Agrarian Institutions Analysis Session 13

1. Agrarian Institutions AnalysisSession 13 Dr. Michael Sykuta University of Missouri-Columbia Department of Agricultural Economics Director, Contracting and Organizations Research Institute 135 Mumford Hall, Columbia, MO 65211-6200 USA Phone: +1-573-882-1738, Fax: +1-573-882-3958 www.cori.missouri.edu sykutam@missouri.edu

2. Review of Basic Concepts • What is New Institutional Economics? • Simply relaxes certain neoclassical assumptions: • Transaction costs are positive • Information is not perfect • Decision makers are “boundedly rational” • “Institutions Matter” • It is necessary to understand the “rules of the game” by which individuals trade in order to understand how they choose to trade.

3. Review of Basic Concepts • What are transaction costs? • The costs of engaging in an exchange transaction: • Search costs • Negotiation costs • Contracting costs • Monitoring costs • Enforcement costs • Note, most all have to do with information costs of some sort.

4. Review of Basic Concepts • What is a transaction? • A (voluntary) reallocation of property rights. • Remember: transactions are not about exchanging goods and services per se, but about exchanging property rights to the valuable attributes embodied in those items. • You need to identify the attributes that are the source of value!

5. Review of Basic Concepts • What are “property rights”? • The right to: • Use the asset (usus) • Appropriate returns/benefits from the asset (usus fructus) • Change its form, substance, location (abusus) • A single “asset” may have multiple dimensions of property rights • Property rights may be partitioned and exchanged in part, or in whole.

6. Review of Basic Concepts • Private property rights • Include ability to exclude others from using asset • May be attenuated by institutional constraints • For property rights to have value: • Must be well-defined • Must be enforced

7. Review of Basic Concepts • Adam Smith: Specialization of labor is an essential element for individual and social wealth creation. • Specialization necessitates exchange. • Exchange requires clearly defined and enforceable property rights. • Exchange also requires sufficiently low costs of exchange (transaction costs).

8. Review of Basic Concepts • “Law of Demand” tells us:When price of exchange falls, the amount of exchange “consumed” increases. • Therefore, we want to identify ways to reduce transaction costs to increase ability to specialize and to increase welfare.

9. Review of Basic Concepts • What are Institutions? • The formal and informal rules of behavior that govern interpersonal relationships • “Formal” or explicit institutions are laws, regulations, etc. • “Informal” rules are those social norms, traditions, and cultural rules

10. Review of Basic Concepts • Institutions • Define property rights • Define rules of exchange • Define incentives and constraints for individual decision makers • Conclusion: Institutions affect transaction costs.

11. Review of Basic Concepts • Institutional and organizational analysis is necessarily comparative: • We must compare feasible alternatives to determine the optimal solution. • We first assume that observed differences in organization/governance reflect differences in institutional environments.

12. The Problem of Social CostRonald Coase, 1960 • Three Primary Contributions • Reconsidering the nature of “externalities” • Stigler’s “Coase Theorem” • Coase’s “Coase Theorem”

13. The Problem of Social CostRonald Coase, 1960 • Reconsidering the nature of “externalities” • The concept of reciprocal harm:An externality cannot be created by one party alone…it takes two for a harm to exist. • If it takes two to create a harm, policies that assign liability to only one party may be economically inefficient.

14. The Problem of Social CostRonald Coase, 1960 • Four possible solutions to “externality” problems: • Market transactions • Integration (incorporate within the firm) • Government intervention • Do nothing. • Which creates the highest NET benefit?

15. The Problem of Social CostRonald Coase, 1960 • Stigler’s “Coase Theorem” • When transaction costs are zero, the initial property right allocation is irrelevant,Or phrased another way • When transaction costs are zero, an efficient allocation will result regardless of the initial allocation.

16. The Problem of Social CostRonald Coase, 1960 • Coase’s “Coase Theorem” • Because transaction costs are not zero, the initial allocation of property rights does matter; • Some welfare enhancing transactions may not occur because the cost is too high; • We need to pay attention to property right allocations and to lower transaction costs.