6.3. Policy Implications

In academia, the New Institutional Economics is a highly successful research programme. This can also be proved by looking at citation records. But in European competition circles, transaction cost economics as an important part of the New Institutional Economics has probably not received the attention it deserves. Policy implications resulting from the programme have not entered the pages of many textbooks. Therefore, we propose to describe the methods used by representatives of the programme to get to policy implications here.

Many approaches in competition theory have traditionally drawn on some ideal state of the world, perfect competition being the most famous such state. Real-world results were then compared with theoretically derived states of the world. Needless to say, reality often appeared as utterly bad compared to the theoretical ideal. For many economists, the next step was then a small one: demand that the state intervene to make the actors behave in such a way that would at least approximate the theoretically derived ideals. Basically, this notion should have been discredited ever since the concept of Second Best was published (by Lipsey and Lancaster in 1956). It is shown that attempts to emulate the prerequisites for the ideal world can lead to outcomes that are worse yet. To take an example from competition theory: an oligopoly is supposed to be an untransparent market structure, theory assumes a transparent market structure. At times, it has then been demanded that official price offices be founded that collect and publish prices by all oligopolists in the market. This could, however, lead to worse outcomes since parallel behaviour by oligopolists would be facilitated.

Transaction cost economists only compare realised states of the world with other realised states of the world. At best, they only take realizable states of the world into consideration. This means that no abstract ideal is painted any more but that one asks for marginal improvements that take the current situation that one finds itself in as the starting point. This approach is today called “comparative institutional analysis” and the idea was first coined by Ronald Coase (1964). When representatives of the welfare-economic approach demand state interventions as corrections to market failure, they often commit a logical mistake: after having identified some “market failure” (as compared to a theoretically derived ideal) they demand state interventions and assume that the state functions perfectly. This is, of course, a dishonest procedure: if market failure is taken into account, then government or constitutional failure should also be taken into account. The state and its representatives do not function without cost. Williamson (1996, 195) tries to take this into account and proposes the concept of “remediableness”. If one proposes a new policy, one better take the costs of getting from the current status quo to the proposed policy explicitly into account. Getting there might be costly (necessary investment but also political opposition are just two possible cost components). The proposed policy only constitutes an improvement if the returns from the new policy are higher after the costs of getting there have already been reduced from the expected benefits. This leads Williamson to redefine the notion of efficiency (1996, 195): „An outcome for which no feasible superior alternative can be described and implemented with net gains is presumed to be efficient.“

Taking both the relevance of transaction costs as well as the modified definition of efficiency into account, a number of policy implications can be derived:

There are conditions under which vertical integration can enhance efficiency. This will be the case when transactions cost savings outweigh additional organisation costs. Under such circumstances, the prohibition of mergers would be detrimental to overall efficiency. They should thus be allowed.

There are conditions under which other forms of governance such as long-term contracts or exclusive dealing contracts can enhance efficiency. If a certain service quality can only be upheld given some exclusive contracts, this might be a case in point. A similar point can be made with regard to geographical restraints. The policy implications are obvious: investigate whether the conditions are fulfilled. If so, do not prohibit the specific restraints because that would decrease overall efficiency.

Furthermore, conglomerate concentration may be inexplicable from the point of view of technology, but may very well be explicable by looking at the firm as a governance structure. If conglomerate concentration can be reconceptualised as a result of economising on transaction costs, it should not be punished anymore because that would decrease efficiency.

These policy implications were derived supposing that governance structures are a result of firms’ attempts to economise on transaction costs. Above, some emphasis was put on the method used by representatives of transaction cost economists, namely comparative institutional analysis. Taking this method seriously can have far-reaching policy implications too. According to it, the existence of barriers to entry as such is not sufficient for demanding intervention by competition authorities as long as it cannot be proven that there is a better structure that can be implemented at reasonable cost. Williamson (1996, 282) writes: „... while the mere existence of entry barriers was previously thought both objectionable and unlawful, this noncomparative approach has been supplanted by one in which (as an enforcement matter) the relevant test is not whether entry impediments exist but whether a remedy can be effected with net social gains. As a result, arguments regarding the mere existence of entry barriers no longer carry the day.”