The Labour government has outlined its plans to 'replace' the competitive internal market with a more collaborative system based on partnership. Agreement amongst purchasers and providers is to be based on co-operation rather than competition. Longer term agreements covering periods of 3-5 years are to replace annual contracts within this new environment. The aim of this paper is to explore the potential economic implications of these policy changes by drawing on the economics of co-operation and the transaction costs approach to longer term contracting. Issues surrounding the role of trust in contractual relationships are explored and the relevance of experience and evidence from non-health care sectors is considered in the context of the NHS. It is concluded that both theory and empirical evidence suggest that co-operation and trust can play a central role in the efficient organisation of contractual arrangements in circumstances similar to those under which the NHS operates. However, we warn against the expectation that the policy changes will produce automatically the scale of benefits predicted by the Labour government, especially as they will have to find a way of extracting reasonable performance from providers under a system of collaboration and long term agreements. They may find they need to tread a fine line between competition and co-operation in order to reap the benefits of both.