al. (2001) and a transaction cost analysis of farm

administration outsourcing by Vernimmen et al.

(2000). Egdell (1998) contacted a number of individ-

uals and organizations regarding the time they spent

participating in a consultation process on the Country-

side Premium Scheme in Scotland. Kuperan et al.

(1998) measured stakeholders’ costs as well as public

sector and NGO costs in the case of fisheries

management regimes using surveys, interviews, and

financial data. Fang et al. (2005) used interviews and

documents to estimate the transaction costs for the

point source and a government agency involved with

a point/nonpoint source trading scheme.

Research on stakeholder costs will also require

surveys or interviews and is prone to many of the

problems discussed for public agency costs. Collect-

ing actual transaction cost data from individuals and

firms: (1) requires careful survey design and pretest-

ing; (2) entails difficulties soliciting respondents,

obtaining completed surveys, and determining bias

due to nonresponses and to those declining to

participate; (3) is unlikely to obtain a random

representative sample of the target population; (4)

often requires the researcher to persuade respondents

to check their own financial records, etc., to provide

accurate responses; and (5) requires measurement

soon after costs are incurred so respondents still have

records to check. Data on perceptions of transaction

costs involve all the typical problems with measuring

perceptions after the fact or in a hypothetical context.

As the preceding discussion has demonstrated,

estimation methods for the various types of costs will

depend on the specific case, and multiple methods

may be required for a particular study. For example,

information may be easily purchased under some

policies and will thus be an explicit cost, while in

other cases, obtaining information may involve a

significant time investment on the part of stake-

holders. If an information clearinghouse develops, the

type of cost (and appropriate measurement method)

may go from an implicit (surveys) to an explicit cost

(financial data). Table 3 summarizes this discussion of

recommended methods for measuring various types of

transaction costs. Certain types of costs would be

more difficult (and costly) to measure, such as ex ante

estimates of implicit costs, while others, such as ex

post estimates of explicit costs, would be rather

straightforward.

5. Future research

There are a number of parallels between trans-

action cost measurement and nonmarket valuation of

environmental goods, so some valuation techniques

could be fruitfully transferred rather than reinventing

the wheel. While market prices would be ideal

4 Colby (1990) did find that average transaction costs per acre

foot of water declined as the volume of water increased due to types

of costs that did not vary with the size of the transaction.


measures of environmental values, they are usually

not available, similar to the nonavailability of detailed

data on transaction costs of environmental policies. In

addition, different types of benefits (use and nonuse

values, option values, bequest values, etc.) require

different measurement methodologies (Freeman,

1993). Revealed preference data can be used to assess

use values, but stated preference techniques, such as

contingent valuation surveys, are required to assess

nonuse values. Similarly, for measuring transaction

costs, different types of costs may require different

methodologies. Reliance on financial data (analogous

to revealed preference techniques) neglects some

types of costs (e.g., farmers’ time) so surveys may

be required to obtain information on these types of

transaction costs. Contingent valuation methods

measure various types of values (use value, option

value, bequest value, etc.), which may be estimated

individually or all together. We have argued that costs

should be separated out in the case of transaction cost

measurement. It may be that choice modeling, which

can value different characteristics of a situation, may

have potential for separating out these types of costs.

This method is gaining prominence in the nonmarket

valuation field as evidenced by two recent handbooks

(Bennett and Blamey, 2001; Louviere et al., 2001).

Crase et al. (2001) used this method to estimate the

value of strengthened property rights to water.

Estimating willingness to pay to reduce transaction

costs via a contingent valuation survey could be a

useful approach in contexts where respondents face

policy-related transaction costs on a regular and

repeated basis such as costs imposed by existing

government programs. Measurement could parallel

CVM research on nonmarket values, with the attend-

ant perils of that approach (Mitchell and Carson,

1989; Arrow et al., 1993).

Another area of research might be to measure

transaction costs with different methods similar to

comparisons between stated and revealed preference

techniques. Kuperan et al. (1998) used several

techniques for different types of costs but did not

compare them. Once enough information on trans-

action costs of various policies is collected, as well as

on the determinants of those costs, we might be able

to use a technique similar to benefits transfer to reduce

the need to measure transaction costs. For example,

while estimates of transaction costs as a percentage of

total costs vary widely, the percentages found by

McCann and Easter (2000) for a technical assistance

program (38%), by Fang et al. (2005) for a pollutant

trading scheme (35%), and by Falconer et al. (2001)

for management agreement schemes (30%) are

surprisingly similar. Howitt’s (1994) and Colby’s

(1990) empirical works on the transaction costs of

water transfers also found similar magnitudes.

Few, if any, researchers involved in transaction cost

measurement have actually tried to examine how

marginal costs change as abatement level or size of

the transaction changes.4 This is similar to nonmarket

valuation studies, which measure the value of going

from one amount of an environmental good to

another, rather than measuring the effect of small

incremental changes. Nevertheless, studies on mar-

ginal transaction costs would be useful for policy

design.

Less developed versus developed country issues

relating to transaction costs have not been examined

and would be a fertile area for future research. There

are two distinct questions: (1) Is measuring trans-

action costs easier or more difficult in the developing

country context? (2) Are transaction costs likely to

be higher or lower in developing countries compared

to developed ones? Institutional frameworks and data

sources might be less available, which would make

measurement more difficult. According to OECD

(2001, p. 4), bBoth policy- and nonpolicy-related

transaction costs could be higher in developing

countries than in developed countries.Q OECD

indicates that developing countries often lack institu-

tional capacity, and there are high administrative

costs associated with collecting taxes and providing

subsidies.

6. Conclusions

Transaction costs have yet to be fully operational-

ized in a neoclassical framework, which hinders

comparative policy evaluation. Addressing measure-

ment issues is important as economists’ move to


incorporate transaction costs in comprehensive policy

evaluation. Knowledge of the magnitude and types of

transaction costs associated with environmental and

natural resource policies will influence the levels of

policy instruments, the choice of policy instrument(s),

and also their design. More fundamentally, it may

contribute to advances in research on the determinants

of transaction costs, sources of institutional change,

and design of institutions. To these ends, we need to

improve our collective ability to measure these costs.

This article provides a framework for future research

on transaction cost measurement and thus the design

of efficient environmental and natural resource

management policies.

Most of the transaction cost measurement studies

to date use words like bcrudeQ or bapproximateQ to

qualify their results. However, these studies have

demonstrated that measuring transaction costs is

important because the magnitudes, particularly for

nonpoint pollution policies, are significant. It has been

argued in this article that progress is needed on three

major fronts: (1) further clarifying the fundamental

issues involved; (2) improving measurement by

increasing the availability of relevant public data;

and (3) improving measurement methods.

In order to improve our measurement techniques,

this article first clarified what it is that we are trying to

measure and the broader context in which it will

be used. We examined the relevance of the transaction

cost economics paradigm developed by Williamson

for public policy issues. Our analysis revealed a

number of issues that require further careful study.

The distinction between abatement/production costs

and transaction costs becomes less clear when one is

dealing with actual data rather than theory. Another

difficult question is determining when, in the life

cycle of a policy, to start measuring transaction costs.

Comparing costs of a new policy to one that already

exists, or which builds upon existing institutional

structures, is also problematic. A number of parties

incur and bear the costs. While some studies have

only examined explicit or out-of-pocket expenses, a

complete analysis would include both implicit and

explicit costs. A final issue that we raised is the level

of precision that is required for different purposes.

Collecting transaction cost data should become a

routine part of public agency activities to increase

efficiency since bwhat gets measured gets managed.Q

For example, documentation protocols could be

incorporated into agency routines and activities to

report staff time, travel, consultant services, and other

financial expenditures associated with development

and implementation of a specific policy. Costs to all

affected parties ideally would be considered—stake-

holders directly involved in policy debate and devel-

opment, public agencies, and taxpayers, as well as

stakeholders not at the table. Despite the many

challenges in measuring transaction costs, economists

can fruitfully contribute to establishing public agency

documentation protocols that will allow more com-

plete economic assessment of policy-related trans-

action costs in the future. It is important to note that

any potential increases in efficiency need to be

compared to the costs of collecting the data. Doc-

umentation protocols need to be designed with this in

mind. As noted previously, transaction cost measure-

ment, particularly using surveys, is expensive. In

addition, having better transaction cost data will not

guarantee that it will be used effectively. In other

words, improved data are necessary but not sufficient

for increased efficiency in environmental and natural

resource policy.

One federal agency that is attempting to document

some of these costs is the U.S. Institute for Environ-

mental Conflict Resolution, established by Congress

in 1998 to assist in resolving disputes involving

federal agencies and federal interests. The institute

has established a standardized framework for doc-

umenting all environmental conflict cases under its

auspices, which includes some elements of trans-

action costs, such as time spent in meetings and direct

financial expenditures by parties (U.S. Institute,

2002). While addressing broader issues than trans-

action cost measurement, Dinar (2000) suggests that

data should be collected on water pricing reforms as

they occur.

Measurement techniques developed for nonmarket

valuation could be adapted for use in transaction cost

measurement since many of the challenges are similar.

Also, many of the survey techniques developed for

production costs could be fruitfully applied to trans-

action cost measurement. Transaction cost measure-

ment is more complex, in that there are a wider range

of costs and parties involved than either of these

cases, but knowledge of survey design and admin-

istration is crucial. The objectives of the study will


dictate the type of measurement method(s) that is (are)

required. There is vast room for improvement in

transaction cost measurement techniques and it will be

useful to eventually develop a professional consensus

as to what techniques are appropriate under what

circumstances (analogous to standards developed for

nonmarket valuation studies). Before this is possible,

however, there will need to be a period of exper-

imentation with a variety of methods.

Acknowledgements

This research was, in part, supported by the

Missouri Agricultural Experiment Station. The helpful

comments of three reviewers and Graham Marshall

are appreciated but remaining errors and omissions are

the responsibility of the authors.

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