Joanna Tyrowicz
Game-theoretic approach
Institutional Economics
Questions
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People say：“institutions matter.”
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Great! 
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But, if institutions are nothing more than codified laws,
organizations and other such explicit, intentional devices, why
can’t badly-performing economies design (emulate) “good”
institutions and implement them?
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Cause they do not change so easily ...
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How do institutions change? Or, why do they not change as people
might like? An answer depends on what institutions are.
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The sense in which “history matters” for development.
2
In what sense can “history matter”?
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Specification of institution-free rule of the game is not
possible
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Where do the rules of the game come from?
Inevitable infinite regression toward historical past...
3
In what sense can “history matter”?
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A domain is conditioned by
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The „function of consequence” is conditioned by
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mental states and
acquired competences of players
may comprise organizations as players.
technology,
statutory laws,
and institutions in other domains.
History matters in all these.
Statutory law is not by itself an institution, unless the enforcer of
the rule of law is believed to have the ability and motivation to
enforce it.
/North and alike would call this dichotomy formal/informal/
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In what sense can “history matter”?
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The selection of an equilibrium (an institution) out of
possible many may be conditioned by dynamic linkages
of various domains /path dependence/
Overall institutional arrangement may be
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coherent,
reinforcing,
diverse across economies,
Pareto-suboptimal (not Pareto-rankable).
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Conceptualising institutions somewhat
differently...
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We would typically call the institutions…
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the humanly devised constraints that structure political,
economic and social interaction
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informal constraints (sanctions, taboos, customs, traditions,
and codes of conduct), and formal rules (constitutions, laws,
property rights)

rules of the game
…but the question is, where do these rules come from???

Face it: anthropology, sociology, history, religious studies, etc.
do not take us anywhere within economics!
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Can we have any ECONOMIC idea for understanding it?
Schedule for today: Game-theoretic approach
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Recent Literature
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Douglass North, Understanding the Process of Economic
Change, CUP, 2005.
Avner Greif, Institutions: Theory and History, CUP
Gerald Roland, Fast-changing and Slow-changing
Institutions, (mimeo)
M. Aoki, Towards a Comparative Institutional Analysis,
MIT Press, 2001 => TCIA
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Alternative game-theoretic concepts of
institutions
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Game form:
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The unit of analysis: Set of players & activated sets of
action choices = the domain;
The rule of the game: the consequence function which maps
the domain to the range of physical consequences (its
composite with the utility functions = pay-off functions)
What are institutions?
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Players (=organizations)? Nelson (ICC 1994)
Rule of the game (exogenous constraints on the
domain/consequence function: law, social norms, etc.)?
North, Williamson
Equilibrium outcome? Young (1998), Aoki, Dixit (2004)
Synthesis of all plus values? Greif (2005)
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Institution as a Nash
Institution is a summary
representation of invariant
and salient features of a
(Nash) equilibrium path, held
as shared beliefs of the
players about how the game
is being repeatedly played.
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Why so? Criticism and defense
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Who specifies the game?
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No game has been specified yet! Anything’s possible!
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Why impose Nash equilibrium?
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Well, it’s not particularly demanding…
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…plus it allows self-enforceability!
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How do you know if it’s efficient?
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Who said the rule was “efficiency”?
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Nash equilibrium doesn’t necessarily imply Pareto optimality,
which is not efficiency yet!
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Why so? Criticism and defense
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People may believe about many things and be unable to
communicate clearly, what is it exactly that they believe
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Word “beliefs” stands more for expectations and these do
not need to be communicated, while they can be updated!
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If it’s equilibrium, why would it change?
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Well, most equilibria are not everlasting
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It’s the transition that exhibits equilibrium properties and
not the end point!
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MASAHIKO AOKI - INSTITUTIONS
JOINTLY CONSTRUCT
GAME
STRATEGIES
ENABLE
INSTITUTIONS
EQUILIBRIUM
LIMIT
SUMMARISED
CONFIRMS
ENDOGENOUS
RULES OF THE
GAME
BELIEFS
COORDINATE
DOMAIN OF THE PLAYER
DOMAIN OF THE GAME
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Dualities in this formulation
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Endogenous  exogenous?
Objective  subjective?
Enabling  constraining?
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Examples to understand better 
Observing the speed limit
 Being faithful to your partner
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Institutional arrangements as equilibrium
linkages
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Complex over-all institutional arrangements evolve,
as various domains
economic,
2.
social,
3.
political and
4.
organizational
=> They become linked/inter-related in an equilibrating manner
1.
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There are two types of equilibrium linkages:
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complementarities
linked games
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Primitive domain and proto-institutions
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Repeated economic exchanges
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Trust, gift exchange (Carmichael & MacLeod)
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The commons
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Customary rights, tragedy
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Asymmetric cooperation
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Asymmetry in complementarity between residual rights of
control and effort → integration of property rights in
physical assets and hierarchy (Grossman & Hart).
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Symmetric cooperation
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Free-riding?
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Social exchange domains
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Non-economic goods/bads
 social symbols, languages, etc. that would directly affect the
payoffs of recipient agents, such as esteem, sympathy,
approval, accusation and so on,
 they are unilaterally delivered and/or traded with “unspecified
obligations to reciprocate”
 are sometimes accompanied by gift-exchanges.
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Expected surplus from repeated exchanges may be conceptualized
as “social capital”.
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Social-embeddedness and bundling
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Social-embeddedness
 On one hand, values and norms may be perceived as
exogenously given by individuals but actually they are
endogenously shaped by them, “in part for their own strategic
reasons.”
 On the other hand, agents in markets and organizations in
modern society generate trust and discourage malfeasance by
being embedded in “concrete personal relations and structures
(networks).” (Granovetter)
 Examples:
 Community of traders
 Community norms in the use of commons, professional
reputation in open software development, etc.
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Social-embeddedness and bundling
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Bundling
 Bundling by an internal player /REMEMBER TCE …/
 Bundling of multiple contracts → factory, multi-vendor
subcontracting system, venture capital, linked contracts.
 Bundling by a third party player.
 The Law Merchant, markets under the rules of law,
contingent governance of (symmetric) cooperation (team)
by the third party as the budget-breaker
 Note that the third party itself is a strategic player.
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The state in political domain
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What is the political domain?
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Elections or policies? How are they interrelated?
The state as an equilibrium with the government (a third party) as
the property rights enforcer cum tax collector → “the
fundamental dilemma of the political economy” (Weingast).
What kind of political domain?
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Democratic, corporatist, collusive, developmental,
delegated bargaining states
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Recall Polish land reforms – discussion about the institutional
change, was it pro-efficiency or was it through bargaining?
Does it really matter for policy implications?
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Institutional linkage of domains (1):
linked games
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Games are „linked” if one or more players choose
strategies across more than one domain in a
coordinating manner
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Because of possible externalities created by such linkage, a
behavioural pattern that would be unsustainable in a single
domain may become sustainable across many and becomes a
viable institution
For example punishment mechanism may become selfenforcing even if players are short-sighted and/or
nonexcludable in a single domain
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Institutional linkage of domains (2):
institutional complementarities
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U(x’) - U(x”) increases on domain X for all the players
when z’ rather than z” prevails in domain Z
Note that it does not require that U(x’) - U(x”)>0
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Then x’ and z’ (alt. x” and z”) complement each other
→ institutional complementarities
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Codetermination + corporatist state,
life-time employment + main bank system
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Institutional change
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Internal dynamics of game induces changes in parameters of the
domain (skills, technology, etc.).
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With environmental changes, sub-optimal mutant strategy
becomes viable and/or the experiments of new strategies are
triggered. The sets of activated choices expand.
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When new strategic choices converge to a new equilibrium, a new
institution emerges. Its characteristics are conditioned by the
dynamic linkages of domains.
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The selection of an equilibrium out of possible many may also be
influenced by predictive beliefs by “entrepreneurs” and/or
normative beliefs of charismatic leader (as distinguished from
“share beliefs), as well as the enactment of statutory law.
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Reconfiguration of linkage
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The same social norm embeds different domains of
economic transactions over time.
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Integrated firms → industrial districts.
Community norm in the transition to market (Aoki and Hayami)
Slow-changing institutions and fast-changing institutions
(Roland)
Schumpeterian dis-bundling and bundling
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Dis-integration of large firms and emergence of supply-chain,
modular entrepreneurial firms
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Dynamic institutional complementarities
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Momentum theorem (Milgrom, Roberts and Qian): Even
if the initial level of human resources supporting
institution A is low, the presence of complementary
institution B may amplify the impact of a policy to
induce A.
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Role of Hong Kong in the China’s market transition
Conversely, even if a law is introduced to induce
institution A, the absence of complementary
institutions B may make its realization difficult.
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Difficulty of enforcing the market-oriented corporate
governance when the rule of law does not prevail.
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Path-dependence and novelty in
institutional change
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What is the role of path dependence?
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We are “sticky” by nature (social embededdness) – people
like repeating games, so equillibria may be stable
What we know limits our ideas of the set of available
alternatives (beliefs included), so difficult to come up with a
NEW strategy
However, innovation (Schumpeterian again!) may come for a
number of fairly uncontrollable reasons, changing the
dynamics of the game! => NEW INSTITUTION
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