2.

Institutions and
Organizations
Emerging Markets
Fall 2019
Jakob Arnoldi
Question
• Find an actual example where you as customer(s) was (were) not
entirely sure about whether you would get what you thought you had
purchased.

• How and by which means did you try to reduce that problem?
Institutions

Basic idea:
Human interactions - including transactions – are guided and
coordinated by social institutions - rules of the game.

Such rules are everywhere. Examples: Also competitions follow rules

Most social interaction guided
by institutions. Most actions
we as humans take are
institutionalized.
Traffic (traffic law);
Going to this class (conventions
about student behaviour/AU code
of conduct);
Playing a football match (Football
rules and unwritten rules
regarding sportsmanship).
Definitions of institutions
• Background conditions for economic activities that
through regularity and enforcement create ‘rules of
the game’, which in turn reduce uncertainty (e.g. by
creating trust/reducing information asymmetries) and
transaction costs.
• Humanly devised constraints that shape human
interaction (North, 1990).
• Institutions are composed of cultural-cognitive,
normative, and regulative elements that, together
with associated activities and resources, provide
stability and meaning to social life. (Scott, 200la: 48)
North, D. C. (1990). Institutions, Institutional Change and Economic Performance.
Cambridge: Cambridge University Press.
Scott, R. W. (2008). Institutions and Organizations. Los Angeles: Sage.
What is a market institution?
• Background conditions for economic activities that through regularity
and enforcement create ‘rules of the game’,
• Entities which reduce information asymmetries; uncertainty about
outcomes
• In many cases the basis on which market intermediaries operate – for
example accountants.
Spot the institution - Pollev.com/badm2
1 2

Marriage A school
Formal and informal

Codified and non-codified:

Institutions are perfectly analogous to the rules of the game in a competitive sport. That is,
they consist of formal written rules as well as typically unwritten codes of conduct that
underlie and supplement formal rules…the rules and informal codes are sometimes violated
and punishment is enacted. Therefore, an essential part of the functioning of institutions is
the costliness of ascertaining violations and the severity of punishments.
(North, 1990)
 Institutions… They do so in different Three main types:
• reduce uncertainty; • ways:
Through rules, constraints or 1. Regulative
• provide a structure to regularities of action – the
everyday life (by breach of which can be
supporting expectations); punished.
• create and enforce • Through legitimacy (in terms 2. Normative
regularity and of trustfulness and fairness)
accountability; and acceptability.
• define and limit the set of • Through taken for granted 3. Socio-cognitive
choices – support “modes of thinking” or
routines; cognitive frames which in turn
• reduce transactions support belief systems.
costs;
• enable cooperation.
Three pillars (Richard Scott, 2008, 51)
Regulative Normative Cultural-Cognitive
Basis of compliance Expedience Social obligation Taken for granted
shared
understanding
Basis of order Regulative rules Binding Constitutive
expectations Schema
Mechanisms Coercive Normative Mimetic
Logic Instrumentality Appropriateness Orthodoxy
Indicators Rules, laws, Certification, Common beliefs,
sanctions accreditation isomorphism
Affect Fear, guilt, Shame, horror Certainty/confusion
innocence
Basis of legitimacy Legally sanctioned Morally governed Comprehensible,
recognizeable,
culturally supported
Cooperation and coordination
• Institutions help cooperation and coordination by Different scenarios:
creating (mutual) expectations. 1. If repeat exercise,
• Example - Prisoners Dilemma: expectations are formed
base on actions in
• If A and B each betray the other, each of them serves 2 years
previous rounds.
in prison
2. If personal trust exists
• If A betrays B but B remains silent, A will be set free and B will between A and B
serve 3 years in prison (and vice versa) premise disappears.
• If A and B both remain silent, both of them will only serve 1
year in prison (on the lesser charge)

I am reluctant to send money to pay for something I only receive upon payment,
the seller is reluctant to send before having received money: Market platforms such
as Ebay helps solve such prisoner’s dilemmas.
What is a market institution?
• Background conditions for economic activities that through regularity
and enforcement create ‘rules of the game’.
• Generally formal institutions in that they are based on codified
information (and provide basis for further codification).
• Basis on which market intermediaries operate – for example financial
services, accounting firms, etc.
Example: used car market
A market with a high degree of
information asymmetry

How to minimize information asymmetry?

• Market Intermediaries (e.g. quality testers).
• Regulatory mechanisms (guarantee schemes, consumer rights).
• Buying from people one know and trusts.

What happens if none of the above are possible?

• Fewer transactions
• Lower prices in the market
Institutions and transactions costs
• Transactions costs: costs of gaining information, ensuring property
rights and otherwise reducing uncertainty due to potential
opportunistic behaviour.
• Opportunistic behaviour: Acting in self-interest, ”self-interest seeking with
guile” (Williamsson, 1975)
• Institutions reduce said costs.
• Transaction costs one part of overall production costs.
Institutions and organizations
• Institutions are rules
• Organizations are players
• Players strategize based on the (institutional) rules.
• Rules are formal or informal, law and norms, ways of seeing the world
(cognitive schemata).
• Organizations are parliaments, firms, schools, trade unions, sports
clubs, gangs…
Stability and change
• Institutions are relatively stable but not necessarily efficient.
• Institutions change incrementally due to actions by organizations (and
individuals).
• Informal institutions build on cultural norms.
• Given cultural differences, this over time leads to divergence across
countries.
Three basic propositions regarding EMs and
institutions:
• Emerging markets are characterized by absence or inefficiency of
markets institutions and market intermediaries. = institutional voids.
• In emerging markets, firms can compensate for inefficiencies in
market institutions by relying on informal institutions (the
substitution thesis). More on this tomorrow.
• Emerging markets exibit – partly due to emphasis on informal
institutions, partly due to developments path different from Western
societies – institutional orders different than from ‘the West.’
Property as example of…er…property rights
• How to assess quality of a house?
• Property as a bundle of rights – not all transferred from seller to
buyer at time of purchase
• Seller responsible for older defects also after sale - some rights also
conferred to insurance agency – yet other rights conferred to
municipality, insurance companies, etc.
Institutions can reduce transaction costs
• By making it less costly to acquire information.
• By making it less costly to maintain and enforce property rights.

Institutions can also enhance markets and create greater

specialization:
• Institutions make it possible to transact with strangers.
• Create standardized information that reduce information
asymmetries and contextual knowledge.
• Creates more efficient markets which enable households and
firms to specialize because they can purchase all other needed
goods and services.
A historical movement towards more
complex trade
1) small and geographically local barter; personalized exchange; repeat
dealing; cultural homogeneity: low transactions costs but high
transformation costs.
2) impersonal exchange (and greater geographical range); supported by
rituals, kinship, codes of conduct; based on rudimentary support of the
state (which however could be partial to one of the sides in the
transaction and highly unpredictable).
3) Impersonal exchange with third party enforcement.
However…
• Such an institutional arrangement still imperfect.
• Agents will try and re-personalize (clientisize) exchange relations,
• …and cheat, manipulate etc.
• All the old institutional elements are carried over.
• Still, no effective complex market possible in conditions of anarchy.
Quiz (instead of summation)
• What is the difference between formal and informal institutions?
• Can you provide examples of two informal and two formal
institutions?
• Are market intermediaries the same as institutions?
• Are institutional voids equivalent to lack of formal institutions.
• https://www.youtube.com/watch?v=NuC9R7omjJ4