Institutional Context Supplement 3 Flashcards
slides and supplement combined
Gradual Change
change within the broader boundaries of an established institutional frame
harder to observe, because incremental
Radical institutional change
brings the institutions to the forefront of attention
Stages of institutional development from local autarky to modern society
- Trade within the tribe/village
- Trade beyond the village
- Long distance trade
- Further expansion of trade
- Modern trade
What happen during the different stages of institutional development?
increasing reliance on specialization and division of labor, which makes trade more dependent on a wide range of institutions
- increasing levels of transaction costs
What are transaction costs related to?
a) search and information costs
b) bargaining costs
c) monitoring and enforcement costs
1) trade within the village
trade exists in a dense network.
There may be quite high social costs to a tribal organization. People stick to the family order.
2) trade beyond the village
- trade in regional markets or bazaars.
- people start to specialize
- transaction costs rise sharply while production costs go down
- religious precepts (rules) determine the standards and rule-compliance of the players.
- effectiveness of the informal institutions depends largely on the extent that these religious precepts are held to be binding.
3) long distance trade
- like caravans on the Silk Road
- economies of scale arise through geographic specialization (Silk in China)
- occupational specialization (farming, trading, transporting)
two transaction problems
- agency problem
- contract problem
agency problem in long distance trade
principal = owner of the goods agent = subordinate who performs activities like transporting goods
trustworthy agents are family members:
–> Success of trade depends on the strength of family ties and the price of defection (Treuebruch)
contract problem
- problem from having to negotiate and enforce contracts over long distances
- enforcement is the agreement of buying and selling and the protection of the goods en route
What institutional development is needed for trade beyond the village?
Trading centers
- Further expansion of trade; urbanization
- towns become more important centers of exchange
- need for effective, impersonal contract enforcement in necessary
- capital markets required that property rights were secured over time
- credible commitment for property rights
- technology enabled manufacturing to advance
How can property rights be secured over time
through credible commitment
How can credible commitment of property rights be accomplished?
If the ruler restrains itself in using coercive force but more often in society constrains the power of rulers
What does the effective use of technology require?
- large investment in factories and machines which is an increase in fixed costs
- uninterrupted production, a disciplined workforce, and transportation networks
- secure property rights
- a political and judicial system that permits low cost contracting
- flexible laws permitting a wide range of organizational structures
- complex government structures to limit agency problems hierarchical organizations
- Modern trade
- specialization is optimized
- everyone has a specialized function
- worldwide network of interconnected players
indicator for institutional devleopment
agriculture requires a small part of labour force
Why do institutions not develop?
- when deviance and innovation are viewed as a threat to group survival
- dominant players have little incentive to change the rules
- path dependency
What are the underlying mechanisms that explain the path dependency?
- Institutions come with high switching costs
- Institutions come with high sunk costs (people become committed because of the sense that they already have invested so much)
Base of the Pyramid
- 4 billion people live in survival markets; income <3K; this is the base of the pyramid
- 2 billion in emerging markets
- 0.1 billion in mature markets
What was developed to reduce poverty of the base?
“business case”
- calls for MNCs to focus on the Base of the Pyramid
- jobs should be created for the Base of the Pyramid
Opportunities for the MNC in the “business case”
- improve profits by exploring new growth markets when home markets are saturated
- aggregate demand (internet or mobile phones)
- low-cost strategies by outsourcing activities to the base
- boost innovation, because decision-makers have to think more efficiently, less costly, and more sustainable
arm’s length transaction
buyers and sellers act independently and have no relationship to each other
- increases as institutions develop
World Bank Institutional Quality Indicators
Selecting and Replacing Governments
Formulating and Implementing Policies
Respecting and Abiding Institutions
Selecting and Replacing Governments
Voice and Accountability
Political Stability
Formulating and Implementing Policies
Government Effectiveness (reliable public service and strong civil service) Regulatory Quality (ability of government to implement sound policies to promote private sector development)
Respecting and Abiding Institutions
Rule of Law
Corruption Control
institutional transition
changing the system from one type to another
from centrally planned to free market
what does the extent and success of transitions depend on?
Pre-conditions: - institutional embeddedness - institutional permeability Transitition approach Internal and External forces
institutional embeddedness
refers to the extent to which the pre-transition institutional context is entrenched in the old system
institutional permeability
extent to which the country’s institutional system already showed holes through which external forces could influence the country
Transitional approach
gradual or abrupt change
“shock therapy” in Poland
–> for Poland tremendous short-term social and transitional costs, but many viewed Poland as most successful transitional economy
Internal and external forces
- common complexity is the divide between adherents and successful users of the new economic reforms (generational divide)
emerging markets
countries that are rapidly growing economically and industrially
BRIC are included for example
MNCs choice of an emerging market is often a result of
herding or mimetic isomorphism where firms mimic the entry decisions of competitors or follow key customers
composites
aggregate data that combines information on a large number of items
Path dependency of transitional economies (from Communism to Capitalism)
Shared History:
- Industry structure
- Dominated by big industrial companies
- Lack of property rights
- Dictatorship
institutional voids
absence of institutions that facilitate exchanges between buyers and sellers (lack of intermediary firms…)
What should executives look at rather than composites?
Institutional voids (called the idiosyncratic approach)
In which ways does the market reveal institutional voids?
- can be related to expectations and information about consumers and suppliers of PRODUCT MARKETS
- LABOR MARKETS tend to have institutional voids (difficult to find good people)
- CAPITAL MARKETS are still developing (effectiveness of banks and insurance companies may vary considerably; no clear expectations regarding corporate governance so it is difficult to trust local partners)
What does a lack of openness create
it creates trade, social, and administrative barriers
What can MNCs do when there are institutional voids but they still want to be successful?
They can fill the institutional voids
Shakti
empowerment. building and supporting a network of female entrepreneurs in India by Unilever.
