Transaction costs, information technology and development

Purpose – The purpose of this paper is to examine the impact of transaction costs on economic welfare and development, and the role of information technology (IT) in reducing transaction costs. Design/methodology/approach – The paper extends the static model of Romer, in which transaction costs reduce welfare by reducing the equilibrium number of intermediate goods, and estimate the welfare losses in the case of domestic transaction costs. The main analysis of the paper extends a dynamic model of Ciccone and Matsuyama to incorporate transaction costs. Also described are case studies of the use of IT in rural India. Findings – In the static model, it is shown that domestic transaction costs have a substantial welfare impact when the number of goods is endogenous. In the dynamic model, it is shown that high transaction costs reduce the long‐run level of development, and may arrest development completely in the extreme case. Some preliminary, qualitative evidence from rural India is offered to illustrate how these reductions may occur through the use of IT. Originality/value – The treatment of transaction costs in a dynamic model is novel, and the use of such a model provides a new theoretical underpinning for understanding the potential impacts of IT on development.