The Economics of Grants and Exchange: The Transactions Matrix

Brown, Alan A., Horvath, Janos, Neuberger, Egon, American Economist

Introduction

The purpose of this paper is to encourage cross-fertilization between Grants Economics and other fields of economics. It continues the evaluation of the contributions made to economics by Grants Economics explored in an earlier paper in this journal (Brown and Neuberger, 1986). Grants Economics is that subfield of economics that focuses on an important subset of transactions - grants or one-way transfers. Grants Economics, as Tibor Scitovsky has said, "in the best orthodox tradition of economics . . . makes perfect competition the pivot around which everything else revolves; but by speaking of grants instead of distortions or divergences or exploitation, it stresses the neutrality of perfect competition from the distributional point of view. Indeed, the use of the word "grants" in this context stresses that it may be desirable to have an income distribution different from the perfectly competitive one" (Scitovsky, 1976, p. 78).

The treatment of all transactions in the economy, but with special emphasis on grants, distinguishes Grants Economics from traditional economics which concentrates on exchange transactions. Grants Economics also helps to identify critical nonexchange components of transactions that might have been regarded as pure exchange transactions.

In order to pursue these goals, grants economists have constructed theoretical frameworks and provided empirical methodologies to analyze case studies. In this paper, we stress the following aspects of all transactions: (1) what is the nature of the transaction, (2) transactions carried out by decision-makers in order to highlight the grant and exchange elements in each transaction.

This paper presents a theoretical framework of Grants Economics, discusses its place in economics by means of a taxonomic matrix of all types of transactions, and considers some interesting theoretical issues.

Theoretical Considerations

Traditionally, economics has focused on the decision-making approach to answer three basic questions: what to produce, how to produce, and for whom to produce. In answering these questions, economists have generally used two narrowing conceptions: (1) that the relevant decision-maker is the "economic man," who is rational and motivated only by self-interest: and (2) economic interaction is typified by market exchange. Hirschleifer (1985) in "The Expanding Domain of Economics," discusses how this narrow approach to economics has been changing. By stressing nonexchange transactions, Grants Economics has been one of the fields of economics most active in trying to broaden our view of economic man. Founded in 1968, Grants Economics was by 1974 already included in a volume commissioned by the American Economic Association as one of the "Recent Advances in Economics" (Fels and Siegfried, 1974, pp. 181-191).(1)

As for the concept of the "economic man," Grants Economics accepts many different types of motivations: benevolence (altruism) and malevolence, love and fear - as well as self-interest. Looking solely at exchange transactions gives us only a partial view; to get a broader perspective, Grants Economics attempts to illuminate the significant role played by nonmarket transactions in furthering social interaction.

It should be noted that the word "grant" in Grants Economics is used in a much broader, more generic sense than is implied by the process of giving or receiving foundation grants.

This broader meaning of "grants" is noted by Abram Bergson: "My impression is that there is a rather general agreement among those who have given serious thought to this matter regarding the meaning of one type of grant, a major type of grant, that has come to be called an explicit grant. I think it is understood that this is a unilateral transfer of material values and as such is to be distinguished from the bilateral, reciprocal transfer of material values which is generally characteristic of the exchange economy and which we usually identify with the exchange economy" (Bergson in Pfaff, 1976, p. 62).

As for implicit grants, they may be defined as the difference between existing relative prices and some norm or benchmark, due to differential taxes, subsidies, price fixing, as well as monopoly power.

At times, it is difficult to differentiate between grant and exchange transactions. In fact, "it has been argued that all grants are exchanges of some kind," as noted by Kenneth Boulding, the founder of Grants Economics (1981, p. 2). In order to define the distinction between a grant and an exchange transaction, Boulding has used the net worth criterion: if there is no decrease in the net worth of either party, the transaction is exchange; if there is, it contains some grant element, and is an explicit or implicit grant (Boulding, 1981, p. 88).

The net-worth criterion is not the only distinction between the exchange and grants economies. In the exchange economy we generally assume consumer sovereignty, and consider it a requirement for the existence of the market system. On the other hand, who is sovereign in the grants economy? Is it the donor, the recipient, or a third party? (For a discussion of this important issue, see the Transactions Matrix section below.)

To the extent that the price system acts as an efficient information signaling device, the exchange economy has two major advantages over the grants economy: (1) The exchange economy requires less resources for the information structure to allocate efficiently goods, services, as well as factors of production; and (2) the exchange economy provides an automatic feedback through the demand-supply nexus of the price system, while there is no such feedback in the grants economy. This latter disadvantage of the grants economy can lead to a pathology of the grants economy that Boulding has called "the ignorance trap." This "arises because of the absence of feedback and the extraordinary difficulty of developing information systems that can report the consequences of grants and . . . any divergences between the objectives of grants and their actual consequences" (1981, p. 126). Boulding stressed the importance of the information problem in the grants economy with considerable flair: "While ignorance may be bliss in the short run it is rarely bliss in the long run. We are left with the problem of how to improve the information processes and feedback processes from grants behavior of all kinds from private charity to foundations to governments, all of which are constantly doing harm in the name of doing good (1981, p. 127, emphasis added).(2)

Although there are important differences in the decision-making and information structures between the exchange economy and the grants economy, there are even more crucial differences in the area of motivation. Adam Smith's famous statement illuminates this point: "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but their self-love, and never talk to them of our necessities but of their advantages" (Smith, 1937/1776, Book 1, p. 14). This is the credo of the pure exchange economy. It explicitly excludes benevolence, humanity, and love (the entire integrative subsystem of the grants economy), as well as malevolence, threat, and fear (the disintegrative subsystem of the grants economy).

A potential weakness in the motivation structure of the grants economy is the "dependency trap." This is a process "in which grants designed to meet a temporary need create such a successful adaptation to them that the need becomes permanent, so that grants actually create the situation in which they are perceived as necessary . . . [e.g., in case of the] . . . infant industry argument for tariffs" (Boulding 1981, p. 125). A recent example of the dependency trap is the fight over the extension of rent controls in New York more than five decades after they were introduced as a wartime emergency measure.

The Transactions Matrix

In order to clarify the nature of …

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Publication information: Article title: The Economics of Grants and Exchange: The Transactions Matrix. Contributors: Brown, Alan A. - Author, Horvath, Janos - Author, Neuberger, Egon - Author. Journal title: American Economist. Volume: 42. Issue: 2 Publication date: Fall 1998. Page number: 19. © 1999 Omicron Delta Epsilon. COPYRIGHT 1998 Gale Group.

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