Institutions and transaction cost approach

There exists no consensus on a standard definition of institutions. Every author formulates the definition according to aspects and characteristics embedded in the context. "Among these characteristics and aspects which vary are the degree to which they are: (a) organizational i.e. the extent to which organizations and institutions coincide, (b) formal, (c) created at specific time and place by a specific means, (d) embedded in, as opposed to differentiated from, other institutions, (e) universal, as opposed to particularistic, in the interest they serve, (f) creating, as opposed to simply maintaining a certain public good, and (g) technology linked" (NABLI/ NUGENT 1989:1334). MANIG (1992:6) defines such institutions as stable regulatory and organizational principles and rules which govern interaction processes between the people themselves and in their relation to

27 Institutional economics has introduced itself as a modified form of neo-classical economics in the second half of this century, although many authors find its elementary features responsible for the expansion of traditional discipline in the work of COASE. The central theme of the so-called 'Coase Theorem' is the costs of carrying out market transactions. These 'transaction costs' can be lowered by substituting market by a firm whose internal administrative decisions are less costly. NABLI/NUGENT (1989:1336) define NIE as an attempt to modify or broaden the mainstream toolkit and then to use this broaden analytical framework to explain phenomena that had previously seemed impenetrable.

28 For instance, institutions based upon ‘mutual co-operation’ and ‘patron-client relation.’

the environment and which are recognized and sanctioned by the societies in which they are found.

The above discussion shows a disagreement as to whether institutions can best be understood from the behavioral perspective, in which "institutions are complexes of norms of behavior that persist overtime, by serving collectively valued purposes" (UPHOFF 1986:9) or "rules of a society or organization that facilitate coordination among people by helping them to form expectations which each person can reasonably hold in dealing with others" (HAYAMI and RUTTAN 1985:204). Regarding this fact the cultural anthropologist MALINOWSKI (1949) already indicated that institutions are a significant, rather elementary component of the culture (Cf. RIEKEN 1994:398). NABLI and NUGENT (1989:1334) relate it to the level and sequence of analysis. For example, at a relatively 'low' level of analysis such as that of contractual arrangements, the rules’

characteristics may dominate but at a relatively 'high' level of analysis, such as that of cultural values and mores, the behavioral norms definition seems more relevant. For the present study therefore, institutions are defined as a "set of constraints on behavior in the form of rules and regulations; a set of procedures to detect deviations from the rules and regulations; and, finally a set of moral ethical behavioral norms which define the contours that constrain the way in which the rules and regulations are specified and enforcement is carried out." (NORTH 1984:8), and the regularities in repetitive interactions among individuals which provide a framework to determine confidence on the outcome of a task (NORTH 1986:231).

Another ambiguity which should be clarified before proceeding further is the distinction between institutions and organizations. "Institutions are not the name of the material infrastructure of institutions (building, machines, etc.), it is rather the whole complex of regulative mechanisms" (LÖFFLER, 1992:39).²⁹

Organizations should not be confused with institutions. Organizations and associations are indeed part of the institutional framework of a society in the sense that they, as executive organs, put into practice and enforce institutional regulative principles;

they should not, however, be regarded as institutions themselves. The interactions between the members of the organizations within the organizations and externally are, however, subject to the general societal regulatory principles and the institutionalized behavior and interaction pattern (MANIG 1991:18). Organization itself may be understood as the operationalization of institutions (DANIEL, 1982:839).³⁰

Apart from a trustworthy indigenous arrangement, the special preference of such saving institutions lies in the transaction cost minimizing function of such institutional arrangements.³¹ Transaction costs contain several different but interrelated themes.³² WILLIAMSON (1975, 1979, 1981) has combined the concepts of bounded rationality and opportunistic behavior. The general hypothesis is that institutions are transaction cost-minimizing arrangements which may change and evolve with changes in the nature

29 See also KÖNIG (1967).

30 DANIEL (1982:834-845)).

31 The New Institutional Economics is not a homogenous and monolithic body of knowledge. Being micro-economic in its perspective, it includes various approaches, each with its own techniques and concepts and advantages and disadvantages for analyzing institutions. Two broad approaches in this regard are transaction and information costs, on the one hand, and the theory of collective action, on the other.

See also, POLLAK (1985) and LÖFFLER (1992).

32 For instance, MATHEWS (1986) and NORTH (1981, 1986a).

and sources of transaction costs and the means for minimizing them.³³ It explains vertical integration as a response to the difficulties of regulating ongoing relationships by means of contracts.³⁴ Thus, contracting difficulties - the problems of negotiating, writing, monitoring, and enforcing agreements - are central instances of transaction costs.

BÖSSMAN (1982:664) includes information costs, costs of specifying and enforcing contracts and the costs of coordinating with formal market. She uses the term 'coordination costs' in the sense of coordinating economic activities. The present study will also discuss transaction costs as coordination costs³⁵.

According to the CDAWN³⁶ school, transaction costs and the institutions that evolve to minimize these costs are the key to the performance of economies. These costs include those of information, negotiation, monitoring, coordination, and enforcement of contracts.

In a small, closed, face-to-face peasant community, transaction costs are kept low because opportunistic behavior (cheating, shirking, moral hazards) is controlled through the personalized exchange process of the small community. In the case of impersonal exchange process (Western societies), some complex structures such as elaborately defined and effectively enforced property rights (formal contracts and guarantees, corporate hierarchy, vertical integration, limited liability, bankruptcy law, and so on) are established to constrain the participants to reduce the uncertainty of social interaction in general, to prevent the transactions from being too costly.³⁷

The village community develops saving arrangements by coordinating the use of scarce resources through customary rules and local institutions. NORTH (1986:231) discusses the formation of organizations to capture gains arising from specialization and division of labor, within this institutional framework. Individuals may form contracts which specify the terms of exchange with each other, either voluntarily or through coercion. "Such 'collective actions' stem to a large extent from pervasive production externalities. By nature, agricultural production activities are strongly interdependent due to the ecological interdependence of biological processes" (HAYAMI, KIKUCHI, 1981:12). Mutual-help relations such as labor exchange³⁸ and exchange of other factors such as draft animals are developed under this ideology. Indeed, clear expectations for the mutual observance of reciprocal rights and duties developed from close social interactions are the basic condition for mutual help and 'patron client relationship' led by traditional and charismatic domination³⁹ (WEBER 1968:226 and HAYAMI; KIKUCHI 1981:17) ⁴⁰.

33 For some limitations on this hypothesis as well as a more complete discussion, see AKERLOF (1970, 1976), BASU (1984), FIELD (1981) and DOW (1987).

34 See also WILLIAMSON, O. E.: (1975, 1979, 1981); SIMSON, A.: 1957; GOLDBERG, V. P.: (1976);

KLEIN, B.: GRAWFORD, R: G.; ALCHIAN, A. (1978).

35 See LÖFFLER (1992:52).

36 An abbreviation for the neo-classical authors famous for their work on transaction costs: COASE, DEMSETZ, ALCHIAN, WILLIAMSON and NORTH.

37 For further details, see BARDHAN (1989:5).

38 See Section 5.5.2.2.

39 WEBER distinguishes three ideal types of legitimacy upon which a 'patron-relationship' may rest:

traditional, legal and charismatic. Traditional authority is based upon the belief in the sanctity of age old rules and powers. In the most elementary kinds of traditional domination, those who rule have no specialized administrative staff through which they exercise their authority. Within the context of the present study, such an authority is held by village elders: those who are oldest are considered to be most steeped in traditional wisdom and thereby qualified to hold authority. A second form of traditional domination, which in fact often exists in combination with gerontocracy, is patriarchalism. In this form, which is normally based upon a household unit, the head of the household possesses authority which is transmitted from generation to generation by definite rules of inheritance. Weber sets out the pure type of legal authority as an individual's authority, who does so in virtue of impersonal norms which are not the