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The economics of grants and exchange: the transactions matrix.


The purpose of this paper is to encourage cross-fertilization between Grants Economics and other fields of economics. It continues the evaluation of the contributions made to economics by Grants Economics explored in an earlier paper in this journal (Brown and Neuberger, 1986). Grants Economics is that subfield of economics that focuses on an important subset of transactions - grants or one-way transfers. Grants Economics, as Tibor Scitovsky has said, "in the best orthodox tradition of economics . . . makes perfect competition the pivot around which everything else revolves; but by speaking of grants instead of distortions or divergences or exploitation, it stresses the neutrality of perfect competition from the distributional point of view. Indeed, the use of the word "grants" in this context stresses that it may be desirable to have an income distribution different from the perfectly competitive one" (Scitovsky, 1976, p. 78).

The treatment of all transactions in the economy, but with special emphasis on grants, distinguishes Grants Economics from traditional economics which concentrates on exchange transactions. Grants Economics also helps to identify critical nonexchange components of transactions that might have been regarded as pure exchange transactions.

In order to pursue these goals, grants economists have constructed theoretical frameworks and provided empirical methodologies to analyze case studies. In this paper, we stress the following aspects of all transactions: (1) what is the nature of the transaction, (2) transactions carried out by decision-makers in order to highlight the grant and exchange elements in each transaction.

This paper presents a theoretical framework of Grants Economics, discusses its place in economics by means of a taxonomic matrix of all types of transactions, and considers some interesting theoretical issues.

Theoretical Considerations

Traditionally, economics has focused on the decision-making approach to answer three basic questions: what to produce, how to produce, and for whom to produce. In answering these questions, economists have generally used two narrowing conceptions: (1) that the relevant decision-maker is the "economic man," who is rational and motivated only by self-interest: and (2) economic interaction is typified by market exchange. Hirschleifer (1985) in "The Expanding Domain of Economics," discusses how this narrow approach to economics has been changing. By stressing nonexchange transactions, Grants Economics has been one of the fields of economics most active in trying to broaden our view of economic man. Founded in 1968, Grants Economics was by 1974 already included in a volume commissioned by the American Economic Association as one of the "Recent Advances in Economics" (Fels and Siegfried, 1974, pp. 181-191).(1)

As for the concept of the "economic man," Grants Economics accepts many different types of motivations: benevolence (altruism) and malevolence, love and fear - as well as self-interest. Looking solely at exchange transactions gives us only a partial view; to get a broader perspective, Grants Economics attempts to illuminate the significant role played by nonmarket transactions in furthering social interaction.

It should be noted that the word "grant" in Grants Economics is used in a much broader, more generic sense than is implied by the process of giving or receiving foundation grants.

This broader meaning of "grants" is noted by Abram Bergson: "My impression is that there is a rather general agreement among those who have given serious thought to this matter regarding the meaning of one type of grant, a major type of grant, that has come to be called an explicit grant. I think it is understood that this is a unilateral transfer of material values and as such is to be distinguished from the bilateral, reciprocal transfer of material values which is generally characteristic of the exchange economy and which we usually identify with the exchange economy" (Bergson in Pfaff, 1976, p. 62).

As for implicit grants, they may be defined as the difference between existing relative prices and some norm or benchmark, due to differential taxes, subsidies, price fixing, as well as monopoly power.

At times, it is difficult to differentiate between grant and exchange transactions. In fact, "it has been argued that all grants are exchanges of some kind," as noted by Kenneth Boulding, the founder of Grants Economics (1981, p. 2). In order to define the distinction between a grant and an exchange transaction, Boulding has used the net worth criterion: if there is no decrease in the net worth of either party, the transaction is exchange; if there is, it contains some grant element, and is an explicit or implicit grant (Boulding, 1981, p. 88).

The net-worth criterion is not the only distinction between the exchange and grants economies. In the exchange economy we generally assume consumer sovereignty, and consider it a requirement for the existence of the market system. On the other hand, who is sovereign in the grants economy? Is it the donor, the recipient, or a third party? (For a discussion of this important issue, see the Transactions Matrix section below.)

To the extent that the price system acts as an efficient information signaling device, the exchange economy has two major advantages over the grants economy: (1) The exchange economy requires less resources for the information structure to allocate efficiently goods, services, as well as factors of production; and (2) the exchange economy provides an automatic feedback through the demand-supply nexus of the price system, while there is no such feedback in the grants economy. This latter disadvantage of the grants economy can lead to a pathology of the grants economy that Boulding has called "the ignorance trap." This "arises because of the absence of feedback and the extraordinary difficulty of developing information systems that can report the consequences of grants and . . . any divergences between the objectives of grants and their actual consequences" (1981, p. 126). Boulding stressed the importance of the information problem in the grants economy with considerable flair: "While ignorance may be bliss in the short run it is rarely bliss in the long run. We are left with the problem of how to improve the information processes and feedback processes from grants behavior of all kinds from private charity to foundations to governments, all of which are constantly doing harm in the name of doing good (1981, p. 127, emphasis added).(2)

Although there are important differences in the decision-making and information structures between the exchange economy and the grants economy, there are even more crucial differences in the area of motivation. Adam Smith's famous statement illuminates this point: "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but their self-love, and never talk to them of our necessities but of their advantages" (Smith, 1937/1776, Book 1, p. 14). This is the credo of the pure exchange economy. It explicitly excludes benevolence, humanity, and love (the entire integrative subsystem of the grants economy), as well as malevolence, threat, and fear (the disintegrative subsystem of the grants economy).

A potential weakness in the motivation structure of the grants economy is the "dependency trap." This is a process "in which grants designed to meet a temporary need create such a successful adaptation to them that the need becomes permanent, so that grants actually create the situation in which they are perceived as necessary . . . [e.g., in case of the] . . . infant industry argument for tariffs" (Boulding 1981, p. 125). A recent example of the dependency trap is the fight over the extension of rent controls in New York more than five decades after they were introduced as a wartime emergency measure.

The Transactions Matrix

In order to clarify the nature of the exchange economy and the grants economy and the types of transactions conducted in them, we have developed the Transactions Matrix (Table 1). This Matrix divides the whole economy into four major components: the pure exchange economy, the implicit exchange economy, the implicit grants economy, and the explicit grants economy.

Three of these components are familiar to economists, and especially to grants economists. Only the implicit exchange economy component is an entirely the new concept. This is being offered to deal more effectively with some transactions that are neither pure exchange transactions nor grants (explicit or implicit), as discussed below.

The Matrix indicates for each of these major categories, as well as for the various types of transactions within each of them, the transaction process or mechanism, the types of decision-makers who participate in each of the categories, their motivation, and the identity of the potential grantors and grantees. Thus, the Matrix provides what we hope will be a useful tour guide through the territory of both the exchange and grants economies.

(1) Pure and Implicit Exchange Economies

There is no need to discuss the pure exchange economy, which represents the traditional competitive market economy, analyzed in every economics textbook.

The implicit exchange economy shares with the pure exchange economy two key conditions for the existence of an exchange economy: the transactions involve bilateral or multilateral exchange of goods or services. and there is an expectation that the net worth of none of the parties to the transaction will be reduced. In the pure exchange economy transactions are based on the existence of legally enforceable contractual arrangements. In the implicit exchange economy, there are no such contractual arrangements: transactions are based only on implicit contracts (or on agreements that are not legally enforceable), stipulating that a quid pro quo will be provided. If no quid pro quo is expected, or if it is not sufficient to provide reasonable assurance for all parties against loss of net worth, then these transactions would be either discontinued or they would become part of the grants economy.

We included in the implicit exchange economy: underground transactions, non-contractual exchanges, and user taxes. All of these are discussed individually below.

(2) Implicit and Explicit Grants Economies

Now we turn to the grants economy. Both the implicit and explicit grants economies differ from the exchange economy by the fact that transactions contain a grant element, i.e., there is a one-way transfer of material benefits. They differ from each other since implicit grants are made from one sector of society to another through the manipulation of the price system, while explicit grants do not impact directly on the price system.

In addition, transactions in the explicit grants economy have no exchange element, while those in the implicit grants economy contain a combination of both grants and exchange. Therefore, the implicit grants economy is by far the most complex and most difficult to measure empirically. As stressed by one of the authors of this paper: "The visible explicit grants are only the tip of the iceberg, while that larger, amorphous bulk of implicit grants remains hidden and, therefore, often escapes attention" (Horvath, 1976, p. 458).(3)

We include in the implicit grants economy: indirect taxes, subsidies, and price and/or quantity restrictions. Again, all of these are discussed individually below.


Under the heading of the explicit grants economy we list transactions that do not directly impact on relative prices, and have no exchange element in them. This includes: gifts, transfer payments, and direct taxes. In addition, we have included in the Matrix two other categories of explicit grants, (1) expropriation of property by governments and wars of conquest, and (2) various anti-social acts performed by individuals, households, or business organizations.

(3) Matrix Categories by Type of Transaction

In the Transactions Matrix, we have made a preliminary attempt to subdivide the total economy (both the exchange and grants economies) into 12 categories of transactions. For each of these categories we posit the following:

(i) The part of the economy they represent;

(ii) The types of transactions or mechanisms that exist in the category;

(iii) The potential decision-makers (individuals/households, business firms, nonprofit organizations, or governments);

(iv) The factors motivating the decision-makers to engage in the transactions; and

(v) The potential grantors and grantees in those cases where grant elements exist.

In this section, we discuss the first four of these issues for each of the twelve categories; in the following section we deal with the identity of the potential grantors and grantees.

In that section. we will note that the decision-maker could be the grantor, the grantee, or a third party (i.e., an intermediary). The possibility of a third party being the decision-maker in the grant transaction is an important new insight. For example the government is the decision-maker but is neither the grantor nor the grantee in the case of tariffs, preferences (e.g., licensing certain activities), zoning, and the setting of price floors or ceilings.

(a) Underground Transactions

In each economy there exists a sizeable sector which is considered illegal. This includes black markets of various shades (from drug trafficking to pornography), where households and businesses are potential decision-makers, motivated by self-interest. Since there is a full quid pro quo, these transactions are exchanges. But, whatever contracts might be involved. they are legally not enforceable; therefore, we classify these transactions under the implicit exchange economy.

(b) Non-Contractual Exchanges

We include in this category legal exchanges without written contracts involving businesses, households and individuals: implicit contracts (e.g., with employees), reciprocal gifts, etc. While none of these transactions are illegal, they involve contracts which are not legally enforceable. (If the contracts are legally enforceable, then the transactions are part of the pure exchange economy.) Since a quid pro quo is expected (but neither guaranteed nor enforceable), these transactions are part of the implicit (not pure) exchange economy.

Transactions in this category differ from those in the underground transactions category not only by being legal but also by being motivated by a desire to maintain social cohesion, as well as self-interest. As for implicit contracts, they are now very much part of the economic literature.(4)

Reciprocal gifts have been a staple of anthropological investigations. Whether in primitive tribes or in modern societies, reciprocal gifts are generally based on tradition, have the force of custom behind them, and tend to be benevolent actions that aim at maintaining social cohesion.(5)

To the extent that our reasoning is correct, we are clarifying the notion that reciprocal gifts should not be considered part of the grants economy (as some grants economists have argued) but rather part of the implicit exchange economy. As long as the giver has reason to expect that an equivalent gift will be returned immediately (as in the case of an exchange of Christmas gifts) or in the near future, the gift is part of the exchange economy, although it is an implicit exchange. If these conditions are not met then it is a grant.

(c) Three Categories of Taxes

It should be noted that we classify taxes in three different categories:

(i) User taxes (e.g., taxes paid for sewers) are part of the implicit exchange economy, as long as the taxpayer receives public goods valued at no less than the taxes paid, so that there is no reduction in net worth. Otherwise, these taxes become part of the implicit grants economy.

(ii) Indirect taxes (i.e., sales and excise taxes and tariffs) belong in the implicit grants economy since they exert direct impact on prices, and therefore modify consumption and production patterns.(6)

(iii) Direct taxes (i.e., income and business taxes) belong in the explicit grants economy, since their impact on relative prices is very indirect, and they do not contain any exchange elements.

In each of these cases, government is the decision-maker but the motivations differ. User taxes aim at efficient allocation of resources, indirect taxes are used to change patterns of production and consumption in order to promote efficiency and equity, as well as to raise revenue, while direct taxes are used to raise revenue and/or to redistribute income.

We might note parenthetically, that a key purpose of both direct and indirect taxes is to raise revenues to pay for government expenditures, and thus avoid the need to increase the money supply and cause inflation.(7) Conversely, if taxes are low relative to expenditures and inflation develops then the result is unintended implicit grants by the government, which may be positive or negative depending on the impact on specific grantees.

(d) Subsidies and Price and/or Quantity Restrictions

Subsidies are, in fact, indirect taxes with a negative sign and are, therefore, part of the implicit grants economy. They exert a direct impact on prices, and their purpose is to modify consumption and production patterns.

Price restrictions include government price controls, as well as the use of private monopoly power to raise prices through restraints on supply. Some examples of quantitative restrictions are quotas, licensing, zoning, etc. An important type of price restrictions takes place when government regulates the pricing policies of a private firm to prevent it from using its monopoly power to redistribute income in its favor. This is generally the case for public utilities that tend to have a natural monopoly in the supply of services they provide. Compulsory deliveries to the government of mandated quantities at lower than market prices represent a combination of both price and quantitative restrictions. Each of these restrictions generally impacts on relative prices, and creates implicit grants.

In all of these cases, government and business are the potential decision-makers, and the transactions represent alternative mechanisms for changing patterns on production and consumption to promote efficiency or equity, or to redistribute income.

(e) Gifts and Transfer Payments

We distinguish between gifts and transfer payments on the basis of the identity of the decision-maker, who is also the grantor in this case. In the Matrix, all explicit grants by the government are listed under transfer payments, while household, business, and nonprofit grants are listed under gifts. On the other hand, implicit grants, whether private or governmental, are listed under "subsidies."

We have classified intra-family transfers under "gifts" since the majority of these transfers are unilateral gifts or bequests, i.e., explicit grants. However, in certain cases these transfers are in the nature of reciprocal gifts, i.e., implicit exchanges (e.g., a parent supports a child in the expectation of being taken care of later), or constitute implicit grants as in the case of loans to family members under more favorable circumstances than would be obtainable on the market.

As indicated in the Matrix, the motivation for these transactions includes benevolence or altruism, promotion of efficiency, and income redistribution.

(f) Expropriation and Anti-social Acts

The primary distinction between expropriation and anti-social acts is the identity of the decision-maker (who is not the grantor in this case but rather the grantee). The decision-makers perpetrating these coercive acts are governments in case of expropriation, and private individuals or organizations in case of anti-social acts.

There is a complex set of motivations underlying those transactions. Governments may be motivated by a desire to inflict punishment or engage in social design, or the motive may be malevolence or just pure greed. Anti-social acts by individuals and organizations are likely to be motivated by illegal self-interest, and possibly by malevolence.

Bribes are a special category of anti-social acts since they may represent either implicit exchanges or explicit grants. They constitute implicit exchange transactions if they are given with the expectation that the recipient of the bribe will provide a service of equivalent value. Otherwise, bribes are "anti-social acts," a type of explicit grant, as indicated in the Matrix.

(4) Matrix Categories by the Nature of Grantors and Grantees

This brings us to the last characteristic of transactions in our Matrix, one particularly important to grants economics - the identity of the likely grantors or grantees. The analysis of the potential grantors and grantees requires some explanation, as the answer is not obvious in each case, and depends on the specific transaction considered.

Neither in the pure exchange nor in the implicit exchange economy are there any grantors or grantees since, by definition, no grant element is involved. In the implicit grants economy, the grantor-grantee relationship can be rather complex. As for indirect taxes, the government is the immediate grantee; although, the secondary effects of indirect taxes will affect producers as well as consumers. However, since one key function of indirect taxes is to raise revenue, we are simply positing that the government (G) is the grantee. As for potential grantors, this can be anyone who has to pay indirect taxes: not only households (H) and businesses (B) but also nonprofit organizations (N), depending on the tax status of the nonprofit organization in question. In the Matrix we have put the grantors in quotes, since they are not the decision makers, and do not make the grants voluntarily. We have done the same for "grantors" in price and quantity restrictions, direct taxes, expropriations, and anti-social acts.

Subsidies can be granted by business and government to households, businesses or other government units, either directly or indirectly through government or nonprofit organizations.

If there are price and/or quantity restrictions, H or B can be grantees as well as grantors. In the special case of compulsory deliveries, G is the grantee. The picture is more complicated in the case of intra-organizational transfers. Here H, B, and G can make grants to other members of each of these categories either directly or through the intermediation of government or nonprofit organizations. In case of intra-family transfers, the individual members of the family can be grantors as well as grantees.

In the explicit grants economy, gifts can be made by H and B directly or through N as an intermediary. Similarly, transfer payments can be made by G directly or through N. Given our classification of grants, anti-social acts are the only cases where all four categories of decision-makers can qualify as grantors (in this case, those who are forced to make grants).(8)

Implicit Grants, Explicit Grants and Implicit Exchanges

In this section, we explore the two most interesting problem areas in the Matrix: implicit grants and implicit exchanges, and compare them to explicit grants.

(1) Implicit Grants

Implicit grants have been defined above as the difference between an existing relative price structure and a hypothetical "no-grants" price system, which represents a norm or benchmark from which to measure these differences.

The issue of what an implicit grant is, and the problem of measuring its size, were both raised by A. Bergson: "The underlying notion here I think is fairly clear: grants made from one sector of society to another, from some individuals to other individuals; not in an explicit way through the transfer of money, nor through taxation, and the like, nor through grants by the government, nor through philanthropy, not in those ways, but through the manipulation of the price system. Through manipulation of the price system, individuals may benefit or suffer. . . . I think this is the notion underlying the concept of implicit grants, but what was troublesome is just how one delineates such a transfer from circumstances where it is believed no transfer occurs" (Bergson in Pfaff, 1976, pp. 62-63).

Consideration of implicit grants raises two key questions: (i) what should be the norm for measuring the size of these grants; and (ii) what is their economic merit, if any?

The problem of selecting a relevant norm can be rather complex: "It is not even clear whether in particular cases we are referring to wealth, income, or economic welfare . . . [and in any case] . . . it is often difficult to agree on a norm from which divergences should be measured" (Boulding 1981, p. 13).

What then is an appropriate set of prices to use as a benchmark, with divergences from these prices constituting implicit grants? Should we insist that only an ideal standard, such as a perfectly competitive set of prices, is appropriate? Or should we be more practical and accept as a norm a set of market prices that are not believed to be seriously distorted by taxes, subsidies, monopoly power or other factors?(9) Similarly, in a centrally planned economy, should we use some adjusted factor cost prices as the benchmark or use shadow prices based on input-output tables?(10)

(a) A Suggested Measure of Implicit Grants

An operational solution for the identification and measurement of implicit grants was indirectly provided by Abram Bergson (1953 and 1961) in his discussion of the Adjusted Factor Cost Standard (AFCS). Specifically, we think that the size of the implicit grants economy may be identified as the difference between national income in a centrally planned economy at "established" prices (i.e., at actually existing prices) and at "adjusted prices."(11) Although the AFCS was applied to a centrally planned economy, it is applicable also to market-type economies; indeed, the methodology explicitly refers to the national income concepts used by the U.S. Department of Commerce (see Bergson, 1961, pp. 15 ff.)

How is the difference determined between "established prices" and adjusted factor costs? "The ruble prices of 1937 deviate from adjusted factor cost on various accounts, among the chief are turnover [or sales] taxes, subsidies, profit charges, which are more or less unrelated to adjusted factor cost, and inadequate depreciation charges. Divergences arise also because of the omission of any systematic charge for agricultural and other rent and for interest on fixed capital" (Bergson, 1961, p. 127-128).

The "divergences" listed above are, by definition, implicit grants if we use the Adjusted Factor Cost Standard as a benchmark. Specifically, turnover (or sales) taxes and subsidies are clearly implicit grants, i.e., grants made from one sector of society to another through the manipulation of the price system.

As for taxes on raw materials and intermediate products, "the issue posed is complex . . . but . . . for practical purposes the tax on intermediate products like one on final products is a source of divergence between market prices and an appropriate factor cost valuation" (Bergson, 1961, p. 106). Generally, sales taxes and subsidies, on final as well as on intermediate products, would be considered implicit grants in market-type economies, as well as in centrally planned ones.

We would like to include in AFCS user taxes and other factor charges. This issue is addressed in calculating adjusted factor costs for the Soviet economy. The potential significance of factor charges that might have been recorded as taxes is noted: "I refer below, however, to one or two outstanding cases where the government may have consciously used the turnover tax as something of a surrogate for a factor charge" (Bergson 1961, p. 107).

As for profits, interest, depreciation, and land rent, they are added or adjusted to eliminate further divergences between established prices and factor costs. We would like to identify similar hidden taxes and subsidies as implicit grants whenever they are present in a market-type economy.

In sum, what we are suggesting here is that the size of the implicit grants economy can be measured by the gross divergences between market prices and adjusted factor costs.(12) This way, the Bergsonian AFCS provides us with a practical method to measure implicit grants, and their impact on efficiency and welfare.

This is especially important when the world market price standard cannot be used as a benchmark because the goods in question are not tradable, the economy in question is not an open economy, or the world market price cannot be effectively measured.

It also helps us to state clearly what the norm or benchmark is from which implicit grants are measured: "On the one hand, I take as a norm the adjusted factor cost standard of valuation pertinent to the appraisal of production potential (and perhaps also to welfare in terms of planners' preferences), and endeavor to adjust the national income data for major divergences between ruble prices and this standard. On the other, for household consumption alone, I consider the effects of possible divergences from the consumers' utility standard pertinent to the appraisal of welfare in terms of consumers' utilities" (Bergson, 1961, p. 103).

Thus, Bergson provides us with two norms that help us determine the existence and size of implicit grants: the production standard and the consumers' utility standard. To estimate these in practice, the Adjusted Factor Cost Standard (AFCS) is used. The process starts with the established prices of final goods or of factors of production, which are adjusted for various price distortions (subtracting taxes and adding subsidies); in fact adjusting for implicit grants.(13)

(b) Welfare Implications

In addition to measuring the size of implicit grants, we should ask whether such grants are desirable? Tibor Scitovsky, in summarizing a discussion at a Grants Economics conference, stated: "We were told that implicit grants are the worst possible ways of correcting income distributions because we have so many undesirable side effects" (Scitovsky in Pfaff, 1976, p. 160).

The problem of implicit grants is a major theme in J. Kornai's highly acclaimed book, The Road to a Free Economy (1990). Kornai most emphatically calls for measures to "eliminate various implicit grants, which distort relative prices by differential subsidies and taxes. In fact, this is a key element of the transition to a market economy" (Brown, 1990, p. 1). The tax system must be as neutral as possible because "biased tax exemptions are bound to be incorporated into the price system, and will prevent us from having a clear conception of the real cost of each product. . . . Ultimately, differentiated and chaotic taxes distort the price system" (Kornai 1990, p. 122). Implicit grants are considered so harmful by Kornai that he is even opposed to "rare exceptions . . . for example, a special tax levied on alcoholic beverages" (Kornai, p. 127, fn. 40), at least during the shift from a socialist system: "only a well-organized economy can afford to have implicit grants" (Brown, 1990, p. 7).

Given the prevalence of implicit grants in every economy, this issue deserves a much more thorough discussion than is possible within the scope of this paper.

The very definition of efficiency is problematic when we want to use it to evaluate the grants economy. There is general agreement that in the exchange economy a unique set of competitive market prices can be used to measure both benefits and costs, and therefore, efficiency. There is no such generally accepted standard of efficiency in the grants economy. A possible definition was suggested by Boulding for the social concept of efficiency: if we are willing to make interpersonal comparisons, then "efficiency is the ratio of perceived benefit to the recipient to the perceived cost for the donor" (1981, p. 15). However, this social concept of efficiency may well diverge from the private concept. When the donor is the decision-maker, as is often the case, the efficiency of the grant to him/her will depend on the donor's perception of both costs and benefits, as well as on his/her degree of identification with the welfare of the recipient (Boulding, 1981, p. 15).

The problem becomes even more serious when the donor is not the decision-maker. For example, if we consider the case of government's imposing taxes on its citizens, with varying degrees of citizen approval, the relevant question of efficiency might be the government's (i.e., the recipient's) perception of the benefits of the government's expenditures compared to the costs imposed on the donors (taxpayers). But the opposite might be true in a representative democracy where the donors' perception that the grant process is conducted efficiently and equitably is crucial to avoid, say, a taxpayers' revolt.

(2) Implicit Exchange

Are the internal transactions of large public or private organizations part of the exchange or grants economy? Kenneth Boulding considers all transactions within large organizations part of the grants economy, since these activities are governed by budget allocations, i.e., grants based on central design. "Budget grants are characteristic of all organizations, whether public, private, capitalist, socialist, religious, and so on. The ability to make decisions about internal transfers, indeed, is one of the principal marks of status in a hierarchy . . . Bosses make budget grants; the bossed receive them" (Boulding 1981, p. 3).

Similarly, the traditional view of bureaucracy by economic analysts has embraced the monopoly-bureau assumption (e.g., Niskanen, 1971). Breton and Wintrobe (1986) cited various cases demonstrating that "The implicit theoretical model of an organization is the command model" (p. 922, fn. 8).

According to our Matrix, however, we should classify bureaucracies or, generally, the majority of internal transactions of large organizations, as part of the implicit exchange economy: remembering, however, that there are also intra-organizational implicit grants (subsidies in the Matrix), as well as occasionally even pure exchanges between members of a single organization. The underlying assumption is the rejection of the "command model [in which] superiors are assumed to give all orders, while subordinates are assumed to obey" (Breton & Wintrobe, 1986, p. 909). A basic problem is that in the command model of bureaucracies "competition is automatically, if inadvertently, ruled out" (Ibid.).

An alternative model of bureaucracy was described in considerable detail in an earlier book by Breton and Wintrobe (1982). According to this model, transactions between superiors and inferiors are in the area of implicit exchanges. Superiors seek to buy "informal services" - i.e., services that cannot be codified in formal documents, and that are the result of the initiative and enterprise of subordinates - in order to advance their own ends. In exchange, they are willing to make "informal payments," which can include rapid promotions, better offices, travel and signing privileges, use of a company car, and so on, quid pro quos that are not part of formal contracts.

Furthermore, there usually exist elements of competition, which are not restricted to price competition. "The competition between bureaus and that between networks for resources, as well as between bureaucrats for jobs, is just as likely to take the form of coming up with new ideas, new initiatives, new policies, or projects leading to what is now often called Schumpeterian competition or entrepreneurship" (Breton & Wintrobe, 1986, p. 909). Thus, transactions within organizations - if there is internal competition - are not grants, since there is some quid pro quo, but are exchanges. To be sure, these transactions are not explicit, but implicit, exchanges. "Sometimes the payment and other times the services rendered will come first, with varying lags between the two" (Ibid., p. 910).(14)

In their analysis of bureaucracies, Breton & Wintrobe argued that it is trust (or loyalty) that provides a framework for continuing reciprocal exchanges. They also discussed in detail two kinds of trust networks; those providing frameworks for vertical exchanges, and others providing for horizontal exchanges. The former are "efficient" (i.e., they promote the goals of the superiors), while the latter are not efficient in this special sense.

The assumption that most transactions within organizations are implicit exchanges and not grants (i.e., a substitution of the competitive for the command-type model) has important implications. For example, the competitive model of bureaucracies was used by Breton and Wintrobe (1986) to invalidate recurrent claims of innocence by Nazi subordinates who eagerly followed orders, facilitating mass murder. Thus, "Eichman did not obey orders any more than a self-employed entrepreneur does when he or she responds to the demands of the marketplace in order to make money" (p. 923, emphasis in original).

This takes us to a consideration of the difference between implicit exchanges and forced grants, which are classified in the Matrix under "antisocial acts."

(3) Implicit Exchanges vs. Forced Grants

Transactions among members within an organization (e.g., by bureaucrats) may legitimately be considered implicit exchanges. On the other hand, transactions by victims who are forced to cooperate, within a threat system, should not be considered exchanges but forced grants. This distinction between implicit exchanges and grants under threats may have important operational significance. Thus, for instance, this distinction has been used by Breton and Wintrobe (1986) to clarify questions of guilt or responsibility. To illustrate the point they presented two hypothetical situations. In the first case, they supposed "that Eichman. rather than being employed by the SS, had been self-employed - he had owned a transportation company - and rather than a rank, a salary, and a prospect for promotions, he had the opportunity to bid against other companies for a contract that involved transporting millions of people to their deaths . . . in such circumstance . . . all would convict Eichman of guilt" (p. 923). After all, exchange transactions are, by definition, voluntary.

The situation would have been very different if we "suppose instead that a gun had been held to Eichman's head and that he had been told to carry out orders or face execution for disobedience. In that case, it would appear to be hard to hold him responsible for carrying out the orders received. There is considerable evidence that these were in fact the incentives facing members of the Judenrate (the Jewish Councils) and the Jewish commandos in concentration camps" (Ibid., p. 924).

The second situation serves to illustrate a forced grant made in a threat system. A similar case would be a holdup which is an example used by Boulding (1981, p. 3) to explain different kinds of grants. Ironically, the same example is employed by Gordon Tullock whose argument runs in the opposite direction. He says: "There is a sense in which any transaction is voluntary. For example, when the gunman says, 'your money or your life,' you make a deal with him which benefits both of you . . . Thus the transaction can be divided into two acts, the first of which was not Pareto optimal and the second of which was" (1971, p. 636).

As the classification in our Matrix shows, we disagree with Tullock's interpretation, and we do not consider it very useful to define all transactions as "voluntary." Indeed, it is useful to separate transactions involving equal values (i.e., exchanges) from one-way transfers (i.e., grants). Surely, handing your money to a gunman is a one-way transfer of material values under threat, or more specifically, a forced grant.

We believe that this morbid discussion of oppressors and victims provides a useful example how concepts of Grants Economics may help to clarify diverse arguments, such as the one tackled by Breton and Wintrobe (the claim that "no one is guilty because everyone acted under orders"), or the one proposed by Tullock (that a holdup, with the option of "your money or your life," represents an exchange transaction).

(4) Nationalization and Privatization

We have not explicitly listed either nationalization or privatization in the matrix categories because these are complex transactions that cannot be easily fitted under any single category.

We may distinguish two stages in the process of nationalization and/or privatization: (1) the transfer of ownership rights from private owners to the government in nationalization and the opposite way in privatization, and (2) the impact of this change of ownership on implicit and explicit contracts within the firm.

The first stage in both of these transactions, which are mirror images of each other, can be considered as pure exchanges if the government pays the owners the market value of the property it is nationalizing, and receives the market value when the property is being privatized. On the other hand, nationalization can be a forced explicit grant when no compensation is paid, or an implicit grant if the payment is lower than market value. A related issue is the precise meaning of the concept of government ownership, and of private ownership in economic systems where the government imposes narrow limits on the rights of private owners.

Since privatization now constitutes a much more important category of transactions in both centrally planned and market economies than does nationalization, we shall concentrate on this transaction, and discuss it briefly, using the tools of Grants Economics.

A key issue in the first stage of privatization is determining whether the transaction is one of pure exchange or implicit grant. To answer this question requires establishing the true market value of the firm. This is a very complex issue since the change in the environment within which the firm will have to operate has a strong influence on the market value of the firm. For example, the sale of large nationalized firms in East Germany and Poland at very low prices implies the existence of large implicit grants. However, such firms which were considered very valuable under the centrally planned system, and were important exporters to other centrally planned economies, are much less valuable within the context of a market system and the loss of previous export markets. Thus, a sale of these firms at bargain basement prices may really constitute a case of pure exchange.

In the second stage, the new private owners will have to deal with a whole set of explicit and implicit contracts. While explicit contracts can be dealt with as part of the pure exchange economy, implicit contracts, which are part of the implicit exchange economy, are much more difficult to handle. They are, by definition, not legally enforceable, and tend to be much vaguer than explicit contracts. For example, the implicit contract of lifetime employment, the guarantees that workers had with socialized firms, may not continue when the firm is privatized and the new owners attempt to eliminate the excess labor force. This will create unemployment and require new explicit grants (in the form of transfer payments, such as unemployment insurance, welfare payments, job training programs, etc.) by the government to replace the previous implicit contracts. This moves us from the implicit exchange economy to the explicit grants economy.

These examples show that the Transactions Matrix provides the tools needed to analyze these interesting borderline cases between exchange and grants economies, and other important types of transactions.

Concluding comments

This paper has presented some of the key theoretical aspects of Grants Economics, and introduced a Transactions Matrix which provides a more comprehensive classification of all types of grant and exchange transactions than has been available up to this point. We consider this the most important contribution of this paper, since it helps to illuminate the distinctions among the implicit and explicit grants economies, and the pure and implicit exchange economies.

The construction of the Transactions Matrix led to the second original contribution of this paper - the identification of a new category of the exchange economy, the implicit exchange economy. This new construct helps us to deal with some vexing issues on the boundary between the grants and exchange economies. Thus, using the tools of Grants Economics, we can distinguish between implicit exchanges and forced grants.

A third contribution is a proposal for measuring the size of implicit grants, which have been defined as the divergences (due to differential taxes, subsidies, price fixing, as well as monopoly power) between existing relative prices and some norm or benchmark. The new approach we suggest is to adapt Abram Bergson's Adjusted Factor Cost Standard (AFCS) to measure the size of the implicit grants economy in both planned and market economies, as a complement to using world market prices for this purpose.

Grants Economics, in the tradition of welfare economics, focuses on equity as well as efficiency. Unlike neoclassical microeconomics, Grants Economics does not automatically consider deviations from the purely competitive market as aberrations.

It has been suggested that Grants Economics could make a unique contribution to policy appraisal, and to regulatory reforms by making explicit the nature and size of grants resulting from any policy decision. This could be accomplished if a grant impact statement was required for every policy decision, analogous to the requirement of an environmental impact statement. By determining who gains, who loses, and who stays unaffected, and by comparing the gains and losses, a critical component of every policy decision would be clarified.

The concept of implicit grants can provide useful insights in the study of comparative economic systems. Grants play a completely different role under various economic systems. For example, price control, which creates implicit grants, is an undesirable interference in market economies, while "price control in centrally planned economies is simply part of the plan. The implicit grant system in such centrally planned economies is extremely interesting and very little studied . . ." (Boulding 1981, p. 75). This issue becomes especially important when economies attempt to move from central planning to a market mechanism. A key requirement is the reduction in the size of the grants economy, especially the elimination of implicit grants wherever possible. Thus, economic reforms require a careful analysis of the nature and size of the implicit grants economy.


1. For a convenient summary of the first ten years of the activities and contributions of the Association for the Study of the Grants Economy, see Pfaff (1978).

2. For a discussion of some other pathologies of the grants economy, see Brown and Neuberger, 1986.

3. For rigorous mathematical techniques and for an elaborate case study wherein implicit grants are ferreted out, see Horvath 1971 and 1976.

4. The literature on implicit contracts was surveyed in Rosen (1985).

5. Reciprocal gifts, however, can be malevolent if the donor gives the gift in the expectation that the recipient will not be able to repay in kind, and will therefore lose status. In this case, we move from the implicit exchange category to the implicit grant category. The gift and the humiliation it inflicts then become a grant transaction in which the donor has a decrease in his material net worth but a gain in status. An extreme example of this is the potlatch of the Northwest Coast Indians where status is achieved by burning valuable possessions (blankets) and giving gifts to your visitor, in the hope that the visitor will not be able to match the gifts and destruction of property, and will therefore lose status.

6. A uniform sales tax is really a consumption tax, and does not change relative prices of consumption goods. However, it combines exchange and grants elements since it does affect prices of consumption goods relative to other goods and relative to wages; therefore, it is still part of the implicit grants economy.

7. In the United States, only the federal government (including the Federal Reserve System) can print money.

8. We are certain that some readers will argue with some of the decisions we made in drawing up this Matrix. Since, to the best of our knowledge, this is the first time anyone has attempted such a detailed taxonomy including a classification of motives, any suggestion to improve this analytical framework of the economic transactions would be appreciated.

9. For an excellent discussion of the appropriate norms to measure implicit grants, see Anita Pfaff (1976).

10. For the use of input-output tables to measure implicit grants in centrally planned economies with some empirical results, see Brown and Licari (1976). Subsequently, the method was used in other studies under the direction of M. Pfaff at the University of Augsburg.

11. For a simplified overview of this adjustment, see Bergson (1953, Tables 8 and 9, pp. 75-76); a thorough discussion is provided in Bergson (1961, Chapter 8). For an explanation of the AFCS, see Bergson (1961, Chapter 3, esp., pp. 104 ff.).

12. On the other hand, following in Bergson's footsteps using net divergences yields a more meaningful measure of the nation's GNP but not of the implicit grants economy. Similarly, the income distributional impact of any policy are again determined by the net divergences. On the other hand, evaluating the efficiency effects of having non-scarcity prices requires the use of gross divergences. We are very grateful to Thomas Wilson for prompting us to consider the gross vs. net aspects of AFCS adjustments.

13. As Bergson did in measuring AFCS, we accept prevailing wages even if they are not perfectly competitive. We do no assume that perfect competition is the norm, but rather prices adjusted for taxes and subsidies.

14. Exchanges not based on contractual arrangements but on prospects of future trades have been analyzed by Telser (1980), Klein and Laffler (1981), and Shapiro (1983).


Bergson, Abram, Soviet National Income and Product in 1937, New York: Columbia University Press, 1953.

Bergson, Abram, The Real National Income of Soviet Russia Since 1928, Cambridge: Harvard University Press, 1961.

Boulding, Kenneth E., A Preface to Grants Economics, New York: Praeger, 1981.

Boulding, Kenneth E., Martin Pfaff and Janos Horvath, "Grants Economics: A Simple Introduction," in Fels and Siegfried (1974), pp. 181-191.

Breton, Albert and Ronald Wintrobe, "The Bureaucracy of Murder Revisited," Journal of Political Economy, 94, 1986, pp. 905-926.

Breton, Albert and Ronald Wintrobe, The Logic of Bureaucratic Conduct, Cambridge: Cambridge University Press, 1982.

Brown, Alan, "A Grants Economics Perspective on Kornai's Proposal," Presented at the Meetings of the ASSA, Washington, D.C., 1990.

Brown, Alan and Egon Neuberger, "Grants and Exchange from a Comparative Systems Perspective," The American Economist, 1986, pp. 14-22.

Brown, Alan and Joseph Licari, "Models of Implicit Grants in East European Price Systems," in Pfaff (1976), pp. 100-113.

Fels, Rendings and John J. Siegfried, Recent Advances in Economics, Homewood. Ill.: Published for the American Economic Association by R.D. Irwin, 1974.

Hirschleifer, Jack, "The Expanding Domain of Economics," American Economic Review, 75, 1985, 53-68.

Horvath, Janos, "On the Evaluation of International Grants Policy," Public Finance, 2, 1971, pp. 379-393.

Horvath, Janos, Chinese Technology Transfer to the Third World: A Grants Economy Analysis, New York: Praeger, 1976.

Horvath, Janos, "Grants Economics," Encyclopedia of Economics, New York: McGraw-Hill, 1981.

Klein, Benjamin, and Laffler, Keith B., "Role of Market Forces in Assuring Contractual Performance." Journal of Political Economy, 89, 1981, pp. 615-641.

Kornai, Janos, The Road to a Free Economy: Shifting from a Socialist System, New York: W.W. Norton, 1980.

Niskanen, William A., Jr., Bureaucracy and Representative Government, Chicago: Aldine-Atherton, 1971.

Pfaff, Anita, "An Approach to Optimal Transfer Policy," in M. Pfaff (1976).

Pfaff, Martin, ed., Grants and Exchange, Amsterdam, North-Holland, 1976.

Pfaff, Martin, Tenth Anniversary Brochure Association for the Study of the Grants Economy (1968-1978), Augsburg, F.R.G.: INIFES, 1978.

Rosen, Sherwin, "Implicit Contract: A Survey," Journal of Economic Literature, 23, 1985, pp. 1144-1175.

Shapiro, Carl, "Premiums for High Quality Products," Quarterly Journal of Economics, 98, 1983, pp. 659-679.

Smith, Adam, The Wealth of Nations, New York: Modern Library, 1937/1776.

Telser, Lester G., "A Theory of Self-Enforcing Agreements," Journal of Business, 53, 1980, pp. 27-44.

Tullock, Gordon, "The Cost of Transfers," Kyklos, 24, 1971. pp. 629-643.
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Author:Brown, Alan A.; Horvath, Janos; Neuberger, Egon
Publication:American Economist
Date:Sep 22, 1998
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