Sergio Beraldo
(University of Naples “Federico II” & ICER)
Lectures delivered at the University of Prague (VSE)
October 2011
I
OUTLINE OF THE COURSE
 I: Institutions
 II: Coordination
 III: Cooperation 1
 IV: Cooperation 2
 V: Institutional structure and economic performance
I LECTURE
Institutions
Some basic questions
 What are institutions?
 Why do economists have dedicated so much attention
to institutions in the last decades?
 Was this widespread interest in institutions justified?
 Have we learned anything valuable?
 Is there any criterion to assess institutions?
 Should economists feel in charge of giving any advice
concerning the “optimal” design of institutions?
What are institutions? - I
 Institutions are the humanly devised constraints that
structure political, economic and social interaction.
They consist of both informal constraints (sanctions,
taboos, customs, traditions, codes of conduct), and
formal rules (constitutions, laws, property rights)

D.C. North, The Journal of Economic Perspectives, 1991.
What are institutions? - II
 A shorter definition by Douglass North: [Institutions
are] the rules of the game…or…humanly devised
contraints

D.C. North, Institutions, Institutional Change, and Economic
Performance, 1990.
What are institutions? - III
 Institutions are systems of established and prevalent
social rules that structure social interactions
 [language, money, law, systems of weights and
measures, table manners, and firms (and other
organizations) are thus all institutions]
 The term rule is broadly understood as socially
transmitted and customary normative injuction or
immanently normative disposition, that in
circumstances X do Y

[G.M. Hodgson, Journal of Economic Issues, 2006]
What are Institutions? - IV
 [Instituions are]…settled habits of thought common to
the generality of men

Veblen, Journal of Political Economy, 1909
Are the above definitions
satisfactory?
 You might find the above definition unsatisfactory!
 This may partly depends on the fact that any definition
is tailored on the basis of the purpose followed by the
scholar who makes the definition!
 Thus, you might either partially or totally reject the
above definition
Are the above definitions
satisfactory?
 Consider for example the first definition, due to
North: “Institutions are the humanly devised
constraints that structure political, economic and
social interaction. They consist of both informal
constraints (sanctions, taboos, customs, traditions,
codes of conduct), and formal rules (constitutions,
laws, property rights)”
 A first flaw of the above definition: speaking of
institutions as “humanly devised constraint” gives
too much emphasis to intentionality
Are the above definitions
satisfactory?


The above definition puts too much emphasis on the
“institutions as a constraint” view – In a different
(personally favourite) perspective, institutions define what
a society can achieve
[e.g.: starting from the extreme situation of an Hobbesian
state of Nature in which mutually beneficial agreements
do not take place, institutions enlarge the set of possible
activities that individuals may wish to perform: before an
institutional structure emerges, some exchanges are
simply not possible]
Are the above definitions
satisfactory?
 The above distinction between formal and informal
institutions gives rise to a certain ambiguity – It is
much better to use more precise terms such as legal
rules (enforced by courts) and nonlegal rules
(enforced by one’s peers) [as suggested by Hodgson,
2006]
Are the above definitions
satisfactory?
 Consider the first part of Hodgson (2006)’s definition:
 Institutions are systems of established and prevalent
social rules that structure social interactions.
 [language, money, law, systems of weights and
measures, table manners, and firms (and other
organizations) are thus all institutions]
Are the above definition
satisfactory?




In Hodgson’s view (Hodgson, JEL, 1998) :each individual is
born into, and molded by, a world of pre-existing
institutions: even if these institutions were made by others
and can be changed
Also the way in which individuals frame problems, their
mental habits, are institutions
Criticism: if every thing is an institutions, explaining
institutions would imply to explain everything!
Moreover: is this way of looking at institutions useful from
an heuristic point of view?
Why do economists have dedicated so much
attention to institutions in the last decades?
 “Institutions (have been designed by human beings) to
create order and reduce uncertainty in exchange” (D.C.
North, Journal of Economic perspectives, 1991)
 “Institutions form the incentive structure of a society, and
the political and economic institutions,
in consequence,
are the underlying determinants of economic
performance” (D.C. North, AER, 1994, Nobel Prize Lecture)
Why do economists have dedicated so much
attention to institutions in the last decades?
 The neo-classical result of efficient markets only obtains when it
is costless to transact; requirements necessary to achieve a Pareto
optimum are very stringent
 When transaction costs are non-zero, then institutions matter!

[transaction costs are those costs born when making economic
exchanges:



search and information costs;
costs of negotiating and writing contracts;
enforcement costs]
 Neo-classical theory is concerned with the operation of markets,
not with how markets develop (so it cannot address neither the
problem of development nor the rise and decline of communism
and Soviet Union) – D.C. North, AER, 1994.
Institutions to capture the gains
from social exchange
 Before reconsidering the problem of
defining institutions, let us address
some key problems related to economic
(or more generally, social) exchange; let
us do it in game theoretical terms
 Two different settings:
 The Prisoner’s dilemma game
 The Stag-Hunt game
The Prisoner’s Dilemma
Player 2
Player 1
Cooperate
Defect
Cooperate
1,1
9,0
Defect
0,9
5,5
Each player may be
tempted to follow a
smaller prey instead
of obeying to a
concerted plan
suitably devised to
catch a deer - the
relevant player does
better by cooperating
only if the opponent
cooperates too.
The Stug-hunt game
Player 2
Hare
Stag
Hare
2,2
2,0
Stag
0,2
3,3
Player 1
What makes it necessary to have
appropriate institutions?
 In both settings there are gains to be made by resisting
the temptation of deviating from the strategy each
player would play if binding agreements where
possible
 There is a surplus which could be generated if
selfishness or lack of confidence were put aside
What makes it necessary to have
appropriate institutions?
 Individuals will usually find it worthwhile to cooperate
with other players when:



the play is repeated
they possess complete information about the other player's
past performance
there is a small number of players
 [Think at earliest economies characterized by local
exchange within a village --reputation ensures
compliance]
What makes it necessary to have
appropriate institutions?
 Cooperation is difficult to sustain when:



the game is not repeated (or there is an endgame);
information on the other players is lacking;
there is a large number of players.
 The productivity gains coming from specialization and
division of labour can only be reaped if there emerges
an institutional structure solving the problem of
human cooperation under the latter conditions
 In other words: anonymous exchange requires a
suitable institutional structure
What makes it necessary to have
appropriate institutions?
 Creating the institutions that will alter the
benefit/cost ratios in favor of cooperation in
impersonal exchange is a complex process,
because it not only entails the creation of
economic institutions, but requires that
they be supported by appropriate political
institutions [D.C. North, AER, 1994]
Is there any criterion
to assess institutions?
 The criterion is the capacity of a given
institutional structure to foster
cooperation among individuals
 Notice that an institutional structure
can be highly inefficient yet persisting
over time
Should economists feel in charge of giving any advice
concerning the “optimal” design of institutions?
 It is worth remembering what North (1994) point out [see
also Dixit, AER, 2009]:
 “It is the admixture of formal rules, informal norms, and
enforcement characteristics that shapes economic
performance. While the rules may be changed overnight,
the informal norms usually change only gradually. Since it
is the norms that provide “legitimacy” to a set of
rules...economies that adopt the formal rules of another
economy will have very different performance
characteristics than the first economy because of different
informal norms and enforcement”