evolution of markets and institutions (murali patibandla, 2006)
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Evolution of Markets and
Institutions: A study of an emerging
economy (2006)
Murali Patibandla
1Evolution of Markets and Institutions (2006)
Contents
I. Introduction (3)
II. The conceptual framework (5)
III. Initial conditions and economic policy reforms (3)
IV. The direction of structural changes (2)
V. Competitive dynamics (3)
VI. Technological change (4)
VII. Organizational change (4)
VIII. The evolution of public and private order institutions (2)
IX. Conclusion (1)
2Evolution of Markets and Institutions (2006)
I. Introduction (1/3)
• Context
• India- One polity, many countries
• 1980s- 90s movement towards free-market economics
• General reduction of international trade barriers and investment barriers
• Rapid progress in ICT
• Indian reforms limited to urban class and western and southern parts
• Workers’ productivity is not just a factor of capital and technology, but also that of property rights, incentives, and TC
• The institutional environment is defined jointly by the rules of the game (formal constraints) and conditions of embeddedness (informal constraints)
• Interaction between institutional environment and governance mechanisms (markets, hierarchies and hybrids) determines economic efficiency of exchange and incentives for investment
• There exist a critical minimum level of capitalist institutions at the onset of economic reforms, on the basis of which further evolution takes place. In the case of India, it was the presence of markets and a critical level of capitalistic institutions pre- 1991
• Entry of TNC (transnational corporations) helped Indian firms become more productive, and economic benefit of IT export revenue from such TNCs
• Case of India
• Endowment, both from free-market mechanism of British rule (railroad, telegraph and human rights institutions ) and import substitution policies post-independence
• Early investment by government, made easy for private players to take over later
• Excessive government intervention trapped economy into distributional politics at the cost of wealth- generation
• Reforms took time to impact the economy
3Evolution of Markets and Institutions (2006)
I. Introduction (2/3)
• Governments are public order
institutional mechanisms that reduce
uncertainty whereby increases gains
from specialization and lowers TC
• Countries that are able to arrive at
governance mechanism that bring out a
fine balance between individual
incentives, and formal and informal rules
formed by collective actions are the ones
that facilitate free markets to germinate
• Overall efficiency of economic activities is
determined by combination of
transformation and transaction costs
• Economic activities is organized in an
economy by balancing trade-off between
high-powered incentives of individual
choices and low-powered incentives of
institutional constraints (e.g. western
economies)
• Success story is Europe, and failure story
is Russia (lack of minimum capitalistic
institutions and mafia property rights).
• Success story of South Korea in 1960s
under President Park (land reforms,
breaking up of trade-unions)
• Institutional failures (collusion of banks
and conglomerates with poor disclosure,
lack of accountability) led to Asian Crisis
of 1997- Crony capitalism
• Slow progress of Japan in 90s due to
lack of institutional reforms
• Highly interventionist planning system
4Evolution of Markets and Institutions (2006)
I. Introduction (3/3)
China
• 1978- totalitarian communism, external
reforms followed by delayed internal
reforms, ambiguous property rights,
focus on state-owned enterprise (SOE),
no attention to private enterprise. capital
access restriction, private firms converted
to foreign firms with borrowed capital
from neighbors, successful community
owned Township and Village Enterprises
(TVEs), high savings rate but still large
foreign capital flow, faster decision
making owing to central control, high
contractual hazards yet attractive for
risky investors,
India
• 1991- democracy, initial reform in
1980s, pervasive government
intervention loosening post
liberalization, internal reforms followed
by external ones, private agents given
property rights but often modified,
distributional- politics, strong local
entrepreneurial class, growth of
internationally competitive knowledge-
based industries, low domestic saving
by better capital utilization, slow
clearance of large scale projects, high
market TC due to independent
judiciary and state- centre split
5Evolution of Markets and Institutions (2006)
II. The conceptual framework (1/5)
• Reforms are parameter (quantitative) and qualitative shifts in elements of institutional environment
• Parameter (taxes, licensing fee, tariffs, exchange, and interest rates)
• Qualitative (removal of licensing, revision of small scale industries, import restriction)
• Qualitative shifts eliminate TC once and for all
• Markets
• Product and factor markets
• Policy interventions address market failures
• Reforms results into removal of government interventions as markets improve
• Reforms impact both efficiency (competition) and distributional (allocation) criteria
• May mean adverse outcomes in short run on distributional grounds
• Prices reach their opportunity cost and new markets emerge (greater participation of agents)
• Economic institutions
• Institutions are humanly devised constraints
that structure political, economic and social
interactions. They consist of both informal
constraints and formal rules (North 1990)
• Interplay of institutional environment
(property rights, custom, traditions and
norms) and institutions of governance
(issues of contracting)
• Collective actions are required when
individual actions cause costs to society at
large, owing to negative externalities
(Coase’s property rights theorem).
• Collective actions could be private ordering
or government enforced
• Social norms and trust are important
elements of private ordering (e.g. throwing
garbage)
• Institutional environment determines micro-
level governance choices, in turn
determines economic efficiency
6Evolution of Markets and Institutions (2006)
II. The conceptual framework (2/5)
• Economic institutions (on TC)
• TC determined by frequency, uncertainty
and asset specificity.
• Asset specificity has a strong contractual
dimension, as it increases opportunism
• All contracts are incomplete
• Assumes bounded rationality and
opportunistic behavior (self- interest with
guile)
• Possible governance structures are markets
(spontaneous adaptation), firms
(coordinated adaptation), hybrids
(negotiated order of credible commitments )
and public bureaus
• Trade-off between public bureau and private
ordering
• Mafia is a form of governance structure
(private ordering) chose by people who are
left out of the rule
• Formal rules and laws
• Increasing specialization and division of
labor calls for formal rules of interaction
• TC depends upon definition of rules and
their enforceability
• Rules can be copied, but their
implementation needs institutional
effectiveness (embeddedness)
• Poorly defined laws discourage individuals
from investing in durable assets
• Common- law countries laws emanate from
judicial decisions (e.g. India, US, Australia),
while in civil- law countries they emanate
from centre (Europe, Russia, China)
• Law enforcement depends upon de/
centralization of governance structure,
higher centralization higher is moral hazard
7Evolution of Markets and Institutions (2006)
II. The conceptual framework (3/5)
• Formal rules of property rights
• Private property is an important institutional
condition and incentive for capitalism
• Clear definition of private versus common
property rights; and between private and
public stock of knowledge
• Enforcement by enforceable government
rules and/ or evolved social norms
• Features of a well- defined property law is:
comprehensively assigned (either privately
or publically owned), exclusive ownership,
transferable with minimum TC, and secure.
• Poorly defined property rights lead to
predation by private agents and government
• Need for clear separation of ownership and
control rights
• Institutional protection of IP rights result in
investment in hi-tech industries
• Proper appropriation of IPRs enable
creation of knowledge assets
• Informal rules and norms
• Societies with embedded norms of trust
incur low TC.
• Evolve through repeated interactions
• Avoids myopic competitive behavior
(Prisoner’s Dilemma)
• Trust comes from experience that shows
that incidences of cheating are few
8Evolution of Markets and Institutions (2006)
II. The conceptual framework (4/5)
• Organization
• Firm is an organization to minimize TC (Coase 1937, Williamson 1975)
• There is no power and hierarchy in organization as firm doesn’t own all inputs. Organizations evolve to measure efforts and assign rewards (Alchian and Demsetz 1972)
• Firm is a nexus of complete contracts under agency problem of separation of ownership and control (Jensen and Meckling 1976)
• Firm has residual decision rights owing to asset ownership under incomplete contracts (Grossman and Hart 1986)
• Firm is an information economizing response to market failures (Arrow 1974, Hayek 1945)
• Firms are complex hierarchies of employees supervisors (Clark & Wolcott 2001)
• One way of solving bureaucracy problem is by adopting M-form (Chandler 1977)
• Market imperfections lead to diversification (Khanna and Palepu 1997)
• The evolution or economic institutions
• More people participation in markets
increase transactions and efficiency
elimination of monopolies transfer of
surplus to customers investment in
durable assets need for strong property
rights increased competition increased
investment
• Reform lower the TC with government but
increases complexity, uncertainty and
frequency of exchange
• Such changes are never piecemeal
• Call for change in formal laws, followed by
governance mechanism
• Institutional elements can change with
change in political economy, or with crisis
• Evolution of norms
• Through cooperation of repeated interaction
in small societies and learning
• Formal laws and rules come into play to
neutralize the costs of freewheeling capital
9Evolution of Markets and Institutions (2006)
II. The conceptual framework (5/5)
• Organizational change
• Organizations are form, while institutions
are substance
• Organizational forms are copies by
developing countries, but implementation
remains a challenge
• Change can happen through: 1) shift in
institutional environment, or 2) engineering
organization by copying a superior form
• Institutional environments can change in
parametric or qualitative ways
• Large parametric changes are required to
induce a shift from market to hierachies,
than from extreme to hybrids
• Innovation and technology change can
bring about superior organizational
practices even in absence of institutional
shift (e.g. entrepreneurial creativity)
• May result in emergence of ‘islands of
competitiveness’ (IT/ ITES industry)
• Feedback effect of institutional
environment
• It the effect of changes in structural factors
and micro level governance on elements of
markets and institutional environments
• Initial policy changes are signaling
mechanism to encourage invest in durable
assets and human capital
• Depends upon credibility of commitment by
the reformists (e.g. IT industry effect on
employment generation)
• The post- reform rewards depend upon
initial conditions
10Evolution of Markets and Institutions (2006)
III. Initial Conditions and Economic Policy
Reforms (1/3)• The Indian Story
• One polity, many countries (Clark and
Wolcott 2001)
• Poor performance, in spite of democracy
and historical advantage, due to inefficient
utilization of technology
• Post- liberalization economic benefits have
only occurred in pockets
• Fragmentation of markets and institutions
• In developed world: Primitive communism
feudalism capitalism (Marx’s
interpretation)
• In India, such systems co-exist
• Elements of institutional environment works
for different agents differently , determined
by one’s social capability
• Prevailing information imperfections,
transaction cost and poor property rights
• Illiteracy is a key cause of fragmentation
• Reforms and investment in primary
education could overcome fragmentations
• British Indian and capitalistic institutions
• Construction of railroads and telegraphs
reduced domestic and international TC
• Adoption of Anglo- Saxon common law
leading to emergence on industrialists
• Elimination of taxes on goods movement
and adoption of common currency
• Implementation of local bureaucracy and
English- based education
• Establishment of BSE in 1875
• Indian industrial houses managed by
managing agency system (joint families)
• Civil services contributing to political and
administrative stability of India
11Evolution of Markets and Institutions (2006)
III. Initial Conditions and Economic Policy
Reforms (2/3)• Independent India
• Nehru’s Fabian socialism with investment in industrialization and import substitution
• Carried out in absence of land reforms
• ‘Soft state’ with complexity of political and bureaucratic systems
• Influence of Soviet style five year plans
• Parliamentary system giving discretionary powers to politicians and bureaucrats
• Higher education subsidized at the cost of primary education
• Product markets
• Five key features were: commanding height given to public sector, regulation of private sector, product reservation for SMEs, price control in certain sectors, and close door policy towards international trade and investment
• Labor markets
• Organized and unorganized segments
• Huge skill and wage difference
• Job security in organized public sector
• Capital markets
• Post –independence autonomy given to
central bank and regulatory institutions
• Pre reforms nationalization of banks and life
insurance companies
• Two challenges with India: high moral
hazard amongst public agents, and
absence of regulatory bodies leading to
criminalization of capital markets
• High savings rate, but poor institutional
arrangement leading to inefficacies
• Poorly managed developmental institutions
IFCI, IDBI, ICICI and UTI
• Presence of large unorganized capital
market (traditional moneylenders)
• A vicious nexus of capital, labor and output
market exploiting the farmers
12Evolution of Markets and Institutions (2006)
III. Initial Conditions and Economic Policy
Reforms (3/3)• Structural outcomes of the policies
• Public sector investment in strategic areas
• Rapid expansion of service sectors
• Inequalities in education system
• Proliferation of employment in unorganized
sectors
• Regional inequalities
• Location of public institutions to bring about
equality
• Incentives to private sectors to locate in
backward areas
• Post liberalization increase in inequality
• Gains limited to regions with endowments of
initial markets and institutions
• Kerala, despite high-literacy levels, didn’t
have necessary institutional conditions for
development
• Market structure and qualitative behavior
of agents
• Inefficient capital utilization on public sector
due to agency problem and lack of
autonomy
• Early industrialists were based upon
managing agency system on lines of joint-
family and created monopolies
• Business houses built family empires from
tax-payers money, and preempted new
entrants
• The policy reforms
• First phase (1980- 1991) and second phase
(post- 1991) triggered by balance of
payment crisis
• Removal of internal licensing policy and
restriction on capacity expansion, reduction
in import tariffs, devaluation of Indian rupee
• Setting up of SEZ in 2001
13Evolution of Markets and Institutions (2006)
IV. The Direction of Structural Changes
(1/2)• Change in attitude and perception of
middle class towards industry, business
and investment
• Reforms induce structural changes by
releasing resources, and by changing
relative prices
• Growth is a factor of initial conditions and
micro level technological and
organization dynamics in response to
reforms
• Reduction in TC in product and financial
market let to increase in resource
productivity by their transfer from
government to private agents
• Public investment of government
decreases TC, while public consumption
increase TC as it requires bureaucracy
• Private sector experiences reduction in
TC in dealing with government
• A one- shot reduction in TC expands
markets, and market expansion reduces
average TC further
• One implication for the firm is lower
inventory carrying cost
• On capital market front, reforms led to
setting up of NSE and SEBI, after 1992
scandal
• Reforms in labor market
• Increasing upper limit of employment large-
scale organizations
• Emergence of contract suppliers and
employment agencies to overcome rigidities
of labor policies
• Specialization of services and skills
14Evolution of Markets and Institutions (2006)
IV. The Direction of Structural Changes
(2/2)• Internationalization
• Increase in international trade, presence of
TNCs, technology flow, international
mobility of talent, and outward investment
by Indian firms
• Gradual improvement in property rights and
allowing of fully-owned subsidiary
• Increasing pace of cross-boarder M&A
• Emergence of service sector attributed to
high subsidy in higher education, growth
of bureaucracy and expansion in public
sector banks
• Highest growth post liberalization is seen
in capital goods and consumer good
industries.
• Fastest growing industries are more
international than others.
• Sectors and regions with rich endowment
were fast growing then rest
• Income growth and distribution
• Reforms benefited those with initial
endowment of durable assets and skills
• Consumption broadened the rural- urban
divide
• Specially the urban middle class was the
largest beneficiary
• Regional distribution of growth
• Industrial development concentrated in
southern and western parts of India
• Low population mobility
• Location decisions of firms governed by
skills availability and low labor disputes
• Greater people movement and trade in
recent decades owing to major
infrastructural projects and implementation
of VAT.
15Evolution of Markets and Institutions (2006)
V. Competitive Dynamics (1/3)
• Propositions of institutional change
(North 1993)
• Competition is key to institutional change
• Competition forces organizations to
continuously invest in skills and knowledge
• Competitive dynamics in India led to
convergence of best practices among
firms, and triggering market and
institutional evolution
• Most of new entrants are industrial
houses, through diversification
• New institutional economies states that
institutional environment determines
micro- level governance choices
• In pre- reforms India, firm size and
market share has no relationship with
relative production efficiencies
• Convergence of best practices
• Through competitive dynamics, joint
ventures and spillovers
• While entering India TNCs have advantage
in intangible assets and capital markets
• Strength of property rights in emerging
economies determine rate of convergence
• Asymmetric advantage can emerge from
two sources: first movers and cost
advantage
• TNCs have to acknowledge the existing
institutional environment in host country
• Most TNCs chose JV approach
• Incumbents shield from TNCs disappeared
post reforms
• Pre-reforms Indian firms had higher X-
inefficiencies
• TNCs invest more in distribution networks
and building local knowledge
16Evolution of Markets and Institutions (2006)
V. Competitive Dynamics (2/3)
• Competition among TNCs
• Japanese versus American and European
TNCs with distinct advantages
• Case of Maruti- Suzuki versus Hyundai
• Growing convergence among TNCs and
domestic firms in auto industry
• JVs between TNCs and local firms
• Driven by policy stipulations and economic
factors
• Accelerates technology transfer, moderated
by the IP regime in host country
• Strong IP regime encourages introduction of
latest technology, and hence diffusion
• TNCs accesses local institutional
knowledge and this might leads to eventual
break-up of JV once need is met
• Made local firms to invest in R&D ex-ante
and helped diffusion of technology
17Evolution of Markets and Institutions (2006)
• Convergence of practices through
intermediate input markets
• Existence is asymmetric contractual relation
between large and small firms, with
assemblers exploiting suppliers
(monopsony)
• Entrant of new TNCs increases suppliers
bargaining power
• Infusion of new technology and practices
make both better off
• Example: agglomeration economies
developed by Maruti and its suppliers by
sharing of best practices and co-location
• Diffusion of practices from tier-I OEMs to
tier-II and tier- III suppliers
• Increase in demand of skilled and semi-
skilled labor, and labor movement; and then
rapid adoption of capital intensive
technology
•
V. Competitive Dynamics (3/3)
• Capital markets and convergence
• TNC’s advantage in access to global capital
at low cost pushing local firms to innovate
• Large Indian houses have premium access
to capital through capture of government
financial institutions
• Reforms forced large firms to look for
alternate sources of finance
• Led to improved functioning of Indian capital
markets and disclosure by companies
giving positive signals to investors
• Positive impacts of FIIs: being efficient and
adopt better disclosure, and better
monitoring
• Banking reforms leading to lower
transaction cost
• Capital costs are pushed to international
levels with entry of global banks and
financial institutions
18Evolution of Markets and Institutions (2006)
• Feedback effects
• Lack of entrepreneurial dynamism due to
poor institutional environment and under-
developed capital market
• TNCs bring superior technologies and
practices to emerging economies
• Emergence of markets for consumer
finance
• Improvement of long term contracts
between buyers and suppliers, with
diminishing roles of third- parties
• Wage rate increase due to better bargaining
power of labor and productivity
• Increase participation in capital market by
institutional investors and FIIs
• Competitive dynamics leading to change in
perception and opportunity set of agents,
thereby bringing about institutional change
VI. Technology Change (1/4)
• Policy reforms (parameter and qualitative) +
Competitive dynamics Technology
change Institutional revival
• Market conditions for technology change
• Competition
• Division of labor
• Labor market conditions
• Development of financial markets
• Technology factors are governed by
organizational issues, such as incentives,
centralization, agency relation, learning
• Main characteristics of innovations: non-
rivalry and non-excludability (Romer
1990)
• Technology change and growth is a
function of human- capital accumulation
and is generated by educational
institutions and learning on the job
(Lacus 1988)
19Evolution of Markets and Institutions (2006)
• Market reforms and adoption of new tech
• Firms having greater access to new tech
• Adjustment and adaptation cost
• Movement from collusion to competition
• Reforms eliminates barriers to new entry,
and new entrants must possess superior
technology
• Technology adoption depends upon
property rights, market conditions and initial
endowment
• Development of product markets (size)
essential for adoption of new technology.
• Openness to international trade hastens
adoption (size and exposure)
• Technology adoption limited by strength of
intellectual property rights: in terms of
spread across industry and ownership
issues
VI. Technology Change (2/4)
• Adoption and adjustment cost of new
technology
• Shaped by market size, competition, initial
endowment of skills, and technology
capability
• Cost involves that of technology transfer,
cost of contract formation, and enforcement
• Issues in adoption of capital intensive
technology, due to lack of skills
• High- firm level investment in training (e.g.
IT firms)
• Adoption in post reform era
• Technology change is a long-run
phenomenon
• TNC operations vary between hi-end and
low-end technology operations while
catering to exports market (e.g. GE)
• Increased technology collaboration between
local and foreign firms
• Spillover effect of CSIR and TNCs
20Evolution of Markets and Institutions (2006)
• Micro-level processes of adoption
• Main factors for building technical
capabilities of follower nations are: initial
endowments in technology competence,
entrepreneurial competence and learning
ability
• Needs mastering of tacit elements of
technology for its transfer to local
production needs
• Adopters can sometime surpass the
creators of new technology (e.g. Japan)
• Calls for organizational restructuring (family-
run to bottom-up approach)
• Poor governmental infrastructure forcing
TNCs to establishing their own
• There has been pockets of successes in
India, such as in IT industry, auto- parts
manufacturers and some cases of pharma
industry (DRL)
VI. Technology Change (3/4)
• Evolution of National Innovation System
• Its an institutional system to encourage
production of S&T in the country
• Imitation and technology bridging is the
concern in emerging economies
• US vs USSR case highlight role of private
players in effective NIS, as they have
incentive for commercialization
• Equally important is the role of government
in generating public stock of knowledge
• Indian government approach of heavily
subsidizing higher-education during pre-
reform era
• Governments role in setting up of BEL and
C-DOT led to emergence of IT industry
• Poor linkage between public sector R&D or
even universities and commercialization
21Evolution of Markets and Institutions (2006)
• NIS in post-reform era
• Indian IT industry is a by-product of import
substitution policy
• Specific incentives given to public R&D
institutions to commercialize basic research,
and private sector to tap into public
institutions (e.g. NCL, IISc)
• TNCs made extensive linkages with Indian
research and educational institutions to
source talent and R&D capabilities (e.g.
Nortel, HP, IBM, Microsoft)
• Industrial clusters
• Clustering activities develop network
externalities by reducing transaction cost
• Easier and faster diffusion of best practices
• Internal rivalry + cooperative networks
• Formation of social capital through repeat
interaction
• Clustering activities lead to emergence of
supportive institutions and markets
VI. Technology Change (4/4)
• Negative externalities
• Presence of TC requires government to
interface and establish public order
institutions
• Even public’s collective action can fail in
such rapidly developing markets
• Export oriented small-firms are labor
intensive and pollution- intensive, and don’t
have incentives or money to implement
pollution-prevention technology
• TC of undertaking countervailing collective
action are too high
• Solution is the development of cooperative
norms in clusters (e.g. Tirupur area)
22Evolution of Markets and Institutions (2006)
• Feedback effects
• Emergence of new industries in response to
the technological and market dynamics (e.g.
biotech industry)
• Enabled by government investment and
enterprising attitude of firms
• Increase technology activity impacts labor
market in two ways: increase in productivity,
and demand of skilled labor
• Increasing emphasis on on-the- job training
• Market development of differentiated skills
• Increasing venture capital activities by
TNCs in India (e.g. Cisco, Intel)
• VC funds set-up by local financial
institutions (e.g. ICICI, IDBI)
• Indian’s adoption of process patent under
TRIPS in 2005 strengthening the IPR
protection
VII. Organizational Change (1/4)
• Resource allocation under new
institutional economics: ‘invisible hand’ of
free markets, and ‘visible hand’ of
organizational hierarchy
• Post- reform efforts on organizational re-
structuring, especially of family business,
emerging from changes in product, labor
and capital markets
• Org. changes in family- run businesses
• Role of family- owned businesses in
developmental stages of US, US, Japan
and Korea
• But Indian firms remained monopolies in
protected environment
• Emergence in western and southern India
under British rule
• Building up of reputation and morality, in
absence of institutional mechanisms ,to
lower transaction cost
23Evolution of Markets and Institutions (2006)
• Family run business (contd…)
• Building of family empires through:
channeling of public saving through public
financial institutions, and extracting
monopoly rents by limiting competition
• Lack of transparency and disclosure helped
move family fund around the empire
• Financial interlocks evade takeovers
• Post- license regime forced family run
business to look for capital and
organizational restructuring, by being more
transparent and hiring professional
managers
• Led to increase number of business schools
and talent management firms
• De-layering and de-centralization
• Development of internal talent building
setups (e.g. TAS, Birla Management
Centre)
VII. Organizational Change (2/4)
• Organization of small- scale businesses
• Specific pre- reforms policies (e.g.
reservations, excise duty policies,
concessional finance)
• High dependence on family capital or
informal capital markets
• Exploitation of bankruptcy laws
• Missing incentives for innovation
• Adoption of premature diversification as few
want to grow in size
• Post- reform scenario increased technology
adoption and efficiency due to export
orientation, but capital markets remain
largely organized
• Very few companies registered and
declared less than 20 employees to save on
PF contribution
• Became frequent harassment and bribe
extraction by inspectors
• Extensive use of contract labors
24Evolution of Markets and Institutions (2006)
• Change in diversification behavior of
large businesses
• Unrelated diversification on account of
economizing the TC of labor and capital
markets
• Capital market imperfections also allowed
large a privileged access to capital.
• Licensing policies resulting into
diversification to block new entrants and
control monopoly positions
• Vertical integration in post- reform era
• High degree of M&A activities in both
domestic and international arena,
• Both divesting and merger happening
• Vertical integration increase even with
technology adoption and specialization
• An inverted- U shape trend in vertical
integration in Indian firms over time, a trend
expected by economic predictions as
counties emerge
VII. Organizational Change (3/4)
• Diversification behavior of unrelated
businesses
• Large business groups continue to diversify
post- reforms as they enjoy reputational
advantage, and utilize internal cash flows
• Sale of unrelated business, adoption of
core- competence, and restructuring
• After adopting focused strategies, several
firms followed market diversification
strategies to translate their cost advantage
into international markets
• Spillover of technology and managerial
learning from TNCs
• Standalone companies
• Cases in areas with market opportunities,
where traditional firms have no advantage
• Adoption of organizational innovation to
overcome institutional constraints
• Enabled mostly by pre- reforms endowment
in human capital (e.g. IT and biotech)
25Evolution of Markets and Institutions (2006)
• Corporate governance
• Two tiers of agency problem: b/w corporate
headquarters and investors, and b/w
corporate headquarters and divisions
• In Indian context, main conflict between
dominant and minority shareholders
• Series of stock market scandals in 1992-94
• Setting up of SEBI and NSE
• Increased role of FII leading to better
monitoring, transparency and disclosure
• Tapping into capital abroad through GDRs
and ADRs
• Internal governance
• Interlocking of directorship to retain control
• Very few companies adopting Anglo-
American corporate governance model
which gives power and information to
stockholders to manage agents effectively
VII. Organizational Change (4/4)
• Changes in debt finance institutions
• Reforms such as deregulation of interest
rates and compulsory lending and
relaxation of reserve requirements
• Still making failure remains highly protected
by the government
• Strengthening of bankruptcy laws over the
period has happened
• Globalization and organizational
innovations
• Three governance mechanisms adopted by
TNCs in India: outsourcing, joint- ventures
and fully- owned subsidiaries
• Outsourcing governance involves the cost of
identifying the country, selecting the partners
and writing the contract (lest level of technology
expertise)
• Setting up of joint- ventures necessitates
formation of comprehensive non- disclosure
contracts (moderate level of technology
expertise )
26Evolution of Markets and Institutions (2006)
• Globalization and organizational
innovations (contd)
• Full- owners subsidiaries are driven by the
need to integrate as TNCs enter into
contract with local firms on BOT mode.
(high level of technology involved)
VIII. Evolution of public and private order
institutions (1/2)• Public order institutions (constitution,
government and judiciary), and private
order institutions (repetitive collective
action by private agents)
• Reforms parametric and qualitative
changes change in scope and
objective of public order institutions
triggers private order actions
economic efficiency
• Coase Theorem: Collective actions can
rectify the cost of negative externalities in
the absence of transaction costs
• One of the important aspects of the
evolution of public and private order
institutions is the issue of improving
governance and the emergence of
private order institutions in reducing
poverty and illiteracy
27Evolution of Markets and Institutions (2006)
• Public order institutions of capitalism
• Support institutions
• Includes legal framework, social security,
primary education, macro policy
management, and provision of public goods
• Regulatory and redistributive
• Often regulations emerge post one- shot
distributional changes
• Establishment and enforcement of property
rights require public order institutional
support
• Regulatory institutions
• Reasons for regulatory state: TC, and
failure of collective action in bargaining
• Enforcement is a prime issue in India
• Vaguely defined rules and laws favored
large agents for long
• Administrative discretion due to absence of
regulatory predictability and procedural
transparency
VIII. Evolution of public and private order
institutions (2/2)• Private order institutions
• Informal rules and norms of collective
actions that evolve over a period of time
(e.g. out of court settlement of IP
infringement in the US)
• Private order institutions emerge mainly for
the distributional politics of zero- sum
interactions
• India adopted Common Law from Britain,
but adopted a s hybrid version of
centralization and decentralization
• 30,000 laws brought by state and central
government leading to enormous complex
system and backlog of cases in courts
• Regulatory institutions in post- reform era
• Ensuring markets remain competitive and
reducing negative externalities
• Market reforms in absence of regulatory
institutions lead to negative externalities
• Continued corruption reduces the respect
for rules of the law
28Evolution of Markets and Institutions (2006)
• Regulatory institutions (contd…)
• A well- developed illegal market is reflection
of a related legal market which is
underdeveloped or regulated
• Enforcement depends upon evolution of
embedded conditions over time
• Surplus generating private- order
institutions
• Imperfect information, adverse selection,
and moral hazard under agency relation
doesn’t vanish once a cooperative is formed
• Cooperation takes place when the surplus
for the agents is higher under cooperation
than under middlemen
• Emergence of self- help groups
• Need for incentive compatible practices and
control rights, further homogeneous groups
are better off
• Success of Amul (leadership and collective
action) and failure of Urban Cooperative
Banks (flawed incentives and organization)
IX. Conclusion
• Capitalism is functional on the basis of
underlying economics, social and political
institutions that evolve over time
• Economic reforms are exogenous
parameter and qualitative shifts in certain
elements of the institutional environment
on the basis of initial institutional
endowments of capitalism
29Evolution of Markets and Institutions (2006)
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