introductory lecture on new institutional economics mv 2011
TRANSCRIPT
Introductory lecture for course Institutions, Behaviour and Welfare
Dr. Maarten Vendrik
20-04-2011
Aim of course Introduction into New Institutional Economics (NIE)
Rather recent development in microeconomics since 1960s
Nobel prize of 2009 for new-institutional economists: Oliver Williamson and Elinor Ostrom
Institutions always important subject in economics, but new in NIE as compared to ‘old’ institutional economics:
emphasis on firm theoretical foundation and analytical models systematic and structured like neoclassical economics (NCE)
However, less rigorous and formal than NCE and themes essentially different
Contents
New Institutional Economics as compared to neoclassical economics
Example: financial crisis Some basic concepts and relations
Examples of Internet and pirates
Mandatory literature and organization of learning
1. New Institutional Economics versus neoclassical economics Central message of New Institutional Economics (NIE):
institutions have an important impact on economic performance
Recognized by classical economists like Adam Smith and even by founding father of neoclassical economics Marshall
However, standard neoclassical (micro) economics abstracts from institutions:Different institutional arrangements merely alternative means to reach Pareto-efficient outcomesConditions for Pareto-efficiency apply equally to capitalististic, socialistic, or any other kind of economic system microeconomics institutionally neutral
Simplifications in neoclassical economics Simplification clear insight into basic mechanisms
and efficiency of allocation of economic resources
However, (implicit) assumptions of perfect information and foresight zero transaction costs
unrealistic ánd consequential
E.g. asymmetric info (intermediate microeconomics course) complications only second-best allocation possible
Already recognized by “old” institutional economists,but also against abstract formal reasoning rather descriptive
Basic themes of NIE Since 1960s: NIE: emphasis on solid theoretical
foundation and analytical reasoning and modeling
Basic themes of NIE: Effects and development of institutions (Sessions 2, 8) Impact of transaction costs (Session 3) Effects and emergence of property rights (Sessions 4,
5) Effects and rationales of various forms of contracts
(Sessions 6, 7) Effects and development of various forms of
organization (Sessions 9-11)
2. Example: financial crisis Started in market for mortgages for houses in USA
Problems: Mortgages given to people with too low incomes Mortgages high relative to value of house
How could this happen? Booming economy underestimation of risks when economy would fall
back imperfect foresight (theme of NIE)
Borrowers less knowledgeable about risks than lenders asymmetric information (NIE)
Lenders could sell risks by bundling mortgages with other mortgages in financial products and selling these products to banks further bundling and selling to other banks and investors worldwide real value of products unclear imperfect information (NIE)
Too much risk taking by banks
Booming economy too much confidence in value of financial products and their reliability too much trust (NIE) too low transaction costs (NIE) too smooth transactions (NIE)
Why did banks take so much risks in buying financial products with unclear value?
Asymmetric performance pay schedules (NIE) for bank employees: high bonus for good performance, but government support in case of failure (too big too fail)
Insufficient laws and regulatory rules that constrain too risky lending andinsufficiently enforced by sanctions from courts and supervisors = formal institutions (NIE)
Deficient ethical norms and professional codes (e.g. honouring and protecting long-run interests of clients) and insufficiently enforced by sanctions of loss of reputation or feelings of guilt = informal institutions (NIE)
Chain reactions and lack of trust In 2008 collapse of mortgage market in USA
fall in value of related financial products spread to whole banking sector solvency problems of banks big banks rescued by governments huge budget deficits of governments creditworthiness problems of Iceland, Greece, Ireland, Portugal, Spain
rescued by other Euro countries because of banks involved ?
General problem: too little trust (among banks, investors, consumers; NIE) too high transaction costs (NIE) too sticky transactions (NIE)See book of Akerlof and Shimer, Animal Spirits, 2009!
3. Institutions: definition What are institutions?
NIE: institutions = rules of the “game” = sets of formal and informal rules that govern economic and social interactions of people in society, including enforcement arrangements
Formal institutions: e.g., laws, formal organizational rulesInformal institutions: e.g., customs, social norms, habits, informal organizational rules
Institutions ≠ concrete organizations like firm or university, but= rules of the game without the players institutions + people using them = organization
Functions of institutions Institutions:
steer individual behaviour in a particular direction provide structure to everyday activity reduce uncertainty in human relations simplify decision making promote cooperation among human agents
Formal and informal institutions both important and reinforce each other’s effect
Hence, Obama promotes informal norms in addition to formal regulation!
4. Transaction costs Costs of running the system (Arrow) like costs of:
search for information bargaining making contracts monitoring and enforcing contracts
Before financial crisis: transaction costs too low In crisis: transaction costs too high
NCE: no frictions in economic transactions transaction costs = 0
No institutions needed to reduce transaction costs No firms of more than one person to economize on market
transaction costs
Transaction costs in crisis Implication: economy before crisis close to neo-classical
ideal?
Not really, as market failures like Asymmetric info in mortgage market Imperfect info and foresight wrt risks and values of financial
products Moral hazard in banking sector
Welfare losses, especially in the long run in crisisalso counted as transaction costs in NIE! Market failures before crisis contributed to huge transaction costs in crisis!
5. Property rights
NCE: it does not matter who owns what.
However, in the real world it does matter a lot!
Example: Care and effort you spend on your apartment or
house strongly depends on whether you own or rent it!
This has strong effect on value of apartment/ house!
6. Example: effects of Internet and e-commerce Themes of transaction costs and property rights
especially salient in modern developments of Internet and e-commerce promises huge saving on transaction costs in markets nearer to NCE ideal of perfect markets?
However, also more time spent on search net effect decrease or increase in transaction costs?
Free dissemination of info by the Internet protection and rewarding of intellectual property rights more difficult higher transaction costs!
7. Contracts Property rights transferred in contracts
Example: labour contract right of employer to gain benefits from labour of employee in exchange for right of employee to receive wage from employer
Problems in making and enforcing contracts: conflicting interests information imperfect and costly and limited capacity to
process information (= bounded rationality) contracts incomplete and asymmetric information room for opportunistic behaviour moral hazard and
adverse selection transaction costs of monitoring and welfare losses
(agency costs)
Contracts, organizations and development of countries Problems can be overcome by trust, cooperation and
shared social norms between contract partners (informal institutions)
Contracts form building stones of markets and other forms of organizations like firms and the state
Contracts shape incentives within such organizations
Organizations form institutional systems.
Ways in which institutional systems are organized crucial determinants of success or failure in economic development of countries explanation why some countries are still underdeveloped (Session 11)
8. Example: pirate economics In developed countries most institutions followed by most
citizens
Exceptions: gangsters and pirates
However, within these groups strong institutions, informal, but also formal, e.g.
Maffia (Godfather movies) Pirates: see chapter for tomorrow
Pirates: Becoming a pirate rational decision as better treated by captain and
more democracy
Democratic decisions on where to steal treasure and unanimous decisions on pirate constitutions = contracts institutions supported by crew self-enforcing less need for sanctions
Institutions of pirates Bloodshed = transaction costs minimized by threat of no
mercy in case of resistance, symbolized by skull-and-crossbones or red flag and supported by reputation of strict observance
Quartermaster in charge of distribution of food and loot = institution to limit power of captain
Cooperation with national governments to attack ships of enemy countries
Cooperation between pirates, e.g. In golden age of piracy (1630-1730) fleets of pirate ships Election of pirate king in international gathering of pirates,
following large pirate constitution (Pirates of the Caribbean movie)
http://www.youtube.com/watch?v=0y98MMmexMo&feature=BFa&list=PL1F187DA52E3ED6CE&index=14
9. Mandatory literature I Problem: no good textbook on NIE on intermediate level
1st year book:
Groenewegen, Spithoven en Van de Berg (2010), Institutional Economics: An introduction
Too superficial for you
Book on graduate level:
Furubotn & Richter (2005), Institutions and Economic Theory: The Contributions of the New Institutional Economics, 2nd ed.: too detailed
Mandatory literature not nice textbook with bullet points, lists of key concepts and summaries at end of chapters, as in previous blocks, but:
Mandatory literature II Introductory chapter from Groenewegen, Spithoven en
Van de Berg
Sections from Furubotn & Richter
Articles from scientific journals and chapters from other books
Copies of section of F&R and some chapters from copyshop (CS in blockbook)
Articles and other chapters from Eleum, Course Material, Learning Resources (LR in blockbook)
Mandatory literature III Sections from F&R give good overviews of basic concepts and
basic theories
Clearly written, but rather detailed and sophisticated try to distil main points and thread from them
Most articles easier to read, some of them demandingAlso here: focus on main points and threadYou have to learn this anyhow in your academic study!
If you don’t understand an argument, post question on that on Eleum
6 lectures are meant to clarify basic concepts and structure of subject area and to explain
unclear relations indicate what are main concepts, ideas and theories that you should
understand and learn for exam
Organization of learning1. Short introduction to mandatory literature of each session in
blockbook with some indication of main and difficult points
2. When reading mandatory literature assess yourself what are main points.
3. In tutorial session presentation surveys main points and tutor takes care that discussion sufficiently covers important and difficult points.
4. Survey lecture indicates main points to understand and learn for exam.
5. Look at old exam (Eleum, Course Material) for kind and level of exam questions
6. Should give you enough guiding in studying for exam.
Additional material for presentation Additional literature for presentation
sometimes indicated in blockbook in Learning Resources on Eleum in books on study landscape
However, nicer to find additional cases/examples from Internet, newspapers, magazines, previous courses or your own experience.Already start to collect this at beginning of block!
Evaluation Final mark for course based on three components:
1. Presentation of mandatory material and additional material and performance as session manager (25%):2/3 of grade for content and 1/3 for form2/3 for mandatory part and 1/3 for additional part
2. Overall participation,incl. posting questions (25%):+ (good/sufficient), 0 (dubious) or – (insufficient) for each session
3. Written exam (50%), at least 5
Thank you!