Institutional Economics

Elephants, Ants and Economics : Understanding Institutional Diversity Amitabha Sinha Associate Professor Department of A & A Economics Tripura University Suryamaninagar – 799130 Tripura (West) One may wonder how elephants and ants coexist indicating that both types of organisms have inherent capacity to survive. Similar questions are faced by economists and social scientists today. The 2009 Nobel Prize in Economics is an example of the direction in which theorization in Economics is moving at present. Two economists who are concerned with demonstrating the efficiency of two types of institutional structures can both be recognized for their intellectual endeavours. Professor Olstrom analyses the efficiency of self-regulating user groups in management of common property resources. Professor Williamson shows how large corporations can be efficient ensuring their survival, neglecting however, the tendency of lobbying by the large corporations and their anti-competition behaviour. Of course, one can argue that it is due to these two components, namely, lobbying and monopolistic practices that the large corporations appear to be efficient. Without these two features large institutional structures could have been smaller in size. Ronald Coase presented the issue in a systematic manner for the first time. He asked the question why markets exist at all when a single firm could have arranged the whole production process under one roof. The answer he provides is based on the concept of minimizing costs of making contracts or transaction costs. Professor Williamson pursues this argument in analyzing the emergence of large corporations through institutional innovations. Of course, there are various grey areas in this method of analysis. Quantifying the components of transaction costs and the factors that influence such costs remain an active area of research. An idea can be intellectually attractive but it losses its scientific relevance if analyzed only in terms of anecdotes. Turning to the question of the problems of over-exploitation of common property resources, there are two trends of analysis to be noted. One is the naive utility maximization approach of neoclassical model. The other is the strategic utility maximization model based on game theory. Both the approaches recognize that the nonoptimal use of the natural resource is because of absence of clearly defined property rights and high transaction costs. The naive approach argues that due to absence of property rights the perceived marginal costs of the private economic agents is zero or negligible. As a result, the agent can keep on using the resource in greater quantity till marginal benefit approaches zero. As a consequence, there is over-exploitation of the natural resource which is called the ‘Tragedy of the Commons’. But there is a more sophisticated explanation of this tragedy. An economic agent can be quite aware of the social cost of over-exploitation of the resource. If there are two players with two strategic options of cooperating and non-cooperating in the management of the natural resource, they may both land up opting for no cooperation. Consequently, the solution of pay-offs they get are not the best possible pay-offs. This is called the Prisoner’s Dilemma (PD).

There are at least four factors which contribute to PD. The first problem is the absence of the possibility of communication among the players. The constraint of communication ultimately influences the costs and benefits of communication. If the costs are too high compared to the benefits then the communication processes will not operate. One can imagine of a situation when each player leaves in a separate island. For the purpose of communication a player has to take a boat and move from one island to another. The cost of communication can be thought of as the cost of procuring the boat. The second problem behind PD may be the absence of trust. If the problems of communication push up transaction costs then lack of trust makes things more difficult. No amount of cost bearing may lead to a better mutual trust situation. However, on the other hand, mutual trust may contribute to reduction of communication cost. In this sense, trust is a more primitive concept than communication. The third problem related to a great extent to the second problem with the possibility of confidence building measures. If the possibility of confidence building measures exists then PD can be mitigated to a large extent by contributing to lowering of transaction costs, that is, the costs of making and maintaining contracts. Finally, PD is influenced by prescriptions of behaviour of regular and repetitive activities, that is, ‘institutions’. Good and healthy institutions contribute to the environment of trust. Therefore, ‘institutions’ may be considered to be a more primitive concept than a concept of trust. It is possible that self-regulating user groups of common property resources can maintain better institutions which are conducive to ameliorating the problems of PD. However, in the context of economic globalization their existence has to be redefined where the role of large transnational corporations and their capacity to influence government policy cannot be ignored. These are the real issues to which the Economics Nobel Prize 2009 may contribute by generating debates on alternative perceptions.