1.

Information technology, transaction

costs and globalization
INTRODUCTION

To some degree, information technology and globalization can be separately

analysed, because there are numerous respects in which these two phenomena
are independent of one another. Defined in terms of an intensification of
global trade and foreign investment, globalization can be partly attributed for
example to the widespread liberalization of policy that has taken place in
recent years (under the aegis in some cases of the World Bank and the IMF).1
By the same token, there are clearly applications of information technology
that cannot be said to enhance these (or other) economic relationships to which
the concept of globalization usually refers. The mere use of a computer, for
example, often has no bearing at all on the relationship of the user to other
countries.
Even when information technology does serve to promote globalization,
moreover, this influence is exerted through a wide variety of different
mechanisms, some of which lie on the demand side, while others lie on the
supply side, some of which affect trade between independent firms while
others affect trade within multinational corporations. It is not our intention
in this chapter to describe the full range of these mechanisms.2 Our goal,
rather, is to show that many of them can be interpreted in one way or another
as a reduction in the costs of transactions between agents in different
countries.

THE CONCEPT OF TRANSACTIONS COSTS

As defined by the New Palgrave Dictionary of Economics,

Transaction costs, like production costs, are a catch-all term for a heterogeneous
assortment of inputs. The parties to a contract have to find each other, they have to
communicate and to exchange information. The goods must be described,
inspected, weighed and measured. Contracts are drawn up, lawyers may be
consulted, title is transferred and records have to be kept. (New Palgrave Dictionary
of Economics (1988) p. 676)

11
12 Conceptualizing the influence of IT on globalization

Thus defined,

Transactions costs, by and large, reduce the volume of transactions. In general

equilibrium without transactions costs, the network of exchanges is indeterminate,
there is no constraint on the gross trading volume. With increasingly costly
transactions, individuals have an ever stronger incentive to economize transactions.
(ibid, p. 677, emphasis added)

In developing countries where information flows on both sides of the

market are typically constrained by poor telecommunications, and where
property rights are often ill-defined, the costs of transactions may be especially
high. And even in the context of modern, developed countries, it can be argued
that a large and growing proportion of resources is allocated to these types of
costs.3 The question that needs to be addressed, therefore, is the manner in
which information technology, by reducing the various types of transaction
costs that pervade economic life (especially in the poorest parts of the world),
is able to induce a greater degree of global integration than would otherwise
be possible. Note that this is not a question normally posed in international
trade theory, which, in common with other traditional theoretical analyses of
(perfect) markets, assumes that transaction costs are zero (indeed, it is difficult
to find even a mention of these costs in most textbooks on the subject).4 Note
too that the question we are about to address is not concerned with the separate
concept of transport costs, which arise once a transaction between buyer and
seller has actually been completed. This is not meant to deny the importance
of these costs to globalization or the fact that they have also been greatly
influenced by technical change. In fact, a series of technological changes
known broadly as ‘containerization’ has

had huge consequences for world trade. The most obvious was that the costs of
shipping fell precipitously, as ships could be loaded by a few dozen longshoremen
rather than hundreds, and as pilferage was much reduced. The need to build wooden
crates to protect individual items was eliminated, making it feasible to ship
consumer goods such as toys and stereo systems halfway around the world.
International shipping capacity soared ... driven by large increases in the volume of
goods shipped. (The Economist (1997) p. 13)

INFORMATION TECHNOLOGY AND TRANSACTIONS

COSTS
As defined above, transactions costs arise because of the real resource and
time costs involved in the striking of bargains between buyers and sellers. In
this section we show how such costs are reduced by the application of infor-
mation technology and, in particular, we shall argue that there are a number of
 Information technology, transaction costs and globalization 13

distinct mechanisms through which this occurs. In this regard it is important

to distinguish between different types of such technology as well as the rela-
tionships between them. And since telecommunications is the basis on which
many other applications of information technology crucially depend, it is the
role played by this particular type of technology that we shall consider first.

TELECOMMUNICATIONS AND INFORMATION

TECHNOLOGY
As is well known, telecommunications infrastructure is most acutely lacking
in developing countries and so too therefore tend to be the costs of undertaking
transactions in and with those countries.

First, in many less developed economies there is a lack of readily available

information, which is costly. Decisions are not made or are made slowly because
agents do not know the alternatives. In short, the information markets are relatively
inefficient compared to those in the developed world. Second, in addition to their
effect in information markets, telecommunications are extremely important to the
functioning of product and factor markets. A telecommunications infrastructure
reduces transactions costs in numerous markets and leads in turn to higher
aggregate output. In terms of Edmund Phelp’s famous ‘island economy’ metaphor,
telecommunications in effect reduce the distance between the islands by facilitating
the flow of information. Thus, when a telecommunications infrastructure exists,
equilibrium-idle resources are lower, or markets are more efficient than when one
does not. (Norton (1992) p. 177)

One of the main ways in which information technology has helped to reduce
the transactions costs cited in this quotation is through the replacement of
analogue by digital switching equipment.5 Switching equipment is the ‘nerve
centre’ or core of the telecommunications network and digital switching tends
to be cheaper, faster and more efficient than the previous generation of
electromechanical exchanges (where the former is defined as switching in
which digitized signals are switched without converting them to or from
analogue signals). The new electronic technology seemed to offer developing
countries not only the chance of extending their more or less inadequate
telecommunications systems, but also the opportunity of engaging in
technological leapfrogging (that is, of assimilating the new technology even
more rapidly than the developed countries and hence of exacting greater
reductions in transactions costs).
Electronic switching, so the argument runs, allows technological
leapfrogging for two reasons. The first is that
Integrating the new electronic switching exchanges into an electromechanical
infrastructure is much more expensive and technically complex than building a
14 Conceptualizing the influence of IT on globalization

network of entirely electronic switching from scratch. The cost of integrating a fully
digital exchange into an electromechanical network involves the purchasing and
installation of gateway technologies that can add as much as 30 to 40 per cent of
original digital lines’ costs. (Antonelli (1990) p. 35)

The second reason is that it is developed rather than developing countries that
usually tend to suffer from this particular disadvantage, that is, of being
encumbered by large established electromechanical networks. Together, these
two recognitions imply that the latter countries ‘had a remarkable opportunity
to completely leapfrog the electromechanical technology, avoiding the
expense of replacing obsolete (though young in age) capital stock and
problems of technological cumulativity, and start their telecommunications
infrastructure from scratch’ (Antonelli (1990) p. 71).
In the 1970s and 80s this opportunity was grasped most firmly by the first
and second-tier newly industrializing countries in Asia. ‘Less committed to
older technologies and suppliers, they leaped to advanced electronics’ (Hanna
et al. (1996) p. 190). Several examples, taken from the period 1977-1987,
serve to illustrate the process of leapfrogging that then occurred.
The most striking case is that of South Korea, where diffusion (of electronic
switching technology) reached the 10 per cent benchmark in 1981, four years
after the United States, but then reached 70.3 per cent in 1987. In Malaysia,
electronic switching accounted in 1977 for 7.4 per cent of total capacity of
switching lines - as much as in the United Kingdom but less than in Canada -
but by 1987 it had reached 64.3 per cent, a higher level than in both countries
(Antonelli (1990) p. 44).
The technological leapfrogging thus achieved by these and other Asian
countries helps to account for the rapid rates of growth in the number of main
telephone lines per 100 inhabitants that were recorded in the region over the
same period. Not surprisingly, for example, the most outstanding performance
again took place in South Korea where the number of main lines grew five-
fold, from 4.2 per cent in 1977 to 20.7 per cent ten years later. In Malaysia, as
well, the rate of growth was rapid, with the number of main lines rising from
1.8 to 7.2 per cent over the same period.6
In subsequent years, a number of developing countries other than the first
and second-tier NICs have also made considerable strides in bringing more
main lines into use on the basis of digital switching technologies. From the
point of view of their role in reducing transactions costs in developing
countries, perhaps the most interesting cases are those which have succeeded
in bringing telephone lines to outlying rural areas on the basis of small-scale
digital exchanges. (The point being that the costs of transactions tend to be
highest in areas most lacking in access to telephones and other forms of
communications.) India has probably been most successful in this regard (on
account of having established 25 000 small-capacity digital exchanges in the
 Information technology, transaction costs and globalization 15

rural areas) but exchanges of this type can also be found in remote parts of
Sub-Saharan Africa.7

Mobile Phones

In spite of the use of digital switching technology that has thus already been
made by some developing countries, there are still large parts of the Third
World that lack access to fixed telephone lines. In some such regions, mobile
phones are increasingly coming to serve as a substitute for these missing lines,
especially but not only outside the capital cities of the countries in question,
partly, it seems, because

cellular operators ... have some inherent advantages over fixed-line companies
when it comes to venturing into poor and isolated areas. Their costs are much lower,
because they do not have to dig holes in the ground and lay expensive copper wire
to get to their customers. ... They can break even with a much smaller number of
subscribers. They can also install new phone services much faster than landline
companies. Lucent Technologies, for example, installed 800 base stations in some
of the remotest bits of Argentina - enough to bring a telephone service to half a
million previously isolated people - in just five months.8

Estimates for a number of developing countries can be used to illustrate just

how far mobile phones have come in substituting for fixed lines that are
difficult to obtain or are entirely unavailable. For example,

In Cambodia, according to the ITU [International Telecommunications Union], 60

per cent of all telephone subscribers now use mobile cellular. Fixed lines account
for a mere 25 per cent and fixed wireless for the rest. In several other Asian
countries - such as the Philippines, Sri Lanka and Thailand - more than 20 per cent
of all telephone subscribers (who in those countries make up a minority of the
population) now have cellular phones. (Cairncross (1997) p. 18)

It seems reasonable to conclude from examples such as these that mobile

phones are ‘bringing many people into the world economy who have hitherto
been excluded from it, and who would probably remain excluded if they had
to rely on fixed-line phones’ (Wooldridge (1999) p. 21). And to the extent that
these otherwise excluded persons are induced by the lower costs of
international transactions to engage in trade, global integration will be
intensified as a result.9

The Internet and Transactions Costs

So numerous are the ways in which the Internet reduces transactions costs
between economic agents that our discussion of the issue has necessarily to be
16 Conceptualizing the influence of IT on globalization

illustrative rather than exhaustive. The cases that follow, therefore, in no way
purport to represent all the possibilities that could have been cited and they
thus tend to underestimate the impact of the Internet on trade in goods and
services.

1. Simplification of the procurement process

A recent document prepared by the US Department of Commerce (2000)
illustrates in considerable detail how the complexity of the procurement
process at the General Electric Corporation was simplified by shifting
purchasing from an essentially manual system to one using the Internet. Under
the former system, for example,
For each requisition, the accompanying blueprints had to be requested from storage,
retrieved from the vault, transported on site, photocopied, folded, attached to paper
requisition forms with quote sheets, stuffed into envelopes and mailed out. ... Now,
the sourcing department receives the requisitions electronically from its internal
customers and can send off a bid package to suppliers around the world via the
Internet.10

Even for a small company operating in a poor country, however, the Internet
can yield substantial gains during the procurement process, as the following
example from Tanzania clearly demonstrates. In particular,

Tanzania Regent Clearing and Forwarding (TRCF), a small import-export

company, now uses $20 international faxes and telexes to place orders for products
in North America and Europe. As a result, the company has seen its telecommunica-
tions bill fall from $ 500 to $ 45 per month. Meanwhile, stationery costs for fax and
telex paper have been eliminated, along with time-wasting, expensive and error-
prone typing of documents.
With cheap and almost immediate access to many of its suppliers, TRCF now is
able to place a series of orders each day as they come in, instead of having to wait
to consolidate orders in one fax or telex. (Jensen (1998) p. 4)

2. New opportunities for trade in existing goods

Trade, as noted above, is often limited because of the difficulties confronted
by buyers and sellers in actually coming into contact with one another. Some
of these difficulties (which in effect translate themselves into high transactions
costs) can be overcome (or at least reduced) by the Internet simply because it
‘operates around the clock and around the world. As a result, business on the
Web can reach new markets they could not reach effectively with an in-person
sales force or advertising campaigns’ (US Department of Commerce (2000)
p. 20).

For instance, a plastics commodity specialist at a large manufacturer can sit down
at his PC, click on a Web browser and search for suppliers selling industrial plastics
online. A small supplier with a limited sales force can now reach that buyer, getting
 Information technology, transaction costs and globalization 17

its first introduction online. Similarly, a vendor’s sales force may not be able to
reach the millions of home offices and small offices around the country. By having
an online presence and creating customized services for the small business market,
that vendor may develop a new, lucrative market, both within the US and globally.
Companies using the Internet to sell products find that they attract new
customers. For example, eighty per cent of the consumers and half of the small
business who purchased from Dell’s Web site had never purchased from Dell
before. One out of four say that if not for the Web site, they would not have made
the purchase. And, their average purchase value is higher than Dell’s typical
customer. (US, Department of Commerce (2000) p. 21)

In the case of another large American corporation, W.W. Grainger, the new
trade opportunities that presented themselves after it had introduced an
Internet-based form of commerce appear to have had much to do with the
associated reduction in the costs of transacting with the corporation. In
particular, ‘Because the virtual store is open seven days a week, 24 hours a
day, customers who wouldn’t otherwise be able to order from a Grainger store
are now able to do so. In fact, more than 50 per cent of all orders are placed
after 5 p.m. and before 7 a.m. when the local store is closed’ (ibid., p. 21).
From the point of view of buyers new opportunities for trade also arise from
the wider selection of goods that is offered by the Internet in comparison with
more traditional modes of product search. The point is that,

The sheer number of stores that can be ‘visited’ online far exceeds even the most
densely populated retail areas. ... No longer do customers find their shopping
limited to the stores within a reasonable driving or walking distance or to the cata-
logues they receive in the mail. Online, customers can shop at stores in other states,
in other countries, and at stores that do not exist in traditional formats. ... Web sites
selling consumer electronics, gardening suppliers, office supplies and other hard
goods ... offer larger selections than do their counterparts in traditional retail.
The largest chain bookstores carry about 150,000 different books. On the Web,
readers can choose from 2.5 million titles under one roof, covering both in-print and
out-of-print books. (ibid., p. 41)

For consumers in developing countries, the range of choice in these as in

most other commodities is likely to be far more limited without the Internet
than it would be for consumers in the developed countries. Consequently, the
introduction of the Internet in the former regions will tend to generate
correspondingly more new opportunities for trade than when it is introduced
in the latter.11

3. Trade in services between countries

Apart from thus promoting trade in existing goods, information technology
also helps, one should emphasize, to bring certain previously untraded
services into the realm of international tradeability and that this too can be
partly explained in terms of transaction costs. The key point here is that in
18 Conceptualizing the influence of IT on globalization

some cases, information technology obviates the need for physical contact
between buyers and sellers of services and hence eliminates the transaction
costs incurred in bringing about such contact. It is now possible, for example,
to purchase medical or educational services over the Internet from sellers
located throughout the world, rather than, as before, via direct physical contact
between the transacting parties12 (see also below in connection with the trade
in services within multinational corporations).

4. Shortening the duration of transactions

One way to estimate the reduction in transactions costs that is occasioned by
information technology is to compare the time taken to perform a given
transaction (or a part thereof) with and without the Internet. The result of one
such exercise is shown in Figure 1.1.
The three activities mentioned in Figure 1.1 are finding a high-rate
certificate of deposit, reordering an inventory item and updating an equity

The benefits of interacting

Time (minutes)
Search
Finding a high-rate certificate of deposit
Telephone 25.0
WWW 10.0 –60%
WWW with agent 1.0 –90%

Co-ordination
Reordering an inventory item
Mail 3.7
E-mail 1.6 –57%
EDI 0.3 –81%

Monitoring
Updating an equity portfolio
Newspaper 5.1
WWW 1.8 –65%
Future network 0.5 –72%
(estimated*)

Note: Intelligent agents, high-speed access and encryption.

Source: Cairncross (1997).

Figure 1.1 Internet and the duration of transactions

 Information technology, transaction costs and globalization 19

portfolio. In the case of the first-mentioned activity, what might take 25

minutes to complete on the telephone could take only a minute using the
Internet and some specialized search software. Sizeable gains in time are also
apparent with regard to the other two activities, when the Internet is
substituted for more traditional modes of communication.13

Information Technology, Transaction Costs and Foreign Investment

So far, we have said little about the links between information technology,
transactions costs and foreign investment, which, as a percentage of world
gross domestic product, is often cited as an indicator of globalization. Yet, just
as the influence of information technology on transactions costs appears to
promote trade between independent parties, so too does it seem to facilitate
trade within the multinational corporation itself. According to Dunning and
Narula, for example,

new technologies have led to improved coordination of cross-border activities. ...

ICT information and communications technology has reduced both the costs of
acquiring and disseminating information and the transaction and coordination costs
associated with cross-border activity. ... MNEs are better able to integrate the
activities of their various affiliates through the use of these technologies and to
more quickly respond to changing conditions in the countries in which they operate.
Taken together, these transaction cost-reducing processes have enabled MNE
activity to be much more efficiently organised across borders. They have also
facilitated a shift towards more rationalised and strategic asset-seeking MNE
activity, and away from the more multi-domestic approach which was more
prevalent prior to the 1970s. (Dunning and Narula (1996) p. 809)

In one of the more striking manifestations of this particular causal nexus,

some large multinational corporations are now able to undertake R&D in
developing countries that are (geographically) far removed from corporate
headquarters.14 One example is Texas Instruments, which

has been able to perform geographically dispersed, but globally integrated, R&D
activities because of information and communication technologies that allow the
exchange of detailed integrated chip designs and scientific simulations across the
world without a time delay. Texas Instruments (India) has the latest HP and Sun
workstations and a variety of computers that are interconnected by a Local Area
Network, which in turn is connected to Texas Instruments’s worldwide data
communications network. Texas Instruments (India) is connected to it on a ‘real-
time’ basis through a dedicated 128 KB link, enabling the company to send and
receive the latest support information, design technology and applications
information for its products and services. (UNCTAD (1995) p. 153)

At the other end of the spectrum of technological complexity, multinational

corporations also make use of information technology to locate routine data-
20 Conceptualizing the influence of IT on globalization

processing activities in parts of the Third World and as such these firms take
advantage of and contribute to the increased tradeability of services that was
described above as being due in part to lower transaction costs. American
Airlines, for example,

assembles accounting material and ticket coupons in Dallas, Texas, for transport on
its scheduled flights to Barbados for processing by its offshore subsidiary. ... In
Barbados, details of 800 000 American Airline tickets are entered daily on a
computer screen and the data are returned by satellite to its data centre in the United
States. (UNCTAD (1996) p. 107)

CONCLUSIONS

One purpose of this chapter has been to illustrate the diversity of mechanisms
through which information technology promotes the ratios of international
trade and foreign investment to total output, especially, but not exclusively in
the developing parts of the global economy. Our main purpose, however, has
been to demonstrate that what is common to these various mechanisms
through which information technology influences globalization is that they all
involve, in one way or another, a reduction in the costs of transactions between
economic agents, whether they be consumers or firms, government or non-
government institutions, buyers or sellers.
Some of the reductions in transactions costs wrought by the new technology
make it easier for buyers and sellers to find one another, others are due to more
accurate information about the product to be traded, while still others enable
previously untraded services to be brought into the realm of international
tradeability. In these respects, the current wave of globalization and its
implications for different countries needs to be distinguished conceptually
from the similar degree of global economic integration that occurred in the
19th century, which was driven not, as now, by a drastic fall in the costs of
transactions, but rather by a fall in the costs of transporting goods from one
country to another.15

NOTES
1. For details see World Bank (1996).
2. For an extended discussion see James (1999).
3. This argument is made in The New Palgrave Dictionary of Economics (1989) under the
entry entitled ‘transactions costs’.
4. According to Apgar and Brown (1987) ‘In general, transactions costs arise because
striking bargains involve real resource and time costs’ (p. 229). They suggest, furthermore,
that ‘the costs of trading must be considered as a real cost just like the cost of production’
(ibid).