Modeling Transaction Costs for a Sustainable Energy Policy: A Review and Illustration

Modeling Transaction Costs for a Sustainable Energy Policy: A Review and Illustration

Ranjan Kumar Ghosh (Swedish University of Agricultural Sciences (SLU), Sweden)
Copyright: © 2016 |Pages: 15
DOI: 10.4018/978-1-5225-0094-0.ch007
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This chapter presents a discussion on the economic governance aspect of sustainability in the context of energy policy and access. It is believed that incentives are sufficient for emergence of competitive energy markets which augment energy access. However, recent developments in Transaction Cost Economics (TCE) have shown that this need not be true when costs arising out of incomplete contracting are high. Yet, the role of transaction costs and the need to identify and model their behavior has not received adequate attention. This chapter reviews the basic tenets of TCE around natural monopoly sectors. It then illustrates in greater micro-analytic detail how transaction costs can be identified and empirically modeled in the context of industrial self-generation of electricity. The conclusion is that in the analysis of production systems, sustainability arguments are not complete unless costs arising out of inefficient contracting are accounted and an adequate economic governance apparatus is set-up.
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1. Introduction

Sustainability science has emerged over the last few decades as an important area of research and enquiry which attempts to uncover the complexities around the interface of economy, society and nature (Clark & Dickson, 2003; Komiyama & Takeuchi, 2006; Orecchini, Santiangeli, & Valitutti, 2011). It is transdisciplinary in approach and oriented towards problem solving in complex situations. It is also problem driven and relies on local knowledge to contextualize the problem. The study of economic systems, on the other hand, have been rather disciplinary as it was ‘developed predominantly as a science of choice’ (Oliver, 2002; p.172). This was especially since Lionel Robbins defined it as the ‘science which studies human behavior as a relationship between ends and scarce means which have alternative uses’ (Robbins, 1932; p.16). Can contributions from the study of economic systems fit the criteria laid down by sustainability science?

I will argue in the affirmative because a fundamental characteristic of an economic society is exchange which is based on relationships guided by (formal or informal) contracts. While James Buchanan (1975) could have been more generous when he said ‘economics as a discipline went “wrong” in its preoccupation with the science of choice and the optimization apparatus’, Oliver Williamson conceded that ‘the parallel development of a science of contract was neglected’ (Oliver, 2002; p.172). Recently, however, institutional theorists have framed an operational contractual paradigm to include the analysis of transaction costs. The prime proposition from such is that effective economic governance minimizes the threats of post-contractual hazards. Transaction cost economics (TCE) takes a micro-analytic view of economic organization and looks at it as a contracting problem. According to a ‘discriminating alignment hypothesis’ (Oliver, 1998), governance structures align themselves to minimize the costs which arise out of the particular attributes of a transaction. Since TCE assumes bounded rationality (instead of the neo-classical complete rationality), under uncertainty, investment in specific assets generate difficulties which need to be governed by institutions of private ordering. However when transactions are complex and uncertainties are high, future events cannot be foreseen and hence contracts or promises are almost always incomplete. This requires adaptation after a contract has been executed. When the costs of adapting to the ex-post contractual changes become very high, vertical integration of production becomes the default option.

Such a study of economic governance should be a critical component of sustainability science. The conceptual framing of economic governance draws from different disciplines and is empirically tied to the problem context. In this chapter, this proposition is verified by showing how a TCE perspective applied to a familiar energy problem helps in making the policy outcomes sustainable. When it comes to energy sustainability, the indicators which have been emphasized are (Orecchini, 2011): renewability of resources; efficiency in conversion, distribution and use; lowered environmental impact; higher energy accessibility and; localized energy systems. To show how the study of economic governance through TCE helps strengthen each of these goals is beyond the scope of this chapter. So I will focus on the energy access aspect of sustainability.

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