Chapter 3

Chapter 3:
Tools for Institutional Analysis
Workineh Eshetu
•By the end of this chapter, students
will be able to explain the
components of the institutional
analysis and development
framework and be familiar with
the use of game-theory as a tool in
institutional analysis.
•Institutional analysis mostly follows a
qualitative approach
•However, quantitative approaches can
be used as supplementary
•There are various frameworks to
structure the analysis of institutions
•We will look into a few most known
Research Questions in Institutional Analysis
• Research questions, of course, depend on the subject
matter under investigation.
• With regard to institutional analysis, three main types
of empirical research questions may be distinguished:
1. The first type is related to effects or consequences of
institutions (and institutional change) at different
2. The second cluster of research questions is
concerned with causes, reasons or determinants
regulating the existence or change of institutions.
3. The third type of research questions seek to discover
processes of institutional development or change.
The common framework of Institutional
1. The Multilevel institutional analysis
2. The Institutional Analysis and Development
(IAD) Framework
3. Institution of Sustainability (IoS)
4. Game-theory and the Nash Equilibrium as
a tools for institutional analysis
1. Multi-Level of Institutional Framework
• The first level is ‘Embeddedness’: It deals with the informal
constraints such as customs, taboos, traditional norms etc. that the
institution is embedded in. Such informal constraints are usually
present in a society for a long period, take centuries or millennia to
change, and are believed to be spontaneous in origin.
• The second level refers to the institutional environment that human
beings create through formal rules (e.g., constitutions, laws, property
rights, etc.). Institutions on this level tend to change faster than at
the previous level, with a time frame of decades or centuries.
• The theoretical framework for this level is given by the economics
of property rights, which implicitly assumes costless or easy
enforcement of rights.
• However, this assumption has been disputed and rejected by the
advocators of transaction cost economics (e.g., Williamson, 1998).
•Level 3 deals with how the game is played or
‘the governance of contractual relations’.
Here, institutions of governance are discussed,
including issues of contract definition and
enforcement, as well as conflict resolution
•The idea is that for each specific transaction
there exists an efficient, i.e. transaction-cost
minimizing governance structure. Changes at
this level take place within much shorter time
than at level 1 and 2 (one to ten years).
•The fourth level deals with economic activities
and is concerned with getting the marginal
conditions right.
• Neoclassical economics (where continuous adjustment of
prices and quantities takes place to optimize marginal
conditions) as well as theories of asymmetric information
(including adverse selection and moral hazard problems) are
located here.
• At this level the incentives are shaped by the combined
effects of the other three levels. ---- cumulative effect
• The arrows that connect a higher with a lower level signify
that the higher level imposes constraints on the level
immediately below.
• The reverse arrows that connect lower with higher levels
signal feedback
• First-order economizing is a conscious effort to craft adaptive
internal coordinating mechanisms, such as efficient
production processes and technology while minimizing
bureaucracy, slack and waste.
• Second-order economizing refers to overall allocative
efficiency gains from first-order economizing that are bound
to arise through price mechanism effects.
Set of variable used to describe Action
The set of actors,
The specific positions to be filled by participants,
The set of allowable actions and their linkage to outcomes,
The potential outcomes that are linked to individual sequences of
(v) The level of control each participant has over choice,
(vi) The information available to participants about the structure of
the action situation, and
(vii) The costs and benefits analysis
Action Situation for overharvesting from
a common-pool resource situation
• The set of actors: Who and how many individuals withdraw
resource units (e.g., fish, water, fodder) from this resource
• The positions: What positions exist (e.g., members of an
irrigation association, water distributors-guards, and a
• The set of allowable actions: Which types of harvesting
technologies are used? (e.g., are chainsaws used to harvest
timber? Are there open and closed seasons? Do fishers
return fish smaller than some limit to the water?)
• The potential outcomes: What geographic region and what
events in that region are affected by participants in these
positions? What chain of events links actions to outcomes?
•The level of control over choice: Do
appropriators take the above actions on their
own initiative, or do they confer with others?
(e.g., before entering the forest to cut fodder,
does an appropriator obtain a permit?)
•The information available: How much
information do appropriators have about the
condition of the resource itself, about other
appropriators’ cost and benefit functions, and
about how their actions cumulate into joint
•The costs and benefits of actions and outcomes:
How costly are various actions to each type of
appropriator, and what kinds of benefits can be
achieved as a result of various group outcomes?
• Institutional Analysis and Development (IAD)
Framework in the case Natural Environment
3. Institutions of Sustainability (IoS)
•IoS framework deals with systems of
rules and governance structures which
emerge in concrete action arenas and
action situations in order to co-ordinate
the co-evolution between ecological
and social systems.
• Institutional innovation and institutional
performance in Social-Ecological Systems (SES) are
considered as the result of four key exogenous
elements: Transactions, actors, institutions and
governance structures.
• In an action arena, participants and an action
situation interact as they are affected by exogenous
variables and produce outcomes that in turn affect
the participants and the action situation.
• An action situation occurs ‘whenever two or more
individuals are faced with a set of potential actions
that jointly produce outcomes.
•Institution of Sustainability (IoS) Framework
for the case Soil Conservations
• As the overall action arena we defined ‘soil conservation practices and policies’.
• The action situations relevant for soil conservation and degradation take place
in this arena.
• More precisely, these action situations take place in three sub-arenas. The subarenas are delineated
1. at the farm level (e.g. a farmer deciding to adopt a particular soil
conservation practice),
2. at the level of policy implementation (e.g. agricultural or environmental
administrations implementing a particular procedure to monitor farmers’
compliance with a restriction in land use) and
3. at the level of policy design (e.g. policy makers at national, or regional level
defining concrete restrictions in land use in nature protection zones or
determining the set of agri-environmental measures to be offered in a
• Four key exogenous factors are identified by the IoS framework that
influence every action situation by shaping the situational context and,
largely, determine its outcome:
1. The properties of the transactions that are induced or prevented in
the action situation (including the bio-geophysical conditions),
2. The characteristics of the actors involved in the action situation,
3. The institutions (i.e., sets of rules or property rights) and
4. The governance structures in place to make the rules effective.
Which institutions and governance structures emerge depends on
the properties of transactions and the characteristics of actors.
• The four exogenous factors are interconnected and also influence each
other. The transactions related to soil determine which institutions
• The institutions influence the type of governance structures that are
chosen so that rules become rules-in-use.
• Actors influence transactions, institutions and governance structures
but are themselves subject to institutions and governance structures at
the same time.
Discussion Question
•Apply the Institutional Analysis and
Development Framework (IAD) in the
case of International Development
•Apply the Institution of sustainability
framework (IoS) for the case of water
4. Game Theory as a Tool of Institutional
•Social interactions can be represented by a
•A game has:
at least two players
a set of strategies and
expected outcomes (also called payoffs),
•Different strategies lead to different payoffs
and each player tries to maximize the
benefits by changing her/his strategies
• The initial node belongs to player 1, indicating that player 1 moves
first. Play according to the tree is as follows: player 1 chooses
between U and D; player 2 observes player 1's choice and then
chooses between u and d. The payoffs are as specified in the tree.
There are four outcomes represented by the four terminal nodes of
the tree: (U,u), (U,d), (D,u) and (D,d). The payoffs associated with
each outcome respectively are as follows (1,1), (1,1), (0,-3) and (2,-2).
Analysis of strategies and Equilibrium
• Each player builds expectations about the behavior
of the other player and assigns probabilities p and
1-p to the strategies of the other player,
max U = ((p).(AiBi)+ ((1-p).(AiBj)), ((p).(AjBi))+ ((1p).(AjBj))
• Each player choose the strategy that maximizes
her/his utility , max U (AiBi, AiBj, AjBi,AjBj)
• Example:
A:UAi((p*3)+(1-p)*2)) -> Strategy I
A:UAj((p*4)+(1-p)*1))-> Strategy J
B:UBi((p*3)+(1-p)*2)) ->Strategy I
B:UBj((p*4)+(1-p)*1)) -> Strategy J
• Nash-Equilibrium: where no player has anything to gain
by changing only his or her own strategy.
• If each player has chosen a strategy and no player can
benefit by changing his or her strategy while the other
players keep theirs unchanged, then this strategy and
the corresponding payoffs constitute a Nash
• A Nash equilibrium embodies a stable “social norm”: if
everyone else adheres to it, no individual wishes to
deviate from it.
• Social Optimum: Sum of the individual utilities
UA+UB== ( +  …  )
Outcome of Interaction
1. Coordination: Nash-Equilibrium is social optimum
2. Conflict: no single social optimum in a zero-sum
Institution and Enforcement
We have two types of sanctions
1) Collective Sanction
2) Individual Sanction
• On Figure A strategy 1 awards each player 6 units of
utility, and strategy 2 awards each player a utility of 13.
This game's equilibrium is for each player to choose
strategy 2
• Figure B and C, modified by collective sanctions, where
the probability of detection of each violation is 1/2 and
the disutility of punishment is 10 in fig. B and 12 in fig.
C. The number in parentheses in each cell is the
expected utility of punishment: 0 for zero violations, -5
or -6 for one violation, and -7.5 or -9 for two violations.
Individual Sanction
•Thank you
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