Syllabus for INSTITUTIONAL ECONOMICS

Lecturer: Marina.I. Odintsova Class teacher: Marina I. Odintsova Course description Syllabus for INSTITUTIONAL ECONOMICS The course in Institutional Economics is taught to the fourth year undergraduate students and is designed to last one semester. The course is delivered in the form of lectures and seminars. A course in Institutional economics accomplishes a series of courses that constitute the basic training for economists. In this course students study the impact of institutions on the incentives of economic agents, and eventually on the wealth of society. The course also gives an economic explanation to institutions of the economy. Neoinstitutional economic theory states that institutions have an impact on the efficiency of resource allocation and on the welfare of all members of the society under the assumption of positive transaction costs. Institutional structure of the economy determines the incentives of the participants of economic activity, the range of their possibilities and the transaction costs they bear. The course in institutional economics introduces the main categories that describe the institutional structure of society and help to understand that institutions matter both in theory and in practice. Prerequisites Before studying institutional economics students should master not only the fundamentals of general economic theory but to have knowledge of historical courses and humanities as well. Students are supposed to be competent in basic economic analysis up to the level of the Introductory Microeconomics and Microeconomics-2 and be familiar with the basics of the game theory. Teaching Objectives to provide an overview of recent developments in the field of institutional economics; to introduce the basic concepts and techniques related to the subject; to show the students how the institutional structure of the economy determines the incentives of economic agents; to help the students to understand the role of institutional environment in economic theory and in business practice. Assessment The following forms of control are used to determine the final grade: 1

written home assignments (5); test (80 min), written exam (120 min) at the end of the fall semester Grade Determination The final grade is determined by average grade for home assignments (10%), test grade (20%), presentations (30%), written exam grade (40%). Main Reading Odintsova M.I. Institutional economics. Textbook. Moscow: Urait, 2014 (rus.) Additional Reading: Books 1. Eggertson Thr. Institutions and Economic Behavior. Cambridge, Cambridge University Press, 1990. 2. Furubotn E., Richter R. Institutions and Economic Theory. Ann Arbor. The University of Michigan Press. 1997. 3. Нart O. Firms, Contracts and Financial Structure. Oxford, Clarendon Press, 1995. 4. Milgrom P., Roberts J. Economics, Organization and Management. Prentice- Hall Int., 1992. 5. North D. Institutions, Institutional Change and Economic Performance. Cambridge University Press, 1990. 6. Williamson O. The Economic Institutions of Capitalism. The Free Press, N.Y. 1985 Papers On introduction to institutional economics 1. Alston, L. New Institutional Economics. /The New Palgrave Dictionary of Economics. 2nd Ed. Eds. Durlauf, S., Blume L. Palgrave Macmillan, 2008. 2. Ellickson, R. The Aim of Order without Law. //Journal of Institutional and Theoretical Economics, 1994, Vol. 150, pp. 97-100. 3. Posner, R. Social Norms and the Law: an Economic Approach. // The American Economic Review, Vol. 87, 1997, pp. 365-369. 4. Posner, R., Rasmusen, E. Creating and Enforcing Norms, with Special Reference to Sanctions. //International Review of Law and Economics, 1999, Vol. 19, pp. 369-382. 5. Young P. H. The Economics of Convention. // Journal of Economic Perspectives, 1996, Vol. 10, pp.105-122. 2

On transaction costs 1. Allen, D. Coasean Method: Lessons from the Farm.//Journal of Institutional Economics. 2015. Vol. 11. N. 1. P. 93-110. 2. Allen, D. Theoretical Difficulties with Transaction Costs Measurement.//Division of Labour and Transaction Costs. 2006. Vol.2. N.1. P. 1-14. 3. Allen, D. What Are Transaction Costs.// Research in Law and Economics. 1991. Vol. 14. P.1 18. 4. Barzel, Y. Measurement Cost and the Organization of Markets.// Journal of Law and Economics. 1982. Vol. 25. N. 1. P. 27-48. 5. Dixit A. Governance Institutions and Economic Activity.// American Economic Review. 2009. Vol.99. N. 1. P. 5-24. 6. Greif A., Milgrom P., Weingast B.R. Coordination, Commitment and Enforcement: The Case of the Merchant Guild.// Journal of Political Economy, 1994. Vol. 102. N. 4. P. 745-776. 7. Greif A. Cultural Beliefs and the Organization of Society: A Historical and Theoretical Reflection on Collectivist and Individualist Societies. //Journal of Political Economy, 1994. Vol. 102. N. 5. P. 912-950. 8. Кronman, A. Contract Law and the State of Nature. // Journal of Law, Economics and Organization, Vol. 1. N. 1. 1985. P. 5-32. 9. North D. Integrating Institutional Change and Technical Change in Economic History. A Transaction Cost Approach. // Journal of Institutional and Theoretical Economics. 1994. Vol.150. P. 609-624. On property rights theory 1. Alchian, A. Property rights./the New Palgrave Dictionary of Economics. 2nd Ed. Eds. Durlauf S, Blume, L.. Palgrave Macmillan, 2008. 2. Allen D. The Rhino s Horn: Incomplete Property Rights and the Optimal Value of an Asset.// Journal of Legal Studies. 2002. Vol.31. N.3. P. 339-358. 3. Demsetz, H. Toward the Theory of Property Rights.// American Economic Review. 1967. Vol. 57. P. 349-359. 4. Dahlman, C. The Problem of Externality. // Journal of Law and Economics. 1979. Vol. 22. P. 141-162. 5. Hardin, G. 1968. The Tragedy of the Commons.// Science. 1968. Vol. 162. P.1243 1248 6. Holderness, C. The Assignment of Rights, Entry Effects, and the Allocation of Resources.// Journal of Legal Studies. 1989. Vol.18. N. 2. P. 181-189. 7. Libecap, G. Common Property. /Newman P. The New Palgrave Dictionary of Economics and the Law. Vol. 1. P. 317-324. 8. Olson, M. Collective action. / The New Palgrave: A Dictionary of Economics. L., Macmillan. 1987. P. 474-477. 9. Tullock, G. The Origin Rent Seeking Concept.// International Journal of Business and Economics. 2003. Vol. 2. N. 1. P. 1-8. On contracts 3

1. Akerlof, G. The Market for Lemons: Quality Uncertainty and the Market Mechanism. //Quarterly Journal of Economics. 1970. Vol. 89. P. 488-500. 2. James, Jr.Н. The Trust Paradox: A Survey of Economic Inquiries into the Nature of Trust and Trustworthiness. // Journal of Economic Behavior and Organization. 2002. Vol. 47. P. 291-307. 3. Joskow, P. Contract Duration and Relationship-Specific Investments: Empirical Evidence from Coal Markets.// American Economic Review. 1987.Vol. 77. P.168-173. 4. Joskow, P. Vertical Integration./ Handbook of Institutional Economics. Ed. Shirley M., Menard R. Springer. 2005. P.435-464. 5. Klein P. The Make-or-Buy Decisions: Lessons from Empirical Studies. // Handbook of Institutional Economics/ Ed/. Shirley M., Menard R. Springer. 2005. P.435-464 6. Klein B., Crawford R., Alchian A. Vertical Integration, Appropriable Rents and the Competitive Contracting Process. //Journal of Law and Economics. 1978. Vol. 21. P. 297-326. 7. Menard, C. Inside The Black Box: The Variety of Hierarchical Forms. /Transaction Cost Economics and Beyond. ed. Groenewegen J. L., Kluwer Academic Publishers. P.149-170. 8. Miller, G. Solutions to Principal-Agent Problems in Firms./ Menar C., Shirley M. Handbook of New Institutional Economics. Springer. 2005. P. 349-370. 9. Shelanski, H., Klein, P. Empirical Research in Transaction Cost Economics: A Review and Assessment. //Journal of Law, Economics and Organization. 1995. Vol. 11. N. 2. P.335-361. 10. Williamson, O. Comparative Economic Organization: The Analysis of Discrete Structural Alternatives. //Administrative Science Quarterly. 1991. Vol. 36. N. 2, P.269-296. On institutional theories of the firm 1. Alchian, A., Demsetz, H. Production, Information Сosts and Economic Organization.// American Economic Review. 1972. Vol. 62. P. 777-795. 2. Coase, R. The Nature of the Firm. // Economica. 1937. Vol. 4. P. 386-405. 3. Fama E., Jensen M. Agency Problems and Residual Claims.// Journal of Law and Economics, 1983.Vol. 26, P. 327-349. 4. Hart, O. An Economist s Perspective on the Theory of the Firm.// Columbia Law Review, 1989, Vol.89. P. 1754-1774. 5. Schleifer, A., Vishny, A. Survey of Corporate Governance. // Journal of Finance, 1997, Vol. 52. P. 737. On economic theory of the state 1. McGuire, M., J Olson, M. The Economics of Autocracy and Majority Rule: The Invisible Hand and the Rule of Force. //Journal of Economic Literature. 1996. Vol. 34 March. P.72-96. 2. North, D. Government and the Cost of Exchange in History. // The Journal of Economic History. Vol. 44. No. 2. 1984. P. 255-264. 4

On institutional change 1. Bromley, D. Institutional Change and Economic Efficiency. // Journal of Economic Issues. Vol. 23. No. 3. September 1989. 2. David, P. Clio and the Economics of QWERTY. // American Economic Review.1985. Vol 75. P. 332-337. 3. Liebowitz, S., Margolis, S. Path Dependence, Lock-in, and History.// Journal of Law, Economics and Organization. 1995. Vol.11. N. 1. P. 205-226 4. Roe, M. Chaos and Evolution in Law and Economics. //Harvard Law Review, 1996. Vol. 109. P. 641-658. Internet resources Current course materials are posted in the ICEF information system http://icef-info.hse.ru Encyclopedia of Law and Economics. http://allserv.rug.ac.be./~gdegeest/ Institutional Society for New Institutional Economics ISNIE http://www.isnie.org Libertarium Library http://www.libertarium.ru/library Course outline 1.Introduction to institutional economics The concept of an institution: attempts at definition. Institutions and organizations. Functions of social institutions. Interaction situations and the types of norms: prisoners dilemma-type situation; coordination situation; inequality situation. Enforcement characteristics. Institutional structure of the society. Formal and informal institutions. Sanctions for disobeying norms (self-enforcing sanctions, guilt, shame, informational sanctions, bilateral costly sanctions, multilateral costly sanctions). Conditions of norms effectiveness. Interaction of formal and informal institutions. The limits of imitations of institutions from best-performing countries. The problems of their enforceability. The new institutional economics and modern institutionalism. Old institutionalism. (O Ch.1; E Ch1; N Chs 5,6,7; F&R Ch. 1) 2. Transaction costs The concept of transaction. Market and intrafirm transactions. Transaction costs as friction in the economy. Two main theoretical approaches to transaction costs. Transaction costs and transformation costs. Interdependency between transaction costs and transformation costs. Types of market transaction costs and means of transaction costs minimization. Search and information costs. Measurement costs. Seach goods, experience goods and credence goods. Excessive measurement. Productive and distributive information. Business practices as means of economizing on measurement costs (warranties, share contracts, brand name). Overseaching and suppression of information - pig in a poke. 5

Bargaining costs. Cooperative surplus and different ways to divide it. Hobbes bargaining as a social dilemma. Battle of sexes, Stackelberg strategy and reputation of the leader. Credible threats. Bargaining costs and types of contracts. Supervision and contract enforcement costs. State of the nature, trust game and contract enforcement. Hostage, collateral, self-enforcing agreement and emotional union as private means of bilateral contract enforcement. Reputation as a contract enforcement device. Bilateral and multilateral reputation. Shortcomings of the reputation as a contract enforcement mechanism. Reputation, information and the free rider problem. Reputational mechanism supported by organisations. Comparative advantages and shortcomings of the legal enforcement mechanism. Contract enforcement mechanisms as second-best solutions. Transaction costs of protection against the encroachment of third parties. Transaction costs, the main types of economic exchange and their supporting institutional structures. Coexistence of the main types of economic exchange in the modern society. Transaction cost measurement. Transaction costs in the Russian economy. (O Ch 2; E Ch 7; N Ch 8; M&R Chs 2,5,8; F&R Ch 2; W Ch 2) 3. Property rights theory The definition of property rights. Property rights in different legal traditions (common law and civil law traditions). The property rights approach: some basic concepts. Specification of property rights, the bundle of rights, partitioning of property rights, attenuation of property rights. Assigning property rights: the internalization of externalities. The Coase Theorem. Critic of Coase (dynamic effects of alternative legal rules, wealth effect, distributional effects, strategic behavior and the problem of holding-out, endowment effect, sociological critic, unrealistic assumption about zero transaction costs) Alternative property rights regimes. Common property (open access) and the tragedy of the commons. Exclusive property rights and the conditions for their emergence. Trasaction costs of property rights specification. Communal property. Optimal group size. The First economic revolution. Private property. Public property. The emergence of property rights. The optimistic theory of the emergence of property rights (naive model). The interest-group theory of property rights. The costs of collective action. The theory of rent-seeking. (O ch 3; E Chs 2,4,8,9; F&R Ch 3; M&R Ch 9) 4. Contracts The definition of a contract. Legal and economic approach to contracts. Bounded rationality and contractual incompleteness. Asymmetric information (hidden characteristics, hidden information/ hidden action, hidden intentions) and opportunistic behavior. Adverse selection and the closing of markets. Signalling, screening and self-selection. Asset plasticity and moral hazard. Principal-agent problem and agency costs. Controlling and preventing moral hazard (controlling the agent, incentive contracts, 6

bonding, do-it-yourself). Case study: crisis of the savings and loan associations in America as an example of moral hazard in financial markets. Attributes of transactions and the choice of a contract. Asset specificity, types of specific assets. Synergy effects, quasi-rents appropriation and hold-up problem. Classification of contracts (classical, neoclassical and relational contracting). Discrete alternative governance structures: market, hybrids and hierarchy. Hybrids: specific assets and their safeguards. Institutional environment and the role it plays in the choice of contract. The role of trust. Economic approach to trust. Types of trust ( contractual trust, competence trust and goodwill trust). Explaining the internal structure of formal organizations: transaction costs approach. (O Ch 4; E Ch 6; M&R Chs 5,6,8,9,16; F&R Ch 4; W Chs 1,2,3) 5. Institutional theories of the firm Neoclassical theory of the firm. Explanations of the firm in the new institutional theory (F.Knight, R. Coase, Simon H., A. Alchian and H. Demsetz, O.Williamson, O.Hart). The market and the firm. Comparative analyses of the alternative coordination forms. Internal market and influence costs. The boundaries of the firm. Ownership structure of the firm. A theory of the owner-monitor (Alchian and Demsetz, 1972). Competing forms of economic organization, relative advantages of alternative structures (proprietorships, partnerships, open corporation, regulated firms, public enterprises, nonprofit organizations, labor-managed firms). Separation of ownership and control in the open corporation. Opportunistic behavior of managers and corporate control. Outsider and insider corporate governance. Privatization in Russia and other transition economies and corporate governance. (О, Ch.5; E Chs. 5,6; М&R Chs 9,15,16; F&R Ch. 8; Hart, Chs 1-4) 6. Economic theory of the state Social mechanisms for constraining open access. Contractual theories of the state (Locke, Rousseau), Hobbes predatory theory of the state. North s model of the state. The regulatory role of the state in the Russian economy. (О Ch. 6; E. Ch.10) 7. Institutional Change Stability of institutions and institutional change. The concept of institutional equilibrium. The main sources of institutional change. Centralized and spontaneous institutional change. The role of the state in the process of institutional change. The problem of the compensation of disadvantaged groups. Selection of efficient institutions in the process of competition ( Alchian, Friedman). Institutional change and path dependence. Forms of path-dependence (weak form, semistrong and strong forms). (О Ch 7; N. Chs 9-14) 7

Distribution of hours by topics and types of work Topic Total hours 1. Introduction to institutional economics Lectures Seminars Self-study 14 4 2 6 2. Transaction costs 24 6 6 16 3. Property rights theory 28 6 6 16 4. Contracts 26 6 6 14 5. Institutional theories of the 20 4 6 10 firm 6. Economic theory of the state 8 2 2 4 7. Institutional change 8 2 2 4 Total: 128 30 30 68 8