A Transaction Cost Analysis of Scheduled international Air Transport of Passengers - Thesis

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A Transaction Cost Analysis of Scheduled international Air Transport of

Passengers

Ravoo, M.

Publication date

2000

Document Version

Final published version

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Citation for published version (APA):

Ravoo, M. (2000). A Transaction Cost Analysis of Scheduled international Air Transport of

Passengers. Universiteit van Amsterdam.

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AA TRANSACTION COST ANALYSIS

OFF SCHEDULED

INTERNATIONALL AIR TRANSPORT

OFF PASSENGERS I I

AA TRANSACTION COST ANALYSIS OFF SCHEDULED INTERNATIONAL

AIRR TRANSPORT OF PASSENGERS S

AA TRANSACTION COST ANALYSIS OFF SCHEDULED INTERNATIONAL

AIRR TRANSPORT OF PASSENGERS S

ACADEMISCHH PROEFSCHRIFT

terr verkrijging van de graad van doctor aann de Universiteit van Amsterdam opp gezag van de Rector Magnificus prof.. dr J.J.M. Franse

tenn overstaan van een door het college voor promoties ingestelde commissie,, in het openbaar te verdedigen in de Aula der Universiteit opp woensdag 25 oktober 2000, te 12.00 uur

doorr Monique Ravoo geborenn te Amsterdam

Promotorr prof. dr A. Heertje

Co-promotor:: prof. drs J.B. Polak, emeritus

Preface e

Too many people, air transport resembles the world of Peter Stuyvesant: glamorous, adventurous and tingedd wim danger. Even if environmental damage and a number of accidents have somewhat changed matt image, air transport still has a trace of the spectacular. The image confirms the idea that 'the pleasuree of travelling is in the journey.'

Travellingg inside, as you do when writing a doctoral thesis, indeed generates pleasure but also pain: thee 'pain' of tracking down «formation, clarifying key questions, developing a model, refining knowledgee of fundamental economics, working hours on end, rethinking, rewriting, checking, editing...and,, finally, seeing light at the end of the tunnel but not seeing it come closer. Even worse, beingg m the light for a short while, only to discover that there is another tunnel ahead. When I began mis thesiss more than five years ago, I could never have imagined what lay ahead of me.

Whyy would anybody m their right minds embark on a thesis, you may ask? Well, because there is also pleasuree ahead. Finding that pleasure requires a strong interest in the subject of investigation. Speaking forr myself, this was certamry the case, wfth a job at Schiphol at the time and a father who had worked theree since I was two years old. To my first memories belong walking with my dad in the Amsterdam woodss and finishing our walk drinking a cup of cocoa at parking lot P3. Who would have thought thenn ?

Writingg a thesis gives pleasure when assumptions are confirmed, new thoughts spring to mind, the scopee for improvement becomes clear, or a line of reasoning appears sound: the 'aha erlebnis'. The journeyy has taken me more than five years. It has both cost me and given me a lot. Now uiat me journey hass ended, I'm glad mat it's over.

Theree are many people who have in one way or another helped me to continue my trip. I am indebted to myy supervisors, Professor Heertje and Professor Polak, for providing me with the inspiration needed to conductt research. They were able to extract the best from me through a unique combination of knowledge,, character and incentives. I also wish to mention Professor Wassenbergh, the well-known professorr of air law at Leyden University, who showed me and my fellow students some years ago how challengingg a course in air law could be. And how you should not proceed from 'what is' but be willing too turn your mind to 'what can be'! The term 'lege fèrenda' should sound familiar to all those who have hadd die opportunity to attend his classes. Thanks are due to my 'paranimfen' - Jacques, who read a lot aboutt what his job implied but didn't fail to act upon k, and Rene, who was busy developing his businesss but always found time to give advice on a whole range of matters - and bom their wives, Dady andd long-time friend Sandra. Jan-Willem, explained a lot to me about the publishing business and was alwayss willing to talk about it over dinner somewhere.

--Family,, friends and colleagues, especially my former employer, Schiphol Group, did not always understandd what I was doing (and why I didn't do all the things a young woman is supposed to do), but sometimess provided great insight into my motives for writing a thesis. Their opinions helped me grow duringg my research.

II certainly need to mention Ivette at this point, who was able with bottomless energy and insurmountablee logic to point out the not so logical parts of both my English and my reasoning. Often, thee solution to our discussion was to delete a sentence. We became masters at leaving things out, notwithstandingg that the book has still reached more than 200 pages! AWiough it may have seemed as if II did not like our discussions, this may have been due more to frustration on my side than anything else. Again,, I learnt a lot.

Lastt but not least, I am greatly indebted to Jan, who facilitated and supported the journey in many ways.. Words fail me here. It's good to know that we have some real travel ahead of us.

Moniquee Ravoo

Amstelveen,, September 2000

Contents s

Preface e

Tablee of abbreviations and acronyms

l l vii i Chapterr I Chapterr II Chapterr m -Introducbon n

1.11 - Objective of the thesis 1.22 -Context of the thesis 1.33 - Central questions 1.44 -Methodology 1.55 - Scope of the thesis 1.66 -Organisation of the diesis Transactionss and transaction cost .n»tv<^ 2.11 - Introduction

2.22 Transactions 2.33 - Transaction costs

2.44 - Factors influencing transaction 2.4.11 -Frequency 2.4.22 - Uncertainty 2.4.33 - Asset specifiry 2.4.44 - Bounded rationality 2.4.55 - Opportunism 2.55 - Effectiveness 2.66 Industry environment 2.77 - Governance structures 2.7.11 - Non-specific structure 2.7.22 - Semi-specific structure 2.7.33 - Transaction-specific structure 2.7.3.11 -General comment 2.7.3.2-Thee 6nn 2.7.3.33 -TheState 2.88 - Concluding remarks Thee Bilateral stmchms 3.11 n 3.2-Bilateralism m

3.3-Partiess to the transaction 3.3.1-States s

3.3.1.1-- Psychological goal 3.3.1.22 - Financial goal 3.3.1.3-Politicall and social goal

3.3.1.44 - Implementation of the air transport goal in the Bilateral structure 3.3.1.4.11 - Traffic votume 3.3.1.4.22 * Fleet composition 3.3.1,4.3-Markett behaviour 3.3.1.55 - Interstate relations 3.3.22 - Airlines 3.3.33 - Airports 3.3.4-Internationall organisations

3.44 - The object of the exchange and property rights

P«fe e 9 9 9 9 12 2 15 5 15 5 17 7 19 9 21 1 22 2 27 7 31 1 31 1 31 1 32 2 33 3 33 3 34 4 35 5 40 0 42 2 45 5 50 0 50 0 51 1 52 2 54 4 56 6 57 7 57 7 58 8 59 9 59 9 64 4 69 9 71 1

3.5-Thee transaction process 75 3.5.11 -Contact phase 75 76 6 78 8 80 0 83 3 3.5.22 - Contract phase 3.5.33 n phase

3.5.44 - Compliance and enforcement 3.66 - Characterization of the Bilateral structure

3.77 - Further developments g4

Chapterr I V - The Community structure

4.1'Introductionn 37 89 9

95 5 4.22 - European integration, EC Treaty and air transport

4.33 - European air transport packages

4.44 - Current Community structure 95 4.55 - Parties to the transaction 99 4.5.1-- EC Commission

4.5.22 - EC Council of Ministers 4.5.33 - EC Parliament 4.5.4-ECCourts s

4.5.55 - Objectives of the EC institutions 104 4.5.66 - Member States 4.5.6.11 - General remarks 99 9 100 0 102 2 102 2 105 5 105 5 4.5.6.22 - Implementation of the air transport goal in the Community structure 109

109 9 109 9 109 9 110 0 4.5.6.2.11 - Traffic volume 4.5.6.2.22 - Fleet composition 4.5.6.2.33 - Market behaviour 4.5.6.33 - Interstate relations 4.5.77 - Community carriers U 2 4.5.88 - Community airports U 5 4.5.99 - International organisations Hg 4.66 - The object of the exchange and property rights 119

4.77 - The transaction process 120 4.7.1-Contactt phase 120 4.7.22 - Contract phase 120 4.7.33 - Execution phase 126 4.7.4-- Compliance and enforcement 128

4.88 - Characterization of the Community structure 130

4.99 - Further developments 131 Chapterr V - Comparison of the Bilateral «id Cmnmmiiiv structures

5.1-Introductionn 133 5.22 -Characteristics of and trends the air transport industry 134

5.2.1-Internationall nature 134 5.2.22 - Co-operation 134 5.2.33 - State intervention and deregulation 13g

5.2.44 - Industry environment 139 5.2.55 - New market players

5.33 - Core dimensions

5.44 - Features of the Bilateral structure 143 5.5-- Effectiveness of die Bilateral structure 145 5.66 -Transaction cost efficiency of the Bilateral structure 147

5.6.11 - Transaction frequency 147 5.6.22 - Uncertainty 149 5.6.33 - Asset specificity 151 5.6.44 - Opportunism 153 141 1 141 1

5.77 - Features of the Community governance structure 158 5.88 - Effectiveness of the Community structure 160 5.99 -Transaction cost efficiency of the Community stmcture 163

5.9.11 - Transaction frequency 163

5.9.2-Uncertaintyy t64 5.9.33 - Asset specificity 167 5.9.44 - Opportunism 168 5.100 -Optimal governance structure 175

Chapterr VI Kmnm«rv . M coremskms

6.11 n 182

6.22 -Summary of the model 184 6.3-Summaryy of findings 185

6.44 - Recommendations and suggestions for improvement 186 6.4.11 - Suggestions for improvement from me perspective of the state

ass member of the Community 186

6.4.1.1-Effectivenesss 186 6.4.1.2-Transactionn cost efficiency 190

6.4.22 - Suggestions for improvement from a state-industry perspective 190

6.4.2.11 - Effectiveness 190 6.4.2.22 - Transaction cost efficiency 191

6.55 Evaluation 192 Summaryy in Dutch ] 95

Literaturee and references 202

Epiloguee 217 Indexx 220

Tablee of abbreviations and acronyms

ACII - Aiiports Council International A£AA - Association of European Airlines

AWBB -the Dutch General Law on Administrative Procedures

BNCC - Working Group for the assessment of new Commission Proposals CAAA - Dutch Civil Aviation Air Transport Division

CABB - Civil Aeronautics Board CMLRR - Common Market Law Review

CoCoo - Inter-ministerial Co-ordination Committee for European Integration and A s s o c ^ ^ COCOHANN - High Level Co-ordination Committee

COMM - Commission document

Commissionn - The Commission of the European Community COREPERR - The Committee of Permanent Representatives Councill -The Council of Ministers of the European Community CRSS - Computerised Reservation System

DOTT - Department of Transport (United States) ECC - European Community

ECAC-- European Civil Aviation Conference

ECOFINN - The Council of Economic and Finance Ministers of the European Community ECRR - Official report of cases before the European Court of Justice in English

EEAA - European Economic Area EFTAA - European Free Trade Association EUU - European Union

FAAA - Federal Aviation Authorities

GATSS - General Agreement on Tariffs and Trade IATAA - International Airlines Association D3VV - Integrale Beleidsvisie

ICAOO - International Civil Aviation Organization ICERR - Interdepartmental Subcommittee on European law JJ AA - Joint Aviation Authorities

JARR - Joint Aviation requirements

KEPDD - Key Environmental Planning Decision OJJ - Official Journal of die European Communities PASOO - Plan van Aanpak Schiphol en Omgeving REIAA - Council for European and International Affairs SEAA - Single European Act

SIDD - Standard Instrument Departure

TACISS - Technical Assistance forme Commonwealth of Independent States TENN - Trans-European Network

TEUU - Treaty on European Union

VROMM - Ministry of Housing, Regional Development and die Environment WTO-Worldd Trade Organisation

--Chapterr 1 - Introduction

1.1-- Objective of the thesis

Thiss thesis aims to examine and analyse the governance of international passenger air transport.. Such governance may take place via one of two alternative structures, namely the traditionall Bilateral structure and the structure that applies within the European Community', alsoo known as the 'Community structure*2. More specifically, the objective is to examine: 1) thee ability of the state to realise certain policy goals in the field of air transport and 2) the transactionn costs which are incurred in that process under each of the two structures. The primaryy focus will be on the Netherlands. Given the reality that the Netherlands are a Member Statee of the European Community, a secondary objective is to investigate possible ways of improvingg the current Community structure. The investigation adapts the theory of transaction costs,, developed by Coase among others, and applies it to the Dutch air transport system. The transactionn that is analysed is the exchange between states of certain rights 1) to enter a foreign airr transport market, 2) to use the airspace to transport people to and from that market and 3) too capture the benefits from such use. These rights will also be referred to as 'air transport rights'. rights'.

1.22 - Context of the thesis

Thee transaction (i.e. exchange) process covers the preparation, conclusion and execution of transactionss and leads to a claim on productive resources. This claim is referred to as 'transactionn costs*. The level of transaction costs varies with the governance structure within whichh the transaction occurs. This structure may be defined as 'the institutionalised matrix in

whichwhich transactions are being negotiated and executed' (Williamson, 1986: 105). It is thus

formedd by the total of rules and institutions that govern the transaction process. A governance structuree may give parties to a transaction the wrong incentives, or the structure may be too inflexiblee to govern the transaction adequately, thus generating transaction costs and necessitatingg an alternative way of governing the transaction. Modelling the governance structuree as an endogenous variable is an integral part of transaction cost economics as its 11 _{The European Community (or: 'EC') is based an the Treaty of Rome of 1957 ('EC Treaty'). The EC} comprisess the EEC, Euratom and ECSC and acquired the name'European Coninmiihy'ibllowing the Treaty onn European Union ('Maastricht Treaty') of February 1992 (entered into force on 1 November 1993). The Europeann Union (or 'EU*) consists of the European Conumimty, augmented by the fields tf

affairss and a common foreign and security policy. Since the European Gmniiunily, but not the European Union,, possesses legal personality, this thesis uses the tenn'EC'to ktaMify the eruity that enacts legislation, to addition,, articles trom the EC Treaty are referred to by the lumbers applicable situs fe

Treatyy of Amsterdam in May 1999 (treaty agreed on 2 October 1997, approved for the Netherlands by law of 24 Decemberr 1998, STB 737). Where necessary thee original numbers will be footnoted.

purposee is to analyse governance structures from the perspective of finding efficient combinationss of governance structures and transactions. Efficiency in this context is looked at fromfrom the perspective of transaction costs, in the sense that an efficient governance structure minimisess those costs. This notion of efficiency will be referred to as 'transaction cost efficiency'.. The definition ignores efficiency of the production process, which reflects the level off production costs associated with the transaction. In a standard transaction cost analysis, transactionn cost efficiency is the sole criterion used to differentiate governance structures. The modell developed below extends existing theory by explicitly introducing a second criterion, namelyy the ability of a governance structure to realise the objectives of transacting parties. Suchh objectives underlie any transaction but are usually not explicitly taken into account. A traditionall objective pursued by the individual is utility maximisation, while the state is often seenn as a social welfare maximiser. The ability of a governance structure to attain given objectivess will be called its 'effectiveness*. More specifically, the definition captures the extent too which certain policies and instruments enable the parties to realise their objectives. The transactionn cost efficiency and effectiveness of a governance structure may interact in the sense thatt a higher effectiveness can imply higher transaction costs and vice versa. For example, a policymakerr may choose to spend more time gathering information on the reputation of a servicee provider, thus increasing the chance of a high quality service. In doing so, the policymakerr may incur transaction costs. Conversely, the policymaker may opt to refrain from informationn gathering and select the service provider on the basis of general information, therebyy running a greater risk of a low quality service. A policymaker may thus have to make a trade-offf between efficiency and effectiveness in choosing the optimal structure.

Thee thesis focuses on air transport and, in particular, on the exchange of air transport rights. Thee state makes use of airlines and airports to execute these rights. Although not in line with standardd literature, in what follows, these industry players together will be referred to as the 'airr transport industry' to capture the idea that air transport services as well as airport services aree an essential part of the execution of air transport rights. At present, the air transport industryy is in turmoil and transition. Whereas it used to be tightly regulated, in recent years the trendd has been towards liberalisation. This is manifest in greater freedom of market access and operation,, which is in turn reflected in such factors as growing market instability, the formation off alliances and the development of transport networks. For many states in Western Europe, liberalisationn is occurring in the context of the more general economic integration pursued withinn the Economic Community. Transport developments as well as general economic integrationn have required transacting states to revise their positions. In Western Europe, one

Thee 'Community structure' is used to refer to the structure governing die exchange «fair transput right* betweenn EC member states. The structure coiop^

otherr rules and institutions governing such exchange.

33

The term usually refers to the airline sector.

importantt consequence of the move towards liberalisation has been a radical transformation of thee structure governing economic exchange. This has had major implications for the states' abilityy to realise certain air transport objectives. There are some good reasons for studying governancee structures in the transport sector. Transport is seen as a facilitator of integration andd a transport sector that functions well stimulates general economic development. Transport cann also help attain social objectives such as the development of regions that are lagging behind.. These functions make it important to know how well a governance structure performs inn the transport sector. Moreover, transport is becoming more important because the trend towardss globalisation is stimulating demand for the transport of persons and goods. The developmentt of transport is enhanced further by the increased modularisation of the production process,, whereby separate modules are produced where production costs are lowest. The relativee importance of air transport as a mode of transport has grown (Schipper, 1999: 1). At thee same time air transport contributes to environmental pollution.

Twoo structures are of primary relevance to this thesis, namely the Bilateral structure, which governss most exchanges of air transport rights, and the Community structure, which governs exchangess of those rights within the European Community. The two structures are built on entirelyy different foundations. The Bilateral structure proceeds from sovereignty and equality. Thee states hold the property rights to the airspace above their territory. Agreements on the use off airspace are concluded between two states, each regarded as sovereign and equal to the otherr in status. Every agreement is formulated as an international treaty and, in line with the principlee of sovereignty, there is no supranational authority. Relationships are very important too the content of the transaction. A central feature of Bilateralism is that the market is closed andd not opened up until a transaction is concluded, and a carrier is designated by the state to operatee the air transport service. The state holds substantial ownership and effective control withh respect to the carrier. In contrast, the Community structure is based on a multiparty agreementt and Community legislation as well as case law have limited the sovereignty of states.. The transaction process and rules are standardised and there is a supranational dispute resolutionn mechanism. The air transport rights are largely delegated to industry players and airliness are subject to a Community ownership and control requirement.

Thee above description shows that more than two parties participate in the exchange of air transportt rights. Although states are the only parties authorised to implement every phase of thee transaction, they use airlines and airports to exercise those rights. These parties are usually privatee entities rather than part of the government administration. In economics, agency theory iss used to discuss the relationship between two parties one of which (the principal) uses the otherr (the agent) to perform services on its behalf; and to analyse the problems of opportunism thatt may arise when the objectives of the agent are not consistent with the objectives of the

principal.. The standard textbook example is the employer-employee relationship (for instance, Holstrom,, Milgrom, 1991). The relationships between the state and the players in the air transportt industry are very similar4. Here, the state is the principal and airlines and airports are thee agents. As private parties, the agents may have objectives that conflict with those of the state.. It may be argued that the relationship between the state and the air transport industry is nott one of agency because the state does not really have a contract with the industry to pursue itss objectives. The relationship is, in fact, no different from that between the state and a shoe manufecturerr that generates foreign exchange income for the state. However, the state issues permitss to carriers and designates airlines and airports to provide services on its behalf. There iss no such explicit agreement between the state and the shoe manufacturer, so that the two situationss are different. It may, however, be possible that the state does not pursue any clear objectives,, in which case the set of objectives is empty. In such a situation agency theory is indeedd not applicable. As will be argued in Chapter ID, the Dutch state as well as industry have clear,, yet different, objectives. Moreover, the state has concluded an increasing number of covenantss with the industry providing explicit agreement to pursue government objectives so thatt the possibility of the empty set does not apply. Thus, apart from a state's ties with other states,, its relationships with various agents play a role in this thesis.

1.3-- Central questions

Thee previous description of the context and key issues of the thesis leads to the following centrall questions:

11 Which of the Bilateral and Community structures is more effective? 22 Which of the two structures is more efficient in terms of transaction costs? 33 What suggestions can be made to improve the Community structure?

Thesee questions will be answered from the perspective of the Netherlands as a sovereign state andd as a Member State of the European Community. The individual state perspective has been chosenn because, as will be seen in Chapters III and TV, current governance structures approach thee exchange of air transport rights from the perspective of a state. In addition, bounded rationalityy on the part of the researcher has limited the analysis to the perspective of the Dutch state.. Finally, this thesis aims to give recommendations to Dutch policymakers. However, the applicabilityy of the model developed below is not limited to situations where the Dutch state is onee of the transactors. The parties to the exchange may include any state or even groups of states. .

Buttonn (1996:284) refers to the state-airline relationship as one of agency in noting that Ihe oljectivcs of principall and agents sometimes coincide. See also Noonialiavm (1990), who discusses the i ^ ^

betweenn the slate and firms that receive subsidies as an agpnry «4^w»diip 4 4

1.4-Methodology y

AA central governance structure in this thesis is the State. As explained in Section 1.2, the states aree the only parties with full authority over the transaction. They derive this authority from theirr ownership of the property rights to the airspace above their territories. Furthermore, their (legal)) power to coerce others within their jurisdiction, gives the states a higher status than any otherr party involved in the exchange of these rights, and makes the states responsible for the welfaree of the public. These features have implications for the nature of the transaction process andd hence for the optimal governance structure. A state's sovereignty and monopoly of power, forr instance, make it relatively immune to sanctions imposed by other states via legal compliancee mechanisms. The Bilateral and Community governance structures, outlined in Sectionn 1.1, may be considered as variants of the State. The analysis of these governance structuress is based on models of transaction costs developed by Williamson (1971, 1985) and Vann der Zaal (1997). In these models, transactions are differentiated according to a number of coree dimensions, namely the frequency of a transaction, the uncertainty arising from the transactionn and the specific investment needed to prepare and execute the transaction. Each coree dimension has certain implications for the level of transaction costs. To illustrate, the need too make investments that are specific to a given transaction increases the dependence of the investingg party on continuation of the relationship and may induce it to search for certainty and protection.. In this way, the party incurs transaction costs. In addition to elements that differentiatee transactions, there are two important factors that differentiate transaction parties. First,, they may differ in their ability to understand the issues in hand and in their ability to transmitt this information. Second, parties may differ in the degree of opportunism in their behaviour.. Each of the in total five core dimensions will be studied in terms of the variables thatt influence them. With this model, the transaction cost efficiency of the two governance structuress can then be analysed.

Thee characteristics of the state make it difficult to evaluate the effectiveness of a governancee structure directly. Although the state's overriding objective may be a general goal suchh as social welfare maximisation, this objective is really an amalgamadon of a number of subgoals.. A contribution to one goal may adversely affect other goals. It is also very difficult to attributee observed effects to given policies without making some strong ceteris paribus assumptions.. This is particularly problematic for the long-term relationships that exist between statess and between states and the industry. The effectiveness of a governance structure will thereforee not be measured directly in terms of the effects of a policy on society. Rather, effectivenesss will be measured indirectly in terms of the characteristics of the interstate and state-industryy relationships. If a governance structure is to be effective in the sense of attaining

thee state's goals, then these relationships need to contain appropriate mechanisms5. Furthermore,, the state's goals will be made concrete by translating them into requirements pertainingg to the provision of air transport and airport services. A governance structure may be consideredd relatively effective if it contains mechanisms inducing the industry to meet these requirements.. Finally, the approach towards measuring the transaction cost efficiency and effectivenesss of a governance structure will be qualitative rather than quantitative. The purpose off the analysis is to explore the nature rather than exact size of the connections between governancee structures and the variables that determine their efficiency and effectiveness.

1.5-- Scope of the thesis

Sectionn 1.2 observed that transaction cost economics focuses on transaction costs and not on benefits.. Although transport generates substantial benefits by allowing a better spatial distributionn of labour and specialisation, these are not considered explicitly here. Nor does the analysiss address the effects of a governance structure on the welfare of the final consumer. Evenn though the state is an important party in the analysis and is considered a social welfare maximiser,, consumer welfare is not the primary focus of the thesis6.

Furthermore,, the notion of efficiency is defined in terms of transaction costs. The analysis sayss very little about the effect of governance structures on production costs. There may be somee interaction between the two types of cost. The use of information technology, for example,, may enable higher output and at the same time reduce uncertainty. A new method designedd to reduce production costs may thus at the same time reduce transaction costs. Similarly,, tying a private firm to public goals by given it an exclusive concession for an unlimitedd period, which may reduce transaction costs, may limit competition and thereby reducee production cost efficiency. As stated in Section 1.4 the analysis essentially focuses on thee Dutch situation although many comments apply more generally to the area where the Communityy structure applies or even air transport relations between states.

Thee scope of the thesis is further limited to scheduled passenger transport and does not considerr charters for passenger transport nor any kind of freight transport7. Scheduled passengerr traffic is the best known, and from the point of view of the thesis, the most interestingg of the various submarkets. It is the form of transport that is most important in meetingg the demand for air transport and consequently receives the greatest attention in regulationn as well as in public and political debate. Freight transport usually follows passenger transportt if sufficient destinations are offered. Further, freight transport is limited to long distancee transport with a high value to weight ratio and air freight transport within Europe is

Suchh mechanisms might revolve around financial incaitives or the riglttioexiHiid operations. Seee Schipper (1999) for an extensive wenare analysis of regulator reform m aviation.

Thee distinction between charters and scheduled traffic has virtually disappeared in the air transport legislationn of the European Community.

almostt negligible (Berechman and De Wit, 1996: 263). Passenger aircraft are responsible for moree than half of total freight capacity (at Schiphol airport and world-wide). Al Schiphol airport,, freighters are responsible for less than 4% of the total number of aircraft movements. Moreover,, for the Netherlands, passenger transport is crucial to attracting new businesses as thee potential of this transport affects the attractiveness of the Netherlands as a location for Europeann Headquarters and distribution centres. The effects of air transport on non-aviation industriess play an important role in Dutch air transport policy (see, for instance, the 1995 Key Environmentall Planning Decision, or *KEPD\ discussed in Section 3.3.1). The country's small territoryy further implies a relatively small amount of originating and destination traffic. If it is too benefit from any scale-related economies (see Section 5.2.4), it must exploit passenger transportt by transferring large numbers of passengers*.

1.66 - Organisation of the thesis

Inn Chapter II, the model outlined above is developed in greater detail. The chapter identifies thee core dimensions of transactions and transaction parties and analyses their determinants and theirr effects on the level of transaction costs. The traditional transaction cost model is then augmentedd by the notion o f the effectiveness of governance structures. This is followed by a descriptionn of a number of governance structures, including the State and some variants of the State. .

Chapterr ID gives a detailed description of the Bilateral structure. It covers the basic elementss of the structure, including the transaction process, parties active in that process, their motivess and their relationships. Chapter IV engages in an analogous discussion of the Communityy structure. The description of the Bilateral and Community transaction will be organisedd around phases and subgoals. The alternative approach of describing one particular exchange,, would not suffice to adequately illustrate the two structures.

Thee material in Chapters H, III and IV provide the basis for an analysis of the two structuress in Chapter V. It applies the terminology developed in Chapter II to the air transport contextt and summarises the distinguishing features of each structure. It then looks at the effectivenesss and transaction cost efficiency of each structure and makes comparisons between thee two structures. In this way Chapter V answers the first two central questions, namely whichh of the two structures is more effective and which is more transaction cost efficient.

Thee margins on transfer traffic are not high but transfer enables a condonation of transport flows. This is vital too a hub-and-spoke netwoifc (sec Section 3.3.3). It atb»^ passengen wlv> are not destined for or do not originatee from the transfer country, thereby increasing the market potential of that country. Transfer traffic is, however,, mach inore susoepti)te fo changes in aircraft it is nott captive) (CPB, 1997).

Chapterr VI contains a summary and conclusions. The chapter also gives some recommendationss for how to improve the current Community structure, with the aim of answeringg the third central question.

Thee analysis covers developments up to January 2000.

Chapterr II - Transactions and transaction cost analysis 2.11 - Introduction

Chapterr I introduced the notion of transactions in air transport rights and noted the various elementss pertaining to such transactions. A detailed analysis of these transactions will be given inn Chapters in and IV. The present chapter analyses the concept of transactions and transactionn costs in the general context of any private good or service. Section 2.2 defines transactionss and elaborates on what is needed in order to conclude and execute them. This sectionn also introduces the concept of governance structures. Section 2.3 explains the concept off transaction costs, while Section 2.4 analyses the factors that are responsible for such costs. Sectionn 2.5 expands conventional transaction cost analysis by introducing the notion of effectiveness.. Section 2.6 introduces the industry environment. Section 2.7 then describes somee of the most frequently found governance structures. Section 2.8 summarises the purpose off this thesis and indicates how the thesis will apply transaction cost theory to the exchange of airr transport rights.

2.22 - Transactions

Thee exchange of scarce goods in a market is a central theme in economics. Man's objective is thee maximisation of utility and he tries to satisfy his needs through exchange. Participants in an exchangee expect that the benefits will outweigh the costs of the exchange. Exchange can be equatedd with the term 'transaction', the latter referring to both the material (or physical -emphasiss added> and contractual aspects of exchange (Francis, Turk, Willman, 1983: 6). To be ablee to conclude and execute transactions, several conditions need to be met. The present thesiss distinguishes the following factors: the existence of an object of trade, property rights, information,, parties, a medium of exchange and a governance structure. These factors are explainedd more fully below.

Thee execution of an exchange requires an exchange object. This could be anything from whichh an individual derives utility or satisfaction, such as a good. Exchange also requires the existencee of property rights with respect to the good. The owner of these property rights can excludee others from free access to the good and can determine what to do with the good (Pejovich,, 1990: 28). Without a system of property rights, exchange is greatly discouraged sincee the execution of a transaction is not guaranteed. Who guarantees, for example, that the agentss who claim competence to decide on the use of a certain good are entitled to conclude a transactionn with respect to the good, and who guarantees that no one can frustrate the exchangee by contesting their claims? Furthermore, the absence of property rights can lead to resourcee depletion. There will be a tendency to overuse the resource as the costs of depletion aree shared with other people, and not to protect the resource as others benefit from any

investments.. Similaiiy, investments made to produce a good other than for direct use are discouragedd since there is no certainty that the investments will be recouped. Property rights cann then be defined as 'sanctioned behavioural relations among men that arise fiom the existencee of scarce goods and pertain to their use' (Pejovich, 1990: 27-28). Property rights comprisee four elements:

1.. the right to use an asset (usus),

2.. the right to capture benefits from the asset (usus fhictus),

3.. the right to change the form, content or location of the asset (abusus) and

4.. the right to transfer all or part of the rights in 1, 2 and 3 to someone else at a mutually agreedd price1.

Inn addition, property rights have to be measurable if they are to exclude others from the use of thee good and thus create incentives for its optimal use. For some goods exclusion is not possible.. Collective goods are an example. One of the characteristics of these goods is that theyy are not divisible into individual units so that others cannot be excluded from their use2. Excludabilityy is also ruled out if the costs of creating or supervising it are prohibhively high. Thiss can change, however, as a result of technological developments that lower these costs. An examplee is the creation of rights to protect intellectual property such as material distributed via thee internet, or the introduction of electronic pricing, which enables the use of road infrastructuree to be priced individually and more cheaply than toU booths. Another example, relevantt to this thesis, are property rights to airspace. To be sure, excludability does not mean unlimitedd rights. There are limits, but these have to be based on legislation or case law (North, 1981:: 36). Another factor that is necessary to conclude and execute transactions is infor-mation.. Information is needed about the characteristics of the good, the trading partner, the partner'ss objectives, the terms of the exchange, and conditions and routines that pertain to the exchangee process. If there is no information, or if information is incorrect, there may not be anyy exchange. For example, a seller may not know that there is a willing buyer. Information failuress could also lead to an exchange that is 'wrong' in the sense that the price at which a goodd is traded does not reflect opportunity cost, or in the sense that the good does not end up withh the person who values it most. Transactions require two or more parties. If a party wants too exchange a good, it needs to identify a trading partner. The identification process can be organisedd in many ways, including various types of markets (e.g. physical markets and auctions),, intermediaries (e.g. travel agencies) and lobbying. In some exchange situations,

11

The right of ownership is not identical to the term 'i«pcrly rigto'used in Üw Eiiglish litcratare Thefonaer alsoo covwsthe rights of tresiassh^ usumict, ose ( ^ ^

termterm property rights can be equated with the Dntch term B«rf.iHri«ipiiTr|rtfn'

AA second feature of collective goods is their ram-rivaby character, which nua^ individuall does not diminish the amount available to other people.

identificationn does not pose great difficulties. It is not difficult to identify a monopolist or a sellerr of goods that are standardised and supplied on a regular basis. In the case of barter, however,, the identification of a trading partner can be very difficult and time-consuming. The availabilityy of a uniform medium of exchange (usually some form of money), with a stable or predictablee value, can facilitate the process considerably. Finally, there should be a governance structure.. The governance structure is a special part of the institutional environment, namely 'thee institutionalised matrix in which transactions are being negotiated and executed' (Williamson,, 1986: 105), and offers a certain method of allocating and distributing resources. Onee aspect of the governance structure is a system of norms and instruments that guarantees compliancee with the terms of transactions. In the absence of institutional restraints, the inclina-tionn of man to promote his own interests, and the consequent risk that the other party will not complyy with the terms of the transaction, will rule out the possibility of concluding complex exchangess (North, 1990a: 33 and 1984: 259). The guarantee can be internalised completely (i.e.. be within the relation itself), such as when an employer exercises authority over an em-ployee.. Enforcement can also occur through the expectation that non-compliance will be penalised,, for example through severance of a relationship. Sometimes this is the only way of penalisingg a violator, for instance, when parties are unwilling or unable to submit their dispute too a third party. Under these circumstances, the agreement can only work if it is self-enforcing, i.e.. if non-performance is against the interest of each party (Telser, 1980). A party will not breachh the relationship if the terms of the agreement or value of the relationship (including the possibilityy of beneficial future trade) are such that the benefits outweigh the costs of adherence. Thee incentive to adhere to the agreement is reinforced in cases where parties do not know whichh transaction will be the last (ibid.: 28, Axelrod, 1984: 188, Zajac, Olsen, 1993: 137, OECD,, 1997: 84). Internal guarantees are sometimes the most efficient as the parties concernedd can devise more satisfactory solutions to their disputes than can professionals who aree constrained to apply general rules on the basis of their limited knowledge of the dispute (Williamson,, 1999a: 130, citing Galanter, 1981). In other situations internal guarantees leave thee parties with too much uncertainty and fail to protect their property rights adequately. An externall compliance mechanism is then necessary. There are various forms of external mechanisms.. They include social norms, which can exert environmental pressure upon a party, andd most importantly they include a system of legal enforcement by a third party. The creation andd maintenance of such a system of third party enforcement is traditionally a task of the state becausee the state has sovereign powers. This implies that sovereignty, or a sovereign power, is importantt for a system of property rights (North, 1981: 21 and 1984, Dugger, 1993: 183 and 189).. In addition to compliance mechanisms, a governance structure contains a system of communicationn to convey information on the good and associated conditions to the trading partners.. The conclusion and execution of the transaction also call for processes and routines,

ass well as 'a set of constraints or arrangements that govern the behavioural relations amongst individualss and groups' (North, 1991: 97). These institutions can help to structure the relationshipss among individuals in a predictable way (Shepsle, 1986: 52), thereby towering uncertaintyy and diminishing the need for guarantees that would otherwise be an explicit elementt of the governance structure3.

Inn traditional microeconomics the market is the governance structure that co-ordinates resourcee allocation. However, there are other governance structures, as will be seen in Section 2.7.. The next sections describe the costs associated with transactions and the factors that accountt for their existence.

2.33 - Transaction costs

Thee central tenet of transaction cost economics is that economic activities will be organised efficiently,, in the sense that the total costs incurred in the transaction process will be minimised (Vann der Zaal, 1997: 155). Efficiency is usually considered from the perspective of the costs of physicall production. However, as observed in Section 2.2, the maximisation of utility requires exchange44 and transacting involves a claim on productive resources, i.e. it generates costs. Thesee 'transaction costs' do not flow from production as such, but constitute the 'costs of runningg the economic system* (Williamson, 1985: 18): they are the costs incurred to prepare, concludee and execute transactions. They are also referred to as 'the costs of running the contractuall relation', emphasising the contractual elements of the transaction (MacNeU, 1981:

1018-1063,, Kneppers, 1988: 59)5. Williamson (1985: 1-2) refers to transaction costs as the economicc equivalent of friction in physical systems. The word 'friction* can give rise to misunderstanding,, since it might suggest that exchange is problematic. Even when exchange proceedss smoothly, however, costs will be incurred in the transaction process, as will be seen inn this section.

Economistss did not pay any attention to transaction costs until the publication of 'The naturee of the firm' by Coase (1937). Following Commons (1934), who gave the transaction a centrall place in his analyses, Coase posed the question of why not all exchange takes place via thee market, given that the market supposedly co-ordinates any exchange through the price mechanism.. He saw the answer in the costs generated by the use of the market, arguing that

Thee institutional environment influences the options from which individuals can choose. In this way, the institutionall environment can influence the course of development of a society (North, 1990a: 78). Note that the institutionall environment itself may also change over time (North, 1978).

Thee Coase theorem states that externalities and ouw econoimc inefficiencies wül be c o n e ^

betweenn thee affected parties (Saroodson, Nordhsus, 1992:732). Tlu^ however, is based on the unrealistic assumptionn that transactions can be prepared, conchided and executed costtessly.

Otherr definitions of transaction costs are 'costs of the exchange of titles of ownership' (Demsetz, 1990:64), andd 'apparently any costs necessarily incident to a tiansactiofl or series ofbinsactioiis above and beyond productionn costs' (Maiuand, 1985:60).

thesee costs justified the existence of the firm as an alternative governance structure6. Sometimes,, the firm is the best resource allocation mechanism, and sometimes the market servess best. Differential transaction costs will give rise to a discriminating assignment of transactionss to governance structures (Williamson, 1996b: 16-17). In his article 'The problem off social cost' (I960), Coase extends the argument to the assignment of property rights to productivee resources. In Coase's opinion, the efficiency of an allocation does not depend on thee initial distribution of property rights provided that there are no transaction costs. Starting fromm a certain assignment, parties will conclude transactions to arrive at a result that maximises utility.. In reality, however, the transaction process generates costs so that the initial assignment off property rights matters. According to Coase and the theory of property rights developed subsequentlyy (Vromen and Groenewegen, 1996: 368,375), property rights need to be assigned inn a manner that minimises transaction costs.

Givenn sufficiently high costs, some transactions might not take place, resulting in a lower welfaree than would otherwise be possible. Similarly, a suboptimal allocation of property rights mayy generate unnecessary transactions7.

Thee literature (among others: Williamson, 1985: 20-21, Kneppers, 1988: 59) generally categorisess transaction costs as follows:

1.. the pre-contractual costs associated with gathering information (e.g. on the relevant prices, trustworthinesss and creditworthiness of the other party) and searching for a contract partner, ,

2.. the costs associated with concluding (negotiating) the agreement, 3.. the costs associated with drafting the agreement,

4.. the costs associated with executing the agreement,

5.. the costs resulting from checking compliance with the agreement,

6.. the costs generated by conflicts arising between the parties after the conclusion of the agreement, ,

7.. the costs incurred in amending the agreement and

8.. the costs associated with enforcing compliance with the terms of the agreement.

Thee costs in 1, 2 and 3 are incurred prior to concluding the agreement. They constitute the ex antee transaction costs of identifying a transaction opportunity, selecting a trading partner, negotiatingg and drafting the agreement and organising supervision. After the agreement has beenn concluded a number of costs will arise. The parties might feel a need to monitor the

Inn this explanation, other factored can e

ignored.. This is one of the critiasrns of transaction cost analjró. Fiuthermore, Sawyw (1993: 33) opines th^, sincee te primary nmctkm of a fira is piod^

alsoo Fourie (1993:44) and infra, pp. 27-28.

Chapterr VI will look into the option of a different assignment of property rights. 13 3

executionn of the agreement, and in case of a deviation from its terms, it might be necessary to enforcee compliance using legal remedies. Furthermore, the agreement will not cover every contingency,, and responding to unforeseen events will lead to ex post transaction costs. A changee in circumstances that prevailed when the transaction was concluded may require a changee in the agreement and generate negotiating costs. A distinction between ex ante and ex postt costs can be arbitrary. Consider, for example, a situation where two parties foresee a sequencee of transactions with each other. The costs that are ex post with respect to one transactionn may alter behaviour - and thereby the level of transaction costs - in a subsequent transactionn (Bokkes, 1989: 37-38). For instance, recurrent transacting can lead to trust, which couldd induce parties to put less effort into fully detailing the terms of any agreement and to foregoo some compliance monitoring. However, a division of the transaction process into phasess is useful in that the factors responsible for transaction costs may be analysed more accurately.. The analysis below uses an extended version of a division by Noteboom (1996: 340).. The transaction process is split into three stages, the first two stages accounting for ex antee costs and the third for ex post costs8.

1.. the contact phase - identifying a transaction opportunity, searching for and evaluating potentiall trading partners,

2.. the contract phase - drafting and negotiating the terms of the transaction and

3.. the execution phase - execution of the transaction, performance monitoring, compliance andd dispute resolution as well as minor adjustments of conditions not requiring a formal negotiation. .

Thee costs incurred in performing the activities belonging to a particular phase will be ascribed too that phase.

Somee authors define transaction costs as the costs incurred to create, use or change a governancee structure and suggest using the term 'co-ordination costs*. They argue that this termm makes clear that not only transactions but also ways of allocating resources not readily associatedd with exchange are covered (for example, Bokkes, 1989, or Kay, 1993: 257). Raes andd Willekens (1994: 25) also refer to costs incurred to arrange for the allocation of resources. Apartt from the costs associated with exchanges between parties, transaction costs include costss resulting from unilateral decisions by the state that affect a governance structure. Some exampless are the cost of imposing a new regulation on firms and the cost of compliance with thiss regulation. These costs are important in the early existence of a new governance structure9,, but they are one-off costs that are negligible in the long run. For this reason, they 88

The phase during which the transaction is implemented is refaral to a s ' e x ^ ^ phase',, which is the term used by Noteboom, to avoid any confusion wittitt» tem'eralior off opportunism (infia, Section 2.4.5).

Forr instance, they influence the ease with which an mdiistry adapts to new conditions. 14 4

willl not be included in the analysis, although Chapter VI will comment on the costs of creating thee current Community structure in the context of air transport.

Whilee there is common agreement on the notion that transacting will give rise to certain costs,, there is less unanimity on the content of the concept. Transaction costs are not easy to operationalisee (Phelis, 1993: 12) and there is a danger that all costs will be subsumed under the concept.. As a result, transaction cost analysis has attracted a great deal of criticism10. A start too giving more operational content to transaction costs can be made by defining and analysing thee factors that are responsible for their existence. This will be done in the next section. 2.44 - Factors influencing transaction costs

Ass Williamson suggests (1985: 30) transaction costs can be explained by the presence and interactionn of two types of factors, namely individual attributes and transaction characteristics. Theyy will be referred to as 'core dimensions', following Van der Zaal (1997). The individual attributess are the behavioural assumption of opportunism and the human attribute of bounded rationality,, which will be described in Sections 2.4.4 and 2.4.5. The transaction characteristics aree discussed below.

Inn a society characterised by numerous combinations of resources, used to create numerous productss and services, there are numerous transactions. These transactions exhibit a variety of characteristics.. Abstracting from such differences as the object of trade and the objectives of parties,, the characteristics of a transaction can be reduced to (Williamson, 1986: 111): 1.. the frequency with which the transaction occurs,

2.. the uncertainty that is associated with the transaction and 33 the degree of asset specificity associated with the transaction.

Thee following sections explain the factors that determine these characteristics. 2.4.11 -Frequency

Ann important factor influencing transaction costs is the frequency of the transaction. Frequency cann be characterised as one-time, occasional and recurrent. On the one hand, one-time transactionss are relatively simple. Parties agree to meet only once, they do not have a relationshipp and are not looking to create one. A motorist, for example, engages in a one-time transactionn when he refuels on a long-distance trip far from home (De Vos, 1987: 272-290, Kneppers,, 1989: 65). On the other hand, the absence of a prior relationship and consequent lackk of a reputation for reliability could mean that a party will feel a need to devise safeguards againstt a breach of agreement by the other party. In the refuelling example, the question could arisee of who will guarantee that the amount of petrol paid for is actually obtained. This could leadd to elaborate monitoring or a legal system of obligatory calibration of petrol pumps,

coupledd with an awareness that non-compliance is penalised. This knowledge influences (constrains)) behaviour (Van Dijk, 1998). One-time transactions thus need not be simple at all. However,, few transactions are truly one-time. The following discussion of the factors that influencee the transaction frequency apply not to one-time transactions but to occasional and recurrentt transactions.

Onee determinant of the transaction frequency is the nature of the good or service transacted.. Public transport, for example, has a high frequency of exchange because of both productt and demand characteristics: it is consumed regularly but it is perishable. For a given levell of consumption, the more perishable is a good, the higher the frequency of transacting. Thee frequency of the transaction is also increasing in the number of alternatives. A large numberr of alternative suppliers and strong competition among them lowers the cost of swit-chingg to other sources of supply. The transaction frequency also rises with an increase in the dynamismm of the environment. For a given agreement, the more dynamic the environment, the moree quickly the agreement becomes inadequate and the greater the need to re-negotiate. Finally,, the flexibility of the relationship affects the transaction frequency. This determinant appliess to the transaction process as well as the ultimate document which formalises the transaction.. If the transaction process is flexible, parties can tailor their relationship by taking intoo account every single need. However, if the ensuing agreement is rigid, the terms of the agreementt will eventually cease to reflect economic conditions. For instance, prices fixed in the agreementt may cease to reflect opportunity costs. The agreement will then give parties inappropriatee production and consumption incentives. Furthermore, a party that feds disadvantagedd by a misalignment between the agreement and the market has an incentive to deviatee from the contract or to negotiate more favourable terms. In order to bring the agreementt back into line with economic conditions, it might be necessary to conclude a new transaction.. A lack of flexibility thereby raises the transaction frequency. Conversely, flexibility offeredd by a framework agreement or an agreement containing procedures that allow parties to adjustt to new circumstances is likely to reduce the transaction frequency (Crocker, 1996: 94).

Tablee 2.1 shows the relationship between the transaction frequency and its determinants.

Determinant t Perishability y

Existencee of alternatives / competition Dynamismm of the environment

Effectt on transaction frequency Positive e

Positive e Positive e

—. . 100

For example, Hodgson (1993) and Pilelis (1996). 16 6

Flexibilityy of the relationship, i.e. of the transac- Negative tiontion process and the agreement

Tablee 2.1

Itt might seem that a high transaction frequency should generate high transaction costs. The argumentt is simple: new transactions lead to new negotiations and more drafting. But, as total costss rise, a higher frequency can induce transacting parties to standardise the transaction process,, thus lowering average transaction costs. Reinforcing the downward effect on transactionn costs are the information and reputation effects of repeated dealings with the same parties.. Repeated transactions enable parties to learn about and monitor each other, while informationn acquired in earlier transactions can be used in later transactions (Ménard, 1996: 158).. Parties also need to gather and process less information because they can re-negotiate or easilyy amend their relationship to bring it into line with economic conditions. An established reputationn engenders trust and reduces the incentive to engage in opportunistic behaviour and hencee the need for elaborate contracting and monitoring mechanisms. The influence of opportunismm is lowered even further as adjustments in the relationship during the execution phasee require fewer corrective measures and less haggling in the contract phase (ibid.: 160). A highh frequency can thus reduce the level of ex ante as well as ex post transaction costs. If conditionss that prevail at the conclusion of the agreement tend to change unexpectedly, then frequentt re-negotiation can prevent the costs associated with agreements that become outdated.. In this way a high frequency can offer the flexibility that may not be provided by an agreement,, once h has been negotiated. The ultimate effect of the transaction frequency on transactionn costs is indeterminate and very much dependent on the relative strength of the factorss discussed above.

2.4.22 - Uncertainty

Inn addition to differences in frequency, transactions exhibit various degrees of uncertainty. Uncertaintyy means ignorance and the need to act on the basis of opinion rather than knowledge orr fact (Knight, 1965: 268). When there is uncertainty, a party cannot determine the probability thatt an event will occur and is therefore unable to cover the negative consequences of the eventt through insurance11. Uncertainty can pertain to many elements of the transaction. It can pertainn to the characteristics of the good transacted, the objectives of the transacting parties, futuree market conditions, or the terms of the transaction. Transactions that are certain are relativelyy uninteresting from the perspective of this thesis. All situations could be anticipated

111

Uiicertainty is not the same as risfc In a situation of risl^

throughh actuarial compulation. With this ooinpntation^ a premium can be established and insurance be^ possiblee (North, 1990a: 126).

andd taken into consideration in the relationship. The governance structure used would become irrelevant;; only the time needed to reach agreement would vary. In the real world, however, uncertaintyy is prevalent.

Followingg Van der Zaal (1997: 142-144), four factors are identified as determinants of uncertainty.. These are the complexity of the transaction, the dynamism of the environment as welll as the information gathering and information processing capacities of the parties12. The transactionn may be complex because of such factors as the objectives of parties, the charac-teristicss of suppliers, or changes in the institutional environment. The environment may be dynamicc because of a large number of competitors and the absence of barriers to market entry. Thee level of uncertainty associated with a transaction increases as the transaction becomes moree complex or the environment more dynamic. The parties' information gathering capacities determinee their ability to access the information relevant to the transaction and transaction partner.. Their information processing capacity enables them to co-ordinate between possibly conflictingg objectives or to deal with changes in the institutional environment. A greater informationn gathering or processing capacity reduces uncertainty as it enables better and faster insightss into new developments and allows information on the nature of the good or the objectivess to be understood more easily.

Tablee 2.2 summarises the effects of these variables on the level of uncertainty.

Determinant t

Complexityy of the transaction Dynamismm of the environment Informationn gathering capacity Informationn processing capacity

Effectt on uncertainty Positive e Positive e Negative e Negative e Tablee 2.2

Peoplee generally prefer a sure thing to uncertainty and, if transactors face uncertainty, they will tryy to limit its influence by stracturing their relationship accordingly. They might engage in costlyy information-gathering activities during the contract phase or write elaborate agreements. Theyy might also spend more time negotiating. In this way uncertainty can lead to high ex ante transactionn costs. Ex post transaction costs are also affected because uncertainty will induce

Unlikee Van der Zaal, there is no division into internal and external factors. Complexity, considered an externall factor by Van der Zaal, can also be internal in the sense u ^ ü can ar*ty to UK objectives of transactingg parties.