Alternative Institutional Structures

Evolution and impact

Sandra Batie, Nicholas Mercuro

• Publisher: Routledge
• Year: 2008
• ISBN:
  9781135974909
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

In the spring on 2006, a workshop was held at Michigan State University to honour the career of A. Allan Schmid and his writings about how institutions evolve and how alternative institutions, including property rights, shape political relationships and impact economic performance. This edited book is the outcome of the workshop. It is a collection

1 Power and the troublesome economist

Complementarities among recent institutional theorists

A. Allan Schmid

Introduction

Contemporary institutional economics theory has come a long way, but it has further to go in recognizing the role of power in the economy. In this chapter – a book review essay – I want to both explore some of the emerging complementarities in this theory, and where power issues might be better inserted. Kurt Rothchild (2002) has noted that economists can’t be accused of overlooking power, but that much of economics makes it of secondary importance. John Kenneth Galbraith (1973) suggested that there were two ideas in economics that tended to remove power from the subject of economics. These were the concepts of the sovereign consumer and voter. Power could not exist in competitive markets and the state is subordinate to the instruction of the citizen. But, Galbraith argued that the corporation had the power to shape consumer demand and lobby government for what it needed. These points are still valid, but other concepts have developed to hide the role of power. To be more useful, economists will have to become more troublesome and expose what is at stake in inevitable power play.

Three recent books are reviewed here with an eye to summarize new theoretical developments. They also serve to illustrate how questions of power still remain subordinate even amongst some institutional scholars. Questions of how institutions shape behavior and evolve are the subject of important new books by Elinor Ostrom, Samuel Bowles, and Avner Greif. Ostrom’s goal is not only to understand institutional diversity, but also to find universal components common to all. She defines institutions as “the prescriptions that humans use to organize all forms of repetitive and structured interactions.… Individuals interacting within rule-structured situations face choices regarding the actions and strategies they take, leading to consequences for themselves and for others” (Ostrom, 2005: 3). Bowles asks what accounts for differences in the wealth of nations. He proposes “a theory of how individual behaviors and economic institutions interact to produce aggregate outcomes, and how both individuals and institutions change.” He defines institutions as “the laws, informal rules, and conventions that give durable structure to social interaction among the members of a population” (Bowles, 2004: 47–8). For Greif (2006: 39), institutions are “systems of interrelated rules, beliefs, norms, and organizations.” Greif offers a theory for investigating the institutional foundations of impersonal exchange. He is particularly interested in self-enforcing institutions that do not require external sanctions and are sources of endogenous change. The similarities of the three authors are obvious, but there are also important differences to be worked out or utilized for different purposes.

Institutional analysis and design

Game theory is a major conceptual framework for these authors.¹ However, it is far from classical game theory. The authors take seriously the evidence from prisoner’s dilemma experiments that a substantial proportion of people are not fully egoists. Ostrom (2005: 131) urges analysts “to animate an initial analysis assuming the participants hold multiple value orientations and use strategies ranging from those used by rational egoists to those used by players who value trust, reciprocity, and equity very highly.” Also see Ostrom, this volume. Further, the authors observe that people learn (preferences not fixed),² valuation is affected by context (frames and multiple mental models),³ and the human brain has limited information processing capacity.⁴ Still, the determinism of calculated behavior is a powerful attractor. There is something beautiful about a neat payoff matrix from which optimal strategies of the parties can be calculated based on their estimate of others’ behavior. In the game theory part of her book, Ostrom introduces “delta parameters” to reflect the satisfaction of norm following, empathy, and sanctioning norm breakers.⁵ This nominally maintains determinism (much in fashion by economists), but makes empirical estimation difficult. The monetary gains to the players can be objectively observed while the value placed on the welfare of others and the satisfaction of being a good norm-following person is subjective. Ostrom wisely turns to field studies to understand the characteristics of “successful” communities. She never tries to relate her design principles to measured delta parameters and is comfortable with qualitative and directional links between institutions and outcomes. “Appropriators in the field rarely face a setting that generates clear-cut expected benefit—cost ratios” (2005: 249). So much for calculation from payoff matrices. To me, this makes instinct, affective evaluation, heuristics, and what is seen as natural key elements in institutional change. See Niederle, this volume.

The title Understanding Institutional Diversity says a lot about the book. Ostrom, a political scientist, observes institutional diversity and insists that the impact of institutions depends on the combination of many features and that these features can be combined in more than one way to achieve a particular performance. “Continuing to presume that complex policy problems are simple problems that can be solved through the adoption of simple designs that are given general names, such as private property, governmental ownership, or community organization, is a dangerous academic approach” (2005: 256). At the same time, detail must be managed to be tractable.

Central to Ostrom’s “Institutional Analysis and Design” (IAD) framework is the idea of complex adaptive systems with layers of units, subunits and larger units above them that make a pattern containing biophysical and cognitive elements. Her core unit of analysis is the “action arena” containing an “action situation” and the participants.⁶ This is reminiscent of John R. Commons and others focus on the transaction. The action situation contains participants, positions, potential outcomes, action-outcome links, the control that the participants exercise, types of information, and the costs and benefits assigned to actions and outcomes (2005: 14). Ostrom has spent a lifetime studying common pool resources (CPR) that have attributes of high exclusion cost and non-rivalness (marginal cost equal zero). These biophysical characteristics (inherent) are part of the action situation. She does not analyze other attributes such as economies of scale. “I do not want even to start a list in this volume” (2005: 26). I boldly suggest that it has been done in Schmid (2004: Ch.6). Ostrom says, “Analysts diagnosing policy problems need to be sensitive to the very large differences among settings and the need to tailor rules to diverse combinations of attributes” (2005: 26). Yes, the kind of institutions that direct the interdependence of common pool resources are not the same that direct those of goods with economies of scale, etc.

Multiple levels of analysis are another central feature of IAD. At the lowest level are the operational actions of firms and individuals given direction by everyday rules and norms that are the result of collective-choice with its own rules for making rules, and then higher level constitutional rules. For example, an individual may have a right to fish in a particular area, that rule having been made by a legislature or community organization within its rules of jurisdiction and procedure. In turn, these collective choice organizations make these rules within the procedures laid down in a constitution or its informal equivalent. People not satisfied with the outcome at one level can try another level.

A database of empirical field studies of CPRs has been assembled by Ostrom and her Workshop in Political Theory and Policy Analysis in order to understand the performance impact of alternative institutions.⁷ To understand these connections, the institutions must be described carefully, and to this end Ostrom, together with Sue Crawford, has developed a syntax and grammar with five components.

1. Attributes: distinguishes to whom the institutional statement applies.
2. Deontic: distinguishes the verbs of “may” (permitted), “must” (obliged), and “must not” (forbidden).
3. Aim: describes the particular actions or outcomes to which the deontic is applied.
4. Conditions: describes those variables that define when and where an action is operative.
5. Or else: the institutionally assigned consequence for not following a rule, i.e., a sanction.

One of the uses of this grammar is to distinguish rules (they have all of these components) from norms that have only the first four. If scholars were to adopt this language, we would talk past each other much less. Further, those constructing formal games, experiments, simulations, or conducting field studies could use a common language.

The rules in an action situation are further classified into boundary, position, choice, information, payoff, aggregation, and scope rules. Institutions assign participants to positions with attached allowed actions (opportunity sets). Potential outcomes are linked with these components. This complexity of real-world institutions leads Ostrom to abandon any attempt to find the optimal institution and to adopt a more experimental stance.

Ostrom demonstrates that there is much to be learned from game theory, experiments and field studies, but to this writer’s mind, the lessons she distills from her review of field studies are the most useful. The empirical testing takes the form of finding the common features in a large number of cases. If a feature is found in a large proportion of successful cases, it becomes a design principle.⁸ It is a qualitative, directional analysis. Out of this experience she offers a list of design principles to obtain sustained yields from CPRs (keeping in mind her admonitions against one size fits all):

1. Clearly defined boundaries.
2. Proportional equivalences between benefits (e.g., harvests) and costs to a user (e.g., required labor and other inputs to maintenance of the resource).
3. Collective-choice arrangements that include users in the group making the rules.
4. Monitoring and accountability.
5. Graduated sanctions for violations.
6. Conflict resolution mechanisms.
7. Minimal rights to organize.
8. Nested enterprises that organize activities at multiple levels.

Principle 2 about proportional equivalencies may be relatively straightforward amongst irrigators from a common ditch. But for many high exclusion cost goods, such as air quality it is difficult to relate taxes to extent and value of use. When this is the case, there is an inevitable tradeoff between the interests of those who want the good provided (wannabe riders) and those who do not and may be forced to pay taxes (unwilling riders) to enable others to avoid the crippling consequence of opportunistic free riders. More attention could be given to conflict resolution. It might be useful to abandon the metaphor of “mechanism” and adopt a more organic one.

One name for conflict resolution is politics and it is perhaps surprising that a political scientist does not give it a more prominent place. Ostrom does note that conflict among appropriators (more likely in large groups and extensive resource systems) may scuttle cooperation and sustainability. She and Bowles (2004: Ch.5) recognize that even in cases where there is a management strategy that maximizes total yield, quarrels over distribution may prevent cooperation. But, the quarrel can be about the future qualities of the pie itself, and not just its division. Both emphasize the need for learned norms and trust. Ostrom further pins her hopes on polycentric governance systems. By polycentric she means “a system where citizens are able to organize not just one but multiple governing authorities of differing scales” (2005: 283). The appropriate level may be contested. Witness states’ rights arguments in the U.S., Ostrom recognizes that peaceful and successful governance depends on attitudes of legitimacy and trust. Polycentric governance may well enhance general feelings of legitimacy, but it is probably a more complex phenomenon. Participation means different things to different people. I believe we must collect field data on how people in different communities make intuitive evaluation of other people and institutions.⁹

Ostrom following John R. Commons clearly understands that freedom for one party is an obligation for another (2005: 144–5). In the prisoner’s dilemma case, a set of rules that facilitates cooperation for the prisoners is not favorable to the prosecutor (2005: 189). So contrary to much used metaphors of “repair and reform” (2005: 180), the best institution is not to be deduced from the facts (the physician myth). We are all tempted to be physicians that people seek out to restore their health wherein there is no quarrel over the definition of health.

In an earlier work, Ostrom, Schroeder and Wynne (1993: 86) observed that “The relative homogeneity of the joint users of an infrastructure facility is a third characteristic affecting the ease with which users can organize to provide for the development and maintenance of the infrastructure.” If you are a governmental agency or NGO, and want your limited budget to produce sustained yields in CPRs, find a community where there are homogeneous preferences and people trust each other. But where does that leave many real world communities? Many of the design principles serve to exclude conflicted communities.

What are the major lessons from Ostrom’s theory and experience? There is a set of universal components out of which institutions are built, but these components can be assembled in diverse ways to achieve rather similar outcomes. The tragedy of the commons (and the social trap of the Prisoner’s Dilemma) is far from inevitable. Many communities solve their commitment problem and do it without central direction.¹⁰ Many others fail. Polycentric governance is the best hope. I hypothesize that alternative rules for making rules make a difference.

Post-Walrasian microeconomic approach

Bowles (2004: 9), like Ostrom, “presents a theory of how individual behaviors and economic institutions interact to produce aggregate outcomes, and how both individuals and institutions change over time.” Rather than a focus primarily on CPRs, Bowles concentrates on a generic situation of non-contractual social interaction and coordination failure to achieve Pareto-better exchange. To this he adds adaptive and other-regarding behaviors and generalized increasing returns. For Bowles, institutional design problems arise from inherent situations where complete contract is difficult. He is interested in power, but in his view, “With all the terms of a transaction contractually specified, nothing is left for the exercise of power to be about” (2004: 10). For example, in the context of the labor market, what the worker promises is hard to specify and monitor. Exchange is contested in Bowles language. So the employer finds it profitable to voluntarily offer a wage above the equilibrium that would prevail under complete contracts – sometimes labeled an “efficiency wage,”¹¹ (a term Bowles dislikes). While the worker can be opportunistic, the threat of discharge upon occasionally effective monitoring keeps them honest. The employer then has “short-side power” (2004: 344). Some workers who would accept less are unemployed in equilibrium. The arrangement is Pareto-superior, but not Pareto-optimal (the latter remains the unobtainable ideal and reference point). Power in this framework is benign between employer and those given jobs (ignoring the interests of the third party unemployed).

The big question for analysis then is to understand why contracts are necessarily incomplete. This seems like a strange place to start for many institutionalists who want to know what the parties bring to potential contracts, i.e., what they have to trade, as this is where real power originates.¹² Bowles notes without comment that the workers can’t threaten to burn down the employer’s factory to avoid the short-side power. He mig...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• List of contributors
• Foreword
• 1 Power and the troublesome economist: complementarities among recent institutional theorists
• 2 Some problems in assessing the evolution and impact of institutions
• 3 Developing a method for analyzing institutional change
• 4 Does economic development require “certain” property rights?
• 5 Institutional economics as volitional pragmatism
• 6 Institutions and rationality
• 7 Simplicity in institutional design
• 8 The essence of economics: law, participation and institutional choice (two ways)
• 9 Is law facilitating or inhibiting transactions?
• 10 On Institutional Individualism as a middle-way mode of explanation for approaching organizational issues
• 11 The role of attitudes in action and institutional change: an evolutionary perspective
• 12 Post-Keynesian institutionalism and the anxious society
• 13 Toward a theory of induced institutional change: power, labor markets, and institutional change
• 14 The instituted nature of market information: the case of induced innovation and environmental regulation
• 15 The role of culture and social norms in theories of institutional change: the case of agricultural cooperatives
• 16 Payment for environmental services and other institutions for protecting drinking water in eastern Costa Rica
• 17 A dialogue on institutions: various approaches to assessing the evolution and impact of alternative institutional structures EDITED BY