Institution/Transaction Costs and Economic Growth: A Governance-Augmented Ramsey-Cass-Koopmans Model

This paper develops a dynamic economic growth model in which institutions are treated as real cost technologies borne directly by households that produce, consume, and own firms. Building on Coase's insight that institutions exist to economize on the costs of exchange, Williamson's theory of comparative governance, North's historical thesis on institutional divergence, and Cheung's claim that transaction costs are institution costs, we construct a framework where governance structures absorb resources and alter intertemporal incentives. In this setting, the representative capitalist household faces not only the usual trade-off between consumption and saving but also the resource drain and dynamic wedges created by supervision, verification, and bureaucratic complexity. Institutions thus determine both the feasibility of exchange and the trajectory of growth. The analysis demonstrates how poor institutions depress capital accumulation and consumption, widen the gap between potential and realized outcomes, and lock economies into low-level equilibria. Reforms that reduce verification costs deliver immediate consumption gains, while reductions in supervision and complexity costs require transitional sacrifices but yield higher long-run capital and welfare. Comparative governance is formalized as a boundary condition that selects markets, firms, or hybrids according to which minimizes institution costs at the relevant scale. When governance intensity both raises productivity and consumes resources, institutional performance follows an inverted-U pattern, generating a Laffer-type curve. The model shows that institutional change is the hinge of capitalist development: societies that reduce institution costs achieve sustained growth, while those that do not stagnate.