““Climbing the Hierarchical Climbing the Hierarchical Ladders of Rules”:Ladders of Rules”:The Dynamic of The Dynamic of
Institutional FrameworksInstitutional FrameworksEric BROUSSEAU Eric BROUSSEAU
(EconomiX, U. Paris X & IUF)(EconomiX, U. Paris X & IUF)
Emmanuel RAYNAUD Emmanuel RAYNAUD (INRA SADAPT & ATOM, U. Paris I)(INRA SADAPT & ATOM, U. Paris I)
MotivationMotivation Two main views of institutions in economics
and two visions of Institutional Changes
Institutions as (designed) rules of the game
Institutional Framework:Political Competition
Institutional Arrangements:Economic Competition
Institutions as (self-enforced) equilibrium of
games
Destabilization of a prevailing equilibrium
…and processes of convergence toward a new set of shared beliefs
MotivationMotivation
Alternative layers are distinguished according to their ability to quickly change (or costs of changing them)
“slow” vs “fast-moving” institutions (Roland, 2004)
Williamson (2000, JEL)
Our contributionOur contribution We provide an We provide an endogenousendogenous justification for justification for
contrasted paces of change across contrasted paces of change across institutional levels of order provisioninstitutional levels of order provision
We explain how and why institutions at one We explain how and why institutions at one level might level might climb the “institutional ladders”climb the “institutional ladders”
Multiples bilateral orders (bilateral GS)
Sets of collective & “local” orders (“intermediate institutions”)
Uniform & generic order (“generic institutions”)
OutlineOutline
Logic of collective order formationLogic of collective order formation => Sponsored Orders=> Sponsored Orders
Incentives to climb the institutional ladderIncentives to climb the institutional ladder => Competition among => Competition among
OrdersOrders
Strategic Interplay among Sponsors Strategic Interplay among Sponsors => Coopetition among => Coopetition among
kernelskernels
Functions of governance level:Functions of governance level:Provision of an orderProvision of an order
GovernanceGovernance
Managing interactions through the definition of
“property rights”
Rules setting
“measurement cost”
Enforcement costs
Transaction Transaction costscosts
Rules setting
Rules enforcement
Provision of an Provision of an economic “order”economic “order”
Analytical Analytical FrameworkFramework
AssumptionsAssumptions Heterogeneity of agentsHeterogeneity of agents Coordination: Trade and Provision of Collective Coordination: Trade and Provision of Collective
ResourcesResources Distance/Proximity: territorial, preferences, Distance/Proximity: territorial, preferences,
agents’ characteristics, etc.agents’ characteristics, etc. Minimization of Private Transaction Costs (mix of Minimization of Private Transaction Costs (mix of
seek for efficiency and rent seeking)seek for efficiency and rent seeking) Process of Emergence Collective GovernanceProcess of Emergence Collective Governance
ConvergenceConvergence/Divergence /Divergence of Interestsof Interests
CoordinatioCoordination Gamen Game Rule 1Rule 1 Rule 2Rule 2
Rule 1Rule 1 (2, 2)(2, 2) (10,10)(10,10)
Rule 2Rule 2 (10,10)(10,10) (2, 2)(2, 2)
Battle of Battle of SexesSexes Rule 1Rule 1 Rule 2Rule 2
Rule 1Rule 1 (3, 6)(3, 6) (8 , 10)(8 , 10)
Rule 2Rule 2 (8 , 10)(8 , 10) (5, 1)(5, 1)
The Evolution of the The Evolution of the Bargaining GameBargaining Game
Battle of Battle of SexesSexes Rule 1Rule 1 Rule 2Rule 2
Rule 1Rule 1 (2, 5)(2, 5) (7 , 12)(7 , 12)
Rule 2Rule 2 (7 , 12)(7 , 12) (5, 1)(5, 1)
Battle of Battle of SexesSexes Rule 1Rule 1 Rule 2Rule 2
Rule 1Rule 1 (3, 6)(3, 6) (8 , 10)(8 , 10)
Rule 2Rule 2 (8 , 10)(8 , 10) (5, 1)(5, 1)
Dynamics of the Evolution of Dynamics of the Evolution of InstitutionsInstitutions
InsightInsight: Alternative governance levels pertain to : Alternative governance levels pertain to a a common life-cycle modelcommon life-cycle model of institutional of institutional evolutionevolution
Main argumentMain argument: Like lava, some : Like lava, some local local institutions spread and “froze”institutions spread and “froze” and become and become genericgeneric
Dynamic of InstitutionsDynamic of Institutions
Local Global
Negotiable
Mandatory
Bilateral institutions of governance
Intermediate institutions
Generic
institution
Benefits/Costs of Collective of Benefits/Costs of Collective of GovernanceGovernance
The Centralization Tradeoff
Scale & ScopeScale & Scope Effects Effects LearningLearning and and
SpecializationSpecialization Benefits Benefits Reduction of Collective Reduction of Collective
Welfare LossesWelfare Losses(Increased consistency (Increased consistency among local rules, among local rules, Internalization of Internalization of externalities, Positive network externalities, Positive network effects in the use of common effects in the use of common standards of interactions, …)standards of interactions, …)
Static Mal-adaptationStatic Mal-adaptation(Increasing heterogeneity of (Increasing heterogeneity of Individual Preferences)Individual Preferences)
Dynamic Mal-Dynamic Mal-adaptationadaptation (Reduced (Reduced Renegotiability)Renegotiability)
Information costs Information costs (Increasing Information (Increasing Information Asymetries)Asymetries)
Enforcement Enforcement RequirementsRequirements (Increasing Incentives to Free (Increasing Incentives to Free Ride)Ride)
Private CapturePrivate Capture(Increasing Incentives to (Increasing Incentives to distort coll. Gov. in favor of a distort coll. Gov. in favor of a minority)minority)
Local orders become Local orders become genericgeneric
Why is there Why is there incentivesincentives for local institutions to for local institutions to grow?grow? DirectDirect positive network externalities positive network externalities
Expansion widens the scope of low TC’s dealsExpansion widens the scope of low TC’s deals IndirectIndirect positive network externalities positive network externalities
New adopters reinforce the attractiveness of a given New adopters reinforce the attractiveness of a given institutioninstitution
Competition among local institutionsCompetition among local institutions // standard race// standard race
Negotiable orders become Negotiable orders become rigidrigid
Local institutions are voluntary devices Local institutions are voluntary devices exit is always exit is always possiblepossible QualityQuality of the collective rules has to be of the collective rules has to be
enhancedenhanced to meet external options to meet external optionsRules that are initially rough become more Rules that are initially rough become more efficiently designed and more tailored to efficiently designed and more tailored to particular needsparticular needs
Exit optionsExit options reduce and reduce and disappeardisappear
At the end of such process, there is At the end of such process, there is no no longer margins of negotiationslonger margins of negotiations
Incentives to climb the Incentives to climb the institutional laddersinstitutional ladders
To sum up: with the passing of timesTo sum up: with the passing of times Incentives to expandIncentives to expand: “Winning” local institutions become : “Winning” local institutions become
more attractivemore attractive and face and face less competitive pressureless competitive pressure Incentives to enhance efficiencyIncentives to enhance efficiency: initial : initial rules rules become become
more more completecomplete and and broader in scopebroader in scope
Reductions of both outside options and margins for Reductions of both outside options and margins for
negotiationsnegotiations
The individual benefits of membership increase and the The individual benefits of membership increase and the outside options decrease: Emerging institutions shift outside options decrease: Emerging institutions shift
from local to globalfrom local to global from negotiable to mandatoryfrom negotiable to mandatory
They become “frozen”They become “frozen”
Horizontal CompetitionHorizontal Competition
Competitive Decisions by “kernels”Competitive Decisions by “kernels” Improving EfficiencyImproving Efficiency
(Uniform Reduction of TCs) (Uniform Reduction of TCs) Switching Cost Manipulation Switching Cost Manipulation
(Rising acquisition costs) (Rising acquisition costs) Poaching of “Go-Betweens”Poaching of “Go-Betweens” Explicit MergerExplicit Merger
=>Kernel’s members drivers of =>Kernel’s members drivers of formalizationformalization
… … while Formalization make their while Formalization make their position contestableposition contestable
Main enabling ConditionNature of the Instit.
Informal
+ formal
Main Causal FactorStruct of Rel. Network
Distant
Intertwined
Vertical Competition as Vertical Competition as the Driver of Institutional the Driver of Institutional
Change and Efficiency Change and Efficiency GainsGains
Step 0
Step 1
Step 2
Step 3
Step 4
A cross section view
Vertical CompetitionVertical CompetitionAvailable Decisions by “kernels” of “Frozen” Available Decisions by “kernels” of “Frozen”
InstitutionsInstitutions
““External” Competition of External” Competition of Successful Local Successful Local
InstitutionsInstitutions
““Internal” Competition to Internal” Competition to take Control of the take Control of the Formal Levers of the Formal Levers of the
Generic InstitGeneric Instit1.1. Eradication/ConfinementEradication/Confinement
2.2. SubstitutionSubstitution
3.3. Recognition*Recognition*
1.1. Strengthening PowerStrengthening Power
2.2. Allowing negotiations and Allowing negotiations and CompromisesCompromises
1.1. Doomed to failureDoomed to failure
2.2. Cognitive boundariesCognitive boundaries
3.3. Increase internal competition Increase internal competition (while mutual recognition)(while mutual recognition)
Increasing amount of Increasing amount of resources dedicated to a zero-resources dedicated to a zero-sum political competition gamesum political competition game
*Driving Factors:
Generic Instit : Degree of Competition among (more) generic institutions; Heterogeneity, Pace of needed evolution
Local Instit: Degree of horizontal competition