Lecture 15
Institutions,
New Institutional Economics, and
Environmental and Natural
Resource Economics
Institutions (North 1991)
• „Institutions are the humanly devised constraints that
structure political, economical and social interaction.
• They consists of both informal constraints (sanctions,
taboos, customs, traditions, and codes of conduct), and
formal rules (constitutions, laws, property rights)
• Throughout history, institutions have been devised by
human beings to create order and reduce uncertainty in
exchange“ (North 1991, p. 97)
The Individual and the Institutional
Structure
Source: Vatn (2005)
Types of Institutions
(Ellickson 1991)
Rules
Enforcement mechanism Example
1. Convention
Self enforcement
Language
2. Ethics
Imperative self binding
Being a veterinatian
3. Norms
Social enforcement
Social codes of conduct
4. Formal private rules
Organized private
enforcement
Self imposed rules inside
organisations
5. Law
Organized state
enforcement
Business Law
What is New Institutional Economics?
• Economic Analysis of Institutions
• Institutions
– Formal and informal rules at different levels
– Emergence, causes, effects, evolution
• Economic Analysis
– Methodological Individualism
– Utility maximization (benefits and costs)
– Incomplete and costly information
– Bounded rationality
– Opportunism
– Transaction costs
Bounded Rationality and Opportunism
• Bounded Rationality
– Incomplete information
– Incomplete processing of information
 All complex institutions are incomplete
• Opportunism
– Taking advantage of information asymmetries
– Following self interest with the help of guile (lying, cheating)
 Institutions need to be safeguarded against opportunistic behavior
Foundations of NIE
• 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
Branches of NIE
• Transaction Cost Economics (Coase,
Williamson, North)
• Property Rights Theory (Alchian, Demsetz,
Furubotn, Bromley, Barzel)
• Contract Theory
– Principal Agent Theory (Stiglitz, Tirole)
– Incomplete Contract Theory (Hart, Moore)
• New Economic History
• New Political Economy
Questions addressed by NIE
• Effects of institutions, e.g. property rights, on
–
–
–
–
Resource allocation
Income distribution
Incentives (efforts, investments, innovation)
Transaction costs
• Choice and change (evolution) of institutions
– Designed or spontaneous development?
– Efficiency or distribution oriented
– Reduction of transaction costs
Analytical levels of
New Institutional Economics
LEVEL
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
L1
L2
L3
L4
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures
with Transactions
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
FREQUENCY
(YEARS)
PURPOSE
often noncalculative,
spontaneous
Social Theory
10² to 10³
10 to 10²
get the Institutional
Environment right, 1st
order economizing
Economics of
Property Rights,
Positive Political
Economy
1 to 10
continuous
get the Governance
structure right, 2nd order
economizing
get the marginal conditions
right, 3rd order
economizing
Williamson (1998)
THEORY
Transaction Cost
Economics
Neoclassical
Economics/Agency
Theory
Research questions
(Alston 1996 & Williamson 2000)
EFFECTS
L1
L2
L3
L4
CAUSES
PROCESSES
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures with
Transactions
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures with
Transactions
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures with
Transactions
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
Econometrics/Experiments
Econometrics/Case studies
Case studies/Historical narratives
Data constraints
MEASURMENT
L1
L2
VARIANCE
Simple discrete to complex
often intangible
(e.g. religion, belief system)
Small to medium
(e.g.. 12 main
religions, 6.800 main
languages)
Simple discrete to very complex
(e.g. parliamentary vs.
presidential system,
proposal for EU constitution)
Small to medium
(e.g. 5 legal origins,
192 states, 2005)
L3
Simple discrete to complex:
(e.g. make or buy, complex
contracting, modern corporations)
Large
(e.g. 2 915 482 firms
in Germany, 2003)
L4
Simple continuous
(e.g. compensation rules, prices
and quantities)
Large to very large
(e.g. annual GDP,
daily prices and
quantities at the stock
market)
DATA
SOURCES
Poorly developed
Some official statistics
International surveys
Less developed
Historical records
Documents
Official statistics
International Surveys
Developed
Official statistics
Accounting
Well developed
Official statistics
Accounting
What is „Institutional Environmental
and Resource Economics“?
• Not Neoclassical Economics?
• Not Ecological Economics?
• Neoclassical Economics
– Rational choice as maximzing individual or social utility
– Stable preferences
– Equilibrium outcomes
– No information costs
– No transaction costs
– Private property rights for all goods which are exchanged in
competetive markets
Neo-classical Environmental and
Resource Economics
• Externalities (Pigou 1920: The
Economics of Welfare)
• Exhaustible resources (Hotelling 1931:
The economics of exhaustible resources)
• Public goods (Samuelson 1954: The
Pure Theory of Public Expenditure )
• Commons (Hardin 1968: The tragedy of
the commons)
Institutional Environmental and
Resource Economics I
•
•
•
•
Problem of Social Costs (Coase 1960)
Property Rights (Demsetz 1967)
Lighthouse in Economics (Coase 1974)
Problem of Externalities (Dahlman 1979)
• New Classics
– Environment and Property Rights (Bromley 1991)
– Governing the Commons (Ostrom 1990)
Institutional Environmental and
Resource Economics II
• Challen (2000): Institutions, Transaction Costs
and Environmental Policy
• Young (2002) The Institutional Dimension of
Environmental Change
• Hagedorn (2002) Institutional Change and
Cooperation
• Saleth, Dinar and Saleth (2004) Institutional
Economics of Water
• Vatn (2005) Institutions and Environmental
Policy
Typology of goods
(Ostrom 1990)
Excludable
Rivalry
Non-Rivalry
Non-Excludable
Private good
Common pool
resource
Club good
Public good
Environmental Economics vs.
Ecological Economics
Source: Vatn (2005)
The Systems Perspective
2
Coordination and Conflict –
Game Theory and
Institutional Analysis
Game Theory -Games, Players, Strategies,
Rules and Payoffs
• Games (coordination vs. conflict, non-cooperative vs.
cooperative)
• Player (individual and collective actors)
• Strategies (set of conditional actions)
• Payoffs (benefits and costs, individual vs. social)
• Rules (intended or unintended, imposed or negotiated)
Assumptions in Games Theory
Rules
Player
Actions
Results (Payoffs)
Environment
Changing the terms
Institutions
Actors
Interactions
Allocation, Distribution
Environment
Simple game theoretic modeling
• Two players A and B
• Each player has two strategies i and j
• The payoffs are a function of the interactions
(combinations of strategies) AiBi, AiBj, AjBi,AjBj
• Each player chooses the strategy the maximizes her/his
expected utility, max E(U (AiBi, AiBj, AjBi,AjBj))
• Each player build expectations about the behavior of the
other player, she/he assigns probabilities p and 1-p to
the other players strategies, max U (pAiBi + (1-p) AiBj,
pAjBi + (1-p)AjBj)
Actor constellations (Scharpf 2000)
Cooperation vs. Conflict
i
Englisch
A
i
j
B
i
j
3,3
0,0
German
0,0
0,0
Pure coordination
j
Don’t steal
Steal
Don’t steal
0,0
-3,3
Steal
3,-3
0,0
Spanish
Englisch
B
Pure conflict
Analysis of strategies and equilibrium
•
•
•
•
•
Each player builds expectations about the behavior of the other player and assigns
probabilities p und 1-p to the strategies of the other player, max U (pAiBi + (1-p) AiBj,
pAjBi + (1-p)AjBj)
Each player choose the strategy that maximizes her/his utility , max U (AiBi, AiBj,
AjBi,AjBj)
Example:
A: UAi(p3+(1-p)0), UAj(p0+(1-p)0) -> Strategy i
B: UBi(p3+(1-p)0), UBj(p0+(1-p)0) -> Strategy i
•
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 the
current set of strategy choices and the corresponding payoffs constitute a Nash
equilibrium.
•
•
•
Social Optimum: Sum of the individual utilities UA+UB
Coordination: Nash-Equilibrium is social optimum
Conflict: no single social optimum in a zero-sum game
Prisoners Dilemma and Chicken Games
(cooperation games)
i
A
i
j
B
i
j
Deliver
Don’t-Deliver
Pay
2,2
0,3
Don’t-Pay
3,0
1,1
Prisoners Dilemma
B
j
Sign Kyoto
Treaty
Refuse Kyoto
Treaty
Sign Kyoto
Treaty
3,3
2,4
Refuse Kyoto
Treaty
4,2
1,1
Chicken Game
Analysis of strategies and equilibrium II
• Prisoners Dilemma (Assumption: p, 1-p = 0,5)
• A: UAi(0,5*2+0,5*0)=1, UAj(0,5*3+0,5*1)=2 ->
Strategy j -> don’t pay
• B: UBi(0,5*2+0,5*0)=1, UBj(0,5*3+0,5*1)=2 ->
Strategy j -> don’t deliver
• Nash-Equilibrium is not a social optimum, social
Optimum is pay and deliver, trade (cooperation)
Institutions, Games and Enforcement
i
A
i
j
Deliver
Don’t Deliver
Pay
2,2
0,3
Don’t Pay
3,0
1,1
i
j
B
Prisoners Dilemma
B
j
Deliver
Don’t Deliver
Pay
2,2
0,3-s
Don’t Pay
3-s,0
1,1
Prisoners dilemma with
sanctions s
Institutions and Enforcement II
i
A
C
j
Sanction
Don’t
sanction
Comply
Ui,0
Ui,0
Don’t comply
Uj-s,s
Uj,0
i
j
Comply with the rules or not
Sanction non-compliance or not
Emergence of Conventions
- the Crossroad Game (evolutionary game theory
• Rules or convention may also emerge spontaneously, example:
stop
continue
stop
0, 0
2, 3
continue
3, 2
-10, -10
• At a crossroad two drivers may stop or continue to drive
• For each driver it is beneficial to continue to drive while the other
stops
• The worst case is that both drivers continue and cause and accident
• A convention right before left of left before right may emerge
spontaneously
Games real actors play
Actors-oriented Institutionalism (Scharpf)
Institutional Context
Problems
Acteurs
Orientations
and
capacities
Action
situation
Forms
of
interaction
Political Environment
Source: Scharpf (2000: 85)
Political
decision
A Framework for Institutional
Analysis (Ostrom 1998)
Attributes of
Physical World
Action Arena
Attributes of
Community
Patterns of
Action Situations
Actors
Rules-in-use
Interaction
Outcomes
Evaluative
Criteria:
Social Auditing
Cost-Benefit
Equity
Environment
Literature and Sources
• Fehr, E. and Gächter, S. (2000) Cooperation and
Punishment in Public Goods Experiments. American
Economic Review 90(4), 980-994.
• Scharpf, Fritz (1998) Games Real Actors Play. Actorcentered Institutionalism in Policy Analysis.
• Ostrom, Elinor (2005). Understanding Institutional
Diversity. Princeton: Princeton University Press.
• Institut für Empirische Wirtschaftsforschung
(http://www.iew.unizh.ch/home/fehr/)
3
Transaction Costs
What is a Transaction? I
• (1) „A transaction occurs when a good or service is
transferred across a technological separable interface.
One stage of activity terminates and another begins.“
(Williamson 1985, p.1)
• A transaction is an elementary coordination problem
connected with the question how to solve this problem
institutionally (and technically)
• Example: Somebody wants to get a transfer of 1000
Euro. What’s the problem? How can it be solved?
What is a Transaction? II
• (2) A transaction is the „alienation and acquisition between
individuals of the rights of future ownership of physical things.“
(Commons 1935, S.58)
• A transaction is a transfer of property rights
• Example: Somebody acquires the right to get 1000 Euro transferred.
What’s the problem?
 How do both perspectives differ?
What is a transaction? III
Transfer
I2
I1
Property Rights
Over a good or service
Definition of
Property Rights of
I1 over ai
ai
Goods or services
Technological - separable
Interface
Source: Beckmann (2000)
Definition of
Property Rights of
I2 over ai+1
ai+1
Markets vs. Hierarchy
Market
Hierarchy
I4
I1
I2
I3
Flow of goods
Money flow
I2
I2
I3
Centralized vs. Decentralized
Resource Management
Source: JAHAN et al (undated)
Transactions Costs
• Costs of running the economic system (Arrow 1969)
• „Cost of establishing, using, maintaining and changing institutions...“
Richter und Furubotn 1996, S. 49
• Resources spend on initiating, negotiating, safeguarding,
monitoring, enforcing and adjusting transactions
• Utility losses due to imprecise arrangements, inefficient
safeguarding, monitoring, enforcement or adjustment
Types of Transaction costs I
• Search and information costs
– Cost of searching for suppliers, customers, products, technologies, etc.
– Information about qualities, prices, etc.
 Function of the distribution of information and the information and
communication technology
• Negotiation and decision making costs
– Negotiation, balancing diverse interests
– Decision making costs, time and resources spend on decision making,
cost of wrong decisions (bounded rationality)
 Function of differences in preferences, number of people involved and
the decision making rule
Types of Transaction costs II
• Monitoring- and Enforcement Costs
– Costs of monitoring, identification of non-compliance with the rules
– Costs of enforcement, sanctioning non-compliance
 Function of the measurability and verifiability of activities and the
monitoring and enforcement technology
• Adjustment costs
– Costs of adjusting the rules to changing environmental circumstances
– Costs of maladaptation
 Function of the environmental uncertainty and the flexibility of rules
Categories of Transaction Costs I
• Sunk and running transaction costs
– Sunk: lost inputs, no opportunity costs
– Running: inputs for which opportunity costs exist
• Fixed und variable transaction costs
– Fixed – not depending on the size and the frequency
of transaction
– Variable - depending on the size and the frequency of
transaction
• Ex-ante and ex-post transaction costs
– Ex-ante costs: before the contract has been made
– Ex-post costs: after the contract has been made
Categories of Transaction Costs II
• Market transaction costs
– Costs of market organization
– Searching, preparation, agreement, supervision,
monitoring, controlling, enforcement, adjustment
• Transaction costs in firms
– Costs of firm organization
– Instruction, controlling, enforcement, adjustment
• Political transaction costs
– Costs of the establishment and maintanance of a
political order
– Decision making, implementation, administration,
enforcement
Measuring Transaction Costs
• Market transaction costs
– Mediator, broker, stock exchange
– Difference between buying and selling price
– Advertisement
• Transaction costs of firms
– Management
– Administration, Accounting
• Political Transaction Costs
– Parliament, government, bureaucracy, courts, police
– parties, interest groups
Measuring transaction costs – the example of
agricultural policy (Rorstad et al.2005)
Problems of measuring transaction costs (Benham
und Benham 2000)
• Problem of definition: different definitions of transaction
costs exists
• Problem of separation: transaction costs are
sometimes difficult to separate from other costs, such as
production costs, transportation costs
• Problem of missing observations: if transaction costs
are very high no transaction can be observed
• Problem of subjectivity: estimations of transaction
costs are often subjective
• Measurement costs: measuring transaction costs is
often costly
Modeling effects of transaction costs I
• Market transaction costs II
S+TC
P - price
S – supply without TC
p+
p
D - demand
X+
Source: Furubotn and Richter (2000)
X
X - quantity
Modeling effects of transaction costs II
• Transactions costs inside the firm
Y =F(Z)
Y - Output
F
Y =F+(Z)
E
Z - Input
B
D
0
A
Source: Furubotn and Richter (2000)
Modeling Causes and Effects, Optimality I
Transaction and production costs
MC
MTC
MPC
0
MC-Marginal Costs
MTC-Marginal Transaction Costs
MPC-Marginal Production Costs
Division of Labor
Modeling Causes and Effects, Optimality II
Optimal monitoring frequency
Costs
Monitoring costs
Utility losses
MF*
Monitoring frequency
(MF)
Modeling Causes and Effects, Optimality III
Optimal searching activities
Costs
Search costs
Utility loss
S*
Search activities S
Modeling Causes and Effects, Optimality II
Transaction costs and institutional choice
• I1 and I2 differ with regard to fix and variable transaction costs
TC
I1
I2
0
Frequency