Transaction Costs and the Structure of the Market: A Case Study

American Journal of Economics and Sociology, The,  Oct, 1999  by Ning Wang

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NING WANG [*]

ABSTRACT. Drawing upon the development of fish markets in a Chinese fishery community, this paper investigates the impact of transaction costs on the institutional structure of exchange. Fish markets in this region are connected and organized into a hierarchical network. This structure of fish markets dramatically reduces the cost for geographically distanced fishermen and consumers to execute trades. However, the provision of the market itself requires entrepreneurial efforts. In this study, the market is conceptualized as a continuum of middlemen, whose entrepreneurial efforts of buying and selling make the market work. When the middleman makes profits, the market is at work. Otherwise, the market fails to emerge. Comparing the different ways of organizing fish transportation at two distinct villages, this paper shows that the choice of the market or the firm to organize fish transportation is determined by the cost of putting the market to work.

I

Introduction

THE MARKET IS A CENTRAL BUILDING BLOCK in the edifice of modem economic theory. Usually pictured as the demand curve crossing the supply curve, the market in standard economics textbooks is free of any institutional structure. [1] Simply reduced as a price-making mechanism, the market serves more as a theoretical construct than as a characterization of the actual process of exchange. [2] Recent development in new institutional economics has drawn much attention to empirical studies of economic institutions. But the emphasis is largely laid on the institutional structure of production, particularly business firms. The institutional structure of exchange is unfortunately overlooked. [3] What Ronald Coase bemoaned more than a decade ago still remains a disturbing reality, "Although economists claim to study the working of the market, in modern economic theory the market itself has an even more shadowy role than the firm" (1988a, 7).

Overlooking the institutional structure of the market leads economists to take the existence of the market for granted. Nothing more than "the law of supply and demand" is required for economists to reach a conclusion on their blackboard that the price mechanism (i.e., the market) is at work. The economists hence seldom bother to investigate how the market as an economic institution emerges and develops in the real world. Even new institutional economists who are committed to studying real life economic institutions are inclined to assume that "in the beginning there were markets" (Williamson 1975, 20; 1985, 87). A casual perusal of the real world, however, makes it clear that this view does not square with the reality. No market is not deliberately created or costly to maintain, be it the Chicago Mercantile Exchange or a Chinese fish market. Taking the existence of the market for granted makes us blind to underlying economic forces that shape the institutional structure of exchange.

Over the past couple of decades, one of the most influential concepts brought into economists' tool-kit is transaction cost (Coase 1937). Admitting the existence of transaction costs helps economists move out of their imaginary world and come down to the reality. In the real world, we can not help but realize that transaction costs are ubiquitous. Without transaction cost as the tool of the trade, it is no wonder that economic analysis in the past was out of touch with real world economic activities. Ever since the introduction of transaction costs, economists have made considerable progress in understanding real world economic institutions, particularly in the field of business firms. It is surprising however that the market--another economic institution of equal if not more significance--has received scant attention.

This paper applies the same approach that has proved to be quite productive in the study of the firm to investigate the working of a real world market. Based upon the development of fish markets in a Chinese fishery community, this paper directs our attention to the institutional structure of exchange. It empirically shows that not only the institutional structure of the market is a response to the cost of carrying out transactions, but the very existence of the market is contingent upon entrepreneurial calculations. In doing so, this paper advances our understanding of the choice between the firm and the market in organizing economic activities for the sake of reducing transaction costs.

II

The Network of Fish Markets

THE FIELDWORK FOR THIS CASE STUDY was done in the Long Lake area, Hubei province, China. Well known in China as the "land of fish and rice," this area abounds with lakes, ditches, and ponds, which provide favorable natural conditions for freshwater fishery. [4] In spite of rich natural resources, the development of a large scale freshwater fishery did not start until the late 1970s when rural economic reforms were initiated. In the pre-reform era, fishing was exclusively for self-consumption because private commercial activities were largely banned. Under the socialist planned economy, there were virtually no market transactions. In the wake of rural economic reforms, the ban on commercial activities was lifted. "Rural petty commodity markets" were encouraged by the reform policy to cater to the increasing needs of the rural population. The opening of fish markets quickly commercialized fishing and peasant-fishermen began to sell their catches in markets for cash. High profits in fishing stimulated the steady growth of freshwater fishery, which in turn pushed for further market integration.