The State as an Instrument of Transaction-Cost Economies

The state plays a role in reducing the transaction costs of an economic system. While the scholarly focus seems to be on the indirect role of the state through the legal system and the definition and enforcement of property rights, economists seem to overlook the direct role the state has to play in allocating economic resources through its centralized, administrative, and direct mode. This role of the state as a transaction-cost economizing agent becomes particularly important in high-transaction cost societies such as transitional economies and especially in view of the difficult process of transition taking place in the past twenty years. Experiencing staggeringly high transaction costs, former socialist economies show that, in contrast to the established clichés, the market does not “always work itself out,” the state is not always “a bad owner,” and it still has a role to play in the economy. The article argues that there are societies and sectors where the state, rather than the market, is a preferable instrument for allocating economic resources. It shows that, from the perspective of transaction-cost economics, markets sometimes do not function smoothly and are costly to use, as in the newly emerging market economies, and there is room for the government in the direct running of the economic system.