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
Institutions(PI)
Democracy
Parliament

Dictatorship
Autocracy

Economic
Institutions(EI)
Property Rights(PR)
Contract
Arrangements
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 HighQuality-Institutions (HQIs) always region
specific no uniform / unique pattern
Role of Local constraints and opportunities crucial
Generally, GrowthMaximising 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 Coases Contribution

Breakthrough by introduction of MultiDisciplinary 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