Just before I left for China earlier this month, the Englishman whom I told about the adventure quipped that nowadays “Britain is more socialist than China.” Be that as it may, as a theorist I’m trained to understand cause and effect, not judge the big picture. One thing I learnt: there are many markets in China that in Western Europe mostly do not exist.
Below is one example: In China, when you go to a popular restaurant, the plate and bowl are brought to your table wrapped in neat plastic film. That’s because the restaurant focuses on two services only: cooking the food and providing seating. As to the dishes, there is another company that picks them up dirty and returns them clean. To the people I met, “that’s normal,” to me it raised the question: “Why don’t London restaurants do things that way?”
Bad answers!
Here are some bad answers (if those have crossed your mind, be reminded to study more economics). Maybe, you may say, the restaurant wants to increase its profit. And not paying a third-party for additional services is a sure way to increase its per-customer profit. This a bad answer because it does not account for all the costs. The issue is that in any case someone must wash the dishes, either yourself or a helping hand in the kitchen. As to the helping hand, they may just as well work for the dish-cleaning company whose economies of scale will be passed on to the restaurant. As to yourself, you run a restaurant because you’re a good cook, not an efficient dish washer. So, your time is better spent elsewhere.
At this point, most observers (including ChatGPT) turn to culture: “In Western countries, the integrated model of restaurants managing all aspects of the dining experience, including dishwashing, is deeply ingrained. This model has evolved over centuries, creating a standard that both customers and restaurateurs are accustomed to.” Said differently, “It has always been so, why should things change?” That’s just decadent.
ChatGPT also tried economics, arguing that “the cost of labor, transportation, and coordination with a third-party service can be higher compared to in-house dishwashing, especially in areas where labor costs are relatively high.” That is of course nonsensical: if outsourcing is more labor intensive, then why do restaurants in China do it? I’ll be sure to ask this question next time I eat out at my favourite Chinese. For the time being, I shall try theory instead.
Economic efficiency in the dishwashing market
Economists (used to) obsess about efficiency. In the dishwashing market, efficiency is easy to come by. Buying a commercial dishwasher makes sense if run non-stop by a large restaurant. For a small restaurant, by contrast, the price tag and occupied space (especially so in London) are prohibitive: there are economies of scale that can be realized if dishwashing services are pooled across restaurants and run at an external facility. The question is: why isn’t this happening?
Coase’s ‘Nature of the Firm’
One of the early insights I encountered in my study of economics is due to Ronald Coase’s ‘Nature of the Firm.’ Coase introduced the idea that there are costs to using the price mechanism, which he later termed as “transaction costs.” These costs include finding relevant prices, negotiating contracts, and enforcing agreements. Coordinating with a third-party service is one such cost. And so is the cost of monitoring the cleanliness of the plates. Coase recognized that a firm always has the option to seek out services and buy goods from other firms. To the extent that it does not, the transaction costs prevailing in the market must outweigh the internal transaction costs of doing things in-house. Or, if markets exist in China that do not in Western Europe, the (tautological) explanation is that market transaction costs are higher in Western Europe.
Why are market transaction costs relatively lower in China?
What explains the transaction cost difference between Western Europe and China? This question is of course, delightfully, political. As such, I can only burn my fingers when attempting to answer it. Regrettably, there is not much discussion of the question underway in other circles either. So let me say this:
First, it is not exactly easy to dismiss workers in Western Europe. When setting up a business, your employees decide when to leave, but never the other way round. As such, a dishwashing company is taking a risk—reflected in market prices—when hiring a (possibly incompetent) helping hand whereas the restaurant owner who washes the dishes themselves is not. More said, the restaurant owner has every incentive to be quick, whereas the worker has sold their time but not yet their effort. Said from a more theoretical perspective, the beautiful economic theory of moral hazard that discusses how employers can use incentives to induce high effort becomes useless if the government prohibits the relevant instruments. Economists know that this hurts both sides. The firm’s cost of providing incentives is the worker’s gain, felt via higher wages upon non-termination. (Somewhat tone-deaf, the new UK government now plans to give employees protection against unfair dismissal from the first day in a job. Good luck with that.)
Second, China, and this has been widely reported, has been a pioneer in the adoption of digital platforms. And no, I do not mean consumer time sinks such as Facebook or Instagram. Economic growth potential lies elsewhere. Abstractly put, platforms can increase the process of finding, negotiating with, and managing third-party service providers. More concretely, the informality of chat allows to communicate a businesses’ need in real time. And seamless integration of payment methods allows to issue payments quickly. If this sounds obvious, let me recall a train conversation I overheard on a Thursday morning in London last month. During this conversation, the person travelling with me sought to explain to the person on the other end of the line that, due to firm policy and limited working hours, the earliest issuance of payment could be the following Monday. In response, I believe that the deal was called off.
Where to go from here?
I suspect that some contemporary observers may exhibit a different reaction to the plastic film covering the restaurant dishes. They may say “if plastic film wrapping is the upside of having a market-centred economy, I’m glad not to have it.”
To the extent that this is an expression of concern over the efficient allocation of resources, I agree with it. Using less plastic is important; oil is a finite resource, and so is the atmosphere’s capacity to absorb emissions. Yet, from an accounting point of view it is mediocre at best. Surely, the cost that these observers miss is the opportunity cost of time. The food that adorned my plate was delicious. Had the cook done the cleaning of the dishes, what would have become of the food? So, I, for one, was glad that the cook spent their time cooking.
