This page intentionally left blank New Institutional Economics Institutions frame behaviors and exchanges in markets, business networks, communities, and organizations throughout the world Thanks to the pioneering work of Ronald Coase, Douglass North, and Oliver Williamson, institutions are now recognized as being a key factor in explaining differences in performance between industries, nations, and regions The fast-growing field of “new institutional economics” (NIE) analyzes the economics of institutions and organizations using methodologies, concepts, and analytical tools from a wide range of disciplines (including political science, anthropology, sociology, management, law, and economics) With contributions from an international team of researchers, this book offers theoreticians, practitioners, and advanced students in economics and social sciences a guide to the recent developments in the field It explains the underlying methodologies, identifies issues and questions for future research, and shows how results apply to decision-making law, economic policy, managements, regulations, and institutional design e r i c b r o u s s e a u is Professor of Economics at the University of Paris X and Director of EconomiX, a research center jointly operated by University of Paris X and the CNRS (French National Science Foundation) j e a n - m i c h e l g l a c h a n t is Professor of Economics and Head of the Electricity Reforms Group in the ADIS Research Center, University of Paris-Sud XI New Institutional Economics A Guidebook Edited by Eric Brousseau and Jean-Michel Glachant CAMBRIDGE UNIVERSITY PRESS Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo Cambridge University Press The Edinburgh Building, Cambridge CB2 8RU, UK Published in the United States of America by Cambridge University Press, New York www.cambridge.org Information on this title: www.cambridge.org/9780521876605 © Cambridge University Press 2008 This publication is in copyright Subject to statutory exception and to the provision of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press First published in print format 2008 ISBN-13 978-0-511-43683-3 eBook (EBL) ISBN-13 978-0-521-87660-5 hardback ISBN-13 978-0-521-70016-0 paperback Cambridge University Press has no responsibility for the persistence or accuracy of urls for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate To the more than six hundred fellows who have been teaching, thinking, learning, discussing, sharing meals, and even dancing at the European School for New Institutional Economics (ESNIE) every spring in Corsica since 2002 Contents List of tables List of figures List of contributors Acknowledgements Foreword o li ve r e w ill ia m s o n A Road Map for the Guidebook e r ic b r o u s s ea u a nd j e an - m ic h el g la ch an t Introduction to New Institutional Economics: A Report Card pa u l l j o s k o w Part I Foundations The Theories of the Firm p i e r r e g a r r o u s t e a n d s t e ph a n e s a us si e r Contracts: From Bilateral Sets of Incentives to the Multi-Level Governance of Relations e ri c bro u s s eau page x xi xiii xxi xxiii xxxix 21 23 37 Institutions and the Institutional Environment john nye 67 Human Nature and Institutional Analysis ~ ad a benito arrun 81 Part II Methodology The “Case” for Case Studies in New Institutional Economics l ee j al s to n 101 103 vii viii Contents New Institutional Econometrics: The Case of Research on Contracting and Organization michael e sykuta 122 Experimental Methodology to Inform New Institutional Economics Issues st e ph a n e r o b i n a n d c a r i n e s t a r o p o l i 142 Game Theory and Institutions t h i e r r y p e n ar d Part III Strategy and Management New Institutional Economics, Organization, and Strategy jackson n ickerson and l yda bigelow 158 181 183 10 Inter-Firm Alliances: A New Institutional Economics Approach j o a nn e e o x le y an d b r ia n s s il ve r m a n 209 11 Governance Structure and Contractual Design in Retail Chains e m m an u e l r a y na u d 235 Part IV Industrial Organization 253 12 Make-or-Buy Decisions: A New Institutional Economics Approach m a n u e l go n z a l ez -di a z a nd l uis v a zqu ez 255 13 Transaction Costs, Property Rights, and the Tools of the New Institutional Economics: Water Rights and Water Markets gary d libecap 272 14 Contracting and Organization in Food and Agriculture m i ch a el l c o o k , pe te r g k l ei n, a nd constantine iliopoulos 292 Part V Institutional Design 305 15 Buy, Lobby or Sue: Interest Groups’ Participation in Policy Making: A Selective Survey p a b lo t s p il le r a nd s an n y l ia o 307 554 Index organizational choice and shift parameters 189–92 and transaction performance 187–9, 206 organizational design xlviii organizational ecology theory 200 organizational inertia 200–2, 203 organizational structure corporate governance 196–7 internal, and performance 194–7 M-Form v U-Form 194–6 team organization 197 organizational vacillation 202–3, 207 organizations xli, xlii–xliii and institutional environment xlviii strategy and management xlvii–xlix see also firms; institutions “OTC” markets, bilateral 350 outsourcing 256 and skills 256 ownership and governance structure 444 and incomplete contract theory 31 in transition privatizations 393 Pareto-criterion, applied to collectivities 365 parliamentary regimes, economic effects of 376–8 patents, and alliance outcomes 227–8 paternalism, southern United States 115–19 path dependency lv, lvi, 439–40 in institutional evolution 460 perfect Bayesian equilibria (PBE) 167 performance, in TCE 183, 184–6 exchange attributes and organizational choice 186–94 and internal organizational structure 194–7 and organizational change 197–203 shift parameters 189–92 Peron, Juan, President of Argentina 113 personalized exchange 74 Pigou, Arthur 331 planning, role of government 68 “play of the game” Poland 393 policy stability 358 policy making and econometrics in party centred systems 323 public interest role of interest groups 307–8, 326 political economy, positive 12 political hazard 190 political influence 274 political parties, and interest group participation 323–5 political system as institutional environment 336 transition economies 401 politicians constraints on 324–5 direct vote buying 310 indirect vote buying 310–11 and institutional reform in transition economies 401 and judicial independence 379 and lobbying for indirect influence 312 “Popitz’ law” 383 Porter, Michael, Competitive Strategy 183 Positive Political Theory xxxiii Posner, Richard 414, 415 precommitment device 368–9 presidential regimes economic effects of 376–8 geographical variables 378 price cap, concept of 330 price mechanism in network industries 328 for resource allocation 123 prices, generated from market activity 331 primitive exchange 74 principal–agent game and commitment 162, 163, 164, 166 and institutional inefficiency 450–3 under asymmetric information 166–8, 167, 168 principal–agent relationship, constitutional contract as 368 prior appropriation, doctrine of 280 prisoners’ dilemma game xxviii, 169, 170–2 and institutional change 449 and social contract 366 privatization of state owned assets 392–3 in transition economies 392–5 probability, and limits of human mind 84–5 Problem Solving Perspective 185, 203–6, 207 empirical tests 205 process view, of economic activity 439–40 production stages of xxxi subcontracting 255 vertical chain 255 Index production costs and theory of economic organization 435 and transaction costs 445, 445, 446 profitability, and discriminating alignment hypothesis 188 property rights xxxvi, 11 and alliances 223 and asset value 105, 106, 110 in broadcasting industries 339 case study (Brazil) 105–12 in Chinese TVEs 394–5 and costs 263 efficiency of 423 and firm theory xxxvi, 33 “ill-defined” 301 and incomplete contracts 44 and institutions 70, 71 law and xxxv legal enforcement of 418 NIE approach to 418 and privatization of state owned assets 392–3 and theory of liability 413 and title 108, 110 in transaction economics xxxv, 418 in transition economies 390, 392–5 transport 339 and water allocation 274, 287, 290 property rights theory, of vertical integration 17 proportional representation systems 372 public services, monopoly rents 335 public trust doctrine retrospective application 279 and water rights 279, 290 public utilities, organizational design of 151 quality control xxxii and contract agriculture 298 quasi-rent, and concept of asset specificity 138 rational choice analysis xlv rational price setting 330–1 rationality 42–3, 84–5 ecological 86 instinctive 85–6 reciprocity 90, 91 in decision making 149 direct and indirect 93 in enforcement 97 models of 150 strong 92–3 referenda, use of in direct democracy 385, 386 555 regulation xxxiv contractual 48–51 food and agriculture 292 and litigation 314–15 water allocations 280–1 renegotiation, of contracts 57, 58 representative democracy, compared with direct 385–6 reputation 164, 177–9, 303 reputation mechanisms bilateral 455 multilateral 455, 456 research agenda for lv interdisciplinary research (R&D) activities, and organizational structure 195 resource allocation remediableness criterion xxxii use of managerial control 123 resource management l resources based view (RBV) xlix retail chains 235–6, 242, 250 contracting models 243–7 dual distribution model 240–3 expansion by franchising 237–8 multi-unit ownership 246 retaliation, psychology of 93 rights, and decision making l risk allocation 264 and contract 297–8 risk aversion xxvii, 87 Roland, Gerard 78 Rostow, W.W 68 Russia 390, 393, 400, 403 scale, economies of 265 Scotland, electricity reforms 361 selfishness, assumptions of 149 Separation of Powers hypothesis 314, 316 horizontal separation 375–81 vertical 381–5 sharecropping 396 shift parameters 189–92, 207, 223 skills, and outsourcing 256 Smith, Adam 67 and human instincts 82 Smith, Vernon 151, 153 social contract constitution as 367 as logical inconsistency 367 social contract theory, and constitutional economics 364, 365 social conventions, definition 454 556 Index social networks, and alliances 232–3 social preferences, in experimental economics 149–51 social welfare, econometric techniques and Solow, Robert 68 Spain construction firms 267 Mesta (shepherds’ guild) 449 specificity network industries 344 transactions 257 see also asset specificity standard microeconomic theory of networks 329 standardization mandated 161 in strategic game 160–1 state to enforce social contract 366 and independence of judiciary 378 role in formal institutions 405 strategic group interest behavior, theories of 316 Strategic Management Journal 183 strategic positioning framework (SPF), in TCE 192–4, 207 strategic-game form of incomplete contract 427–8, 427 structural inertia theory 201, 207 “stylized facts” xlvi subcontracting 255 and changes in institutional environment 267–8, 267, 268 transaction costs 256 and uncertainty 261–2 see also make-or-buy; outsourcing suing see litigation supply chain management (SCM) 295 and “net chain” 296 surveys, use of 103 Switzerland 383, 385 symmetric information benchmark 318–20 taxation 72 in direct democracies 386 in federal states 381, 382 revenue from 71 team theory xxxvi teams, family-based li technological change liii, 3, technological overlap, and alliances 219–20, 227 technology and change in institutional environment 268–70 and development of institutions 68, 69 and trucking industry 268 telecommunications industry, and standardization 161 theory(ies) 5, 463 idealism in 409 see also agency theory; firm, theory of; game theory; Incentive Theory; incomplete contract theory; Law and Economics theory; neoclassical economics; transaction cost theory (TCT) third parties, role of public 341 township–village–enterprises (TVEs), as hydrid transitions in China 394–5 trading relations international barter 399 network-based 397 transaction cost theory (TCT) 26, 27, 425, 426, 442 of alliances 215–24 and definition of firm 28–9 and incomplete contract theory 31 transaction costs xxxvi, 256, 417–21, 443 and asset specificity xxxi and contracts 48 and discriminating alignment hypothesis 139–40 dynamic 435 ex post bargaining 14 in firm theory xxxvi and governance structure 15, 132 and incomplete contract theory 45–6 and institutional inefficiency 443–9 and mechanisms of governance 259–65 positive xxiii and uncertainty 261–2 and value chain xxviii and vertical integration 261 water trades 287 of water transfers 277, 282, 290 zero 411 transaction costs economics (TCE) xxx xlvii–xlix, lv, 13, 425 and agricultural cooperatives 301–2 and business strategy research 183 internal organizational structure 194–7 performance in 184–6 and strategic positioning 192–4 and theory of alliances 209 see also property rights Index transaction-cost predicted alignment 187, 189 transactional hazards 38 transactions 13 complex (jural relations) 418–20, 421–4 connectedness 259 dimensions of 257–9 frequency and duration 258, 262–3 measurement/search cost 258, 263–4 specificity 257 and transaction costs 259 uncertainty and complexity 257 see also contracts transition economies xxxiv, 389–405 contracts 390, 395–400 economic declines 400 managing institutional change 389, 400–3 property rights and privatization 392–5 role of politics 401 transport property rights 339 trucking industries 198, 268 trust compared with formal rules 73, 74 in contracts 57 pre-existing 190, 191 Ultimatum Game (UG) experiment 149–51 unanimity, principle of 365 unbundling, boundaries of 347–8 uncertainty 25 and contract agriculture 298 in demand 261 environmental 262 technological 262 theory of 415 and transaction costs 261–2 transactions 257 in transition economies 396 United Kingdom agricultural tractors cartel 174 electricity reforms 359–60 electricity transmission system 350, 351 licence auctions 339 United States Administrative Procedure Act (1946) 313 and antitrust 250 black population 116 Congress 117, 118, 119, 323 Congressional Dominance hypothesis 310 557 early auto industry 199 electrical transmission rights 340 electricity transmission system 350, 351 Fair Labor Standards Act 117 Farm Security Administration 117 farming 297, 299 Federal Bureau of Reclamation 283 Federal Communications Act (1934) 307 franchising contracts 236 Indian tribes 284 legislature model 323 misallocation of water in West 275–84 Mono Lake case (National Audubon Society v Superior Court, 1983) 279 Social Security Act 117 Southern paternalism and welfare provision, case study 115–19, 120 telecommunications 307 Telecommunications Act (1996) 308 trucking industry 198, 268 water transfers 276, 276, 277, 278 Webb-Pomerene Act 174 used car market, imperfect information 168 valuation of non-rivalrous public goods 274, 290 of water 276, 276, 277, 280 value, capturing 203 vertical agreements, in franchising 237, 249 vertical coordination, in food system 295 vertical integration 3, 12, 136–7, 193 as asset ownership 136 and comparative governance paradigm 12–17 and connectedness 264 and contracts 296–300 empirical studies 15 in franchising 239, 248, 249, 250 as governance mechanism 261 and technology 269 in transaction costs 463 vertical separation of powers 381–5 veto players, in institutional design 356–9, 357, 362 video cassette industry 211 voluntary exchanges, voluntary multilateral markets 350 Wason psychological tests 91 water 272, 278 groundwater 286 interdependent claims on 287 market allocation 273–5, 290 558 Index water (cont.) misallocation of water in American West 275–84 transfers to non-agricultural uses 276, 276, 277, 278 policy responses 288–90 pricing of (American West) 276, 276, 277 private and public characteristics 286–7 public and private demands 273 upstream diversions 286 urban demand for 272 and weak property rights 274 and weak water rights 284–7 water rights xxxii, l, 272–91 appropriative, subject to state regulation 280–1 non-vested usufruct rights 278–80 and policy responses 288 and public trust doctrine 279 riparian 280 and transaction costs 277, 282, 290 weak rights 274, 278–81, 284–7, 290 water trades 281, 288, 290 decision-makers 282–4 high costs of bounding 284–5 high costs of measurement 285–6 irrigation districts and water suppliers 282–3 state regulatory agencies 282 third-party effects 281 weak form selection hypothesis 198–200, 207 weakness of will xxvii wealth effects 447 Weingast, Barry 70 welfare economics 331 West Africa, Islam in 79 Williamson, Oliver xxxix, 40, 122 and institutionalism 78 multi-level model of economic systems 389, 391 New Institutional Economics 416 ... Santa Barbara, USA Before this he was Anheuser Busch Professor of Economics and Law at the University of Arizona He is also a research associate at the National Bureau of Economic Research and... n ar d Part III Strategy and Management New Institutional Economics, Organization, and Strategy jackson n ickerson and l yda bigelow 158 181 183 10 Inter-Firm Alliances: A New Institutional Economics. .. present-day Latin America, and on issues of land use and agricultural contracting in North and South America ~ DA, B E N I T O A R R U NA Professor of Business at Pompeu Fabra University, Barcelona, has