Transaction Cost Impairments to International Trade: Lessons from Egypt

Beginning of article

I. INTRODUCTION

In a world with perfect markets and zero transaction costs, penetrating international markets is a simple matter of production cost--comparative advantages determine which producers penetrate international markets and when. Yet, despite remarkable technological improvements relevant to the costs of international transacting and despite considerable-relaxation of exchange controls, the costs of international transactions generally are far from negligible. (See, for example, Wortzel and Wortzel, 1979, on developing country producers or local agents who persistently receive a low share of an exported good's eventual sale price.) In particular, from around the world growing evidence suggests that reforms designed to provide the right economic environment and incentives for exports are insufficient in themselves to generate rapid export growth (Keeling, 1979; Morawetz, 1981; Dean et al., 1994; Greenaway and Morrissey, 1993). In some respects, international marketing transaction costs even may be increasing over time, preventing otherwise beneficial transactions from taking place. Failure to recognize the high transaction costs in international marketing and to design appropriate strategies for dealing with them may doom to failure even excellent policy reforms. The costs of reform failures are high--as are the costs of failing to try reform.

This paper uses Egypt as a case study to: (i) develop socially relevant but testable hypotheses concerning the ways and means of exporting, (ii) test the validity of such hypotheses, and (iii) derive practical policy proposals to help producers in Egypt and in other less developed countries (LDCs) take better advantage of international market opportunities.

II. TRANSACTION COSTS IN INTERNATIONAL MARKETING

Transaction costs include (i) the costs of obtaining information about market conditions in any given foreign market (the quantities and qualities desired and the prices prevailing for each different quality) and the reciprocal costs for agents in foreign countries, (ii) the costs of information about government regulations and other policies in both foreign and home markets (including exchange rate policy, exchange restrictions, tariff and non-tariff barriers, and health and environmental regulations), (iii) the costs to each potential party of identifying appropriate trading partners in these markets, (iv) the costs of negotiating, writing, and enforcing contracts and resolving disputes between the parties, and (v) the costs of financing the transaction, which generally involves a long lag between placing an export order and making final payment for it, and of bearing the risks of default throughout the process.

Many factors tend to make these costs much higher than those of domestic transactions. Such factors include (i) differences in language, culture and taste, laws and dispute resolution procedures, income and information sources, the modus operandi of markets, and the extent and character of competition, and (ii) difficulties of enforcing contracts across countries, and hence the higher risks of payment default.

These transaction costs are not merely static. They change substantially over time with changes in the identities of the trading agents, environmental conditions, and the character of the respective markets. An exporter may possess all the right information about all the relevant factors in a particular market at one point in time, but rapid change can easily make that information obsolete. Indeed, for any individual country, over time two important trends tend to raise transaction costs for developing country exporters: (i) the growing relative importance in developing country exports of quality-differentiated and increasingly specialized products for which distinguishing between contract fulfillment and non-fulfillment (deliberate or otherwise) is difficult and (ii) the growing use in developed countries (at both the national and subnational levels) of various non-tariff barriers to trade, including environmental regulations, which are subject to more abrupt changes over time than are tariff barriers.

Another such factor is the asymmetry of information that characterizes many of the relationships, actual or potential, among the different agents. Asymmetries of information give rise to problems of adverse selection and moral hazard. Such asymmetries are likely to arise simultaneously in several different components of transaction costs. For example, at the level of the rules and regulations, countries may want conditions to look different than they really are or may be unwilling to enforce existing laws. Likewise, the agents responsible for implementing the rules may have little incentive to do so and indeed may have the incentive to leave the interpretation of these rules sufficiently ambiguous so as to generate rents for themselves. Even more relevant and important, each potential trading partner has better information about his own characteristics and propensities (appropriate to defining the terms of the contract) than does the other party, inducing adverse self-selection for any given terms. In principle contracts could contain sufficient detail so as to be complete and self-enforcing. In practice, the costs of negotiating sufficient detail are excessive, and actual contracts thus are incomplete and hence vulnerable to opportunistic behavior. Moreover, the lags between the time of writing the contract and that of delivering on it and between delivering on it and receiving payment create incentive for each party to default in some way--i.e., to practice moral hazard or opportunistic behavior relative to the other party.

These problems often are further compounded by the fact that many of the information and enforcement costs are subject to economies of scale, economies of scope, and externalities. The externalities imply that the incentives for investing in such information and in adequate enforcement mechanisms and insurance may be insufficient. The economies of scale and of scope imply that competitive markets for such services may not exist even though a role for intermediaries specializing in the production of these relevant services does. Instead, these services may be monopolistically supplied, but this creates the basis for government regulation and intervention.

Still another complication arises from the multiplicity and magnitude of the risks involved in such contracts. Because of the importance of these risks, once the contracts are in place, one or another of the parties to the contracts may seek insurance against these risks. Such insurance is subject to asymmetries of information and hence is vulnerable to both adverse selection and moral hazard.

Naturally, the magnitude …