INSTITUTIONAL

ECONOMICS (IE)
(RG6 Module 4 / WPG7 Module
5)
Dr. C S DESHPANDE
 ‘Role of Institutions in
Performance of Economies’
• Introduction
– IE deals with role of Evolutionary Process of
Institutions in shaping Economic Behaviour
– ‘Performance of Economy over time critically
dependent on History of Institutions therein
– Institutions create order and reduce
Uncertainty in Transaction and Exchange
 What are Institutions
• Definition
– “ Institutions are Rules of Game or humanly
devised Constraints that structure / shape
Political, Economic and Social Interaction”
( by Douglas North )
– Two principal types of Institutions
• A. Formal - Laws / Rights
• B. Informal – Traditions, Customs, Culture etc..
 Political and Economic
Institutions
• Political • Economic
Institutions(PI) Institutions(EI)
– Democracy – Property Rights(PR)
• Parliament – Contract
– Dictatorship Arrangements
– Autocracy – Entry Barriers
– Regulatory Structures

Institutions differ because of ‘formal methods of decision-making’

 Political Power (PP)
• Importance of PP –
– The prevailing form of PP largely determines
shape of interface between PIs and EIs
– PP also determines choice of EI
– PP of two principal types ;
• De Jure PP – Allocated by PIs ( through Election /
Constitution etc. )
• De Facto PP – Acquired by Brute Force / Bribery /
Lobbying / Para-militaries etc.
 Institutions and Economic
Performance
• Importance of Institutions
– They are the principal explanation of the
central question – “ Why some countries are
richer and / or Grow faster than Other
Countries”
– Their magnitude, quality and role are
Fundamental and Deep determinants of
Countries’ Economic Performance
 Quality of Institutions
• Quality and Stability of Institutions crucial
to the behavior of Economic Performance
• Quality of Institutions to ensure
fundamental / enduring change in PIs and
EIs, not just replacement of one elite /
ruling Group by another
• ( Example of South Korea vs. North Korea
in making Choice of Institutions)
 Institutional Reform and
Economic Performance
• Mere Policy changes ineffective unless
grounded in Institutional Reforms
• Acquiring, Nurturing and Preserving High-
Quality-Institutions (HQIs) – always region
specific – no uniform / unique pattern
• Role of Local constraints and opportunities crucial
• Generally, ‘Growth–Maximising’ Economic
Performance delivered by “Inclusive”
Institutions, while “Extractive” or “Predatory”
Institutions obstruct Economic Growth
 Transaction Cost Economics
(TCE)
• ‘TCE is a tool to analyse – how
Governance of Economic Organization
(such as Firm), affects its Economic Value
• TCE matches Transactions to their
Optimal Governance Structures
– Transaction, as distinct from Exchange, is
“legal transfer” of Ownership or Property Right
 ‘Transaction Costs’ (TCs)
• TCs - various overlapping Connotations -
– “ …Costs of entering into and executing
Contracts and managing Organizations…”
– “…Costs of running Economic System :
information gathering, controlling contracts.”
– “…Costs of planning, adapting and monitoring
Task under consideration…”
Ronald Coase’s Contribution
• Breakthrough by introduction of Multi-
Disciplinary Approach - Law, Economic
History and Organization Theory
• Paved the way for IE by emphasising cost
of entering and executing contracts
• Shifting analytical focus to “Contracts”
from “Choice”
• Importance of PRs stressed
 New Institutional Economics
(NIE)
• NIE – Study of Institutions and their
Interaction with Organizational
Arrangements (OAs)
• OAs – Different modes of Governance to
support Production and Exchange
• Focus on Process of Change and Role of
Human Incentives / Beliefs
• Multi-disciplinary Approach emhasised