Transaction costs

“If you make $30 per hour, you should outsource everything you do that you could hire someone else to do for less than $30.”  Rubbish. I don’t know how many times I’ve heard this advice. It sounds good, for about two seconds. But it doesn’t work because it ignores transaction costs.

Suppose you’re an accountant making $60,000 per year, an hourly rate of $30. If someone is standing in front of you and says “Hey, I’ll do your yard work for the next hour for $20. Why don’t you go inside and do an hour of accounting?” In that case, it makes sense to take the yard worker up on his offer (unless you want to work outside for non-monetary reasons). But reality is seldom so simple. First of all, if you are a salaried employee, you probably don’t have the option of putting in an extra hour’s work for an extra hour’s pay. But even if you do freelance accounting, you may not be able to find an hour’s work when you want it.

Say you have some freelance accounting to do, and you’d like to get out of your yard work. You’ve got to find someone to do the work unless there happens to be landscaper standing outside your door. You might ask friends for recommendations, search the web, make a few phone calls, etc. Finding a landscaper is easier than finding accounting work, but it still takes effort.

The effort necessary to find work or to find workers is called a transaction cost. So is negotiating compensation, drawing up contracts, etc. If you have a steady stream of accounting work, you might think “I’m going to need to free up some time to do this extra work. I’ll outsource some of my chores, like my yard work.” And that makes sense. But unless you have enough work at hand, it’s worthwhile to do many things for yourself that in theory you could pay someone else to do.

Transaction costs are not all bad. They give life stability and variety. Salaried jobs exist because transaction costs make it expensive to put every task out for bid. And we develop a variety of skills because it is impractical to ask someone else to do everything for us outside of our narrow professional specialization.

Related posts:

Parkinson’s law
Specialization is for insects
Organizational scar tissue

3 thoughts on “Transaction costs

  1. A major part of transaction costs is making sure that the work is done correctly, which is a problem with computer programming. Outsourcing to India may work, but not if it doubles or triples the amount of time spent writing specifications and checking that they are met.

  2. plus there’s the small matter of taxes. If you’re in a marginal 40% tax bracket, you will receive only $18 for the extra hour of work.

  3. Mostly, I’d rather do my own yard work. I need the exercise and my wife likes to get me out of the house. About the only thing I will pay good money for is a painter.

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