Seminar Ideologi Prof. Wihana Kirana Jaya
NEW INSTITUTIONAL ECONOMICS FOR PUBLIC POLICY:
AN OVERVIEW
PROF WIHANA KIRANA JAYA
FACULTY OF ECONOMICS AND BUSINESS
UNIVERSITAS GADJAH MADA
INSTITUTIONS
Institutions are the humanly devised constraints that structure political, economical
and social interaction.
They consists of both informal constraints (idioelogy, sanctions, taboos, customs,
traditions, and codes of conduct), and formal rules (constitutions, laws, property
rights)
Throughout history, institutions have been devised by human beings to create order
and reduce uncertainty in exchange“ (North 1991, p. 97)
NEW INSTITUTIONAL ECONOMICS
New Institutional Economics
incorporates a theory of
institutions - laws, rules, customs,
and norms - into economics. It
builds on, modifies, and
extends neoclassical theory.
allocation of scarce
resources among
alternative uses
Neoclassical
Economics
New Institutional Economics objects to the
notion that the "laws" constructed by
Neoclassical economists were timeless
generalizations and contended instead that
the economic behavior of men, like any
other human activity, had to be analyzed in
terms of the social context in which it was
imbedded.
New
Institutional
Economics
how the institutional structure
evolved and how institutions
reflected the prevailing
social/political/economic
structure
THEORETICAL BUILDING BLOCKS
Principal-Agent Theory
Formal-Informal Institutions Theory
Transaction Cost Theory
Property Right Theory
Social Capital Theory
THE INDIVIDUAL AND THE INSTITUTIONAL STRUCTURE
Source: Vatn (2005)
TYPES OF INSTITUTIONS
Rules
Enforcement mechanism Example
1. Convention
Self enforcement
Language
2. Ethics
Imperative self binding
Being a veterinatian
3. Norms
Social enforcement
Social codes of conduct
4. Formal private rules
Organized private
enforcement
Self imposed rules inside
organisations
5. Law
Organized state
enforcement
Business Law
Source: Ellickson, 1991
ECONOMIC ANALYSIS OF INSTITUTIONS
Institutions
Formal and informal rules at different levels
Emergence, causes, effects, evolution
Economic Analysis
Methodological Individualism
Utility maximization (benefits and costs)
Incomplete and costly information
Bounded rationality
Opportunism
Transaction costs
BOUNDED RATIONALITY AND OPPORTUNISM
Bounded Rationality
Incomplete information
Incomplete processing of information
All complex institutions are incomplete
Opportunism
Taking advantage of information asymmetries
Following self interest with the help of guile (lying, cheating)
Institutions need to be safeguarded against opportunistic behavior
FOUNDATIONS OF NIE
Ronald Coase (Law and Economics)
1937 – The Nature of the Firm
1960 – The Problem of Social Costs
1974 – The Lighthouse in Economics
Douglass North (Economic History)
1973 – The Rise of the Western World
1981 – Structure and Change in Economic History
1992 – Institutional Change and Economic Performance
Oliver E. Williamson (Economics and Organization)
1975 – Markets and Hierarchies
1985 – Economic Institutions of Capitalism
1996 – Mechanism of Governance
ANALYTICAL LEVELS OF NIE
LEVEL
L1
L2
L3
L4
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures
with Transactions
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
FREQUENCY
(YEARS)
PURPOSE
often noncalculative,
spontaneous
Social Theory
10² to 10³
10 to 10²
get the Institutional
Environment right, 1st
order economizing
Economics of
Property Rights,
Positive Political
Economy
1 to 10
continuous
get the Governance
structure right, 2nd order
economizing
get the marginal conditions
right, 3rd order
economizing
Source: Williamson (1998)
THEORY
Transaction Cost
Economics
Neoclassical
Economics/Agency
Theory
BRANCHES OF NIE
Transaction Cost Economics (Coase, Williamson, North)
Property Rights Theory (Alchian, Demsetz, Furubotn, Bromley, Barzel)
Contract Theory
Principal Agent Theory (Stiglitz, Tirole)
Incomplete Contract Theory (Hart, Moore)
New Economic History
New Political Economy
QUESTIONS ADDRESSED BY NIE
Effects of institutions, e.g. property rights, on
Resource allocation
Income distribution
Incentives (efforts, investments, innovation)
Transaction costs
Choice and change (evolution) of institutions
Designed or spontaneous development?
Efficiency or distribution oriented
Reduction of transaction costs
RESEARCH QUESTIONS FOR UU SJSN DAN JKN ???
EFFECTS
L1
L2
L3
L4
Source: Alston 1996 and Williamson 2000)
CAUSES
PROCESSES
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures with
Transactions
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures with
Transactions
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures with
Transactions
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
Econometrics/Experiments
Econometrics/Case studies
Case studies/Historical narratives
DATA CONSTRAINTS
MEASURMENT
L1
L2
VARIANCE
Simple discrete to complex
often intangible
(e.g. religion, belief system)
Small to medium
(e.g.. 12 main
religions, 6.800 main
languages)
Simple discrete to very complex
(e.g. parliamentary vs.
presidential system,
proposal for EU constitution)
Small to medium
(e.g. 5 legal origins,
192 states, 2005)
L3
Simple discrete to complex:
(e.g. make or buy, complex
contracting, modern corporations)
Large
(e.g. 2 915 482 firms
in Germany, 2003)
L4
Simple continuous
(e.g. compensation rules, prices
and quantities)
Large to very large
(e.g. annual GDP,
daily prices and
quantities at the stock
market)
DATA
SOURCES
Poorly developed
Some official statistics
International surveys
Less developed
Historical records
Documents
Official statistics
International Surveys
Developed
Official statistics
Accounting
Well developed
Official statistics
Accounting
GETTING PUBLIC POLICY EXAMPLE:
TAX AMNESTY INTO NIE PERSPECTIVE
The Four Levels of Institutional Analysis
These rules, norms and customs take a long time to change and are generally
found to have a strong underpinning in the religion, culture, and tradition of
society sense of belonging towards nation through tax payment
It deals with the lack of well-defined and secure property rights
property right conflict over tax amnesty
This level is concerned with the contractual relations (contract
laws and enforcement) transaction cost of tax amnesty
It emphasizes the nature of individual incentives to participate
in different levels of decisions making and activities and to
comply with rules incentive to participate in tax amnesty
CONT’D
Transaction Cost
Andreoni (1991): the possibility of a tax
amnesty actually decreasing, rather than
increasing, the efficiency and equity of the tax
system.
Contract
Stella (1991): if taxpayers are in expectation for
an amnesty, this situation may risk tax
compliance in the long term and also it may
cause negative outcomes on honest taxpayers’
perceptions about justice.
Property Right
As the probability of an amnesty rises, and thus
the future opportunity to declare any
dishonesty free of penalty, people report less
income.
CONT’D
CRITICAL ASPECT
Distributive
Justice
Social
Contract
FRAMEWORK OF ANALYSIS
Incentive Compatible
Contract
Costly State
Verification
Incentive to Comply
CONT’D
On Distributive Justice …
Distributive justice is concerned with
the fair allocation of resources among
diverse members of a community.
The distribution of economic benefits
and burdens could be affected by
government.
John Rawls
A Theory of Justice
(1971)
Governments continuously make
and change laws and policies
affecting the distribution of
economic benefits and burdens in
their societies.
Tax as a means of resource reallocation in society.
Is it justified to forgive the non-compliance party
over the taxpayer?
CONT’D
On Social Contract …
Social contract occurred
when men would transfer
some or all of their rights
to the government in
order to ensure a
comfortable living.
Man is born free, but he is
everywhere in chains.
Jean-Jacques Rousseau
Du contrat social ou
Principes du droit politique
(1750)
While each individual has a
particular will that aims for his
own best interest, the
sovereign expresses the
general will that aims for the
common good.
John Locke
Second Treatise of Government (1689)
Tax compliance serves as
a route for state-society relations.
CONT’D
Taxpayers are encountered with
various factors that cause tax
incompliance:
Educational level
Age intervals
Income level
Religious perspective
What affects tax paying culture?
appropriate conditions for tax evasion and tax
avoidance
existence of policies designed with short-term
approaches
regulations for satisfying some certain groups
belief that tax systems are unfair and unequal,
psychological factors
inadequacy of inspection and audits by tax authorities,
immature moral obligation
inefficiency of coercion and deterrence mechanisms
the lack of state legitimacy
THANK YOU
AN OVERVIEW
PROF WIHANA KIRANA JAYA
FACULTY OF ECONOMICS AND BUSINESS
UNIVERSITAS GADJAH MADA
INSTITUTIONS
Institutions are the humanly devised constraints that structure political, economical
and social interaction.
They consists of both informal constraints (idioelogy, sanctions, taboos, customs,
traditions, and codes of conduct), and formal rules (constitutions, laws, property
rights)
Throughout history, institutions have been devised by human beings to create order
and reduce uncertainty in exchange“ (North 1991, p. 97)
NEW INSTITUTIONAL ECONOMICS
New Institutional Economics
incorporates a theory of
institutions - laws, rules, customs,
and norms - into economics. It
builds on, modifies, and
extends neoclassical theory.
allocation of scarce
resources among
alternative uses
Neoclassical
Economics
New Institutional Economics objects to the
notion that the "laws" constructed by
Neoclassical economists were timeless
generalizations and contended instead that
the economic behavior of men, like any
other human activity, had to be analyzed in
terms of the social context in which it was
imbedded.
New
Institutional
Economics
how the institutional structure
evolved and how institutions
reflected the prevailing
social/political/economic
structure
THEORETICAL BUILDING BLOCKS
Principal-Agent Theory
Formal-Informal Institutions Theory
Transaction Cost Theory
Property Right Theory
Social Capital Theory
THE INDIVIDUAL AND THE INSTITUTIONAL STRUCTURE
Source: Vatn (2005)
TYPES OF INSTITUTIONS
Rules
Enforcement mechanism Example
1. Convention
Self enforcement
Language
2. Ethics
Imperative self binding
Being a veterinatian
3. Norms
Social enforcement
Social codes of conduct
4. Formal private rules
Organized private
enforcement
Self imposed rules inside
organisations
5. Law
Organized state
enforcement
Business Law
Source: Ellickson, 1991
ECONOMIC ANALYSIS OF INSTITUTIONS
Institutions
Formal and informal rules at different levels
Emergence, causes, effects, evolution
Economic Analysis
Methodological Individualism
Utility maximization (benefits and costs)
Incomplete and costly information
Bounded rationality
Opportunism
Transaction costs
BOUNDED RATIONALITY AND OPPORTUNISM
Bounded Rationality
Incomplete information
Incomplete processing of information
All complex institutions are incomplete
Opportunism
Taking advantage of information asymmetries
Following self interest with the help of guile (lying, cheating)
Institutions need to be safeguarded against opportunistic behavior
FOUNDATIONS OF NIE
Ronald Coase (Law and Economics)
1937 – The Nature of the Firm
1960 – The Problem of Social Costs
1974 – The Lighthouse in Economics
Douglass North (Economic History)
1973 – The Rise of the Western World
1981 – Structure and Change in Economic History
1992 – Institutional Change and Economic Performance
Oliver E. Williamson (Economics and Organization)
1975 – Markets and Hierarchies
1985 – Economic Institutions of Capitalism
1996 – Mechanism of Governance
ANALYTICAL LEVELS OF NIE
LEVEL
L1
L2
L3
L4
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures
with Transactions
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
FREQUENCY
(YEARS)
PURPOSE
often noncalculative,
spontaneous
Social Theory
10² to 10³
10 to 10²
get the Institutional
Environment right, 1st
order economizing
Economics of
Property Rights,
Positive Political
Economy
1 to 10
continuous
get the Governance
structure right, 2nd order
economizing
get the marginal conditions
right, 3rd order
economizing
Source: Williamson (1998)
THEORY
Transaction Cost
Economics
Neoclassical
Economics/Agency
Theory
BRANCHES OF NIE
Transaction Cost Economics (Coase, Williamson, North)
Property Rights Theory (Alchian, Demsetz, Furubotn, Bromley, Barzel)
Contract Theory
Principal Agent Theory (Stiglitz, Tirole)
Incomplete Contract Theory (Hart, Moore)
New Economic History
New Political Economy
QUESTIONS ADDRESSED BY NIE
Effects of institutions, e.g. property rights, on
Resource allocation
Income distribution
Incentives (efforts, investments, innovation)
Transaction costs
Choice and change (evolution) of institutions
Designed or spontaneous development?
Efficiency or distribution oriented
Reduction of transaction costs
RESEARCH QUESTIONS FOR UU SJSN DAN JKN ???
EFFECTS
L1
L2
L3
L4
Source: Alston 1996 and Williamson 2000)
CAUSES
PROCESSES
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Embeddedness:
Informal Institutions, Customs,
Tradition,Norms,
Religion
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Institutional Environment:
Formal Rules of the Game – esp.
Property (Polity, Judiciary,
Bureaucracy)
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures with
Transactions
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures with
Transactions
Governance:
Play of the Game – esp. Contract
(aligning Governance Structures with
Transactions
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
Resource
Allocation and Employment
(Prices and Quantities, Incentive
Alignment)
Econometrics/Experiments
Econometrics/Case studies
Case studies/Historical narratives
DATA CONSTRAINTS
MEASURMENT
L1
L2
VARIANCE
Simple discrete to complex
often intangible
(e.g. religion, belief system)
Small to medium
(e.g.. 12 main
religions, 6.800 main
languages)
Simple discrete to very complex
(e.g. parliamentary vs.
presidential system,
proposal for EU constitution)
Small to medium
(e.g. 5 legal origins,
192 states, 2005)
L3
Simple discrete to complex:
(e.g. make or buy, complex
contracting, modern corporations)
Large
(e.g. 2 915 482 firms
in Germany, 2003)
L4
Simple continuous
(e.g. compensation rules, prices
and quantities)
Large to very large
(e.g. annual GDP,
daily prices and
quantities at the stock
market)
DATA
SOURCES
Poorly developed
Some official statistics
International surveys
Less developed
Historical records
Documents
Official statistics
International Surveys
Developed
Official statistics
Accounting
Well developed
Official statistics
Accounting
GETTING PUBLIC POLICY EXAMPLE:
TAX AMNESTY INTO NIE PERSPECTIVE
The Four Levels of Institutional Analysis
These rules, norms and customs take a long time to change and are generally
found to have a strong underpinning in the religion, culture, and tradition of
society sense of belonging towards nation through tax payment
It deals with the lack of well-defined and secure property rights
property right conflict over tax amnesty
This level is concerned with the contractual relations (contract
laws and enforcement) transaction cost of tax amnesty
It emphasizes the nature of individual incentives to participate
in different levels of decisions making and activities and to
comply with rules incentive to participate in tax amnesty
CONT’D
Transaction Cost
Andreoni (1991): the possibility of a tax
amnesty actually decreasing, rather than
increasing, the efficiency and equity of the tax
system.
Contract
Stella (1991): if taxpayers are in expectation for
an amnesty, this situation may risk tax
compliance in the long term and also it may
cause negative outcomes on honest taxpayers’
perceptions about justice.
Property Right
As the probability of an amnesty rises, and thus
the future opportunity to declare any
dishonesty free of penalty, people report less
income.
CONT’D
CRITICAL ASPECT
Distributive
Justice
Social
Contract
FRAMEWORK OF ANALYSIS
Incentive Compatible
Contract
Costly State
Verification
Incentive to Comply
CONT’D
On Distributive Justice …
Distributive justice is concerned with
the fair allocation of resources among
diverse members of a community.
The distribution of economic benefits
and burdens could be affected by
government.
John Rawls
A Theory of Justice
(1971)
Governments continuously make
and change laws and policies
affecting the distribution of
economic benefits and burdens in
their societies.
Tax as a means of resource reallocation in society.
Is it justified to forgive the non-compliance party
over the taxpayer?
CONT’D
On Social Contract …
Social contract occurred
when men would transfer
some or all of their rights
to the government in
order to ensure a
comfortable living.
Man is born free, but he is
everywhere in chains.
Jean-Jacques Rousseau
Du contrat social ou
Principes du droit politique
(1750)
While each individual has a
particular will that aims for his
own best interest, the
sovereign expresses the
general will that aims for the
common good.
John Locke
Second Treatise of Government (1689)
Tax compliance serves as
a route for state-society relations.
CONT’D
Taxpayers are encountered with
various factors that cause tax
incompliance:
Educational level
Age intervals
Income level
Religious perspective
What affects tax paying culture?
appropriate conditions for tax evasion and tax
avoidance
existence of policies designed with short-term
approaches
regulations for satisfying some certain groups
belief that tax systems are unfair and unequal,
psychological factors
inadequacy of inspection and audits by tax authorities,
immature moral obligation
inefficiency of coercion and deterrence mechanisms
the lack of state legitimacy
THANK YOU