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The New Institutional Economics Approach to Economic Development — An Analytic Primer
Working paper
Omar Azfar
March 2002 |
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The aim of this paper is to introduce the reader involved in foreign assistance to some ways in which the New Insitutional Economics (NIE) can provide insights that help in the design of reform programs. This is not meant to be an exhaustive review of NIE and development. The paper is organized as follows: I begin by describing Williamson’s hierarchy of institutions: social structure and human motivations that take centuries or millennia to evolve, political institutions that take decades to gel, legal institutions that take years to be legislated, and the use of law by private parties that can be established over much shorter periods.
Within this discussion I introduce several conceptual ideas and theoretical insights from NIE: - Transactions costs and the components of transactions costs (informational asymmetries and the administrative costs of reducing informational asymmetries).
- The incomplete contracts problem, which refers to how to design contracts when important variables cannot be observed.
- The principal-agent problem, which refers to how a principal who cannot observe the agent’s action, can induce the agent to take the right action.
- The adverse selection problem, which refers to the problem of creating markets where the quality of the goods or the trustworthiness of the participants is in question.
- The collective action problem, which refers to how any rational agent alone would undersupply effort or resources to resolve group problems.
The paper discusses the following insights: Aligning the incentives of agents with the interests of principals, and improving information flows about actions and outputs can improve outcomes. This applies to principal agent relationships in both the political sphere (voter-prime minister-civil servant) and the economic sphere (creditor-debtor, shareholder-manager). It also applies to clear property rights, which give private agents sharp incentives to minimize on costs while maintaining quality; and to solutions for collective actions like rewarding citizens who detect defectors. The paper also points out the limitations of NIE: Incentives are at times not appropriate; and NIE does not help much in changing human nature, rather it offers insights on how to harness existing human motivations for socially advantageous ends.
I then turn to empirical methods used in NIE, which are discussed in more detail in the Appendix. I start with cross-country empirics, which involves the study of statistical relationships between institutions and economic performance across countries. I then turn to micro empirics and describe how institutions can be measured by surveys and in-depth interviews. The next method discussed is analytic narratives, which combine theoretical models with rich description. Finally I discuss experiments, which are now entering the mainstream of economic analysis but have only begun to be applied to institutions. |
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| Last updated on: 3/23/2006 |
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