Chapter 3: Tools for Institutional Analysis Workineh Eshetu Objective: •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. Introduction •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 ones 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 levels 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 Analysis 1. The Multilevel institutional analysis Framework 2. The Institutional Analysis and Development (IAD) Framework 3. Institution of Sustainability (IoS) Framework 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 mechanisms. •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 Situation (i) (ii) (iii) (iv) 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 actions, (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 system? • The positions: What positions exist (e.g., members of an irrigation association, water distributors-guards, and a chair)? • 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 outcomes? •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 management: 3. Institutions of Sustainability (IoS) Framework •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 region). • 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 emerge. • 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 Cooperation? •Apply the Institution of sustainability framework (IoS) for the case of water conservation? 4. Game Theory as a Tool of Institutional Analysis •Social interactions can be represented by a game •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 equilibrium. • 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== (𝑈𝑎 + 𝑈𝑏 … 𝑈𝑛 ) Outcome of Interaction 1. Coordination: Nash-Equilibrium is social optimum 2. Conflict: no single social optimum in a zero-sum game 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