Institutional Economics: Neoclassical Assumptions

• Institutional economics is the study of how institutions and social norms shape economic behavior

Lecture 1: Basic Assumptions of Neoclassical Economics

• Neoclassical economics assumes rational agents, perceived value, savings deriving investment, free markets, and market equilibrium.
• It also assumes relevant and perfect information, marginal utility, and rational agents.
• Methodological individualism and reductionism suggest collective actions can be analyzed by examining a single entity.
• Exogenous preference assumes everyone has the same, given preferences.
• Instrumental rationality means maximizing utility by balancing budget and the prices of goods/services.
• Perfect information assumes resources are allocated through market systems, leading to a static view of equilibrium without needing institutions.
• Individual choices and outcomes are independent of others.

Lecture 2: From Old to New Institutional Economics

• It started as a reaction to the neoclassical economics school with Thorstein Veblen (1857-1929) and Oliver Williamson (1932-2020).
• Institutional economics focuses on the dynamics and transformation processes, emphasizing the historical evolution of institutions and systems where humans are central.
• Imperfections are part of free markets, which are not always efficient, necessitating empirical studies to understand complex realities.
• Veblen saw markets as not governed by natural law and stressed the importance of empirical studies in economics.
• The whole is greater than the sum of its parts, with behaviors and institutions influencing individual levels to aggregate ones.
• Understanding humans requires understanding society, which in turn requires studying individual humans.
• Old Institutional Economics (IE) focused on a substantive view of the economy as an instituted process of interaction between humans and their social environment.
• Reciprocity involves non-monetary exchange to maintain social relationships, like giving gifts.
• Redistribution involves a group producing for an entity (e.g., government redistributing money/services), relating to citizenship, socialism, and communism.
• Exchange refers to the normal market
• Householding involves a close family group and self-provision, common in rural economies.
• New Institutional Economics (NIE) focuses on markets and capitalism, refining the core of old IE.
• Game theory studies interdependent decision-making

Lecture 3

• Rivalry occurs when goods consumed are no longer available to others.
• Excludability refers to the ability to prevent someone from consuming a good.
• Free riding is taking advantage of a common resource without paying.
• The tragedy of the commons is the neglect of society's well-being in pursuit of personal gain, leading to overconsumption and depletion of resources.
• The conditions required for a "tragedy of the commons" to occur: resource scarcity, rivalrous consumption, and non-excludability.

Transaction Costs

• Search and information costs involve identifying trading opportunities, outlets, and exchange partners.
• Bargaining costs refer to negotiating acceptable trading agreements.
• Policing and enforcement costs include monitoring trade conditions and enforcing contractual terms.
• Trading characteristics involve uncertainty (generic, bounded rationality, opportunism), frequency, with more uncertainty in small markets and high administrative/bargaining costs in large ones.
• Asset specificity includes exchange involving investment in unique, non-marketable, non-re-deployable assets, leading to incomplete contracts and hold-up problems.
• Incomplete contracts arise from costs to anticipate all possible scenarios and the difficulty in unambiguously describing contingencies for court verification.
• Hold-up happens when one party exploits the prior commitment of another party in a relationship for their own gain.

Types of Asset Specificity

• Site specificity is the co-location of power plants and coal mines.
• Physical asset specificity involves investment in specialized equipment.
• Human asset specificity deals with firm-specific knowledge.
• Dedicated capacity refers to assets designed for a specific consumer.
• Brand name capital maintains reputation for example in franchise relationships.
• High specificity means an asset is only useful for certain tasks or circumstances.
• Internal transaction costs are within a company
• External transaction costs occur between companies

Lecture 4: Markets and Governance

• Internalization means executing transactions within the organization instead of relying on the market.
• Vertical integration is when a company owns its supply chain.
• Firm size and transaction costs dictate that companies grow when external transaction costs are higher than internal ones; they downsize (outsource) when external costs are lower.
• A higher degree of asset specificity leads to more vertical integration.
• Physical assets: chemical industry's need for on-site service leads to vertical integration.
• Human assets such as specific know-how are a reason for vertical integration.
• Frequency: nuclear power plants' frequent tasks are done in-house.
• Uncertainty prompts more control over operations.
• Market governance involves simple transactions with easily transmitted product specification information and minimal buyer input.
• Forms of hybrid governance include joint ventures, partnerships, and franchises.

Lecture 5: Allocation of Property Rights

• These entail the right to use a good, manage it (and earn from it), and transfer it to others; ownership is having all three rights.
• Owners can transfer a good to others and are ready to pay the highest price.
• Outsourcing increases market regulation due to market failures, free riding, and transaction costs.
• Market safeguards arise from market pressure, safeguarding against opportunistic behavior because of reputation concerns.
• Administrative safeguards, such as international regulation, protect against opportunistic behavior.
• Property rights determine control within an institutional arrangement, dictating who has rights over residual income.

Examples of Property Rights

• Renting a flat, renting land for farming benefits, having ultimate rights of disposal and the power to exclude others.
• Owners of fairground attractions are responsible for injuries.
• Renters with electricity problems rely on owners for solutions.
• Users have less incentive to care for goods, so they pay deposits for flats.

Different forms of ownership

• Free use/access lacks clear property rights, leading to the tragedy of the commons.
• Private property gives individuals/organizations the right to use, manage, and transfer assets.
• State/government property gives the state the right to use, manage, and transfer assets.
• Common property is managed by a group with rights to use, manage, and transfer.
• Prisons, being a public service, concerns the use of force and food quality.

Public or Private Decision

• The decision involves a balance between cost-cutting, quality, innovation possibilities, and competition effects.
• Public ownership is stronger when: non-contractible cost reductions significantly affect quality, not needing incentives for competition.
• Privatization is stronger when: quality-reducing cost reductions can be controlled and when incentives for innovations are important, allowing competition
• Commons cause rivalry and low excludability. Cooperation is rare without institutions or partnerships.
• Efficiency is shaped by informal norms, values and ideology. In Africa, commons are more prevalent.

Characteristics of National Cultures

• Level 1: Embeddedness, informal institutions, customs, traditions, norms and religions
• Level 2: Institutional environment, formal rules of the game - property, judiciary and bureaucracy

Lecture 7: Between Methodological Individualism and Methodology

• Culture (Guiso): Customary beliefs/values ethnic, religious and social groups transmit unchanged.
• Culture (Hofstede): Collective programming of the mind distinguishing the group from others groups.

Characteristics of national cultures:

• Power distance (large versus small) relates to solutions of human inequality - hostile overall society.
• Uncertainty avoidance (strong versus weak) relates to the level of stress in a society. Weak not many rules, strong has.
• Individualism versus collectivism relates to integration into groups and impacts relationships
• Masculinity versus femininity relates to the emotional roles between women and men - economic growth and profit is masculine.
• Long-term versus short-term orientation relates to the focus of effort, society/firms
• Indulgence versus restraint relates to gratification of desires for enjoying behaviour.
• Methodological individualism, social science should be in relation to individuals
• Methodological collectivism - sociology, the idea that knowledge should come from groups
• Social capital, culture that comes from different groups. The supports of the construction of your own individual capital structure. Values and beliefs with relationships with individual groups
  • Helps to access resources using a social networks to find a job
  • Is the reason that can influence behaviours - recycle
  • Important when formal situations, trust in others for property protection.
  • Lack of connections to other communities, hinder their economic process

Lecture 8: Institutions and Development

• De facto political power: Influence groups have on official rules (money and contacts).
• De jure politics: How demoocracy is organized.
• Economic situations determine the other institution and politics
• Influenced by path dependency is often not optional but can be made made
• More social structure = better economic control

Lecture 9: Evolution of Welfare States

• Social security is the type of healthcare, or insurance etc.
• Is very easy to have a wellfare state when you are no longer taxed, costly
• Concept of government that the role in the public and private roles of citizen
• Welfare and markets of rights plus state activities are interacted with the market and family

1. Decommodification living more or less independent of markets
2. Social structure, intervenes to social inequality

Important Context

• 3 ideal states of welfare
• Social democratic
• Liberal
• Conservative Corporatist

Emergence of two main models first

• Bismarck model (19th) century

  • Economic production
  • Socialist alternatives in union

• goal: Living standards corporation Well fair

• Beverage model (1942

• include entire pop uniform intervention to mindset goal

• Subsistence /social demo wll fair -two