Managing Transaction Costs in the Era of Globalization

Managing Transaction Costs in the Era of Globalization

Advances in New Institutional Analysis series

Frank A.G. den Butter

Frank A.G. den Butter explains the importance and means of keeping transaction costs as low as possible. He illustrates how this transaction management can contribute to making firms and nations more competitive by exploiting gains from the division of labour and international fragmentation of production, and uses relevant case studies to illustrate how value is created by reducing transaction costs. Policy recommendations for strengthening the competitive position of trading nations and reducing implementation costs of government policy are presented, and management methods for creating value in organizing production on a global scale are prescribed.

Chapter 6: Transaction costs as determinants of trade flows

Frank A.G. den Butter

Subjects: economics and finance, institutional economics, international economics


This chapter outlines how an empirical analysis of international trade flows using gravity equations can provide information for transaction management at the macro-level. Bilateral trade between countries is explained in these equations by the sizes of the countries and the distances between them, as in Newton’s explanation of gravity. In these analyses distances do not only relate to physical distances between these countries, and hence to transport costs, but also to other transaction costs, including soft transaction costs such as cultural differences. The sizes of the coefficient values with respect to various distance indicators in these equations show how bilateral trade can be enhanced by reducing the specific transaction costs associated with these distance indicators. Two examples of such calculations are summarized, namely the role of trust as a determinant of trade and the determinants of trade between China and the Netherlands. China–Dutch trade witnessed a relatively large increase in recent decades. Trade flows and the role of transaction costs as a determinant of such flows can be empirically explained by a gravity equation. The gravity model of trade, already mentioned by Tinbergen (1962), is commonly used for quantitative analysis of trade in contemporary economic research. The dependent variables in such a gravity equation are the bilateral trade flows, namely imports from country A to B, exports from country A to B, imports from country B to A, and exports from country B to A. The distance between countries is an important explanatory variable in these equations.

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