Evolution of Markets and Institutions (Murali Patibandla, 2006)

Evolution of Markets and

Institutions: A study of an emerging

economy (2006)

Murali Patibandla

1Evolution of Markets and Institutions (2006)

Contents

I. Introduction (3)

II. The conceptual framework (5)

III. Initial conditions and economic policy reforms (3)

IV. The direction of structural changes (2)

V. Competitive dynamics (3)

VI. Technological change (4)

VII. Organizational change (4)

VIII. The evolution of public and private order institutions (2)

IX. Conclusion (1)


I. Introduction (1/3)

• Context

• India- One polity, many countries

• 1980s- 90s movement towards free-market economics

• General reduction of international trade barriers and investment barriers

• Rapid progress in ICT

• Indian reforms limited to urban class and western and southern parts

• Workers’ productivity is not just a factor of capital and technology, but also that of property rights, incentives, and TC

• The institutional environment is defined jointly by the rules of the game (formal constraints) and conditions of embeddedness (informal constraints)

• Interaction between institutional environment and governance mechanisms (markets, hierarchies and hybrids) determines economic efficiency of exchange and incentives for investment

• There exist a critical minimum level of capitalist institutions at the onset of economic reforms, on the basis of which further evolution takes place. In the case of India, it was the presence of markets and a critical level of capitalistic institutions pre- 1991

• Entry of TNC (transnational corporations) helped Indian firms become more productive, and economic benefit of IT export revenue from such TNCs

• Case of India

• Endowment, both from free-market mechanism of British rule (railroad, telegraph and human rights institutions ) and import substitution policies post-independence

• Early investment by government, made easy for private players to take over later

• Excessive government intervention trapped economy into distributional politics at the cost of wealth- generation

• Reforms took time to impact the economy



• Governments are public order

institutional mechanisms that reduce

uncertainty whereby increases gains

from specialization and lowers TC

• Countries that are able to arrive at

governance mechanism that bring out a

fine balance between individual

incentives, and formal and informal rules

formed by collective actions are the ones

that facilitate free markets to germinate

• Overall efficiency of economic activities is

determined by combination of

transformation and transaction costs

• Economic activities is organized in an

economy by balancing trade-off between

high-powered incentives of individual

choices and low-powered incentives of

institutional constraints (e.g. western

economies)

• Success story is Europe, and failure story

is Russia (lack of minimum capitalistic

institutions and mafia property rights).

• Success story of South Korea in 1960s

under President Park (land reforms,

breaking up of trade-unions)

• Institutional failures (collusion of banks

and conglomerates with poor disclosure,

lack of accountability) led to Asian Crisis

of 1997- Crony capitalism

• Slow progress of Japan in 90s due to

lack of institutional reforms

• Highly interventionist planning system



China

• 1978- totalitarian communism, external

reforms followed by delayed internal

reforms, ambiguous property rights,

focus on state-owned enterprise (SOE),

no attention to private enterprise. capital

access restriction, private firms converted

to foreign firms with borrowed capital

from neighbors, successful community

owned Township and Village Enterprises

(TVEs), high savings rate but still large

foreign capital flow, faster decision

making owing to central control, high

contractual hazards yet attractive for

risky investors,

India

• 1991- democracy, initial reform in

1980s, pervasive government

intervention loosening post

liberalization, internal reforms followed

by external ones, private agents given

property rights but often modified,

distributional- politics, strong local

entrepreneurial class, growth of

internationally competitive knowledge-

based industries, low domestic saving

by better capital utilization, slow

clearance of large scale projects, high

market TC due to independent

judiciary and state- centre split


II. The conceptual framework (1/5)

• Reforms are parameter (quantitative) and qualitative shifts in elements of institutional environment

• Parameter (taxes, licensing fee, tariffs, exchange, and interest rates)

• Qualitative (removal of licensing, revision of small scale industries, import restriction)

• Qualitative shifts eliminate TC once and for all

• Markets

• Product and factor markets

• Policy interventions address market failures

• Reforms results into removal of government interventions as markets improve

• Reforms impact both efficiency (competition) and distributional (allocation) criteria

• May mean adverse outcomes in short run on distributional grounds

• Prices reach their opportunity cost and new markets emerge (greater participation of agents)

• Economic institutions

• Institutions are humanly devised constraints

that structure political, economic and social

interactions. They consist of both informal

constraints and formal rules (North 1990)

• Interplay of institutional environment

(property rights, custom, traditions and

norms) and institutions of governance

(issues of contracting)

• Collective actions are required when

individual actions cause costs to society at

large, owing to negative externalities

(Coase’s property rights theorem).

• Collective actions could be private ordering

or government enforced

• Social norms and trust are important

elements of private ordering (e.g. throwing

garbage)

• Institutional environment determines micro-

level governance choices, in turn

determines economic efficiency



• Economic institutions (on TC)

• TC determined by frequency, uncertainty

and asset specificity.

• Asset specificity has a strong contractual

dimension, as it increases opportunism

• All contracts are incomplete

• Assumes bounded rationality and

opportunistic behavior (self- interest with

guile)

• Possible governance structures are markets

(spontaneous adaptation), firms

(coordinated adaptation), hybrids

(negotiated order of credible commitments )

and public bureaus

• Trade-off between public bureau and private

ordering

• Mafia is a form of governance structure

(private ordering) chose by people who are

left out of the rule

• Formal rules and laws

• Increasing specialization and division of

labor calls for formal rules of interaction

• TC depends upon definition of rules and

their enforceability

• Rules can be copied, but their

implementation needs institutional

effectiveness (embeddedness)

• Poorly defined laws discourage individuals

from investing in durable assets

• Common- law countries laws emanate from

judicial decisions (e.g. India, US, Australia),

while in civil- law countries they emanate

from centre (Europe, Russia, China)

• Law enforcement depends upon de/

centralization of governance structure,

higher centralization higher is moral hazard



• Formal rules of property rights

• Private property is an important institutional

condition and incentive for capitalism

• Clear definition of private versus common

property rights; and between private and

public stock of knowledge

• Enforcement by enforceable government

rules and/ or evolved social norms

• Features of a well- defined property law is:

comprehensively assigned (either privately

or publically owned), exclusive ownership,

transferable with minimum TC, and secure.

• Poorly defined property rights lead to

predation by private agents and government

• Need for clear separation of ownership and

control rights

• Institutional protection of IP rights result in

investment in hi-tech industries

• Proper appropriation of IPRs enable

creation of knowledge assets

• Informal rules and norms

• Societies with embedded norms of trust

incur low TC.

• Evolve through repeated interactions

• Avoids myopic competitive behavior

(Prisoner’s Dilemma)

• Trust comes from experience that shows

that incidences of cheating are few



• Organization

• Firm is an organization to minimize TC (Coase 1937, Williamson 1975)

• There is no power and hierarchy in organization as firm doesn’t own all inputs. Organizations evolve to measure efforts and assign rewards (Alchian and Demsetz 1972)

• Firm is a nexus of complete contracts under agency problem of separation of ownership and control (Jensen and Meckling 1976)

• Firm has residual decision rights owing to asset ownership under incomplete contracts (Grossman and Hart 1986)

• Firm is an information economizing response to market failures (Arrow 1974, Hayek 1945)

• Firms are complex hierarchies of employees supervisors (Clark & Wolcott 2001)

• One way of solving bureaucracy problem is by adopting M-form (Chandler 1977)

• Market imperfections lead to diversification (Khanna and Palepu 1997)

• The evolution or economic institutions

• More people participation in markets

increase transactions and efficiency

elimination of monopolies transfer of

surplus to customers investment in

durable assets need for strong property

rights increased competition increased

investment

• Reform lower the TC with government but

increases complexity, uncertainty and

frequency of exchange

• Such changes are never piecemeal

• Call for change in formal laws, followed by

governance mechanism

• Institutional elements can change with

change in political economy, or with crisis

• Evolution of norms

• Through cooperation of repeated interaction

in small societies and learning

• Formal laws and rules come into play to

neutralize the costs of freewheeling capital



• Organizational change

• Organizations are form, while institutions

are substance

• Organizational forms are copies by

developing countries, but implementation

remains a challenge

• Change can happen through: 1) shift in

institutional environment, or 2) engineering

organization by copying a superior form

• Institutional environments can change in

parametric or qualitative ways

• Large parametric changes are required to

induce a shift from market to hierachies,

than from extreme to hybrids

• Innovation and technology change can

bring about superior organizational

practices even in absence of institutional

shift (e.g. entrepreneurial creativity)

• May result in emergence of ‘islands of

competitiveness’ (IT/ ITES industry)

• Feedback effect of institutional

environment

• It the effect of changes in structural factors

and micro level governance on elements of

markets and institutional environments

• Initial policy changes are signaling

mechanism to encourage invest in durable

assets and human capital

• Depends upon credibility of commitment by

the reformists (e.g. IT industry effect on

employment generation)

• The post- reform rewards depend upon

initial conditions


III. Initial Conditions and Economic Policy

Reforms (1/3)• The Indian Story

• One polity, many countries (Clark and

Wolcott 2001)

• Poor performance, in spite of democracy

and historical advantage, due to inefficient

utilization of technology

• Post- liberalization economic benefits have

only occurred in pockets

• Fragmentation of markets and institutions

• In developed world: Primitive communism

feudalism capitalism (Marx’s

interpretation)

• In India, such systems co-exist

• Elements of institutional environment works

for different agents differently , determined

by one’s social capability

• Prevailing information imperfections,

transaction cost and poor property rights

• Illiteracy is a key cause of fragmentation

• Reforms and investment in primary

education could overcome fragmentations

• British Indian and capitalistic institutions

• Construction of railroads and telegraphs

reduced domestic and international TC

• Adoption of Anglo- Saxon common law

leading to emergence on industrialists

• Elimination of taxes on goods movement

and adoption of common currency

• Implementation of local bureaucracy and

English- based education

• Establishment of BSE in 1875

• Indian industrial houses managed by

managing agency system (joint families)

• Civil services contributing to political and

administrative stability of India



Reforms (2/3)• Independent India

• Nehru’s Fabian socialism with investment in industrialization and import substitution

• Carried out in absence of land reforms

• ‘Soft state’ with complexity of political and bureaucratic systems

• Influence of Soviet style five year plans

• Parliamentary system giving discretionary powers to politicians and bureaucrats

• Higher education subsidized at the cost of primary education

• Product markets

• Five key features were: commanding height given to public sector, regulation of private sector, product reservation for SMEs, price control in certain sectors, and close door policy towards international trade and investment

• Labor markets

• Organized and unorganized segments

• Huge skill and wage difference

• Job security in organized public sector

• Capital markets

• Post –independence autonomy given to

central bank and regulatory institutions

• Pre reforms nationalization of banks and life

insurance companies

• Two challenges with India: high moral

hazard amongst public agents, and

absence of regulatory bodies leading to

criminalization of capital markets

• High savings rate, but poor institutional

arrangement leading to inefficacies

• Poorly managed developmental institutions

IFCI, IDBI, ICICI and UTI

• Presence of large unorganized capital

market (traditional moneylenders)

• A vicious nexus of capital, labor and output

market exploiting the farmers



Reforms (3/3)• Structural outcomes of the policies

• Public sector investment in strategic areas

• Rapid expansion of service sectors

• Inequalities in education system

• Proliferation of employment in unorganized

sectors

• Regional inequalities

• Location of public institutions to bring about

equality

• Incentives to private sectors to locate in

backward areas

• Post liberalization increase in inequality

• Gains limited to regions with endowments of

initial markets and institutions

• Kerala, despite high-literacy levels, didn’t

have necessary institutional conditions for

development

• Market structure and qualitative behavior

of agents

• Inefficient capital utilization on public sector

due to agency problem and lack of

autonomy

• Early industrialists were based upon

managing agency system on lines of joint-

family and created monopolies

• Business houses built family empires from

tax-payers money, and preempted new

entrants

• The policy reforms

• First phase (1980- 1991) and second phase

(post- 1991) triggered by balance of

payment crisis

• Removal of internal licensing policy and

restriction on capacity expansion, reduction

in import tariffs, devaluation of Indian rupee

• Setting up of SEZ in 2001


IV. The Direction of Structural Changes

(1/2)• Change in attitude and perception of

middle class towards industry, business

and investment

• Reforms induce structural changes by

releasing resources, and by changing

relative prices

• Growth is a factor of initial conditions and

micro level technological and

organization dynamics in response to

reforms

• Reduction in TC in product and financial

market let to increase in resource

productivity by their transfer from

government to private agents

• Public investment of government

decreases TC, while public consumption

increase TC as it requires bureaucracy

• Private sector experiences reduction in

TC in dealing with government

• A one- shot reduction in TC expands

markets, and market expansion reduces

average TC further

• One implication for the firm is lower

inventory carrying cost

• On capital market front, reforms led to

setting up of NSE and SEBI, after 1992

scandal

• Reforms in labor market

• Increasing upper limit of employment large-

scale organizations

• Emergence of contract suppliers and

employment agencies to overcome rigidities

of labor policies

• Specialization of services and skills


IV. The Direction of Structural Changes

(2/2)• Internationalization

• Increase in international trade, presence of

TNCs, technology flow, international

mobility of talent, and outward investment

by Indian firms

• Gradual improvement in property rights and

allowing of fully-owned subsidiary

• Increasing pace of cross-boarder M&A

• Emergence of service sector attributed to

high subsidy in higher education, growth

of bureaucracy and expansion in public

sector banks

• Highest growth post liberalization is seen

in capital goods and consumer good

industries.

• Fastest growing industries are more

international than others.

• Sectors and regions with rich endowment

were fast growing then rest

• Income growth and distribution

• Reforms benefited those with initial

endowment of durable assets and skills

• Consumption broadened the rural- urban

divide

• Specially the urban middle class was the

largest beneficiary

• Regional distribution of growth

• Industrial development concentrated in

southern and western parts of India

• Low population mobility

• Location decisions of firms governed by

skills availability and low labor disputes

• Greater people movement and trade in

recent decades owing to major

infrastructural projects and implementation

of VAT.


V. Competitive Dynamics (1/3)

• Propositions of institutional change

(North 1993)

• Competition is key to institutional change

• Competition forces organizations to

continuously invest in skills and knowledge

• Competitive dynamics in India led to

convergence of best practices among

firms, and triggering market and

institutional evolution

• Most of new entrants are industrial

houses, through diversification

• New institutional economies states that

institutional environment determines

micro- level governance choices

• In pre- reforms India, firm size and

market share has no relationship with

relative production efficiencies

• Convergence of best practices

• Through competitive dynamics, joint

ventures and spillovers

• While entering India TNCs have advantage

in intangible assets and capital markets

• Strength of property rights in emerging

economies determine rate of convergence

• Asymmetric advantage can emerge from

two sources: first movers and cost

advantage

• TNCs have to acknowledge the existing

institutional environment in host country

• Most TNCs chose JV approach

• Incumbents shield from TNCs disappeared

post reforms

• Pre-reforms Indian firms had higher X-

inefficiencies

• TNCs invest more in distribution networks

and building local knowledge



• Competition among TNCs

• Japanese versus American and European

TNCs with distinct advantages

• Case of Maruti- Suzuki versus Hyundai

• Growing convergence among TNCs and

domestic firms in auto industry

• JVs between TNCs and local firms

• Driven by policy stipulations and economic

factors

• Accelerates technology transfer, moderated

by the IP regime in host country

• Strong IP regime encourages introduction of

latest technology, and hence diffusion

• TNCs accesses local institutional

knowledge and this might leads to eventual

break-up of JV once need is met

• Made local firms to invest in R&D ex-ante

and helped diffusion of technology


• Convergence of practices through

intermediate input markets

• Existence is asymmetric contractual relation

between large and small firms, with

assemblers exploiting suppliers

(monopsony)

• Entrant of new TNCs increases suppliers

bargaining power

• Infusion of new technology and practices

make both better off

• Example: agglomeration economies

developed by Maruti and its suppliers by

sharing of best practices and co-location

• Diffusion of practices from tier-I OEMs to

tier-II and tier- III suppliers

• Increase in demand of skilled and semi-

skilled labor, and labor movement; and then

rapid adoption of capital intensive

technology

•


• Capital markets and convergence

• TNC’s advantage in access to global capital

at low cost pushing local firms to innovate

• Large Indian houses have premium access

to capital through capture of government

financial institutions

• Reforms forced large firms to look for

alternate sources of finance

• Led to improved functioning of Indian capital

markets and disclosure by companies

giving positive signals to investors

• Positive impacts of FIIs: being efficient and

adopt better disclosure, and better

monitoring

• Banking reforms leading to lower

transaction cost

• Capital costs are pushed to international

levels with entry of global banks and

financial institutions


• Feedback effects

• Lack of entrepreneurial dynamism due to

poor institutional environment and under-

developed capital market

• TNCs bring superior technologies and

practices to emerging economies

• Emergence of markets for consumer

finance

• Improvement of long term contracts

between buyers and suppliers, with

diminishing roles of third- parties

• Wage rate increase due to better bargaining

power of labor and productivity

• Increase participation in capital market by

institutional investors and FIIs

• Competitive dynamics leading to change in

perception and opportunity set of agents,

thereby bringing about institutional change

VI. Technology Change (1/4)

• Policy reforms (parameter and qualitative) +

Competitive dynamics Technology

change Institutional revival

• Market conditions for technology change

• Competition

• Division of labor

• Labor market conditions

• Development of financial markets

• Technology factors are governed by

organizational issues, such as incentives,

centralization, agency relation, learning

• Main characteristics of innovations: non-

rivalry and non-excludability (Romer

1990)

• Technology change and growth is a

function of human- capital accumulation

and is generated by educational

institutions and learning on the job

(Lacus 1988)


• Market reforms and adoption of new tech

• Firms having greater access to new tech

• Adjustment and adaptation cost

• Movement from collusion to competition

• Reforms eliminates barriers to new entry,

and new entrants must possess superior

technology

• Technology adoption depends upon

property rights, market conditions and initial

endowment

• Development of product markets (size)

essential for adoption of new technology.

• Openness to international trade hastens

adoption (size and exposure)

• Technology adoption limited by strength of

intellectual property rights: in terms of

spread across industry and ownership

issues


• Adoption and adjustment cost of new

technology

• Shaped by market size, competition, initial

endowment of skills, and technology

capability

• Cost involves that of technology transfer,

cost of contract formation, and enforcement

• Issues in adoption of capital intensive

technology, due to lack of skills

• High- firm level investment in training (e.g.

IT firms)

• Adoption in post reform era

• Technology change is a long-run

phenomenon

• TNC operations vary between hi-end and

low-end technology operations while

catering to exports market (e.g. GE)

• Increased technology collaboration between

local and foreign firms

• Spillover effect of CSIR and TNCs


• Micro-level processes of adoption

• Main factors for building technical

capabilities of follower nations are: initial

endowments in technology competence,

entrepreneurial competence and learning

ability

• Needs mastering of tacit elements of

technology for its transfer to local

production needs

• Adopters can sometime surpass the

creators of new technology (e.g. Japan)

• Calls for organizational restructuring (family-

run to bottom-up approach)

• Poor governmental infrastructure forcing

TNCs to establishing their own

• There has been pockets of successes in

India, such as in IT industry, auto- parts

manufacturers and some cases of pharma

industry (DRL)


• Evolution of National Innovation System

• Its an institutional system to encourage

production of S&T in the country

• Imitation and technology bridging is the

concern in emerging economies

• US vs USSR case highlight role of private

players in effective NIS, as they have

incentive for commercialization

• Equally important is the role of government

in generating public stock of knowledge

• Indian government approach of heavily

subsidizing higher-education during pre-

reform era

• Governments role in setting up of BEL and

C-DOT led to emergence of IT industry

• Poor linkage between public sector R&D or

even universities and commercialization


• NIS in post-reform era

• Indian IT industry is a by-product of import

substitution policy

• Specific incentives given to public R&D

institutions to commercialize basic research,

and private sector to tap into public

institutions (e.g. NCL, IISc)

• TNCs made extensive linkages with Indian

research and educational institutions to

source talent and R&D capabilities (e.g.

Nortel, HP, IBM, Microsoft)

• Industrial clusters

• Clustering activities develop network

externalities by reducing transaction cost

• Easier and faster diffusion of best practices

• Internal rivalry + cooperative networks

• Formation of social capital through repeat

interaction

• Clustering activities lead to emergence of

supportive institutions and markets


• Negative externalities

• Presence of TC requires government to

interface and establish public order

institutions

• Even public’s collective action can fail in

such rapidly developing markets

• Export oriented small-firms are labor

intensive and pollution- intensive, and don’t

have incentives or money to implement

pollution-prevention technology

• TC of undertaking countervailing collective

action are too high

• Solution is the development of cooperative

norms in clusters (e.g. Tirupur area)


• Feedback effects

• Emergence of new industries in response to

the technological and market dynamics (e.g.

biotech industry)

• Enabled by government investment and

enterprising attitude of firms

• Increase technology activity impacts labor

market in two ways: increase in productivity,

and demand of skilled labor

• Increasing emphasis on on-the- job training

• Market development of differentiated skills

• Increasing venture capital activities by

TNCs in India (e.g. Cisco, Intel)

• VC funds set-up by local financial

institutions (e.g. ICICI, IDBI)

• Indian’s adoption of process patent under

TRIPS in 2005 strengthening the IPR

protection

VII. Organizational Change (1/4)

• Resource allocation under new

institutional economics: ‘invisible hand’ of

free markets, and ‘visible hand’ of

organizational hierarchy

• Post- reform efforts on organizational re-

structuring, especially of family business,

emerging from changes in product, labor

and capital markets

• Org. changes in family- run businesses

• Role of family- owned businesses in

developmental stages of US, US, Japan

and Korea

• But Indian firms remained monopolies in

protected environment

• Emergence in western and southern India

under British rule

• Building up of reputation and morality, in

absence of institutional mechanisms ,to

lower transaction cost


• Family run business (contd…)

• Building of family empires through:

channeling of public saving through public

financial institutions, and extracting

monopoly rents by limiting competition

• Lack of transparency and disclosure helped

move family fund around the empire

• Financial interlocks evade takeovers

• Post- license regime forced family run

business to look for capital and

organizational restructuring, by being more

transparent and hiring professional

managers

• Led to increase number of business schools

and talent management firms

• De-layering and de-centralization

• Development of internal talent building

setups (e.g. TAS, Birla Management

Centre)


• Organization of small- scale businesses

• Specific pre- reforms policies (e.g.

reservations, excise duty policies,

concessional finance)

• High dependence on family capital or

informal capital markets

• Exploitation of bankruptcy laws

• Missing incentives for innovation

• Adoption of premature diversification as few

want to grow in size

• Post- reform scenario increased technology

adoption and efficiency due to export

orientation, but capital markets remain

largely organized

• Very few companies registered and

declared less than 20 employees to save on

PF contribution

• Became frequent harassment and bribe

extraction by inspectors

• Extensive use of contract labors


• Change in diversification behavior of

large businesses

• Unrelated diversification on account of

economizing the TC of labor and capital

markets

• Capital market imperfections also allowed

large a privileged access to capital.

• Licensing policies resulting into

diversification to block new entrants and

control monopoly positions

• Vertical integration in post- reform era

• High degree of M&A activities in both

domestic and international arena,

• Both divesting and merger happening

• Vertical integration increase even with

technology adoption and specialization

• An inverted- U shape trend in vertical

integration in Indian firms over time, a trend

expected by economic predictions as

counties emerge


• Diversification behavior of unrelated

businesses

• Large business groups continue to diversify

post- reforms as they enjoy reputational

advantage, and utilize internal cash flows

• Sale of unrelated business, adoption of

core- competence, and restructuring

• After adopting focused strategies, several

firms followed market diversification

strategies to translate their cost advantage

into international markets

• Spillover of technology and managerial

learning from TNCs

• Standalone companies

• Cases in areas with market opportunities,

where traditional firms have no advantage

• Adoption of organizational innovation to

overcome institutional constraints

• Enabled mostly by pre- reforms endowment

in human capital (e.g. IT and biotech)


• Corporate governance

• Two tiers of agency problem: b/w corporate

headquarters and investors, and b/w

corporate headquarters and divisions

• In Indian context, main conflict between

dominant and minority shareholders

• Series of stock market scandals in 1992-94

• Setting up of SEBI and NSE

• Increased role of FII leading to better

monitoring, transparency and disclosure

• Tapping into capital abroad through GDRs

and ADRs

• Internal governance

• Interlocking of directorship to retain control

• Very few companies adopting Anglo-

American corporate governance model

which gives power and information to

stockholders to manage agents effectively


• Changes in debt finance institutions

• Reforms such as deregulation of interest

rates and compulsory lending and

relaxation of reserve requirements

• Still making failure remains highly protected

by the government

• Strengthening of bankruptcy laws over the

period has happened

• Globalization and organizational

innovations

• Three governance mechanisms adopted by

TNCs in India: outsourcing, joint- ventures

and fully- owned subsidiaries

• Outsourcing governance involves the cost of

identifying the country, selecting the partners

and writing the contract (lest level of technology

expertise)

• Setting up of joint- ventures necessitates

formation of comprehensive non- disclosure

contracts (moderate level of technology

expertise )


• Globalization and organizational

innovations (contd)

• Full- owners subsidiaries are driven by the

need to integrate as TNCs enter into

contract with local firms on BOT mode.

(high level of technology involved)

VIII. Evolution of public and private order

institutions (1/2)• Public order institutions (constitution,

government and judiciary), and private

order institutions (repetitive collective

action by private agents)

• Reforms parametric and qualitative

changes change in scope and

objective of public order institutions

triggers private order actions

economic efficiency

• Coase Theorem: Collective actions can

rectify the cost of negative externalities in

the absence of transaction costs

• One of the important aspects of the

evolution of public and private order

institutions is the issue of improving

governance and the emergence of

private order institutions in reducing

poverty and illiteracy


• Public order institutions of capitalism

• Support institutions

• Includes legal framework, social security,

primary education, macro policy

management, and provision of public goods

• Regulatory and redistributive

• Often regulations emerge post one- shot

distributional changes

• Establishment and enforcement of property

rights require public order institutional

support

• Regulatory institutions

• Reasons for regulatory state: TC, and

failure of collective action in bargaining

• Enforcement is a prime issue in India

• Vaguely defined rules and laws favored

large agents for long

• Administrative discretion due to absence of

regulatory predictability and procedural

transparency

VIII. Evolution of public and private order

institutions (2/2)• Private order institutions

• Informal rules and norms of collective

actions that evolve over a period of time

(e.g. out of court settlement of IP

infringement in the US)

• Private order institutions emerge mainly for

the distributional politics of zero- sum

interactions

• India adopted Common Law from Britain,

but adopted a s hybrid version of

centralization and decentralization

• 30,000 laws brought by state and central

government leading to enormous complex

system and backlog of cases in courts

• Regulatory institutions in post- reform era

• Ensuring markets remain competitive and

reducing negative externalities

• Market reforms in absence of regulatory

institutions lead to negative externalities

• Continued corruption reduces the respect

for rules of the law


• Regulatory institutions (contd…)

• A well- developed illegal market is reflection

of a related legal market which is

underdeveloped or regulated

• Enforcement depends upon evolution of

embedded conditions over time

• Surplus generating private- order

institutions

• Imperfect information, adverse selection,

and moral hazard under agency relation

doesn’t vanish once a cooperative is formed

• Cooperation takes place when the surplus

for the agents is higher under cooperation

than under middlemen

• Emergence of self- help groups

• Need for incentive compatible practices and

control rights, further homogeneous groups

are better off

• Success of Amul (leadership and collective

action) and failure of Urban Cooperative

Banks (flawed incentives and organization)

IX. Conclusion

• Capitalism is functional on the basis of

underlying economics, social and political

institutions that evolve over time

• Economic reforms are exogenous

parameter and qualitative shifts in certain

elements of the institutional environment

on the basis of initial institutional

endowments of capitalism


Date post:	06-Jul-2015
Category:	Business
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