How Can The New Institutional Economics Framework Be Applied To Agricultural Policy Research In Developing Countries?

“New institutional economists are the blue-collar guys with a hearty appetite for


Oliver Williamson, 2000a

1. An Overview of the New Institutional Economics


The New Institutional Economics is a vast and relatively new multidisciplinary

field that includes aspects of economics, history, sociology, political science,

business organization and law. Oliver Williamson coined the phrase the “New

Institutional Economics” (Coase, 2000) but it is commonly known that the New

Institutional Economics emerged with Coase’s 1937 article “The Nature of the

Firm”. This article and his other famous essay “The Problem of Social Cost”

(1960) started what many, including North (2000), considered to be a revolution

in economics. This new direction of economics considers that the cost of

transacting – determined by institutions and institutional arrangements – is the

key to economic performance. It is therefore argued that the institutions of a

country – such as its legal, political, and social systems – determine its economic

performance, and it is this, according to Coase (2000), that gives the new

institutional economics its importance for economists.


Williamson coined the phrase “New Institutional Economics (NIE)” to distinguish

it from the “old institutional economics” pioneered by Commons and Veblen. The

old institutional school argued that institutions were a key factor in explaining and

influencing economic behavior, but there was little analytical rigor and no

theoretical framework in this school of thought. It operated outside neo-classical

economics and there was no quantitative theory from which reliable

generalization could be derived or sound policy choices made. Neo-classical

economics, on the other hand, ignored the role of institutions; economic agents

were assumed to operate almost in a vacuum.


The NIE acknowledges the important role of institutions, but argues that one can

analyze institutions within the framework of neoclassical economics. In other

words, under NIE, some of the unrealistic assumptions of neo-classical

economics (such as perfect information, zero transaction costs, full rationality)

are relaxed, but the assumption of self-seeking individuals attempting to

maximize an objective function subject to constraints still holds. Furthermore,

institutions are incorporated as an additional constraint under the NIE framework.

As Langlois (1986, p.5) puts it, “the problem with many of the early

institutionalists is that they wanted an economics with institutions but without

theory; the problem with many neoclassicists is that they want economic theory3

without institutions; what the New Institutional Economics tries to do is provide an

economics with both theory and institutions.”


The purpose of the NIE is both to explain the determinants of institutions and

their evolution over time, and to evaluate their impact on economic performance,

efficiency, and distribution (Nabli and Nugent, 1989). There is also a sort of twoway

causality between institutions and economic growth. On the one hand,

institutions have a profound influence on economic growth, and on the other

hand, economic growth and development often result in a change in institutions.

In the second theme, for example, growth in international trade and globalization

trigger the need to develop official and internationally recognized grades and

standards. However, not all institutional changes are beneficial. In fact, by

influencing transaction costs and co-ordination possibilities, institutions can have

the effect of either facilitating or retarding economic growth. That explains for

example why we have various institutions that develop in different countries and

why we have different paths of economic development.


1.1 Institutions defined


The most commonly agreed upon definition for institutions is: a set of formal

(laws, contracts, political systems, organizations, markets, etc.) and informal

rules of conduct (norms, traditions, customs, value systems, religions,

sociological trends, etc.) that facilitate coordination or govern relationships

between individuals or groups. Institutions provide for more certainty in human

interaction (North, 1990). Institutions have an influence on our behavior and

therefore on outcomes such as economic performance, efficiency, economic

growth and development.


It is important to note that the NIE operates at two levels – macro and micro

(Williamson, 2000b). The macro level deals with the institutional environment, or

the rules of the game, which affect the behavior and performance of economic

actors and in which organizational forms and transactions are embedded.

Williamson (1993) describes it as the set of fundamental political, social, and

legal ground rules that establish the basis for production, exchange and

distribution. The micro level analysis, on the other hand, also known as the

institutional arrangement, deals with the institutions of governance. These,

according to Williamson, refer more to the modes of managing transactions and

include market, quasi- market, and hierarchical modes of contracting. The focus

here is on the individual transaction and questions regarding organizational forms

(vertical integration versus out- contracting) are analyzed. An institutional

arrangement is basically an arrangement between economic units that governs

the ways in which its members can cooperate and/or compete. For Williamson,

the institutional arrangement is probably the closest counterpart of the most

popular use of the term ‘institution’.


It is also useful to distinguish institutions from organizations. Organizations can

be defined as a structure of roles. Many institutions are organizations; for

instance, households, firms and co-operatives. Other types of institutions, on the

other hand, are not organizations, such as money or the law. Likewise, there are

organizations (for example grass-root organizations) that are not institutions.



2. How can the New Institutional Economics framework be applied to

agricultural policy research in developing countries?


In order to start the debate on the relevance of the New Institutional Economics

for agricultural policy research in developing countries it is appropriate to refer

the following paragraph from North (2000):


“The cost of transacting, to put it in it bluntest form, is the key to economic

performance. When I go to third world countries and look at why they

perform badly and examine how factor and product markets are really

working, in every case, be it capital, labor or product markets, one observes

that the cost of transacting is high. The cost of transacting results in the

economy performing badly because it is so costly for human beings to

interact and engage in various kinds of economic activity that the result is

poor performance and poverty and so on. Where this takes us, of course, is

to try to understand why the cost of transacting is so high,…”


Since institutions and the institutional framework provide the incentives for

efficient production and for people to engage in economic activity, an institutional

analysis is required to explain why the cost of transacting is so high in developing

countries. The frequent occurrence of market failure and incomplete markets

(because of higher transaction costs and information asymmetries) in developing

countries cannot be explained by conventional neo-classical economics and

requires an institutional analysis. Many of the institutions or formal rules of

behavior that are taken for granted in developed countries and that facilitate

market exchange are absent in low-income countries. Therefore, the NIE is a

useful framework that could help determine the types of institutions needed

(either formal or informal) to improve economic performance in developing



The NIE framework has previously been used by a number of authors (see for

example Binswanger and Rosensweig, 1986; Binswanger and McIntire, 1987;

Stiglitz, 1974; Hayami and Otsuka, 1993) in applications to the problems of

developing country agriculture. Dorward et. al. (1998) provide a detailed review

of these applications. These studies are amongst a large body of literature that

applies aspects of the NIE framework – mainly the cost of information and the

lack of property rights – to explain market failures in the main intertemporal

markets (insurance, credit, futures markets) and the labor market. Some authors

also illustrate how institutions such as sharecropping and other forms of

interlinked contracts emerge to overcome market failures.


In addition to the many applications of the NIE framework to input market failures

it can now also be argued that the rapid changes in the food and agricultural

sector in developing countries in the aftermath of market liberalization and

government devolution provides an additional and probably much more fertile terrain for the application of the NIE framework.



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