Any time individuals wish to exchange with one another there are transaction costs. The cost of travelling to the location of the exchange, choosing the goods or services and the quantity to buy or sell, settling on a price, communicating the price to the other party, agreeing on the terms of the sale; all of these are a part of the transaction cost of an exchange.

Transaction costs exist for non-material exchanges as well. There is a cost to you of reading this information and a cost for me typing it. There are costs incurred in forming social bonds like friendships or marriage – traveling to the places people meet, taking the time to get to know each other, the effort of putting thoughts into words through speech, trying to decide who is trustworthy, who will think your jokes are funny or who will be offended by them. None of these are insignificant costs, and many times the transaction cost of a social interaction, just like a market exchange, may deter us from engaging in the exchange at all.

The reduction of transaction costs plays an important role in shaping how humans interact with one another and how institutions evolve. Economist Ronald Coase noted that in markets for goods and services people often form cooperative enterprises, or firms, to reduce transaction costs. For example, when an auto mechanic wishes to contract with an accountant there are costs associated with finding an accountant, drawing up the contract, deciding and enforcing the terms, monitoring the activities of the accountant and, if need be, finding a new accountant if the results are unsatisfactory. The accountant incurs the same costs on his end of the exchange. The mechanic and accountant may decide to discontinue the high-cost practice of their contractual arrangement and form a single firm – an auto garage with an in-house finance department.

Firms are not the only mechanism that makes transactions less costly. In market and social arrangements societal norms and beliefs play a major role in reducing transaction costs. People with shared values and language can better communicate, rely on each other to fulfill promises, and behave in predictable ways, which greatly reduces search and information costs when engaging in exchange.

Religion is one of the strongest institutions of shared norms and beliefs. It provides a shortcut to individuals seeking to exchange by providing common terminology and assumptions that reduce the costly process of discovering the foundational beliefs that guide the actions of others. Predictability on the part of a partner in exchange is incredibly valuable, and shared religion provides a large degree of predictability. Thus, those with similar beliefs band together under the umbrella of a religious tradition and enjoy the reduced transaction costs of an easily identifiable brand, specialization within the institution, etc.

We see examples of religion being used to reduce transaction costs in the material sense all the time. Many businesses have the Ichthus symbol in their logo. In my home town there was a car dealership called “The Christian Car Company”. These businesses were attempting to signal potential customers that they had a predictable set of beliefs and would, presumably, conduct their business affairs in a way consistent with Christian values. The intent is to reduce the search cost on the part of customers looking for businesses with a particular ethic.

In non-material transactions religion also serves to reduce transaction costs. When I was on the dating market I spent much of my time involved with a church college group. Not because I was some kind of creepy stalker consciously looking for a wife, but because I sought to form friendships with the kind of girls I may someday want to marry and I thought it unlikely to find them in bars and clubs. I am not opposed to bars and clubs per se, but the transaction cost of forming relationships with people whose values I knew nothing about was much higher than it was for people who had at least somewhat of a shared philosophical and moral foundation. I grew up in church so I knew something about church people. It took me less time and effort to discover compatibility, since I could skip over many foundational beliefs and start with a common language and assumptions.

(I do not intend here to make religion into a purely economic institution. The fact that religion serves an important role in reducing transaction costs need not diminish the other spiritual, emotional, intellectual and physical roles it plays. Indeed, the practical benefits of religion seem to me to make it more, rather than less intriguing and sacred. Any married person can describe the material benefits of their marriage – a division of labor, economies of scale, ease of communication (sometimes) – yet no one I know would claim these material benefits are the only desirable thing about marriage or that they somehow diminish the romantic or emotional benefits.)

It cannot be denied the tremendous impact religion has on reducing transaction costs in our social exchanges, just as a firm does for material exchanges in the marketplace.

Agency Costs

If creating cooperative enterprises reduces transaction costs, why doesn’t the market evolve into one giant firm? There are benefits to creating a firm, but there are also costs.

One of the chief benefits of creating a firm is that each participant is freed up to spend more resources specializing in what they do best (or in economic terms, where their opportunity cost is lowest). This means that one or a few individuals serve in the role of manager, visionary, or entrepreneur, allowing the others to serve in their specialized roles. Not everyone has to create and maintain the goals of the firm, track the long-term outlook and make strategic “big-picture” decisions. Engineers don’t have to worry about branding, marketers can ignore supply chain management, and maintenance personnel need not concern themselves with bookkeeping. But where specialization within a firm reduces some costs, it increases others.

The larger the firm the harder it is for individual agents to hold each other accountable. The gains of reduced transaction costs may be more than offset by the losses from absence of competition. No one in the marketing department is likely to know whether or not the finance department is using the most efficient methods. A shared culture can reduce the risk of bad actors and instill trust, but as firm size increases the ability of culture to keep wayward individuals in check diminishes. These are called agency costs.

Public Choice Economics reveal how agency costs are starkly evident in political institutions. Most governments are so large and voters and taxpayers so many that the cost of a single government program or action is spread very thin over the population. Each individual citizen has very little incentive to spend valuable time and resources monitoring the behavior of a program for which their share of taxes is only a few cents. Those who are supposed to be filling a specific role within the government to benefit all citizens have incentive to stray far from the constraints of that role and serve interests other than those of the citizens.

Firms face these same problems. Shareholders, CEO’s, managers, board members, workers in different departments, contractors and customers often want different things and keeping all of their actions within the optimal range for the firm is impossible. An IT department, for example, may have every incentive to provide less than optimal services, since an increase in computer problems may lead to an increase in the department’s budget.

Small firms or individuals under contract can avoid many of these agency costs by engaging in continual competition and by having personal knowledge of each other. In a firm of just a few people it is much harder to get away with slacking or sub-optimal behavior. Short term contracts which can be bid out to many providers allow competitive pressure to produce better results. But, as we saw earlier, smaller firms or individual contractors also face high transaction costs.

This is why there is no optimal size for a firm. Instead, cooperative arrangements in the marketplace are constantly in flux, always trying to reduce both transaction costs and agency costs as much as possible. Terry Anderson and Peter J. Hill, in their excellent book The Not so Wild, Wild West discuss the ever-changing arrangements for protecting grazing land, mines and scarce water in the American West. Anderson and Hill talk about the “Institutional Entrepreneurs” who innovated and forged new arrangements when transaction costs or agency costs became prohibitive.

Just as religion reduces transaction costs like firms in a market, religious institutions also face the problem of agency costs. As churches or value systems become larger and more inclusive they suffer from rogue agents who use the institution for their individual benefit and to the detriment of the congregation. It becomes increasingly difficult to monitor and reign in those who are behaving in ways that are destructive to the religious mission of the institution as specialization increases and the number of members grows.

The reduced transaction cost of forming relationships with people of the same faith is offset by the increased agency cost when that faith becomes so broadly defined, or that church so large that it is no longer possible to predict what kind of assumptions members will have in common. Hence a person identifying as “religious” or, “Christian” today conveys very little information and does not greatly reduce the search and information costs of discovering what their core beliefs and values are.

Enter the Religious Institutional Entrepreneur. Just as with firms, there is no optimal size or scope for a religious institution. Religion and its sub-groups are constantly in flux. When agency costs are perceived to be too high – corruption, conflicts of vision, confusion of terms – religious entrepreneurs split off and form institutions with tighter bonds and a more defined set of beliefs.

The Great Schism, the Protestant Reformation, and the myriad denominational disputes and church splits of today are examples of the constant search for the most efficient religious arrangement.

I am not claiming that in these instances the actors involved consciously sought to reduce transaction and agency costs and create the most efficient religious institution. The reason for these divisions and innovations is usually theological, emotional, and very complex and messy. But because an outcome is not the product of human design, but merely of human action, does not mean it is any less a part of the search for the optimal institutional arrangement. Individual actors in the marketplace rarely calculate all the transaction and agency costs present in their potential decision, yet over time the market process results in institutions that work to reduce these costs as much as possible. This is the fundamental insight of Adam Smith’s “Wealth of Nations” regarding markets, and of F.A. Hayek’s work regarding social institutions in general.

I am not saying that innovations are always an improvement, or that the innovative process itself (what Joseph Schumpeter called “creative destruction” in the market) is painless or pleasant. In fact, in both the market and society at large, most innovations are not improvements and do not survive. I speak from personal experience when I say that church splits and denominational squabbles can be deeply painful and counter-productive for the individuals involved. As the common economic example illustrates, the automobile was not a welcome change for buggy whip makers, and I do not wish to downplay their pain. But in the long run and for the whole of society, disruptive innovations and the constant evolution towards optimal arrangements is a tremendous blessing.

I have compared religious institutions in society to firms in the marketplace, both in their ability to reduce transaction costs and their propensity to suffer from agency costs. What is the take-away?

Orders Emerge

It is common for religious and non-religious people alike to criticize massive religious institutions for both their material largesse and theological shallowness. Mega-churches, televangelists, and “watered-down” denominations are often mocked and criticized. Many of the criticisms are well-founded no doubt, but if the economic insights of the marketplace teach us anything it is to give pause before judging these institutions.

Large firms and large churches alike exist because of their ability to greatly reduce transaction costs and provide a valuable shortcut to those seeking to contribute to and benefit from their products and services. When a massive firm or institution exists, it exists for a reason and is the result of a dynamic process of seeking optimality. Though it is not permanent, its existence in the present speaks something of its ability to meet the needs of its agents and customers better than other arrangements.

Likewise, when we feel the urge to criticize the lack of unity among religions and denominations, or lament the infighting and sectarianism constantly taking place in the church community we would do well to consider the service such innovations may be providing. Divisions are another part of the dynamic process of seeking to meet our needs with the lowest cost.

Seeking truth, attempting to discover the most fundamental principles of existence and share them with our fellow man, is (ideally at least) the business of religion. We ought not judge too quickly the way that religious institutions form and are reformed, since the process itself is a necessary part of finding the best arrangement to find eternal truths. Finding truth and sharing it is important. So too are the institutions that aid us in the search by reducing the costs involved. And if these institutions are important, so too is the process by which they continually evolve.

In eternal truths, values, beliefs and institutions as in goods and services, the spontaneous order of the competitive market – both when it is creative and when it is destructive – cannot be overlooked. We should not be quick to judge it, or to presume that we know the why’s and how’s of the orders that emerge as a result.