Relationship Economics: The Core Ideas

Introduction to Relationship Economics

Relationship economics is a form of Ronald Coase's transaction cost economics which hypothesizes that the costs of forming and maintaining personal relationships, and the benefits of those relationships, dominate decision-making in many contexts. It therefore emphasizes the capital element in transaction cost economics, an element that Brian Loasby (1996: 46) notes has often been overlooked by economists:

Casson (1982: 179) concludes that 'the set-up costs of a market organization are likely to be quite high compared with its recurrent costs'... [T]his emphasis on the capital element in transaction costs, which Casson shares with Marshall, is surprisingly rare in transaction cost analysis.

A look at everyday life, however, confirms that decisions about relationships are often more important than decisions about transactions. The importance of relational decisions was noted by Friedrich Hayek (1948: 97):

In actual life the fact that our inadequate knowledge of the available commodities or services is made up for by our experience with the persons or firms supplying them ... is one of the most important facts which enables us to solve our daily problems. The function of competition is here to teach us who will serve us well: which grocer or travel agency, which department store or hotel, which doctor or solicitor.

Thus people often choose a travel agent while leaving to later dates decisions about whether, when, and how to take vacations; choose a grocer while leaving to later dates decisions about whether and when to buy bananas or apples; choose a dentist while leaving to later dates decisions about cleanings, root canals, and crowns. And for the travel agent, grocer, and dentist, it is the consumer's relational decision that is critical to his business success, not the later transactional decisions. The grocer may not care whether you buy bananas or apples, but he does care that you choose him as your source for food. The grocer, like most businesses, competes for your relationship, not your transactions.

As in the grocery business, so also in the largest and most complex businesses are relational decisions primary. Famed CEO Jack Welch (Welch and Byrne 2001: 348) offered this as his "cardinal rule of business":

Never allow anyone to get between you and your customers or your suppliers. Those relationships take too long to develop and are too valuable to lose.

Welch's rule is difficult to reconcile with neoclassical economics, as the perfectly competitive model assumes that alternative and equally suitable relationship partners can be acquired costlessly.

Ronald Coase's enumeration (1960: 114) of the sources of transaction cost suggests that he intended 'transaction costs' to embrace the costs of finding a suitable relationship partner:

In order to carry out a market transaction, it is necessary to discover who it is that one wishes to deal with ... and on what terms ...

However, despite Coase's suggestion, economists have made little progress in accounting for the costs of choosing with whom to deal.

Sociologists, especially since Mark Granovetter's stimulating 1985 paper, have often pointed out the need to study relational decisions. James Coleman (1988: S97) made the excellent observation that

social organization and social relations [should be seen] not merely as a structure that springs into place to fulfill an economic function, but as a structure with history and continuity that give it an independent effect on the functioning of economic systems.

From the standpoint of relationship economics, the structure that Coleman refers to consists of networks of personal relationships. New relationships do not automatically "spring into place" whenever there is an economic opportunity, because relationships are costly to create. The social structure has an independent effect on decisions because the costliness of transactional alternatives depends upon which, and what kind of, relationships exist. The social structure has history and continuity because it is costly to abandon old relationships, and so social structure tends to evolve incrementally.

I would say of relationship economics what Ronald Coase (1991: 3) said of transaction cost economics:

My contribution to economics has been to urge the inclusion in our analysis of features of the economic system so obvious that, like the postman in G. K. Chesterton's Father Brown tale, "The Invisible Man," they have tended to be overlooked. Nevertheless, once included in the analysis, they will, as I believe, bring about a complete change in the structure of economic theory ...

Relationship economics is thus an effort to bring to fruition the new growth of theory that Coase initiated.

References

Casson, Mark (1982) The Entrepreneur: An Economic Theory, Oxford: Martin Robertson.
Coase, Ronald H. (1960) 'The Problem of Social Cost,' Journal of Law and Economics 3 (Oct 1960); in Coase (1988), pp 95-156.
Coase, Ronald H. (1988) The Firm the Market and the Law, Chicago: University of Chicago Press.
Coase, Ronald H. (1991) 'The Institutional Structure of Production' (Nobel address); in Coase (1994), pp 3-14.
Coase, Ronald H. (1994) Essays on Economics and Economists, Chicago: University of Chicago Press.
Coleman, J.S. (1988) 'Social Capital in the Creation of Human Capital,' American Journal of Sociology 94 (Supplement): 95-120.
Granovetter, Mark (1985) 'Economic Action and Social Structure: The Problem of Embeddedness,' American Journal of Sociology 91 (November 1985): 481-510.
Hayek, Friedrich (1946) 'The Meaning of Competition,' in Hayek (1948), pp 92-106.
Hayek, Friedrich (1948) Individualism and Economic Order, Chicago: University of Chicago Press.
Loasby, Brian J. (1996) 'The Organization of Industry,' in Foss, N. J. and Knudsen, C., eds., (1996) Towards A Competence Theory of the Firm, London: Routledge, pp 38-53.
Welch, Jack and John Byrne (2001) Jack: Straight From the Gut, New York: Warner Books.