Public Speaking & Institutional Economics

• The lecture discusses the topic of institutional economics

Public Speaking Sessions

• The public speaking session is 90 seconds per student, and it is timed
• Students should wait in a queue at the podium
• Speakers can share news related to course themes
• Speakers can share cultural, political, or societal events in their country if significant or impactful
• Speakers can express criticism of a policy, event, or trend
• Speakers can respond to previous speakers, challenging what others have said, adding their perspective or information
• Speakers can share updates about their group's events, initiatives, or achievements

Rules for Public Speaking

• Public speaking in class provides a chance to practice
• Due to class size and time limitations, speeches are limited to 90 seconds per person, with a maximum of 10 students per class
• Public speaking accounts for a maximum of 5% of the grade
• A decision needs to be made whether public speaking should be mandatory
• Considerations: If mandatory, how many times? (Max 2 times); if not, could the session be monopolized?
• A plan is needed on how to motivate participants within each class and across classes
• A method is required to decide which participants to select if there are multiple volunteers
• There needs to be a way to compare performance across different topics

Cooperation

• The field of institutional economics focuses on the problem of human cooperation
• The problem of of human cooperation specifically allows economies to capture gains from trade
• Wealth-maximizing behavior by individuals can lead to outcomes that are not optimal for the group shown in the Prisoner's Dilemma
• Institutions play a crucial role by creating an environment conducive to cooperative solutions for complex exchange

Standard Behavioral Model of Economics

• The neoclassical model assumes individuals maximize their preferences
• Completely rational individuals can foresee everything and evaluate and optimally choose among available actions
• The model assumes no costs are associated with using the market
• Prices become a sufficient mechanism for allocating resources to their highest value uses because the market functions perfectly

Limitations of Standard Behavioral Model of Economics

• Violations of the assumptions include:
  • Transitivity
  • Framing effects
  • Preference reversals
  • Formulation, manipulation, and processing problems of subjective probabilities in uncertain choices.
• Exchanges are not repeated in real-world scenarios, reducing the incentive to cooperate.
• Impersonal exchange involves large numbers of participants and limited information about them

Game Theoretic Cooperation

• Literature explores conditions under which cooperation can be sustained
• Wealth-maximizing individuals will usually be willing to cooperate with other players, when...
  • The play is repeated
  • They possess complete information about the other players' past performances
  • There are small numbers of players
• The economic potential is not realised throughout history and in present economies
• The economic potential has been realised in the modern Western World (at least partially)

Modifications to the Standard Behavioral Model

• Bounded rationality is assumed instead of perfect rationality
• Individuals are assumed to maximize utility in a perfectly rational manner traditionally
• Individuals act on incomplete information
• Individuals have subjectively derived models of the world that may be erroneous
• Limited ability to process information leads to simplify interactions and it's evolution via rules/procedures
• Economic exchange cost considerations include information costs, search costs, negotiation costs, fulfillment costs
• Level of each depends on institutions in effect
• Standard behavioural models assume economic exchanges are costless

Transaction Cost

• The classical model posits no costs associated with using the market
• Institutions are irrelevant and not needed to facilitate exchange.
• Using hierarchies (firms) are costly when use of markets is costless
• For some activities, costs of using markets are higher than those of using hierarchies like firms
• Institutions matter when it is costly to transact

Cost of Using the Market

• The costliness of information is key to transacting
• This includes costs of measuring valuable attributes and enforcing agreements
• Recognizing that production costs include transaction costs requires a new microeconomic framework
• Higher transaction costs = fewer transactions
• A lower number of transactions means a lower degree of specialization and less income

Measurement Cost

• When we engage in an exchange, we are concerned with attributes that make a product valuable, not simply trading generic goods or services
• Resources (time, effort, expertise) are required to accurately measure these attributes
• Sellers often know more than buyers about the valuable attributes of a good/service, leading to information asymmetry
• Measurement costs arise because it is expensive to ascertain valuable attributes of goods, services, or the performance of agents

Enforcement Cost

• Enforcement is typically imperfect due to the cost of measuring contract performance and due to enforcement being carried out by agents
• It is often costly to discover if a contract/agreement has been violated
• Resources must be spent on apprehending the violator and imposing penalties Because...
  • Measuring the extent of the violation
  • The consequent damages is also costly
• Contracts may be self-enforcing if it is in the interest of the parties to live up to the terms
• Self-enforcing occurs when there is substantial knowledge between parties and repeat dealings

More Enforcement Cost

• Agent costs arise when a principal delegates tasks or responsibilities to an agent
• These costs occur due to the fact that the agent's goals and motivations may not aligned with the principal's goals
• Information asymmetry creates opportunities for agents to act in ways that benefit themselves at the expense of the principal
• Principals must incur costs to monitor agent performance and to enforce agreements
• The principal-agent issue is ubiquitous in hierarchical organizations

Institutions

• Institutions are the rules of the game in a society
• Or the humanly devised constraints that shape human interaction
• Institutions whether formal or informal function to limit choices
• Institutions structure incentives in human exchange, whether political, social, or economic
• Institutions can be created or evolve over time
• They define prohibitions and conditions under which certain activities are permitted
• Institutions do not guarantee efficient outcomes
• Institutions that create monopolies, restrict opportunities, or favor redistributive over productive activity are common

Why Institutions are Necessary

• Institutions reduce uncertainty by establishing a stable structure for human interaction
• The importance of institutions arises from the costliness of measuring what is valuable, protecting rights, and enforcing agreements
• Resources may be allocated to activities that exploit information asymmetry rather than to productive activities
• Because of the cost of measuring all aspects of an exchange, most contracts will be incomplete and require informal constraints to supplement them
• As self-enforcement is insufficient in many situations, complex exchanges in an impersonal world require third-party enforcement to ensure compliance
• Institutions affect the economy's performance by impacting exchange and transformation (production) costs

Informal Constraints

• Informal constraints include conventions, codes of conduct, and norms of behavior
• Culture defines how individuals process information and affects how informal constraints are specified
• In the absence of formal rules, kinship ties often form the basis of social order as insurance, protection, and law enforcement mechanisms
• Family members deter other members from engaging in harmful behavior because a feud would be harmful to all members

More Informal Constraints

• Informal constraints can include internally enforced codes of conduct
• Those codes of conduct can make individuals give up wealth for some other value, such as altruism, fairness, and justice
• Ideas, ideologies, and convictions play a major role in choices, when the cost of expressing them is low
• Institutions can reduce the price individuals pay to express ideologies and convictions
• Formal institutions can enable individuals to express views and influence outcomes
• Lifetime tenure for judges can allow them to act on their own conviction, shielding individuals from interest group pressures

Formal Constraints

• Formal constraints include rules and laws that are explicitly stated and provide a framework for exchange
• Contracts are frameworks to provide evidence about forms of organization and reflect ways to facilitate exchange
• The need for a state to enforce agreements creates a dilemma because the state can also act in ways that are harmful to economic growth
• Political institutions evolve to lower the costs of exchange among legislators
• Establishing credible commitments for future payoffs Formal rules alone are insufficient to explain outcomes because they interact with informal norms and enforcement characteristics

Research Questions

• Effects of Institutions; institutions assumed to be exogenously given
  • How institutions affect economically relevant variables     - EG: How do institutions affect GDP growth and economic development? -Exogenous variables determined outside the model
• Origins of Institutions; institutions are endogenized
  • Origins of institutions and how certain institutions develop     - EG: How do economic growth and inequality explain democratization?
  • Endogenous variables are determined within the model

Goals and Challenges

• Descriptive inference:
  • Empirically founded relationship between the independent/dependent variables
  • Based on a number of observations allowing generalization over and beyond cases under review
• Internal validity:
  • Degree to which descriptive or causal inferences from a given set of cases are indeed correct for most
  • External Validity
  • Extent to which the results of the comparative research can be considered to be valid for other more or less similar cases
• Causality:
  • Variation in dependent variable is evidently & systematically related to variation in (one of) the independent variable(s)
• The challenge of causal inference in social science:
  • We cannot control exposure to independent variables (treatments)
  • There is always a chance that a third (confounding) variable is causing Y
• We cannot randomly 'assign' a country a type of regime or a level of social expenditures
• Genuine experiments are rare in comparative politics

Toolkit of Institutional Economists

• Institutional economists employ a variety of tools to analyze how institutions affect economic outcomes and how institutions themselves evolve
• Game Theory reduces complex interactions to essential components and it helps predict behavior and understand how institutions can reduce strategic uncertainty.
• Essential game theory components:
  • Players
  • Rules
  • Strategies
  • Information Set
  • Payoff Functions
• A Nash equilibrium represents outcomes of the game:
  • With other players acting in the current way, players can't benefit by altering their own action.

Toolkit of Institutional Economists Continued

• Comparative Institutional Analysis compares actually realized institutions to understand how institutional arrangements affect economic outcomes/transaction costs
• Case Studies: -Economic history including detailed analysis of specific cases
  • Analysis focus is on the emergence/impact of institutions in a specific country/time period
  • 'Most Different Systems Design’,
  • 'Most Similar Systems Design'
• Experiments:
  • Experiments in the Laboratory or the Field test behavioral predictions, often revealing deviations from the standard behavioral model.
  • Experiments help assess relevance of internal institutions like social norms/ values

Economists Toolkit

• Econometric Tests
  • Quantitative data used to test determinants/effects of institutions
  • Allows for the comparison of institutions and impact of on economic outcomes such as growth rates/investment
  • Confounder
  • Collider
  • Mediator
• Remember that: “Correlation doesn’t equal causation”

Data in Social Sciences

• Spatial: cross-sectional
• Functional: cross-organizational or cross-process
• Longitudinal: cross-temporal
• The number of cases:
  • Small N: case studies, and process tracing
  • Large N: statistical techniques, parsimonious explanatory designs
• Type of data:
  • Official statistics: aggregate data at some territorial level
  • Individual level data
  • Text as data

Review Topics

• Institutions and Cooperation
• Neoclassical behavioral assumptions
• Limitation and modification to classical assumptions
• Transaction costs
• Measurement and enforcement costs
• Informal and formal institutions
• Internal and external validity
• The challenge of causal inference
• Confounder variable

Exploration of institutional economics topics. Key aspects of the public speaking session. Rules and guidelines for effective class presentations and discussions.