Notes on: Economic Behavior and Institutions by Thrainn Eggertsson, Cambridge Surveys of Economic Literature, Cambridge University Press, 1991.
Chapter 1: "A new research program ... aimed at generalizing microeconomic theory while retaining all the essential elements of the economic approach -- stable preferences, the rational-choice model, and equilibria.
Research programs are composed, according to Imre Lakatos, into a hard core of unquestioned ideas and a protective belt of adjustable concepts. For microeconomics the protective belt consists of specifications of the information economic agents possess. It also includes transaction costs and the institutional constraints on actions. Neoinstitutional economic theory does not alter the hard core of microeconomic theory whereas Oliver Williamson's school of New Instituitionalism incorporates Herbert Simon's theory of satificing behavior as opposed to optimizing behavior.
Neoinstitutionalists feel the addition of transactions costs and property rights to standard microeconomic theory gives a better theory.
"What, then, are transactions costs? In general terms, transactions costs are the costs that arise when individuals exchange ownership rights to economic assets and enforce their exclusive rights. A clear definition of transactions costs does not exist, but neither are the costs of production in the neoclassical model well defined." p.14
Eggertsson quotes R.C.O. Matthews, "The Economics of Institutions and the Sources of Growth," Economic Journal, (December 1986), p. 906, on transactions costs,
"The fundamental idea of transactions costs is that they consist of the cost of arranging a contract ex ante and monitoring and enforcing it ex post, as opposed to production costs, which are the costs of executing a contract."
Transaction costs are related to the cost of acquiring information, but they are not identical to information costs. Costs of acquiring information arise in situations not related to contracts and therefore are not transactions costs. Thus information cost is more general than transactions costs.
Eggertsson gives a list of transactions costs on page 15. He cites on the empirical study by North and Wallis (1986) on transactions costs in the U.S. 1870-1970.
Chapter 2 (Property rights, agency, and economic organization)
Three categories of property rights:
There is another three-way classification of property rights:
Ownership rights may be partitioned.
The Principal-Agent Problem
Shirking, or Post-Contractual Opportunistic Behavior.
Forms of enterprise:
Steven Cheung's Contractual Theory of the Firm.
Exclusive ownership calls for the costly measurement and delineation of assets and enforcement of ownership rights.
Michael Jensen surveyed the literature on the principal-agent problem. He found a theoretical category and an empirical category. The theory emphasized three things:
The cost to principals of relying on agents involves the costs of opportunistic behavior and the cost of monitoring. There are institutions which have arisen to deal with the problem of agency costs; e.g., profit sharing, bonding, and bonuses. The concepts of adverse selection and moral hazard are relevant.
Problem of creating market socialist organizations, as in Yugoslavia.
Chapter 3 (Explaining the rules)
Problems of Iceland, Soviet Union.
Power of special interest groups, Arthur Samish.
Free rider problem, Mancur Olson.
Equilibrium political institutions. Structure-induced equilibria.
Arrow's Impossibility Theorem.
Summary:
"In sum, the basic structure of propery rights is determined by the state and reflects the preferences and constraints of those who control the state." p. 79
Chapter 4 (The economics of exclusive rights)
Resources are wasted in the competition for a nonexclusive asset, but they are also used up in creating and maintaining a system of exclusive rights.
Common property (consequences of nonexclusive ownership)
De Facto Common Property
Property rights assigned only upon harvesting or extraction
Steven Cheung, "The Structure of a Contract and the Theory of a Nonexclusive Resource," Journal of Law and Economics, vol. 13 (April 1970), pp. 49-70.
Gordon's theory of the dissipation of rents in the common resource case.
Example of real estate agents
Public Choice analysis of rent seeking.
Privatization of Federal land in the nineteenth century.
Proliferation of cabins.
Disguised unemployment in India in World War II.
Two hundred mile coastal limits. Nigeria, Canada and Spain
p. 105 The Other Coase Theorem: "When transaction costs are high, the allocation of resources in a market economy can be strongly affected by the assignment of legal rights."
The Employers' Liability Act of 1880 in Britain
Before this Act employers were not legally responsible for negligent acts of their agents.
A study found that compared to the long run downward trend in the rate of industrial injury the effect of the Act was an increase in the injury rate.
Chapter 5 (The ownership structure of firms and economic outcomes)
Chapter 6 (The contractual nature of hte firm)
Right to smoke. p. 106
Rent control in Hong Kong.
The Economist articles on revisionist views of minimum wage legislation and rent controls.
Chapter 7 (The logic of economic organization)
Neoinstitutionalism holds that economics of organization is the economics of contracts. The relative economic advantage of alternative contractual forms is determined by transactions costs and cannot be explained by standard microeconomic analysis.
Search goods versus experience (or convenience) goods.
Search goods are ones whose quality can be determined by inspection whereas experience goods are ones whose quality can only be determined by consumption.
Investment in reputation.
George Akerlof's "The Market for Lemons."
Chapter 8 (The emergence of property rights)
According to Neoinstitutionalist Economics the state has a definite role to play in promoting economic efficiency. The state:
Eggertsson formulates a general version of Coase's Theorem: "The economic growth and development of a country are basically unaffected by the type of government it has, if the costs of transacting in both the economic and political spheres are zero. However, when transaction costs are positive, then the distribution of power within a country and the institutional structure of its rule-making institutions are critical factors in its development." p. 248
The Naive theory of property rights (Harold Demsetz) The development of rights to hunting grounds for beaver and other game animals in eastern Canada in the 18th century. Rights were not exclusive. Hunting for trade was exclusive but hunting for personal consumption was allowed. Also the game animaals could move so private property rights were only established upon harvesting of the resources. This led to an overhunting of the area and the end of the beaver populations.
In the American west the invention of barbed wire drastically reduced the cost of enforcing exclusivity.
Libecap's study of the Comstock Lode in Nevada
Ownership of fishing rights in the U.S. and in Japan.
Petroleum fields.
Chapter 9 (Property rights in stateless societies)
Group responsibility and vengence as a substitute for the state.
John Umbeck's study of mining claims in the gold rush days of California. He developed a model to determine the size of the claims.
Hirschliefer's evolutionary models.
Chapter 10 (The State in Neoinstitutionalist Economics)
North's theory of the state combines transactions cost analysis with agency theory in a rational choice analysis of political institutions and processes.
"The existence of a state is essential for economic growth; the state, however, is the source of man-made decline."
D. North
The resource endowment and stock of knowledge of a societ determine a technical production frontier. The structure of property rights of a society determine how close it gets to this technical production frontier. The production possibilities curve for a given property rights structure is called the structural production frontier. Appropriate structures of property rights are required to reduce transactions costs to manageable levels and the state has a comparative advantage in supplying those structures.
"The economies of scale associated with devising a system of law, justice, and defense are the basic underlying source of civilization."(North)
Findley and Wilson developed a formal version of North's model.
Y = f(L,K)p(G),
where Y is output, L and K are the labor input and the capital input, respectively, and G is the number of government workers.
The factor p(G) rises to a maximum and then declines. There is also a labor constraint L + G = H, where H is the available labor force.
The socially efficient objective would be to choose G so as to maximize Y, but there are other consideration to be taken into account. If the state state has to balance its budget then the government workers will have to be paid for by a tax. If it is an income tax and the tax rate is t then the cost of the government workers is tY. But the government workers pay is also taxable so when the state increase G the net cost is (1-t)w, where w is the wage rate. In a competitive labor market the wage rate in the government sector will be the same as in the private sector. If the wage in the private sector is based upon the marginal productivity of another worker then increasing government workers decreases the private sector workers and thereby increases the wage rate because the marginal labor productivity in the private sector will rise. This would be an impediment to policy that wanted to maximize G. The model could have the state choosing a tax rate that will enable it to balance its budget at the socially optimal level of government employment G*. Or the state could strive to maximize its wealth by choosing a level of government employment where the difference between tax revenues and costs is the largest, given an exogenously set tax rate.
North argued that the development of representative democracy in western Europe may have been tied to advances in military technology. More advanced weapons required a larger budget which the aristocracy could get only by surrendering some of its prerogatives to the cities.
Robert H. Bates' study of coalitions, Markets and States in Tropical Africa.
Jan Waniecki's analysis of Soviet-Type Economies (STE's).
North and Weingast's comparative analysis of England and France in the 17th century. Separation of powers and the financial revolution in England gave it an edge over France.
Anthony Downs economic model of democracy
Public Choic Theory
Committee structure and trading votes
Gary Becker's economic analysis of social institutions
Economists, whenever they give public policy choice a thought, decry the results of political policy making. Any actual public policy, be it fiscal, monetary, public welfare, international aid, unemployment, medical care, tax, drug, or transportation, is looked upon as an abomination to be considered briefly while holding the nose. As a consequence of this disdain of practice, economists spend most of their time fruitlessly considering optimal choices that ignore the organizational and political constraints on public policy choices. Harold Demsetz, in a different context, referred to this orientation as a nirvana complex. If economics is to have a positive marginal social product, economists must be cognizant of institutional frameworks and the constraints they impose. I propose that we light one candle by providing our students with a course which deals with these topics in a practical as well as an analytical way. There is, of course, an institutionalist school of hoary if not ancient tradition in economics. It has not had much of an impact on mainstream economics, perhaps because its proponents proposed to surplant neoclassical economics rather than augment it. As so often is the case people go wrong intellectually not because their ideas are completely without validity but instead because they attempt to establish that their ideas are the total truth. (This, of course, also applies to neoclassical economics.) While the primary focus of the proposed course is not traditional institutionalist economics, it is appropriate to provide a survey of the teachings of Thorstein Veblen, John Commons, Alan Gruchy, Morris Copeland (Flow of Funds Accounts) and Clarence Ayres. There are also more recent proponents of an instituionalist focus who constitute the neo-institutionalist school such as Oliver Williamson and Douglass North who would also be covered. The neo-institutionalists, in contrast to the institutionalists, seek to generalize neo-classical analysis. There is also a school of thought within economics that sees social institutions as the outcome of economic processes such as Gary Becker, Friedrich Hayek, Ludwig von Mises and, of course, Karl Marx. Ronald Coase and the Law and Economics movement would also fit in here as well. It would be appropriate to give some time to these people in the context of how institutional structures affect economic decisions. There is a more recent field of economics that should also be covered. That is Public Choice Theory. Before Gordon Tullock and James Buchanan's work there were some attempts to apply microeonomic analysis to political processes, such as Anthony Downs analysis of democracy. I should note here that the word "institution" is used differently by different groups. For some "institution" refers to what might be called social institutions, such as private property. Others use "institution" to refer to organizational or political structure. Still others would refer to laws as institutions. The heart of the course should be case studies of legislative, executive, and regulatory organizations and their policy making. Often the outcome of the policy making these bodies is the creation of other governmental bodies such as urban planning departments and regulatory agencies. Economists should know about the operation of urban planning and its effects on cities. The course should also cover legislation such as those requiring environmental impact analyses for all major projects. This is quite important in the education of economists because they often are involved in research that stems from these regulations.
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