Posts filed under ‘New Institutional Economics’
What Does the Rule of Law Variable Measure?
| Peter Klein |
Bill Easterly poses this question, referring to his NYU colleague Kevin Davis’s work on law and development. Davis has several papers criticizing economists’ use of rule-of-law variables in development research (1, 2, 3). As summarized by Easterly:
Kevin points out that two current measures of “rule of law” used by economists in “institutions cause development” econometric research are by their own description a mixture of some characteristics of the legal system with a long list of non-legalistic factors such as “popular observance of the law,” “a very high crime rate or if the law is routinely ignored without effective sanction (for example, widespread illegal strikes),” “losses and costs of crime,” “corruption in banking,” “crime,” “theft and crime,” “crime and theft as obstacles to business,” “extent of tax evasion,” “costs of organized crime for business” and “kidnapping of foreigners.” Showing that this mishmash is correlated with achieving development tells you what exactly? Hire bodyguards for foreigners?
What if “institutions” are yet another item in the long list of panaceas offered by development economists that don’t actually help anyone develop?
Easterly opens with a clever example of a legal rule that doesn’t make sense outside an informal, non-rule context. But overall I think he’s a little unfair to the development and financial economists working in this area, many of whom are sensitive to these problems but are doing the best they can with the data available. It’s true, however, that much of the early work, particularly in the LLSV tradition, conflated de jure and de facto rules (particularly in over-emphasizing differences between common-law and civil-law countries). Benito Arruñada’s critique of the Doing Business Project is also informative in this regard.
Greif Under Fire Again
| Peter Klein |
We noted previously Jeremy Edwards and Sheilagh Ogilvie’s challenge to Avner Greif, contenting that he misread his primary source material, and Greif’s response. Now Charles Rowley has published a paper in Public Choice accusing Greif of academic dishonesty, namely by failing to cite Janet Landa’s prior work on the economics of identity and trust:
This commentary demonstrates that Avner Greif, through his citation practices, has denied Janet Landa her full intellectual property rights with respect to her contributions to the economic analysis of trust and identity. He has done so by systematically failing to cite her published papers in this field, incidentally promoting his own publications as meriting priority. In consequence, he has effectively blocked out Janet Landa’s work from the mainstream economics literature, albeit not from the literature of law and economics, where his own writings have not been directed.
It’s an odd piece. I’m not sufficiently familiar with Landa’s work to evaluate its place in the history of thought in this area, or to judge whether Greif has appropriated her ideas without attribution. Rowley doesn’t accuse Greif of plagiarism, only of failing to cite an important predecessor and overstating the novelty of his own work. This is a difficult claim to substantiate; obviously the evaluation of prior contributions in one’s own area is highly subjective. And the implication (later in the piece) that Greif’s citation practices contributed to his Genius Award seems like a cheap shot. It is true, however, that contemporary economists tend to be woefully ignorant of the history of economic thought (and, as Rowley implies, that game theorists have what might be called a “healthy sense of self”).
Update: I missed earlier discussions of the Rowley piece at Monkey Cage and Crooked Timber. The Monkey Cage commentary is disappointing, mostly ad hominem snarks at Rowley, the field of public choice, and (most bizarre, but it’s Brad Delong), the Mont Pelerin Society. Henry’s analysis at Crooked Timber is more serious, and I think he gets it right.
The Organization of Firms Across Countries
| Peter Klein |
Interesting new NBER paper by Nicholas Bloom, Raffaella Sadun, and John Van Reenen, “The Organization of Firms Across Countries” (ungated version here, may be older):
We argue that social capital as proxied by regional trust and the Rule of Law can improve aggregate productivity through facilitating greater firm decentralization. We collect original data on the decentralization of investment, hiring, production and sales decisions from Corporate Head Quarters to local plant managers in almost 4,000 firms in the US, Europe and Asia. We find Anglo-Saxon and Northern European firms are much more decentralized than those from Southern Europe and Asia. Trust and the Rule of Law appear to facilitate delegation by improving co-operation, even when we examine “bilateral trust” between the country of origin and location for affiliates of multinational firms. We show that areas with higher trust and stronger rule of law specialize in industries that rely on decentralization and allow more efficient firms to grow in scale. Furthermore, even for firms of a given size and industry, trust and rule of law are associated with more decentralization which fosters higher returns from information technology (we find IT is complementary with decentralization). Finally, we find that non-hierarchical religions and product market competition are also associated with more decentralization. Together these cultural, legal and economic factors account for four fifths of the cross-country variation in the decentralization of power within firms.
The emphasis on institutional determinants of organizational form makes this a welcome addition to the (slim) set of papers relating institutional arrangements to the institutional environment. (more…)
Doug North Line of the Day
| Peter Klein |
From Bob Margo’s EH.Net review of North, Wallis, and Weingast’s Violence and Social Orders: A Conceptual Framework for Interpreting Recorded Human History:
In my book people are iconic if I can summarize their life’s work in ten words or less. North takes two: “Institutions matter.”
He adds: “The opposite perspective — viewed in isolation most institutions don’t matter much, being Harberger triangles and small ones at that — has its fans in modern economics. But North has convinced the majority of economic historians, a goodly share of world’s development wonks, and the Nobel Prize Committee that he’s right.”
Update: Art Carden beat me to this.
Is the Future in Contract Manufacturing?
| Benito Arruñada |
The purchase of Opel by Magna shows the strength of contract manufacturers and their strategies, which I discussed with Xosé H. Vázquez in our 2006 article in the Harvard Business Review. Once thought of as a lifebelt for the decreasing margins of large-brand owners, contract manufacturing has now become a major source of competition. Shanghai Automotive Industry Corporation (SAIC), which learned the business by producing initially for Volkswagen and GM, has actually started to sell its own cars in Europe and North America. It has even bought R&D knowledge, acquiring from bankrupt MG Rover the drawings needed to build the Rover 25, Rover 45, and Rover 75.
The economic crisis is accelerating this process. The need to liberate assets to increase ROI has been facilitated by technological and organizational change. This is stimulating business practices at the corporate level that are pushing outsourcing practices to dangerous limits. The wrong management of contract manufacturing will thus increasingly provoke knowledge leaks to direct competitors and the loss of internal manufacturing knowledge; more importantly, it will continue to eliminate barriers to entry, allowing large distributors and contract manufacturers themselves to market their own brands much more easily.
De Figueiredo on Political Strategy
| Peter Klein |
We’ve previously mentioned the chapters by Nicolai and Nils Stieglitz and by Lasse and me in the forthcoming Advances in Strategic Management volume titled Economic Institutions of Strategy. John de Figueiredo’s chapter, “Integrated Political Strategy,” is now available as an NBER Working Paper. John is a leader of this emerging field, which studies how firms attempt to influence the legal and political environment to achieve competitive advantage. As he points out:
Legal and acceptable competitive behavior is determined endogenously by legislators, regulators and judges who are influenced, positively and negatively, by the very same firms the regulations are designed to control. By understanding the theories of how firms affect politics, one can better determine how to gain competitive advantage through political institutions. This is a natural extension of the traditional tools of strategic management. Moreover, for young scholars, this is an area in which the lines of investigation are clear and the openings for serious research opportunities available. In this sense, it is robust area for future research and major contributions to understanding firm performance.
Introducing Guest Blogger Benito Arruñada
| Peter Klein |
We’re delighted to announce Benito Arruñada as our newest guest blogger. Benito is Professor of Business Organization at Pompeu Fabra University in Barcelona, a former President of ISNIE, and a prolific researcher in the areas of organization, law and economics. Most of his work focuses on the organizational conditions that facilitate impersonal exchange, from property titling or business regulation to moral systems. He has published widely in journals such the Journal of Law and Economics, Industrial & Corporate Change, Harvard Business Review, Journal of Law, Economics, and Organization, Journal of Economic Behavior & Organization, Journal of Comparative Economics, and International Review of Law and Economics.
Benito will be blogging about his new book on property and business formalization, Building Market Institutions: Property Rights, Business Formalization, and Economic Development, coming out next year from the University of Chicago Press, and other topics that strike his fancy. Welcome, Benito!
Research Workshop on Institutions and Organizations
| Peter Klein |
The IV Research Workshop on Institutions and Organizations takes place at Insper (formerly Ibmec) São Paulo 5-6 October 2009. Lee Alston and David Stark are keynoting. There are panels on “Judicial Norms and Development,” “New Theories of the Firm,” and “Social Capital and Organization.” There’s an open call for papers, with abstracts due 20 July.
I attended the 2007 version and enjoyed it very much.
Vive la Révolution!
| Peter Klein |
So says the all-star team of Acemoglu, Cantoni, Johnson, and Robinson in “The Consequences of Radical Reform: The French Revolution.” Check it out:
The French Revolution of 1789 had a momentous impact on neighboring countries. The French Revolutionary armies during the 1790s and later under Napoleon invaded and controlled large parts of Europe. Together with invasion came various radical institutional changes. French invasion removed the legal and economic barriers that had protected the nobility, clergy, guilds, and urban oligarchies and established the principle of equality before the law. The evidence suggests that areas that were occupied by the French and that underwent radical institutional reform experienced more rapid urbanization and economic growth, especially after 1850. There is no evidence of a negative effect of French invasion. Our interpretation is that the Revolution destroyed (the institutional underpinnings of) the power of oligarchies and elites opposed to economic change; combined with the arrival of new economic and industrial opportunities in the second half of the 19th century, this helped pave the way for future economic growth. The evidence does not provide any support for several other views, most notably, that evolved institutions are inherently superior to those ‘designed’; that institutions must be ‘appropriate’ and cannot be ‘transplanted’; and that the civil code and other French institutions have adverse economic effects.
Think of this as a fixed-effects model estimating the within-country effect of legal origin; what happens when a society’s institutional (particularly, legal) environment changes suddenly and unexpectedly? If a common-law country is invaded and occupied by a civil-law country, what happens to financial-market development? An interesting counterpoint to the cross-sectional studies that are the norm in this field.
Economic Institutions of Strategy
| Peter Klein |
That’s the title of a forthcoming volume of Advances in Strategic Management edited by Jackson Nickerson and Brian Silverman. You’ll recognize the allusion to a certain classic book. Like that book, this volume maps out an ambitious agenda for new scholarship on institutions and organizations, particularly within the field of strategic management. The chapters provide critical reviews and syntheses of various strands of the strategy literature, intended to support and to challenge new and established scholars starting work in these areas. (They should make excellent readings, for example, for doctoral courses in strategy and the economics of organization.)
Lasse and I contributed a chapter, “Diversification, Industry Structure, and Firm Strategy: An Organizational Economics Perspective,” that you can download on SSRN. Here’s the abstract:
We review theory and evidence on corporate diversification, industry structure, and firm strategy from an organizational economics perspective. First, we examine the implications of transaction cost economics (TCE) for diversification decisions. TCE is essentially a theory about the costs of contracting, and TCE sheds light on the firm’s choice to diversify into a new industry rather than contract out any assets that are valuable in that industry. While TCE does not predict much about the specific industries into which a firm will diversify, it can be combined with other approaches, such as the resource-based and capabilities views, that describe which assets are useful where. We also discuss the transaction-cost rationale for unrelated diversification, which focuses on the potential efficiencies from exploiting internal capital markets. We review this argument as it emerged in the transaction cost literature in the 1970s and 1980s and, more recently, theoretical and empirical literature in industrial organization and corporate finance. We then discuss how diversification decisions, both related and unrelated, affect industry structure and industry evolution. Here, the stylized facts suggest that diversifying firms have a crucial impact on industry evolution because they are larger than average at entry, grow faster than average, and exit less often than the average firm. We conclude with thoughts on unresolved theoretical, methodological, and empirical issues and problems and provide suggestions for future research.
GM vs. TCE: Another “Block Upon Block”?
| Mike Sykuta |
Ronald Coase has spent the past two decades or more lamenting the lack of progress in economic theory. He bemoans the fact that economics, unlike its physical-science counterparts, fails to dispose of (or pursue new versions of) theories when facts show that prevailing theories are inaccurate or incomplete.
Among his many arguments, Coase has pointed to Williamson’s Transaction Cost Economics (TCE) as one that seems impervious to the facts. Part of Coase’s discontent with the TCE story rests on his observation that many firms sustain relationships characterized by high degrees of asset specificity using contractual means. While Ben Klein and others pointed to General Motors-Fisher Body as evidence to support the TCE story, Coase pointed to relations with auto frame manufacturer A.O. Smith at the same time that were not subsumed by vertical integration. This eventually led to the infamous GM-Fisher Body debate that seems for want of a real conclusion (see some of Peter’s previous comments on this here, here and here).
Well once again, General Motors seemingly plays the foil against TCE. Several weeks ago, GM announced plans to purchase Delphi Group’s global steering manufacturing operations. Delphi operated the steering unit solely for GM’s use. Delphi, in bankruptcy since October 2005, has been able to use GM’s dependence on Delphi’s operations to secure roughly $450 million in liquidity capital from GM to maintain its operations. Sounds like the classic hold-up problem, doesn’t it? But wait! (more…)
The Economics of Prehistory
| Dick Langlois |
Greg Dow at Simon Fraser is organizing a conference this summer on “Early Economic Developments.”
This conference is a meeting for scholars interested in economic aspects of prehistoric events. The organizers welcome proposals for papers on topics at the boundaries among economics, archaeology, and anthropology. Topics can include economic prehistory, the economics of human biological evolution; pre-industrial economic history; and the evolution of economic, social, and political institutions.
Looks interesting. Abstract deadline is April 15, which I guess isn’t tax day in Canada.
Conference on Law and New Institutional Economics
| Peter Klein |
Vic Fleischer and Phil Weiser have organized a conference on Law and New Institutional Economics at the University of Colorado, 4-5 June 2009. Along with Lee Fennel, Mark Ramseyer, Henry Smith, and Eric Talley, Vic and Phil will facilitate discussion of classic (Demsetz 1967, Klein, Crawford, and Alchian, 1978) and contemporary papers dealing with property rights, contract design, behavioral finance, the teaching of NIE, and more. See the link for details.
The Political Economy of Vertical Integration
| Peter Klein |
An understudied area in the organizations literature is the effect of organizational form on lobbying, rent-seeking, tax-rate arbitrage, and similar kinds of political behavior. The accounting literature on transfer pricing looks at the ability of vertically integrated multinationals to shift income between tax jurisdictions to reduce the overall tax burden, and regulators have expressed concerns about diversified multinationals putting downward pressure on environmental and labor regulations (by threatening to withdraw production from countries with high tax or regulatory burdens). Of course we know that as industries mature, firms are more likely to open lobbying offices in state or national capitols. But, in general, we know little about how firms organize to take advantage of political processes and institutions.
Joseph Fan, Jun Huang, Randall Morck, and Bernard Yeung have a new NBER paper on vertical integreation in China showing that vertical integration in highly interventionist environments may be aimed not at reducing transaction costs, protecting relationship-specific investments, and the like, but at rent-seeking and the pursuit of other forms of political privilege. Abstract:
Where legal systems and market forces enforce contracts inadequately, vertical integration can circumvent these transaction difficulties. But, such environments often also feature highly interventionist government, and even corruption. Vertical integration might then enhance returns to political rent-seeking aimed at securing and extending market power. Thus, where political rent seeking is minimal, vertical integration should add to firm value and economy performance; but where political rent seeking is substantial, firm value might rise as economy performance decays. China offers a suitable background for empirical examination of these issues because her legal and market institutions are generally weak, but nonetheless exhibit substantial province-level variation. Vertical integration is more common where legal institutions are weaker and where regional governments are of lower quality or more interventionist. In such provinces, firms led by insiders with political connections are more likely to be vertically integrated. Vertical integration is negatively associated with firm value if the top corporate insider is politically connected, but weakly positively associated with public share valuations if the politically connected firm is independently audited. Finally, provinces whose vertical integrated firms tend to have politically unconnected CEOs exhibit elevated per capita GDP growth, while provinces whose vertically integrated firms tend to have political insiders as CEOs exhibit depressed per capita GDP growth.
Reducing Transaction Costs in Government Procurement
| Mike Sykuta |
Lest anyone think I (or, by association, O&M) am just a disgruntled Obama-basher, let me applaud the Administration’s announcement today of its intent to overhaul the ways in which the government contracts for goods and services, particularly in the Department of Defense. I suspect the collective “we” are all in favor of identifying methods and processes that will reduce transaction costs (and overall costs) in government procurement programs.
On this point, there is economic research that should help guide the Administration’s deliberations. To wit, William Rogerson provides a pretty thorough assessment of the economic incentives in defense procurement (JEP, 1994) and has a follow-up article on the optimal structure of fixed-priced cost reimbursement contracts (AER, 2003). Bajari and Tadelis (RAND J., 2001) provide a study of incentives versus transaction costs in procurement contracts. Although focused on private-sector construction, their findings are likely relevant to government procurement as well. Important lesson: cost-plus is not necessarily bad.
Accounting Rules and Spontaneous Order
| Peter Klein |
David Albrecht thinks the US should not replace its accounting rules (GAAP) with the new, international standard (IFRS).
A language evolves to fit its culture. Language is not static. Moreover, there is no one best way for a language to be. . . .
If Americans wish to speak to a person from Peking, they can get their communication translated. The translation comes at a cost. The benefit from avoiding this cost by switching [to Chinese] would be much less than the huge opportunity costs of educating everyone in the U.S. to speak another language. If we continued using English, the translation to Chinese would (and is) a trivial expense, and a minor inconvenience.
Similarly, there is no good reason for anyone to have the U.S. discontinue using its accounting language (GAAP) and switch over to IFRS. Having multiple accounting languages in the world is a minor inconvenience and translation expenses are, in the grand scheme of things, trivial. Moreover, GAAP seems to fit our culture, economy and system of financial markets. . . .
Who would benefit if the U.S. switched to IFRS? Certainly not investors, for the same reason that they would not benefit if the country moved immediately to Chinese. The beneficiaries would be the accounting firms that would teach us the new IFRS, and company executives. (more…)
An Empirical Test of Williamson’s Adaptation Theory
| Peter Klein |
We’ve noted before, following Bob Gibbons, how Williamson’s transaction-cost approach can be called an adaptation theory of the firm. Vertical integration, in this context, is seen as an efficient means of adjusting a production process to unanticipated changes in market conditions, regulation, or technology.
Most of the empirical TCE literature focuses on the equilibrium rent-seeking version of the story, however (perhaps more influenced by Klein, Crawford, and Alchian’s interpretation). Vertical integration is viewed as an efficient means of mitigating holdup in the presence of asset specificity — and, in equilibrium, holdups don’t occur, so there is nothing to mitigate. Hence the typical TCE empirical paper which compares observed organizational forms to observed transactional characteristics (e.g., the degree of asset specificity). Newer studies attempt to test the relationship between efficient alignment, in the sense above, and long-term performance or survival, but few study the process of adaptation itself. (Exceptions include Mayer and Argyres, 2004 and Argyres and Mayer, 2007.)
Arnaud Costinot, Lindsay Oldenski, and James Rauch have written what I think is the first large-N empirical paper on the adaptation theory, “Adaptation and the Boundary of Multinational Firms.”They construct an occupation-level measure of “routineness” — whether a job involves mainly routine tasks or more creative, problem-solving activities — and show that routineness and vertical integration are negatively correlated. An interesting operationalization of the theory. Abstract:
What determines the boundary of multinational firms? According to Williamson (1975), a potential rationale for vertical integration is to facilitate adaptation in a world where uncertainty is resolved over time. This paper offers the first empirical analysis of the impact of adaptation on the boundary of multinational firms. To do so, we first develop a ranking of sectors in terms of their “routineness” by merging two sets of data: (i) ratings of occupations by their intensities in “problem solving” from the U.S. Department of Labor’s Occupational Information Network; and (ii) U.S. employment shares of occupations by sectors from the Bureau of Labor Statistics Occupational Employment Statistics. Using U.S. Census trade data, we then demonstrate that, in line with adaptation theories of the firm, the share of intrafirm trade tends to be higher in less routine sectors. This result is robust to inclusion of other variables known to influence the U.S. intrafirm import share such as capital intensity, R&D intensity, relationship specificity, intermediation and productivity dispersion. Our most conservative estimate suggests that a one standard deviation decrease in average routineness raises the share of intrafirm imports by 0.26 standard deviations, or an additional 7% of import value that is intrafirm.
ESNIE 2009
| Peter Klein |
The European School on New Institutional Economics is taking applications for its 2009 Summer Institute, 18-22 May in Corsica. Speakers include Kenneth Binmore, Peter Murrell, John Wallis, Peter Maskell, Scott Masten, John de Figueiredo, Jackson Nickerson, Florencio Lopez-de-Silanes, and Antonio Estache. PhD students and junior faculty are encouraged to apply. Deadline is 8 Mar 2009.
Google: Too Big to Fail?
| Peter Klein |
It’s horrible to contemplate, but is Google a future candidate for subsidization and regulation under the essential facilities doctrine? Matt Asay wonders. It’s right to ask these questions, but I think people who worry about the catastrophic effects of a Google failure on the economy underestimate how quickly market participants adapt to changes in product offerings, even in the presence of network effects.
That Great Klein (1996) Paper
| Peter Klein |
No, not this one. I’m talking about Ben Klein’s 1996 Economic Inquiry paper, “Why Would Hold-Ups Occur: The Self-Enforcing Range of Contractual Relationships.” It’s from a special issue honoring Armen Alchian, the entire contents of which are worth reading. Klein’s paper extends the Klein, Crawford, and Alchian (1978) model by explaining why, in equilibrium, holdups can occur, even if parties are farsighted. The basic story — that parties deliberately leave “gaps” in their contracts because the marginal costs of filling in the gaps exceed the marginal benefits — is closer in spirit to neoclassical economics than is Williamson’s Carnegie-style appeal to bounded rationality. Writes Klein:
[In an uncertain world where complete contractual specification is costly, transactors use incomplete contracts that deliberately do not take account of every contingency. As a result, transactors knowingly leave themselves open to the possibility of hold-ups.
The costs associated with contractual specification that lead transactors to use incomplete and imperfect contracts involve much more than the narrow transaction costs of writing down responses to additional contingencies. In addition to these extra “ink costs,” complete contractual specification entails wasteful search and negotiation costs associated with discovering and negotiating prespecified contractual responses to all potential contingencies. Because most future events can be accommodated at lower cost after the relevant information is revealed, much of this activity involves largely redistributive rent dissipation with little or no allocative benefit. Transactors are merely attempting to obtain an informational advantage over their transacting partners, hoping to place themselves in a position where they will be more likely to collect on (and less likely to pay for) hold-ups. Therefore, rather than attempting to determine all of the many events that might occur during the life of a contractual relationship and writing a prespecified response to each, the gains from exchange are increased by the use of incomplete contracts.
Transactors also use incomplete contracts because writing something down to be enforced by the court creates rigidity. Since contract terms are necessarily imperfect, once something is written down transactors can engage in a hold-up by rigidly enforcing these imperfect contract terms, even if the literal terms are contrary to the intent of the contracting parties (p. 447). (more…)
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