Transaction Cost Busting!

November 2017

Jeff Paddock

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To make and maintain development programs at the grassroots level we need to have a lot of tools in our toolkit and one of those should be transaction costs. Thinking like an economist doesn’t have to be as tedious as the college course you took that one time. Basic measurements like transaction costs (TRCs) can illuminate small inefficiencies in almost any program.

 

If your area of focus isn’t economic development, there may still be hidden TRCs embedded in your work. Imagine that you’re a marketing agent working for a website: the more clicks it takes for a customer to reach the desired information, the more it costs them to use your site. This can be in time, effort, and sometimes money. The same concept applies to NGOs and their programs. The more micro-costs your beneficiaries have to swallow to use the service you provide, the less likely they are to do it and the less likely you are to succeed. This can include opportunity costs, inefficiencies, and any other debris stuck in the joints of your program.

 

So what are TRCs and how can we find them? Robert Coase introduced TRCs in 1960 as any costs incurred during an economic exchange. A few decades later in 1992, Douglas North applied the idea to economic development, demonstrating how a better understanding and accountability to TRCs could boost economic growth. Part of the idea was to make us, the institutions creating the rules and the programs, listen to the communities calling for changes. In short, if NGOs look through the lens of the beneficiaries in the grassroots movements, they could better see the barriers to development from their point of view. Doing so reveals what needs to be added or deleted to make it easier for beneficiaries to engage in programs and escape poverty. One of these barriers that needs deleting is transaction costs.

 

There are three types of TRCs you’ll find embedded in the joints of your program. Search Costs come from trying to find and identify the service, while Bargaining Costs are what’s sacrificed in order to use it. Remember that these are from the beneficiary’s point of view. Rural farmers, for example, will have to identify and navigate your agricultural program, costing them time and possibly money. The third TRC, Enforcement costs, are more on your end as you keep the program well oiled and make sure it has the desired effect. However, the beneficiaries also accrue costs as they deal with your oversight and frequent visits.

 

The TRC approach is much easier to understand in an example. In 2016, we designed a new program here at La Ceiba Microfinance that perfectly illustrates TRC busting. The low-income families we serve had been calling for a savings program. We listened to what they had to say and designed a system around it called the Incentivized Savings Program that rewarded people for saving with a bank and building their assets. Basically, we paid people to save in an account instead of hiding it under their mattress. To decide how much we should pay in incentives, we looked at how much one transaction cost the client.

 

The Search costs were some of the highest. To open an account, potential savers had to find a bank, provide identification, and cover the minimum balance. This could take almost an entire day and cost, by our estimates, anywhere from $6.50 to $10. Having found the TRC we got out our TRC hammer and started busting. We researched all 18 banks in the area. We documented what IDs and opening balances they required. Then we set the first incentive at $5 to cover most of the cost so the client received the money up front upon opening the account.

 

Then we moved on to the Bargaining costs. We asked ourselves, how much does it take a community member to make one deposit in their account? To take the bus from the rural area to the town center cost $0.52 one-way - $1.04 both ways. Hence, we provided an incentive of  $1.04 for every deposit made, sent directly to their account. The best part was that to the client it looked like we were giving them free money when in fact we were covering the cost of them using our program.

 

Finally, the Enforcement costs were easy. Each client carried a booklet that the bank stamped every time she deposited. To check these booklets we would have to visit 20 people in the pilot program which could take one to three days of work and a lot of house calling. Instead, we held a monthly meeting where clients gathered to present their booklets and receive their incentive money. The best part about busting these TRCs is that enforcement acts like a feedback mechanism.

 

During the meetings, clients told us that the incentives per deposit weren’t high enough. We hadn’t considered that the women had a high opportunity cost when they went into town to make a deposit. They had to find a neighbor to watch their kids, prepare meals in advance, and possibly take time away from other income generating activities. Thus, we increased the amount from $1.04 to $1.30 and saw the number of deposits increase.

 

TRCs are hidden in the connective tissue of our programs. It’s up to us to sniff them out and remove them. This goes for any flavor of development. If you’re a healthcare professional providing vaccines, what does your patient have to do in order to get to the hospital? If you do house visits, what are the social costs a mother must endure to present her child to a foreigner? Many vaccinations take three to five injections for full immunity. What are the Bargaining costs for a family to get one of those shots?

 

If you can identify the hidden costs in each interaction between you and the beneficiary, you can break them down; make your program more efficient; more likely to succeed. Whether you’re a social worker, WASH specialist, or policy maker, there will always be hidden TRCs in your work. Add a hammer to your toolkit and get to busting; make grassroots movements cheaper and the results will follow.

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About the Author

Jeff works on the ethical considerations of economic development and cash aid programs around the world. He currently works in Honduras, supporting local community projects through micro-finance and holds two degrees in Philosophy and International Affairs.