How is credibility related to transaction costs? Or, can the price of institutional arrangements (e.g. informal housing) be related to transaction costs?

In line with a general transaction costs perspective it may be hypothesized that informal housing – as an institutional arrangement – is less efficient than formal housing. In effect, informal housing would lead to higher transaction costs for information, contracting and enforcement (in comparison with formal housing). These higher costs are needed for: i) information on the property (e.g. is the seller the rightful owner?); ii) contracting (e.g. how to track payment of the property transaction from seller to buyer?); and iii) enforcement (e.g. how to monitor and sanction if the seller or buyer violates the contract?). Due to these higher costs for transaction, informal housing is not as easily transacted on the market. As a result, it is transacted against a lower price (= discount) than formal housing.

However, there is a potential problem with this argumentation: there has been such a huge and exploding market in China’s informal housing that one may question whether informal housing is less easily transacted on the market than formal housing. Ergo, does informal housing as an institution really lead to higher transaction costs, and is it, therefore, less efficient?

The credibility theory has a different take on the issue, and would hypothesize two points:

  1. Informal housing does not necessarily lead to higher transaction costs.
  2. The discount (lower price) of informal housing is the result of its  function, not the transaction costs;