Institutional Perspective

vs Alternate theories
Why do Institutions differ?
Why institutions differ?

 Q- Why institutions differ across countries and regions?

 Argument was- The variation in institutions - attributed to a combination of
historical, cultural, and economic factors.
 Key factor: The legacy of colonialism - Some countries with extractive
institutions that controlled power and wealth in the hands of a few elites.
 Or we can say-economic institutions must be treated as endogenous
OR
 which economic institutions emerge depends on the distribution of political power
in society.
 In contrast, other countries were able to establish more inclusive institutions
that promoted economic growth and development (case of Korea)
Two Arguments
The authors argue:
 Cultural factors play a role in shaping institutions.
 societies with a strong tradition of property rights and rule of law are more likely
to have inclusive institutions than those with a history of authoritarianism or
corruption.

 Economic factors, such as natural resource endowments and the level of

economic development, can also influence the quality of institutions.
 Countries with abundant natural resources may be more susceptible to extractive
institutions that benefit a small elite at the expense of the broader population.
Three main founders and authors of New
Institutional Economics
 Ronald Coase (Law and Economics)
 1937 – The Nature of the Firm
 1960 – The Problem of Social Costs
 1974 – The Lighthouse in Economics
 Douglass North (Economic History)
 1973 – The Rise of the Western World
 1981 – Structure and Change in Economic History
 1992 – Institutional Change and Economic Performance
 Oliver E. Williamson (Economics and Organization)
 1975 – Markets and Hierarchies
 1985 – Economic Institutions of Capitalism
 1996 – Mechanism of Governance
Alternative Approaches
 Alternative approaches exist (in developing a theory of
economic institutions).
 Four main approaches to the question of why institutions
differ across countries
 The efficient institutions view- the Political Coase
Theorem
 The ideology view
 The incidental institutions view
 The social view
The efficient institutions view- Political
Coase Theorem
 According to this view:
 Societies will choose the economic institutions that are socially efficient.
 (How this surplus will be distributed among different groups or agents does not
affect the choice of economic institutions.

Political Coase Theorem, is a perspective on institutional design that suggests that,

under certain conditions, political and economic institutions will converge on efficient
outcomes even in the absence of perfect property rights.
 The idea is named after Ronald Coase, a Nobel Prize-winning economist who first
proposed the concept.
Who was Ronald Coase?
 Ronald Coase (1910-2013)WAS A BRITISH ECONOMIST AND
AUTHOR
 Professor of Economics at University of Chicago Law
School.
 He received” THE NOBEL MEMORIAL PRIZE IN ECONOMIC
SCIENCES IN 1991” for his discovery and clarification of
the significance of transaction costs and property rights
for the institutional structure and functioning of the
economy.”
 Coase is an unusual economist for the twentieth century,
and a highly unusual Nobel Prize winner.
 His famous book “THE NATURE OF THE FIRM”.
Development of Coase Theory
 Developed through the criticism of Pigouvian theory.
 Pigouvian solution- prefer to use government intervention to solve externality
while
 Coasean solution -prefer to use market method to solve externality
 Pigouvian Solution-government should impose taxes and subsidies, the
externality problem could be internalized. (The tax is called Pigouvian tax.
Pigovian solution has been widely used. In the field of infrastructure, the policy
is who invest who benefits; in the environmental protection, the policy is who
pollute who pay(Polluter Pays).
 Coase theorem- If the transaction cost is zero, no matter how the initial
definition of property rights is, optimal allocation of resources can be
achieved through market.
 Coasian solution shows that even there is a market failure it doesn't
automatically means we should use government intervention.
Example
 If a factory pollutes the river, then fishermen are affected.
 Their income is reduced or their health suffers this is external cost of
pollution.
 Lets suppose if factory has right to pollute- in such a situation the
fishermen needs to pay to the industry to reduce pollution or may
move to other place.
 If fishermen have right to clean river then the factory owners needs
to compensate the damage caused or can move to other place and all
of which is not economical.
 Therefore according to coase this can be achieved through bargaining
by both the parties, without government regulation.
 Coase shows that ‘least cost’ method can lead to optimum solution.
Details

 The Coase Theorem addresses that private parties can solve the problem of
externalities on their own, if they can bargain over the allocation of
resources without cost.

 Explanation: where there is a conflict of property rights, the involved

parties can bargain or negotiate terms that are more beneficial to both
parties than the outcome of any assigned property rights.
 In order for this to occur, bargaining must be costless; if there are costs
associated with bargaining, such as those relating to meetings or
enforcement, it affects the outcome.
Coase Theorem
Another way to think
The efficient institutions view- Political
Coase Theorem (Formal way)
The basic idea of the Political Coase Theorem:
 In the presence of transaction costs, political actors will bargain to reach a
mutually beneficial agreement. This agreement can result in an efficient
allocation of resources, even if property rights are not clearly defined.
 Institutions will emerge to facilitate efficient outcomes even if they are not
formally designed to do so.
View of various researchers
 Assuming that existing economic institutions are efficient is a standard
methodological approach of economists, i.e., observing an institution, and finding
the circumstances that lead it to be efficient.
 Demsetz (1967) argued that private property emerged from common property
when land became sufficiently scarce and valuable that it was efficient to
privatize it.
 Williamson's (1985) research, as well as Coase's (1937) earlier work and the
formal analysis by Grossman and Hart (1986), argues that the governance of firms
or markets is such as to guarantee efficiency (given the underlying constraints).
 Williamson argued that firms emerged as an efficient response to
contractual problems that outbreak markets, particularly the fact that there
may be ex-post opportunism when individuals make specific
deals/investments.
 North and Thomas (1973) who argued that feudal economic institutions. The
lords provided a public good, protection, in exchange for the labor on their
lands. In this view, without a modem fiscal system this was an efficient way to
organize this exchange.
Limitations of the Political Coase
Theorem
 Political Coase Theorem can be a useful way of thinking about institutional
design, it has limitation.
 Transaction cost may not be zero
 Transaction costs can be high, particularly in environments with weak rule of law or
high levels of corruption. In such settings, political actors may be unwilling or
unable to engage in the type of bargaining necessary to reach an efficient
outcome.
 Acemogll(2003)pointed towards commitment problem in politics which makes this
theorem inapplicable.
 Political Coase Theorem assumes that political actors have perfect
information and are acting rationally.
 In reality, political actors may be subject to biases or motivated by factors other
than efficiency, such as personal gain or political power.
 Political Coase theorem doesnot take us too far to understand political institutions
on economic outcomes
Ideology view perspective
 The ideology view : suggests that political and economic
institutions are shaped by ideological factors, such as
the beliefs and values of key actors in society.
 The beliefs and values of key actors, such as political
leaders or influential elites, can shape the design and
implementation of institutions.
 EX: if a society values individual rights and freedoms, it
may be more likely to develop institutions that protect
those rights(eg an independent judiciary).
Modified view ??
 Due to similarity with the last view Acemoglu (2003a) calls this the
Modified Political Coase Theorem.
 According to this view:
 Societies may choose different economic institutions, with very
different implications, because they/ their leaders - disagree about
what would be good for the society.
 There is uncertainty about the right economic institutions because
political actors opinion differ about what's good for their own people.
 Societies where the leaders or the elected members turn out to be
right are those that prosper.
Contd….
 The ideology view can help explain why institutions vary
across countries and regions.
 For example, they point to the influence of religious
beliefs on institutional development, noting that
societies with strong religious traditions may be more
likely to develop institutions that reflect those beliefs.
 The ideology view has limitations.
 Itdoes not account for the role of historical, cultural,
and economic factors in shaping institutions.
 It can be difficult to measure the beliefs and values of
key actors in society and to determine how they
influence institutional development.
The identical institution view
“Successful institutions can be transplanted from one society to another
without major modifications, and that these institutions will produce
similar outcomes regardless of the social, cultural, or economic
context”.
 There is a set of institutions that are universally optimal, and that
these institutions can be applied in any society to produce positive
economic outcomes.
 Proponents of this view might argue that a specific type of
property rights system or legal framework can be successfully
transplanted from one country to another, and that these
institutions will function effectively in both contexts.
Key points noted
 The identical institution view is problematic for several reasons.
 First, it assumes that institutions operate in a vacuum, and that their
success or failure is determined solely by their design. In reality,
institutions are embedded in complex social, cultural, and economic
contexts that can affect their effectiveness.
 The identical institution view assumes that there is a one-stategy applied
on institutions and they can be easily transplanted from one society to
another.
 In reality, institutional development is a complex and context-specific
process that requires careful consideration of local conditions.
 The identical institution view offers a useful perspective on institutional
development as the authors also argue that it should be viewed with
caution.
 Institutional development is a complex and context-specific process that
requires careful consideration of local conditions, and there is no one
strategy that can be applied to institutional development.
The social conflict view

“Institutions are shaped by power struggles between different

groups in society”.
 Differentgroups in society have different interests and
values, and they compete for power and influence in shaping
institutional design.
A ruling elite might design institutions to protect their own
interests at the expense of the broader population
The marginalized groups might seek to design institutions
that protect their own rights and interests
Key points noted by authors
 The social conflict view can help explain why institutions vary across
countries and regions.
 For example, they point to the influence of colonialism on institutional
development, noting that colonial powers often designed institutions that
protected their own interests at the expense of the colonized population.
 The social conflict view has limitations. In particular, it can be difficult to
determine which groups in society hold power and influence, and how
they shape institutional design. (the social conflict view does not account
for the role of economic or technological factors in shaping institutional
development).
 The social conflict view discusses on institutional development, the authors
argue that it should be viewed in conjunction with other explanations for why
institutions differ across countries and regions.
 Institutional development is a complex process that involves multiple
factors, including historical, cultural, economic, and technological factors, as
well as power struggles between different groups in society.