Listener 27 March 1999.

Keywords Business & Finance; Regulation & Taxation

Just suppose there was no government agency concerned with accurate weights and measures. How would you know that the `kilogram’ of the bananas you were buying weighed a thousand true grams? You could carry you own scales. Not trusting the draper when you want to buy two metres of cloth, better carry your own ruler. A few percent difference – the butcher’s thumb on the scales – may be the difference between profit and loss, between whether the customer gets a fair deal or is ripped off.

It is no surprise, then, that the first New Zealand statute was as early as 1846, based on existing British standards. The classical Maori had, of course, mathematical concepts of measurement, but they do not seem to have had standard measures. This was possible because their trading involved one-off (and often complex) deals. It would be like haggling at the supermarket counter over a bunch of bananas (moderated, in the Maori case, by the transaction usually being between relatives). As we moved to routine transactions, between people who do not know one another, and a seller who may not even own the product (a shop assistant for instance), trading standards became necessary. Many readers will be familiar with the fast food outlet caught selling underweight mashed spuds and coleslaw. It has been estimated that consumers were at least $4m a year out of pocket, from all the known instances of underweight. On the other hand a baker was unsuccessfully prosecuted in 1968 for his loaves being overweight. And while I have written thus far in terms of consumers, exporters also need precise international standards. (The International Metric Convention established an international bureau in France in 1875.) As technology becomes more sophisticated those standards have to be increasingly accurate.

“Metrology” is the name for the science of weights and measures. A witty book on the subject is The Sizesaurus, by Stephen Strauss, rich with idiosyncratic information. (What is the pressure of a shark’s bite? What is the air pressure required to burst a condom?) But the humour facilitates the serious purpose of explaining measurement. In an ideal world, every science student would have mastered the book before leaving school.

Systematic standards are a sort of oil which ensures the market transactions run smoothly. Without it we would have to carry our own standards when shopping, if we wanted to be sure of purchases because we did not trust the retailer. We have an example of reducing `transactions costs’, the friction in the market machine. Typically we leave competition to minimize transaction costs, just as we do for production and distribution costs. However, the private sector cannot always do so alone, and sometimes a public initiative (in this example the Trading Standards Service of the Ministry of Consumer Affairs) lowers the costs for the entire economy.

Another effective public facilitator of transactions are the courts. A good legal service means that contracts can be enforced, so there is the confidence to enter into them. This is starkly illustrated in those countries where it takes years to get a disputed credit contract into the courts. Hire purchase is limited, because traders cannot recover the goods if the customer refuses to pay. The way the law is structured is also important. A clumsy or ambiguous law may add to the costs of the transaction. On the other hand the law may provide cheap ways to resolve disputes – a small claims tribunal for instance. Even if you never have to use one, they are of advantage because you know you can enter into an honest transaction, and if anything goes wrong there is a redress mechanism. Similarly when the courts process credit failures efficiently, sellers can advance hire-purchase, confident that on the rare occasions when action is necessary, the matter can be resolved. We all benefit, including those who never fail on their debt commitments.

The Trading Standards Service is an example of those government agencies modestly operating away, yet vital for an effective economy. As with the courts and good law it provides a practical illustration that some sorts of intervention work.

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A New Microeconomic Policy Approach?

Such musings have led to a the argument that microeconomic policy should be based on the “Coase Normative Principle” (CNP – Ronald Coase was the economist who started us thinking about transaction costs). It states “organise the government’s interventions in order to minimize transaction costs.”

There are, of course, other reasons for intervening, such as distributional fairness, promoting social goods, limiting social bads, and seeking non-material social objectives, but the CNP especially applies to industry and consumer regulation. A strength is that it is not extremist for it neither supports commercialising everything, nor heavy public involvement. Since public intervention can add to transaction costs instead of reducing them, the CNP provides a rule which limits government involvement, as well as guiding where it may be appropriate. The CNP is not at the heart of today’s economic policy. Not yet, but one day it may well be.