transaction costs – Page 2 – Pertinent Observations

The fundamental problem with the world economy

… is that wages are sticky.

With increased globalization, it has become significantly cheaper to produce certain goods and services in countries that were hitherto “low income” or “less developed’ or whatever you call it. In the past, in part due to protectionism at various levels and in part due to high transaction costs (transport, communication, etc.) “developed economies” such as the US or Europe had got adjusted to a reasonably high wage structure. In fact, it is possible that in the absence of trade with the rest of the world these countries might still be able to support that structure.

However, with the walls of protectionism and transaction costs falling, these traditionally high wage economies haven’t been able to compete with the up and coming economies where production costs are significantly lower. And because wages are sticky, i.e. it is impossibly hard to cut wages across the board, this has resulted in unemployment. Worse, a lot of other benefits (such as Social Security or Medicare in the US) have been set based on the high wage structure these countries used to enjoy.

And then you have unions, which makes it even tougher for you to cut wages which might make you competitive. It’s a combination of sticky wages and unionism that the various austerity measures in Greece haven’t managed to go through (of course, Greece has another set of problems in terms of law enforcement and tax collection).

And so, in short

1. Wages are sticky. Even though your current wages are not competitive enough, you can’t cut wages

2. That leads to high unemployment

3. That leads to lower economic activity and thus depression

4. The government needs to spend more to “stimulate” the economy, but hasn’t collected enough in good times. And the “level” of the economic cycle itself has gone down now. And the government itself has other obligations linked to the high wage levels

And so it goes. One thing I can think of is “devaluation” (in these times of floating currency rates, that term has lost all meaning), but then now these countries import so much that will again not be a good idea.

Fun!

PS: please note that this post has been filed under “Arbit”

Methods of Negotiations

There are fundamentally two ways in which you can negotiate a price. You can either bargain or set a fixed price. Bargaining induces temporary transaction costs – you might end up fighting even, as you are trying to negotiate. But in the process you and the counterparty are giving each other complete information of what you are thinking, and at every step in the process, there is some new information that is going into the price. Finally, if you do manage to strike a deal, it will turn out to be one that both of you like (ok I guess that’s a tautology). Even when there is no deal, you know you at least tried.

In a fixed price environment, on the other hand, you need to take into consideration what the other person thinks the price should be. There’s a fair bit of game theory involved and you constantly need to be guessing, about what the other person might be thinking, and probably adjust your price accordingly. There is no information flow during the course of the deal, and that can severely affect the chances of a deal happening. The consequences in terms of mental strain could be enormous in case you are really keen that the deal goes through.

Some people find the fixed price environment romantic. They think it’s romantic that one can think exactly on behalf of the counterparty and offer them a fair deal. What they fail to discount is the amount of thought process and guessing that actually goes in to the process of determining the “fair deal”. What they discount is the disappointment that has occurred in the past when they’ve been offered an unfair deal, and can do nothing about it because the price is fixed. But I guess that’s the deal about romance – you remember all the nice parts and ignore that similar conditions could lead to not-so-nice outcomes.

Bargaining, on the other hand has none of this romance. It involves short-term costs, fights even. But that’s the best way to go about it if you are keen on striking a deal. Unfortunately the romantics think it’s too unromantic (guess it’s because it’s too practical) and think that if you want a high probability of a deal, you should be willing to offer a fixed price. And the fight continues.. Or maybe not – it could even be a “take it or leave it” thing.