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

Question

Accepted Answer

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:

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

Informal housing does not necessarily lead to higher [simple_tooltip content='The transaction costs for informal institutions are not necessarily higher, as they can be as easily transacted at informal markets (as formal housing would be at the formal market). They would be higher if they are transacted as if they were formal housing at a formal market, but the reality is, that they are transacted at an entirely different market with a different demand and supply (different sellers and buyers). ']transaction costs.[/simple_tooltip]
The discount (lower price) of informal housing is the result of its [simple_tooltip content='The primary functions of informal housing consists of: (i) A profitable business for rural collectives and real estate developers by illegal transformation of rural land into urban construction land without payment of the land conveyance fee. Moreover, it is an arrangement that is silently condoned by local government; (ii) An affordable, good-quality property for rural-urban and urban-urban migrants providing asset-based welfare and access to urban facilities (employment, education, and health). In effect, the primary function consists of the provision of affordable housing for low-income groups (rather than a function as a commodity for economic transaction). See: Li Sun and Peter Ho, “Formalizing informal homes, a bad idea: The credibility thesis applied to China’s “extra-legal” housing”, Land Use Policy, 2017, in press.'] function[/simple_tooltip], not the transaction costs;