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www.elsevier.com/locate/ecolecon
Ecological Economics 5
ANALYSIS
Transaction cost measurement for evaluating
environmental policies
Laura McCanna,*, Bonnie Colbyb, K. William Easterc,
Alexander Kasterined, K.V. Kuperane
aDepartment of Agricultural Economics, University of Missouri, 214B Mumford Hall, Columbia, MO 65211-6200, United StatesbAgricultural and Resource Economics, University of Arizona, Arizona, United States
cDepartment of Applied Economics, University of Minnesota, United StatesdAgra CEAS Consulting Ltd., Imperial College, Wye, University of London, England
eWorld Fish Center, Dhaka, Bangladesh
Accepted 4 August 2004
Abstract
Policy choice and policy design need to take account of transaction costs in order to increase the efficiency and sustainability
of policies. However, transaction costs must first be measured to be included in the evaluation of alternative environmental or
natural resource policies. While a number of studies measure transaction costs, there has been no systematic treatment of the
fundamental issues involved. This article examines the issues involved in transaction cost measurement and makes
recommendations regarding a typology of costs as well as the measurement methodologies themselves. In particular, methods
used for nonmarket valuation of environmental goods may have potential for the measurement of transaction costs.
D 2004 Elsevier B.V. All rights reserved.
Keywords: Transaction costs; Environmental policy; Measurement methodologies
1. Introduction
bWhat gets measured gets managedQ is an axiom in
the business world. Analyses of public policies need
to include transaction costs, as well as transformation
0921-8009/$ - see front matter D 2004 Elsevier B.V. All rights reserved.
doi:10.1016/j.ecolecon.2004.08.002
* Corresponding author. Tel.: +1 573 882 1304; fax: +1 573 882
3958.
E-mail address: [email protected] (L. McCann).
costs, and to be included, they must be measured.
Transaction costs can be substantial; measured mag-
nitudes have ranged from 8% of water purchase cost
for the California Water Bank (Howitt, 1994) to 38%
of total costs for an agricultural technical assistance
program (McCann and Easter, 2000). Nontrivial
magnitudes mean that transaction costs will affect
the optimal choice and design of policy instruments.
Yet another reason for incorporating transaction costs
in our empirical analysis of public policies is that, by
2 (2005) 527–542
L. McCann et al. / Ecological Economics 52 (2005) 527–542528
ignoring important costs, which are obvious to the
agencies involved, the economics profession is less
credible. The profession has not been able to
incorporate these costs in our analyses because of
inconsistent definitions and frameworks, and difficul-
ties in measurement—a dilemma that this article seeks
to address. While the specific context and examples
relate to natural resource and environmental policies,
the issues raised and recommendations are relevant for
the analysis of other types of public policies such as
food safety, education, and monetary policy, and may
be useful for measurement of transaction costs in the
private sector as well.
A large literature, following Williamson (1985)
and Coase (1937), has empirically demonstrated that
transaction cost minimization can help explain indus-
try structure and decision making by economic agents
in the context of market transactions (Globerman and
Schwindt, 1986; Pittman, 1991; Leffler and Rucker,
1991; Lyons, 1994; Moss et al., 2001). This literature
is relevant to, but distinct from, our focus on
measurement issues associated with public policies.
Coase (1937) wrote pioneering works on transaction
costs as related to the firm, as well as public policy
issues (Coase, 1960). In bThe Problem of Social
Cost,Q Coase (1960) compares bargaining, court
decisions, and regulation to resolve externalities.
There is also a relevant literature concerned with
factors that influence the magnitude of transaction
costs (Coase, 1960; Williamson, 1985; Oates, 1986;
North, 1990; Griffin, 1991; Milgrom and Roberts,
1992; Easter, 1993; Vatn and Bromley, 1994; Stavins,
1995; Challen, 2000; Vatn, 1998, 2001). In order to
focus on measurement, we are not addressing factors
affecting the magnitude of transaction costs or sources
of institutional change (Libecap, 1989; Feeny, 1993;
Zhang, 2001) in this article.
While much of the research in new institutional
economics (NIE) is empirical in nature, Masten et al.
(1991) indicate that this research could be improved
by measuring transaction costs. Although the magni-
tudes of transaction costs associated with environ-
mental and natural resource policies are
demonstrably important (Kuperan et al., 1998;
McCann and Easter, 1999, 2000; Falconer et al.,
2001), few studies to date have attempted to actually
quantify transaction costs. This may be because,
despite the pressing need, bthe measurement of
transaction costs poses formidable difficultiesQ (Wil-
liamson, 1996, p. 5).
Transaction costs have in the past been viewed as
wasteful and as something to be minimized. Randall
(1981) argues that bThese costs are not dmoney
down a ratholeT but are expended in exchange for
transactions services.Q Nevertheless, there are likely
to be efficient versus inefficient types and magni-
tudes of transaction costs, analogous to efficient and
inefficient combinations of inputs in a production
process.
In practice, transaction costs are not usually
included in empirical evaluations of alternative
environmental or natural resource policies, although
they are recognized in some theoretical work (Stavins,
1995; Fullerton, 2001). However, to fully compare
alternatives, policy choice and policy design should
take account of the transaction (including adminis-
trative) costs involved, as well as production costs and
abatement costs. In particular, an emphasis on trans-
action costs may serve to moderate government
failure (Falconer and Whitby, 1999; McCann and
Easter, 1999). More specifically, accounting for
transaction costs can:
1) improve preliminary comparison and screening
across alternative policy instruments;
2) enhance effective design and implementation of
policies to achieve particular objectives;
3) evaluate current policies in order to improve their
effectiveness; and
4) assess the budgetary impacts of policies over their
life cycle.
The goal of this article is to improve our
profession’s collective ability to incorporate trans-
action costs in our research models and policy
analyses, and to measure transaction costs in a
consistent and meaningful way. It advances this
effort by summarizing the foundational issues that
need to be resolved, proposing a typology and
chronology of transaction costs, reviewing how
transaction costs have been measured and the
strengths and weaknesses of the various method-
ologies, proposing measurement methodologies and
protocols, and suggesting new avenues of research in
order to improve transaction cost measurement theory
and techniques.
L. McCann et al. / Ecological Economics 52 (2005) 527–542 529
2. Fundamental issues
There are a number of fundamental issues relating
to transaction cost measurement, which underlie the
subsequent discussions of typology, chronology, and
measurement methodologies. These can be grouped
as: (1) integrating transaction costs in policy analysis;
(2) defining transaction costs; (3) the effect of time on
transaction costs; and (4) the tradeoff between
precision and measurement cost.
2.1. Integrating transaction costs in policy analysis
Transaction costs need to be measured within a
larger framework of the overall costs and benefits of a
proposed policy. Many transaction cost measurement
studies have implicitly or explicitly assumed that the
benefits provided by different policies are similar so
that a cost-effectiveness framework is sufficient. This
may not always be the case. For some policies, there
is a much broader range of benefits than the other
policies examined. For example, a land retirement
program has wildlife and aesthetic benefits, in
addition to reducing phosphorous runoff, while a tax
on phosphorous would only affect the latter (McCann
and Easter, 1999). It is rarely the case that the types
and levels of benefits are the same for all the options,
so a full cost–benefit analysis is desirable.1
It is essential to make a distinction between
decreasing transaction costs and increasing efficiency
for a number of reasons. A policy should not be
rejected due to high transaction costs alone since there
may be tradeoffs between transaction costs and other
types of costs. Some policies with low abatement
costs may have higher transaction costs. Transaction
costs also need to be viewed in the context of what
costs would be incurred in the absence of the policy
being evaluated. For example, a policy to reduce catch
in a declining fishery may be costly but the alternative
may be the eventual loss of an industry or the
extinction of a species.
1 While recognizing that benefits of policies and their types and
incidence are important, the issues involved in benefit estimation are
the subject of a voluminous literature and are beyond the scope of
this article. The partial focus on costs here mirrors the environ-
mental economics literature’s partial focus on benefit estimation.
Coase (1960) and Demsetz (1969) advocated
comparing policies based on the extent to which they
improve upon the current situation, not compared to
some ideal. Some studies of environmental and
natural resource policies inappropriately compare a
totally inflexible command and control approach to an
optimal tax. Comparing the transaction costs of a
poorly designed policy (existing or hypothetical) to an
optimally designed one may similarly bias the
evaluation of the transaction cost characteristics of
alternative instruments. It is probably the case that
many current policies are not optimally designed
(Falconer et al., 2001).
While detailed analysis is beyond the scope of this
paper, it may be that NIE concepts and methods need
to be broadened for evaluation of public policy issues.
The models based on the Williamson framework do
not account for government failure or public choice
issues. Observed policy choice is affected by property
rights and politics, and a policy outcome will probably
not have efficiency as its main goal (Colby, 2000).
Therefore, one does not necessarily observe policy
choices that minimize transaction costs in a manner
analogous to the choice of organizational form in the
private sector. A related issue is that the factors that
are assumed to affect transaction costs, and thus
decision making in the private sector (frequency,
uncertainty, and asset specificity) may not be the most
important factor for environmental and natural
resource policy. Other factors, such as monitoring
technologies (Fullerton, 2001), property rights (De
Alessi, 1983; Allen, 1991), and other institutions
(North, 1990), may be paramount.
2.2. Defining transaction costs
Empirical work causes researchers to confront
details in a way that theoretical work does not and
motivates the issues discussed in this section. Meas-
urement of transaction costs forces examination of
what is and is not a transaction cost. Transaction cost
measurement also requires researchers to look at the
reality of how policy is made and implemented.
Kuperan et al. (1998) demonstrate the importance of
detailed knowledge of the political and natural
resource system to ensure that all costs are accounted
for. Such knowledge allowed them to recognize that
the government is involved at many different stages
Fig. 1. Boundary issues relating to transaction costs.
L. McCann et al. / Ecological Economics 52 (2005) 527–542530
with respect to both central management and co-
management of a fishery.
There are numerous definitions of transaction costs
and inconsistencies among them that confound the
development of consistent transaction cost measures.
A very narrow definition was used by Demsetz (1968,
p. 35), bTransaction cost may be defined as the cost of
exchanging ownership titles,Q while Barzel (1985,
p. 4) used the somewhat broader bcosts of effecting
exchange.Q Gordon (1994) defines transaction costs as
the expenses of organizing and participating in a
market or implementing a government policy. In his
article on externalities, Coase (1960) uses the phrase
bthe cost of carrying out market transactionsQ to refer
to interactions between firms or between individuals
and firms. Coase refers to administrative costs when
the resolution of the externality comes about within a
firm or by government regulation. Some authors treat
transaction costs and administrative costs as essen-
tially interchangeable terms (Stiglitz, 1986). When
evaluating alternative policies to achieve environ-
mental or natural resource objectives, distinguishing
between transaction costs and administrative costs can
confuse the issue, particularly if both market and
nonmarket policies are being evaluated (Stavins,
1995); therefore, we define the term transaction costs
as including administrative costs.
Allen (1991, p. 3) presents a definition that, while
designed to be generally applicable, is particularly
well suited to environmental and natural resource
policies since many market failure issues stem from
incomplete property rights: bTransaction costs are the
resources used to establish and maintain property
rights. They include the resources used to protect and
capture (appropriate without permission) property
rights, plus any deadweight costs that result from
potential or real protecting and capturing.Q Some of
these costs may represent lost opportunities for
productive innovations since human competence is
scarce (Eliasson, 1996). However, Allen (1991)
explicitly excludes many of the information costs that
are key components of the NIE literature such as costs
of finding a trading partner, decision costs, and search
costs. In addition, for many environmental problems,
the bgoodQ (in addition to the rights regarding it) is not
well defined so resources will be expended to define
the bpropertyQ under dispute. North (1984) indicates
that measuring valued attributes embodied in a good,
such as an orange, is costly. Therefore, a broader
definition is used in this paper: transaction costs are
the resources used to define, establish, maintain, and
transfer property rights.
There are a number of issues that relate to the
boundaries of transaction costs and their measure-
ment, which are illustrated in Fig. 1. Several
distinctions have been developed in the literature that
are not as clear-cut as they first appear. The dichotomy
between policy (associated with the implementation
of policies) versus nonpolicy costs (incurred by
parties to voluntary transactions) (OECD, 2001) is
not readily applicable. Simply analyzing the costs
involved with market transactions (area A in Fig. 1)
will underestimate total transaction costs of market-
based instruments. Government is involved in any
definition or reallocation of property rights that
enables private trade. Furthermore, public agencies
record, monitor, and enforce trades, so the full cost is
area A plus area B. In market failure issues such as
pollution (overfishing), government establishes the
total amount of pollution (catch) allowed and thus the
number of tradable permits (fishing licenses) issued.
In the case of water markets, questions of who has
rights to how much water must be addressed prior to
water trading (Colby, 2000). Furthermore, transaction
costs will depend on the broader institutional environ-
ment, such as the legal system (Easter et al., 1998;
Saleth and Dinar, 2003). If changes in the institutional
environment are required, total costs would include
areas A, B, and C, as illustrated in Fig. 1.
Another distinction has been made between pro-
duction or abatement costs (or transformation costs),
and transaction costs. The distinction is less clear
when one examines actual cost data. For technical
2 Part of the increase in transaction costs from the early 20th
century demonstrated by Wallis and North (1986) might be due to
implicit costs becoming explicit.
L. McCann et al. / Ecological Economics 52 (2005) 527–542 531
assistance programs, some costs incurred by govern-
ment agencies, such as design costs related to abate-
ment technologies, could be categorized as either
transaction costs or abatement costs (McCann and
Easter, 2000). The distinction matters when compar-
ing the magnitude of abatement costs versus trans-
action costs, but is less of a problem if the analytic
goal is simply to account for all costs related to a
policy instrument.
There are other unresolved boundary issues related
to transaction cost measurement. For example, should
basic research on the cause of a problem, such as
nitrates in groundwater, be included in policy analysis
as a transaction cost? What about research on the
effectiveness of various technical solutions to the
problem? Should we incorporate social science
research on the effectiveness of alternative policy
instruments? What about costs of social conflict
before the issue is resolved by the legislature or the
courts? Should we incorporate enactment costs of a
legislative process? Or, should we only count the
costs of the policy from the time a policy instrument
has been formally selected? In general, researchers
should follow the with/without principal to determine
whether it is appropriate to allocate a cost to a
particular policy. Transaction cost measurement
should be explicit about what costs have been
included and excluded and why. This paper presents
a broad typology, which may be adapted by other
researchers for specific purposes.
Another problematic issue is implicit versus
explicit costs. For instance, in evaluating agricultural
policies, certain costs, such as family labor and
opportunity cost of capital, are not out-of-pocket
expenses. Determining the hours spent and then
attaching an appropriate value to that time is a
standard technique to deal with family labor. Still,
there are problems involved with valuing the cost of
farmers’ time since they may enjoy extension meet-
ings or have a low opportunity cost of time at some
periods of the year (Berkes, 1992; Abdullah et al.,
1998; McCann, 2001). Time that farmers spend
talking to government officials or reading documents
relating to environmental programs is an implicit cost,
whereas paying a consultant to evaluate the program
is an explicit cost. In the public sector, reallocation of
agency staff time is an implicit cost, while allocation
of additional staff and monies is an explicit cost. Both
types of cost need to be accounted for and implicit
costs pose greater difficulties. Policy changes
designed to reduce transaction costs may merely
move costs from one party, where they are an explicit
cost, to another party, where they are an implicit cost.2
This may, in fact, be strategic in some cases.
2.3. The effect of time on transaction costs
Transaction costs consist of both ex ante and ex
post costs—those occurring before and after the actual
transaction. Yet, defining the transaction with respect
to an environmental or natural resource policy is not
straightforward. Ramstad (1996) points out the differ-
ences in the definition of a transaction between
Commons (1934) (ba transaction is a transfer of
property rightsQ) and Williamson (1985) (ba trans-
action is a transfer of a good or service across a
technologically separable interfaceQ). Coase’s (1960)
discussion of transaction costs seems to be consistent
with Commons’ definition and is the more appropriate
definition to use with respect to the problem of
externalities or high exclusion cost goods. The
btransactionQ could be thought of as the enactment
of legislation or a court ruling. However, there may be
a number of transactions prior to and subsequent to
the primary one. For instance, a policy that establishes
tradable permits will entail transactions for years after
the policy is established. It may be appropriate, in the
case of public policies, to focus on stages of
development of policy instruments, rather than trying
to define specific transactions. We explore this further
in Section 3 (Table 2).
In the context of policy evaluation presented here,
a distinction should be made between measurement ex
ante and measurement ex post, before or after a policy
decision is made (Hicks, 1946), although one could
also make a distinction between before and after
implementation. If several policies are being eval-
uated prior to making a decision, ex ante measure-
ment is what is both feasible and useful. Ex post
measurement is feasible only for the alternative that
was actually chosen. Many of the studies measuring
L. McCann et al. / Ecological Economics 52 (2005) 527–542532
transaction costs have been ex post, so some cost data
were available (Falconer and Saunders, 2000;
McCann and Easter, 2000; Falconer et al., 2001).
Falconer et al. (2001) have pointed out that
transaction costs vary over the life cycle of a program.
They may decrease with time due to learning, similar
to the literature on learning by doing in manufacturing
(Arrow, 1962), and to the presence of fixed or sunk
costs, which are incurred primarily at the beginning of
a program. Fang et al. (2005) found that 65% of the
transaction costs of a point–nonpoint source trading
program were incurred before any trades took place.
In some cases, costs may also change with changes in
monitoring technologies, abatement technologies,
related legislation, or changes in implicit property
rights, and these changes may themselves be induced
by adoption of the policy. Many of these changes
could be expected to reduce transaction costs, but
increasing scarcity may increase transaction costs
(Libecap, 1989). McCann and Easter (1999, 2000)
have also identified the issue of fixed costs associated
with agri-environmental programs, while Abdullah et
al. (1998) discuss it in terms of dynamic and static
costs. It is analogous to construction costs versus
operating costs of an irrigation system. The issue of
learning and sunk costs is important when the costs of
a new program are being compared with one that has
existed for some time (Falconer and Saunders, 2000).
Existing institutional arrangements and policies may
lower the costs of one program relative to another
(OECD, 2001). History matters, in that an efficient
new policy may appear to be more costly than a less
efficient program that was set up long ago. Typically,
the status quo is used as a baseline for a with/without
comparison; however, this baseline tends to bias the
analysis against new policies that entail start-up costs
(McCann and Easter, 1999). In another setting, where
there is no existing policy, it may be less costly to
adopt the more efficient policy. Regardless of the
baseline chosen, researchers need to be explicit
regarding how costs may be affected by pre-existing
policies.
There are tradeoffs among costs over time. There-
fore, the time period covered by the analysis and the
discount rate used become important. For instance, a
policy/program might incur high initial transaction
costs as part of a broad stakeholder outreach and
consensus-building process and have lower litigation
and noncompliance costs later (Egdell, 1998; Colby
and Pearson d’Estree, 2000a,b). Kuperan et al. (1998)
found that while overall costs were similar for central
management versus comanagement of a fishery, the
latter had higher costs associated with decision
making, while central management had higher
ongoing enforcement costs. Another example of
tradeoffs among types of costs are the arguments
made for the efficiency of targeting (i.e., treating
different agents differently), but this increases trans-
action costs (Gordon, 1989; Milgrom and Roberts,
1992; Kozloff et al., 1992).
2.4. Precision versus measurement cost
For the differing purposes of transaction cost
measurement, how precise do our estimates need to
be? As an initial screening across policy instruments,
rough borders of magnitudeQ may be good enough and
would represent an improvement over current prac-
tice. If these types of costs are to be used as evidence
in court, as with nonmarket valuations of natural
resource damages, a much higher standard will be
required. However, collecting detailed data on trans-
action costs is difficult and costly. Different method-
ologies may be required for these different uses. It is
also important to be aware of the distinction between
accuracy and precision so researchers do not fall into
the trap of having precise, inaccurate measurements
(Mayer, 1993). For example, if researchers only
measured types of costs for which there is abundant,
reliable data and ignored other types of costs, the
measured values would be biased.
3. Transaction cost typologies/framework for
transaction cost measurement
Separating transaction costs into categories is
important for measurement and policy design. A
typology can help compare empirical studies since
some studies incorporate a wider range of transaction
costs than others. It may also help to ensure that all
relevant types of costs have been accounted for, and
facilitate the collection of data on transaction costs.
Different types of costs may be borne by different
agencies or at different points in the life cycle of a
policy. Meaningful categories can also be used to
Table 1
Typology of transaction costs associated with public policies and
who incurs costs
Type of transaction cost Incurred by
Legislature/
courts
Agencies Stakeholders
Research and information + ++ +
Enactment or litigation ++ + ++
Design and implementation ++ +
Support and administration ++ +
Contracting + ++
Monitoring/detection ++ +
Prosecution/enforcement + ++ +
( ) Negligible transaction costs; (+) low transaction costs; (++) high
transaction costs.
3 Rosegrant and Binswanger (1994) indicate that the incidence of
the costs of moving to a new water allocation system will affect the
magnitude of transaction costs. Fang et al. (2005) found that a
government agency bore 81% of the cost of a point/nonpoint source
trading program.
L. McCann et al. / Ecological Economics 52 (2005) 527–542 533
improve policy design. Some costs may be positively
(complements) or negatively (substitutes) correlated
with other types of costs. Again, costs associated with
stakeholder participation at an early stage may
decrease monitoring and enforcement costs later
(Egdell, 1998). Also, different types of policy instru-
ments may entail a different mix of costs or a
difference in the costs’ relative importance. Attention
to such differences will help to identify the funda-
mental determinants of transaction costs.
A number of typologies exist (Dahlman, 1979;
Stiglitz, 1986; Foster and Hahn, 1993), but that of
Thompson (1999) seems to subsume most other
recent typologies and is used as our starting point.
Thompson develops an institutional transaction cost
(ITC) framework, which incorporates enactment costs
as well as implementation and monitoring/enforce-
ment costs. His focus on enactment costs can be seen
as reflecting an emphasis on the transaction as the unit
of analysis. The primary btransactionQ occurs when
property rights are implicitly or explicitly defined or
redefined. Creating a market for tradable permits
requires decisions regarding the initial allocation, and
therefore subsequent trades involve second-order
transaction costs. We have added a contracting
category to reflect these second-order costs and to
emphasize the fact that much of the NIE literature
concerns this component of transaction costs. We have
also modified Thompson’s model by including initial
research and information costs as they are important
for the full life cycle of a policy (and thus for
choosing the optimal level of abatement), but are not
explicitly incorporated in the ITC framework
(McCann and Easter, 1999). Within each category,
costs may consist of supplies, travel, labor, etc., with
labor usually being the most important component.
It is important that any framework be general
enough to include both market and nonmarket policy
instruments since both alternatives may be under
consideration (Coase, 1960). Table 1 presents a
typology of transaction costs for environmental and
natural resource policies including an indication of who
might incur the costs. As indicated above, this table
represents modifications of the models developed and
used by Thompson (1999) and McCann and Easter
(1999). Transaction costs associated with public
policies thus include: (1) research, information gather-
ing, and analysis associated with defining the problem;
(2) enactment of enabling legislation, including lobby-
ing and public participation costs, or, alternatively, the
costs of changing laws through the courts or modifying
existing regulations; (3) design and implementation of
the policy, which may include costs of regulatory
delay; (4) support and administration of the ongoing
program; (5) contracting costs, which may include
additional information costs, bargaining costs, and
decision costs, which are relevant when a market has
been set up for a pollutant, or natural resource; (6)
monitoring/detection, which may include both the
monitoring of the environmental outcome, or the level
of compliance with the regulation, tax/subsidy scheme,
or private contract, as well as the development of
monitoring technologies; and (7) prosecution/induce-
ment/conflict resolution costs incurred if lack of
compliance is found. Most measurement studies are
not comprehensive, in that they have focused on some
subset of these costs, either regarding the type of cost or
who bears them.
Who bears the transaction costs is a fundamental and
relatively unexamined issue.3 In addition, identifying
who pays the costs, which enables their measurement,
is distinct from the question of who ultimately bears
the costs. For example, while costs are incurred by the
legislature, the courts, or a government agency,
taxpayers ultimately pay. For purposes of transaction
L. McCann et al. / Ecological Economics 52 (2005) 527–542534
cost measurement, we focus on the parties who
initially incur the costs. Given the paucity of data in
this area, the incidence and magnitudes presented in
Table 1 require empirical verification.
The categories are listed roughly in the order of the
life cycle of a policy. While other ways of organizing
costs may exist, this framework facilitates transaction
cost measurement. Colby (2000) discusses stages in
the implementation of cap and trade policies. We
present a chronology for environmental and natural
resource policies based on her work and combine it
with the associated transaction costs (Table 2). When
costs are incurred is an important question for
transaction cost measurement, but another issue is
when transaction costs should be measured. With
respect to the best points in time to measure trans-
action costs, many of the categories can be assessed at
several points in time over the life cycle of a policy.
The first stage is the baseline period when there is
growing awareness of the need for policy action but
before a new policy is proposed or implemented.
Research on the technical and social aspects of the
problem may be funded and stakeholder groups may
incur costs to raise the visibility of the issue.
Estimating research costs enables bdoing somethingQto be compared with bdoing nothing,Q even though
Table 2
Chronology of when transaction costs occur and when they should be me
Shaded areas indicate that the type of transaction cost is incurred during
this research may be relevant for several policy
options. Ex ante evaluation of the costs of alternative
policies is necessary to provide information for the
policy instrument selection and design process (the
second, or development stage).
In the development stage, policies are proposed,
debated, negotiated, lobbied for and against, defined
and redefined, formally considered by Congress or
state legislatures, and ultimately adopted. Alterna-
tively, there may be an analogous process occurring
through the legal system in which case evidence is
gathered and the case is argued in court. Executive
branch policy decisions can also set policy and change
property rights. Formal adoption of a particular
policy, or a court ruling, represents the first-order
btransaction.Q The types of costs incurred can be
classified as enactment/lobbying or litigation costs. In
addition, there are information and design costs
occurring during this process. Data could be collected
in this stage and subsequent stages in order to develop
accurate ex post estimates of transaction costs for the
policy instrument that is chosen.
The third stage is early implementation. Admin-
istrative rules are designed and adopted, agency staff
are hired to administer the program, public notices
and hearings are conducted, short-term adjustment
asured
this stage.
L. McCann et al. / Ecological Economics 52 (2005) 527–542 535
occurs as the affected population reacts to the new
policy, the agency responds to litigation and resolves
conflicts, and implementation details are worked out.
The costs incurred are primarily design and imple-
mentation costs, although information costs continue
to be important.
In the fourth stage, full implementation, policies
are actually put into effect. Depending on the actual
policy instrument selected, bids are taken for land
retirement programs, tradable permit markets are
established and trades begin to occur, taxes are
collected or subsidies are paid, land use plans are
developed, or educational programs are conducted.
The btransactionsQ at this stage are what we have
termed second-order transactions. The working out of
implementation details is necessarily an iterative
process since some issues will only become apparent
during full-scale implementation (e.g., the approval
process for trades or bids may need to be adjusted).
There will be a learning curve for both the agency
staff and the stakeholders so information costs will be
high compared to the subsequent stage. Lobbying and
court challenges by negatively affected parties may
continue for the life of the policy. Those benefited will
seek to maintain the new status quo. Costs incurred
during this stage include implementation costs, sup-
port and administration costs, and contracting costs.
After the new policy has been in place long enough to
have measurable effects on transaction costs, prelimi-
nary ex post estimates could be developed, recogniz-
ing that there will be ongoing costs during the next
stage, which will necessarily be ex ante.
In the fifth and final stage, established program, the
policy instrument has become well-established, fully
implemented, and is part of the routine for the affected
population. Permit trading becomes routine and
brokers may appear as in the case of SO2 permits,
compliance with land retirement or conservation
tillage programs is routinely monitored, payments
are made, and, if necessary, prosecution and enforce-
ment occur. In the case of trading, price information
and rules for trades are well known so transaction
costs for implementing trades are lower. For both
agency staff and stakeholders, information costs
decrease. Other costs incurred during this stage,
which is ongoing, include support and administration
costs, contracting costs, monitoring and detection
costs, and prosecution and enforcement costs.
Because this stage is ongoing, the discount rate used
will affect the magnitude of transaction costs. As soon
as the policy is fully established, finalized ex post
transaction cost measurements can be developed. If
transaction cost measurement stopped at the end of
stage 4, this would seriously disadvantage new
policies as compared to established ones (see Section
2.1). These finalized estimates can then be used to
develop better ex ante measurements of policy
instruments in the future.
4. Methods for transaction cost measurement
In Section 3, we discussed the stages at which
transaction costs occur in the policy process and when
we would ideally develop estimates of transaction
costs. This section addresses transaction cost measure-
ment methodologies. A number of methods have been
used to measure transaction costs. Incorporation of
transaction costs in a neoclassical framework is the
perspective that seems to underlie most of the trans-
action cost measurement work to date. Williamson
(1993) suggests that researchers may be able to
measure a lower bound of transaction costs indirectly.
For instance, the difference between buying and
selling price for SO2 permits has been used as a
measure of transaction costs although it does not
include time spent within the firm, nor monitoring and
enforcement costs borne by the government (Stavins,
1995). It also does not include enactment or design
costs, which we have argued are part of the full costs
of any policy instrument. There are some empirical
studies that have tried to measure transaction costs
more directly. Wallis and North (1986) tried to
estimate the transaction bsectorQ for the United States
using public data. They classified certain jobs in firms
(shipping clerk) and certain industries (real estate) as
being primarily associated with transactions. They did
not attempt to measure information costs by consum-
ers, etc. They estimated that public and private sector
transaction costs increased from one-fourth to one-
half of GNP in this century.
There have been a number of transaction cost
measurement studies related to water markets. Nunn
(unpublished) looked at transaction costs involved
with water markets in New Mexico. She directly
surveyed water users who had recently been involved
L. McCann et al. / Ecological Economics 52 (2005) 527–542536
in a water transaction to determine their transaction
costs. Colby (1990) measured policy-induced trans-
action costs in western water markets through surveys
of buyers, sellers, and agency staff. She suggested that
these costs may indirectly serve a useful role in
signalling the external effects on third parties of water
transfers. Colby compared actual transaction costs
among various western states (measured through
surveys of water purchasers and state agency staff)
and found that transaction costs averaged 6% of the
price paid by the applicant to transfer water, with
Colorado having higher costs than the other states.
Howitt (1994) reported that the overhead costs
incurred by the State Department of Water Resources
for the California Water Bank were about 8% of the
water purchase cost. Hearne and Easter (1995)
surveyed farmers and found that the transaction costs
involved with water transfers in Chile represented 7–
23% of the transaction price.
In the area of agri-environmental policy, govern-
ment figures have been used by a number of
researchers (Falconer and Whitby, 1999; McCann
and Easter, 2000; Falconer et al., 2001). Publicly
available financial data would seem favorable from the
point of view of accuracy and ease of measurement.
They represent actual expenditures and do not require
surveys or interviews on the part of the researchers.
There are, however, a number of disadvantages
including: (1) incomplete coverage of types of costs;
(2) not well-organized data for research purposes in
that it may be difficult to separate out transaction costs
for different policies, or to clearly separate transaction
costs from abatement costs; (3) requirement for
cooperative agency contacts willing to pull together
information; (4) confidentiality issues; and (5) can
only be used for ex post studies. Access to the
necessary data is a major problem faced by researchers
examining transaction costs. Private and public sector
managers are understandably suspicious about the
collection of information that may reflect unfavorably
on them or their programs, but this information is
necessary to make programs more efficient. This
problem may become more acute as more transaction
cost measurement studies are published. For example,
Whitby says that not long after they completed their
study on countryside stewardship policies using
government data, the government stopped reporting
the data (personal communication, July 2001).
Government documents can be used to develop
estimates of transaction costs of public policies.
Falconer and Saunders (2000) examined documents
such as correspondence, invoices, legal agreements,
and information on phone calls, meetings, site visits,
etc., to estimate costs for the formal negotiation
process involved with agri-environmental manage-
ment agreements in a region of Britain. In-depth case
studies allowed them to estimate standard costs for
various types of documents. This method required
them to make a number of assumptions regarding the
value of time for various stakeholders, homogeneity
among the agreements in a given program, etc.
Systematically collecting information while the
policy is being planned and implemented would be
ideal. Governments should be encouraged to collect
this type of information and economists could help
develop useful data collection frameworks. In Victo-
ria, Australia, a pilot project evaluating the potential
of environmental management agreements includes
measuring transaction costs as part of the evaluation
(Strappazzon, personal communication, April 2001).
Other options would be to examine budgets in
proposals for new programs (McCann, 2001), assum-
ing that these costs have been accurately projected.
Other researchers looking at environmental and
natural resource policies have used either surveys or
interviews to estimate agency transaction costs, which
is time-consuming and costly. If we assume that, prior
to the policy, staff time allocation was such that the
marginal benefits from their activities were at least as
high as the marginal cost, a new activity would displace
other valuable activities, which are no longer being
carried out. This opportunity cost, an implicit cost,
could be estimated by taking the hours spent on the
new activity and multiplying by the salary and fringe
benefits rate. McCann and Easter (1999) interviewed
government staff regarding time spent on various
activities within their organization and then used a
standard value of time for various categories of staff.
This strategy has been used by a number of researchers
(Egdell, 1998; Kuperan et al., 1998; Fang et al., 2005).
Surveys and interviews usually require people to
either remember information about a time in the
(possibly distant) past, or to predict costs for a
hypothetical scenario. The closer in time the survey
takes place to when activities occurred, the better. If it
is an ex ante study, the interviews have the potential
Table 3
Type of cost and recommended measurement methods
Type of cost Ex ante Ex post
Implicit Explicit Implicit Explicit
Research and information 1, 2 5 1 1, 3, 4, 5
Enactment or litigation 1, 2 1 1, 3, 4, 5
Design and implementation 1, 2 5 1 1, 3, 4, 5
Support and administration 1, 2 1 1, 3, 4, 5
Contracting 1, 2 5 1 1, 3, 4, 5
Monitoring/detection/
conflict resolution
1, 2 5 1 1, 3, 4, 5
Prosecution/enforcement 1, 2 5 1 1, 3, 4, 5
(1) Surveys or interviews of government personnel and stake-
holders; ex post results from other studies; (3) government reports;
(4) financial accounts; (5) proposed budgets.
L. McCann et al. / Ecological Economics 52 (2005) 527–542 537
for interviewer, information, strategic, and hypothet-
ical bias, similar to nonmarket valuation studies. On
the other hand, staff in government agencies are used
to estimating human resource needs for projects and
developing budgets, so it is a more familiar task than
asking consumers how much they value a wetland.
Surveys or interviews are usually the only way to
obtain estimates for implicit costs or for an ex ante
evaluation of policies. It also allows researchers to
collect information on the types of costs that are of
interest for the study. If a very similar policy has been
implemented in the past in a similar institutional
environment, it may be possible to extrapolate data
obtained on the previous program.
Recent research has estimated the size of public
agency transaction (administration) costs in the
provision of environmental public goods in the
European Union (Falconer and Whitby, 2000). In
contrast, there is little work estimating the size or
importance of costs that fall on farmers or other
stakeholders who must comply with new policies.
Recent studies include an estimation of farmers’
transaction costs of participating in agri-environ-
mental schemes by Falconer (2000) and Kasterine et
al. (2001) and a transaction cost analysis of farm
administration outsourcing by Vernimmen et al.
(2000). Egdell (1998) contacted a number of individ-
uals and organizations regarding the time they spent
participating in a consultation process on the Country-
side Premium Scheme in Scotland. Kuperan et al.
(1998) measured stakeholders’ costs as well as public
sector and NGO costs in the case of fisheries
management regimes using surveys, interviews, and
financial data. Fang et al. (2005) used interviews and
documents to estimate the transaction costs for the
point source and a government agency involved with
a point/nonpoint source trading scheme.
Research on stakeholder costs will also require
surveys or interviews and is prone to many of the
problems discussed for public agency costs. Collect-
ing actual transaction cost data from individuals and
firms: (1) requires careful survey design and pretest-
ing; (2) entails difficulties soliciting respondents,
obtaining completed surveys, and determining bias
due to nonresponses and to those declining to
participate; (3) is unlikely to obtain a random
representative sample of the target population; (4)
often requires the researcher to persuade respondents
to check their own financial records, etc., to provide
accurate responses; and (5) requires measurement
soon after costs are incurred so respondents still have
records to check. Data on perceptions of transaction
costs involve all the typical problems with measuring
perceptions after the fact or in a hypothetical context.
As the preceding discussion has demonstrated,
estimation methods for the various types of costs will
depend on the specific case, and multiple methods
may be required for a particular study. For example,
information may be easily purchased under some
policies and will thus be an explicit cost, while in
other cases, obtaining information may involve a
significant time investment on the part of stake-
holders. If an information clearinghouse develops, the
type of cost (and appropriate measurement method)
may go from an implicit (surveys) to an explicit cost
(financial data). Table 3 summarizes this discussion of
recommended methods for measuring various types of
transaction costs. Certain types of costs would be
more difficult (and costly) to measure, such as ex ante
estimates of implicit costs, while others, such as ex
post estimates of explicit costs, would be rather
straightforward.
5. Future research
There are a number of parallels between trans-
action cost measurement and nonmarket valuation of
environmental goods, so some valuation techniques
could be fruitfully transferred rather than reinventing
the wheel. While market prices would be ideal
4 Colby (1990) did find that average transaction costs per acre
foot of water declined as the volume of water increased due to types
of costs that did not vary with the size of the transaction.
L. McCann et al. / Ecological Economics 52 (2005) 527–542538
measures of environmental values, they are usually
not available, similar to the nonavailability of detailed
data on transaction costs of environmental policies. In
addition, different types of benefits (use and nonuse
values, option values, bequest values, etc.) require
different measurement methodologies (Freeman,
1993). Revealed preference data can be used to assess
use values, but stated preference techniques, such as
contingent valuation surveys, are required to assess
nonuse values. Similarly, for measuring transaction
costs, different types of costs may require different
methodologies. Reliance on financial data (analogous
to revealed preference techniques) neglects some
types of costs (e.g., farmers’ time) so surveys may
be required to obtain information on these types of
transaction costs. Contingent valuation methods
measure various types of values (use value, option
value, bequest value, etc.), which may be estimated
individually or all together. We have argued that costs
should be separated out in the case of transaction cost
measurement. It may be that choice modeling, which
can value different characteristics of a situation, may
have potential for separating out these types of costs.
This method is gaining prominence in the nonmarket
valuation field as evidenced by two recent handbooks
(Bennett and Blamey, 2001; Louviere et al., 2001).
Crase et al. (2001) used this method to estimate the
value of strengthened property rights to water.
Estimating willingness to pay to reduce transaction
costs via a contingent valuation survey could be a
useful approach in contexts where respondents face
policy-related transaction costs on a regular and
repeated basis such as costs imposed by existing
government programs. Measurement could parallel
CVM research on nonmarket values, with the attend-
ant perils of that approach (Mitchell and Carson,
1989; Arrow et al., 1993).
Another area of research might be to measure
transaction costs with different methods similar to
comparisons between stated and revealed preference
techniques. Kuperan et al. (1998) used several
techniques for different types of costs but did not
compare them. Once enough information on trans-
action costs of various policies is collected, as well as
on the determinants of those costs, we might be able
to use a technique similar to benefits transfer to reduce
the need to measure transaction costs. For example,
while estimates of transaction costs as a percentage of
total costs vary widely, the percentages found by
McCann and Easter (2000) for a technical assistance
program (38%), by Fang et al. (2005) for a pollutant
trading scheme (35%), and by Falconer et al. (2001)
for management agreement schemes (30%) are
surprisingly similar. Howitt’s (1994) and Colby’s
(1990) empirical works on the transaction costs of
water transfers also found similar magnitudes.
Few, if any, researchers involved in transaction cost
measurement have actually tried to examine how
marginal costs change as abatement level or size of
the transaction changes.4 This is similar to nonmarket
valuation studies, which measure the value of going
from one amount of an environmental good to
another, rather than measuring the effect of small
incremental changes. Nevertheless, studies on mar-
ginal transaction costs would be useful for policy
design.
Less developed versus developed country issues
relating to transaction costs have not been examined
and would be a fertile area for future research. There
are two distinct questions: (1) Is measuring trans-
action costs easier or more difficult in the developing
country context? (2) Are transaction costs likely to
be higher or lower in developing countries compared
to developed ones? Institutional frameworks and data
sources might be less available, which would make
measurement more difficult. According to OECD
(2001, p. 4), bBoth policy- and nonpolicy-related
transaction costs could be higher in developing
countries than in developed countries.Q OECD
indicates that developing countries often lack institu-
tional capacity, and there are high administrative
costs associated with collecting taxes and providing
subsidies.
6. Conclusions
Transaction costs have yet to be fully operational-
ized in a neoclassical framework, which hinders
comparative policy evaluation. Addressing measure-
ment issues is important as economists’ move to
L. McCann et al. / Ecological Economics 52 (2005) 527–542 539
incorporate transaction costs in comprehensive policy
evaluation. Knowledge of the magnitude and types of
transaction costs associated with environmental and
natural resource policies will influence the levels of
policy instruments, the choice of policy instrument(s),
and also their design. More fundamentally, it may
contribute to advances in research on the determinants
of transaction costs, sources of institutional change,
and design of institutions. To these ends, we need to
improve our collective ability to measure these costs.
This article provides a framework for future research
on transaction cost measurement and thus the design
of efficient environmental and natural resource
management policies.
Most of the transaction cost measurement studies
to date use words like bcrudeQ or bapproximateQ to
qualify their results. However, these studies have
demonstrated that measuring transaction costs is
important because the magnitudes, particularly for
nonpoint pollution policies, are significant. It has been
argued in this article that progress is needed on three
major fronts: (1) further clarifying the fundamental
issues involved; (2) improving measurement by
increasing the availability of relevant public data;
and (3) improving measurement methods.
In order to improve our measurement techniques,
this article first clarified what it is that we are trying to
measure and the broader context in which it will
be used. We examined the relevance of the transaction
cost economics paradigm developed by Williamson
for public policy issues. Our analysis revealed a
number of issues that require further careful study.
The distinction between abatement/production costs
and transaction costs becomes less clear when one is
dealing with actual data rather than theory. Another
difficult question is determining when, in the life
cycle of a policy, to start measuring transaction costs.
Comparing costs of a new policy to one that already
exists, or which builds upon existing institutional
structures, is also problematic. A number of parties
incur and bear the costs. While some studies have
only examined explicit or out-of-pocket expenses, a
complete analysis would include both implicit and
explicit costs. A final issue that we raised is the level
of precision that is required for different purposes.
Collecting transaction cost data should become a
routine part of public agency activities to increase
efficiency since bwhat gets measured gets managed.Q
For example, documentation protocols could be
incorporated into agency routines and activities to
report staff time, travel, consultant services, and other
financial expenditures associated with development
and implementation of a specific policy. Costs to all
affected parties ideally would be considered—stake-
holders directly involved in policy debate and devel-
opment, public agencies, and taxpayers, as well as
stakeholders not at the table. Despite the many
challenges in measuring transaction costs, economists
can fruitfully contribute to establishing public agency
documentation protocols that will allow more com-
plete economic assessment of policy-related trans-
action costs in the future. It is important to note that
any potential increases in efficiency need to be
compared to the costs of collecting the data. Doc-
umentation protocols need to be designed with this in
mind. As noted previously, transaction cost measure-
ment, particularly using surveys, is expensive. In
addition, having better transaction cost data will not
guarantee that it will be used effectively. In other
words, improved data are necessary but not sufficient
for increased efficiency in environmental and natural
resource policy.
One federal agency that is attempting to document
some of these costs is the U.S. Institute for Environ-
mental Conflict Resolution, established by Congress
in 1998 to assist in resolving disputes involving
federal agencies and federal interests. The institute
has established a standardized framework for doc-
umenting all environmental conflict cases under its
auspices, which includes some elements of trans-
action costs, such as time spent in meetings and direct
financial expenditures by parties (U.S. Institute,
2002). While addressing broader issues than trans-
action cost measurement, Dinar (2000) suggests that
data should be collected on water pricing reforms as
they occur.
Measurement techniques developed for nonmarket
valuation could be adapted for use in transaction cost
measurement since many of the challenges are similar.
Also, many of the survey techniques developed for
production costs could be fruitfully applied to trans-
action cost measurement. Transaction cost measure-
ment is more complex, in that there are a wider range
of costs and parties involved than either of these
cases, but knowledge of survey design and admin-
istration is crucial. The objectives of the study will
L. McCann et al. / Ecological Economics 52 (2005) 527–542540
dictate the type of measurement method(s) that is (are)
required. There is vast room for improvement in
transaction cost measurement techniques and it will be
useful to eventually develop a professional consensus
as to what techniques are appropriate under what
circumstances (analogous to standards developed for
nonmarket valuation studies). Before this is possible,
however, there will need to be a period of exper-
imentation with a variety of methods.
Acknowledgements
This research was, in part, supported by the
Missouri Agricultural Experiment Station. The helpful
comments of three reviewers and Graham Marshall
are appreciated but remaining errors and omissions are
the responsibility of the authors.
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