CHAPTER TWO

INSTITUTIONS FOR
RURAL DEVELOPMENT
• Economic growth :cannot be achieved by capital
accumulation alone, even if capital embraces
both tangible and intangible capital. In order to
exploit complementarities between tangible
(physical, natural and financial) and intangible
capital (R&D and education) for maximizing
economic growth, designing appropriate
institutions is very important.
• In this chapter we will discuss the nature of
institutions in general and explain some of the
most important rural institutions
Institutions: are rules that facilitate coordination
among people by helping them form expectations for
dealing with each other. They reflect the conventions that
have evolved in different societies regarding the behavior
of individuals and groups.
• In the area of economic relations they have a crucial
role establishing expectations about the rights to use
resources in economic activities and about the
partitioning or distribution of the income streams
resulting from economic activities.
• Institutions define the structure of the relations.
 Definition and Concepts of Institution
• Agricultural production variation can be explain in terms of
 Variation in type of institution like variation in the type of
property right regime
 Conventional variable like technology and quality of productive
resource
So, Institution is very much for rural development
• It is a system of rules, beliefs, norms and organizations that
generate a regularity of (social) behavior together.
• It is a set of formal (laws, contracts, constitutions, political
systems, organizations, property rights, market, etc) and informal
rules of conduct (sanctions, taboos, customs, traditions, codes of
conduct , social norm of behaviour, habits, routines, values,
aspirations) that facilitates coordination between individuals or
groups.
 Definition and Concepts of Institution….
• Many institutions have been created by the more
powerful members of a society to regularize and
entrench mutually beneficial relationships.
• Thus institutions do not necessarily serve the needs and
interests of all, only of enough influential persons to be
maintained.
• Poor women and men are often peripheral to or even
excluded from societal institutions
• Institutions are found all along a continuum of scale, from the micro or local
level to the macro or national and international levels.
 Definition and Concepts of Institution….

• It is always important to remember that

informal institutions are as important as formal
institutions. This is so, given the fact that
“rules that contradict the moral of the people
would not be sanctioned socially and, if
stipulated formally, would not function
effectively” (Haymai, 1997).
Cnt,d

• Some institutions have organizational form,

such as banks,
• others are more diffuse patterns of norms and
behavior about which there is some social
consensus, for example the expectation of trust
or dishonesty in particular social interactions.
• Institutions that have organizational form are
broadly divided into state and civil society
institutions.
 State Institutions
• Formal institutions that are state-affiliated or state-
sponsored.
• They include national, regional, and local governments;
the judiciary; and police.
• They are vested with the power and authority of the state
• Legal sanction and state control give these institutions
authority and power not necessarily related to their actual
performance.
• Strong and legitimate state fosters institutions that work
to equalize existing social and economic inequalities by
extending assistance and opportunities to those citizens
possessing fewer resources and less power.
 Civil Society Institutions
• Institutions that are not state-affiliated and exist
between the household and the state.

• They include NGOs, trade unions; social

associations; kinship networks; and the like.
• They deriving their authority from legal recognition
• Connect people in collective efforts and keep states
accountable both at the macro and micro levels.
• Points of access to social, material, and natural
resources when states are weak or illegitimate by
particular social groups
 Organization
• It is a systematic arrangement or structure of roles, or group of
individuals bound by some common purpose to achieve
objective.
• Many institutions are organization, or vice versa, and other
institutions are not organizations.
• Institutions that are not organizations: law, marriage, land
tenure, higher education, technical assistance, etc
• Institutions that are organization, and vice versa: central bank,
the supreme court, Ethiopian Standard and Quality Assurance
Authority, the land registrar’s office, the World Bank, etc
• Organizations that are not institutions: local bank, a particular
family, tutorial service, consulting firm, etc
 Market as Institution and Rural Development

• Market: is an institution b/n the producer and the consumer.

There fore market can have negative or positive effect on both
production and consumption.
• Marketing institutions:
• associations of farmers, traders, and others in the value chain
• cooperatives and government marketing agencies.
• Commodity associations
• interest groups related to a particular commodity
• Such associations can draw membership from:
 individual farmers or their associations,
 crop buyers, processors, distributors and exporters
 suppliers of support services.
 Sometimes government agencies are also members.
Con,d

• Market traders associations

• Associations of agricultural traders
• paid attention to post-harvest handling
improvement
• Traders provide training to farmers to improve
their linkage
 Market Failure
• It is a situation in which the allocation of goods and
services is not efficient.
• It is imperfections in the exchange process between
buyers and sellers that prevent markets from
efficiently allocating scarce resources.
• Often associated with
 time-inconsistent preferences,
 information asymmetries
 non-competitive markets
 principal–agent problems
Market fails to be perfect because of unrealistic
assumption, discrimination and equity efficiency issue
 Traditional Market Failures
1. Public Goods:
• goods that can be consumed by a large number of people
without imposing opportunity cost on others,
• Termed as non-rival consumption.
• non-payers cannot be excluded from consumption (gives
free-rider problem)
• Common examples of public goods include:
• national defense, national security, official statistics
• public health, environmental quality, air, street lighting
• In each case consumption by one does not impose an
opportunity cost on others
• And in each case, markets fail to efficiently allocate the
production, consumption, or provision.
 Near-public goods
• non-rival in consumption like public goods
• but non-payers can be excluded.
• Non-rival consumption means efficiency is achieved
if near-public goods are provided at a zero price,
which markets don't do.
• E.g education, transportation, communication

• Common-property goods
• non-payers cannot be excluded from consumption
like public goods
• rival in consumption.
• E.g fish stocks,
 Characteristics of Public goods

• Non-excludable:
• it is impossible to exclude other individuals from
deriving a benefit.
• E.g street lighting, all passers-by can benefit

• Non-diminishable non-rivalry:
• When consumption of goods by one individual, the
stock available for others does not diminish,. E.g
street lighting,
• the stock of a public good does not diminish with use,
consumers do not need to compete with each other to
get access to them.
• For example, individuals do not need to queue to get
access to street lighting.
 Characteristics of Public goods…

• Non-rejectable:

• Unlike a private good, consumers cannot reject a pure

public good, and are forced to consume it.

• An individual cannot reject being defended by the

armed forces of a country, nor can they reject the

benefit of street lighting.

 2. Externalities
• Externality exists if a benefit is not included in the
demand price or a cost is not included in the supply
price.
• This means that the demand price does not reflect the
complete value of the good produced or the supply
price does not reflect the complete value of goods not
produced.

• As such, market equilibrium does not achieve an

efficient allocation.
• A noted externality example is pollution.
• The emission of residuals in the production or
consumption of goods impose opportunity costs on
others not involved the market exchange.
 2. Externalities….
• In this case the supply price in the market does not
include all opportunity costs of production, the
omitted costs are those imposed on others harmed by
the pollution.
• On the benefit side, education provides an example of
an externality.
• The benefits of education extend beyond those
receiving the education and thus beyond the market
exchange.

• In this case the demand price in the market does not

include the full value of the good production, the
omitted value is that received by others benefitting
from the education
 3. Competition/ Market Control/
• The market must be competitive.

• Competition among buyers and sellers is what creates

equality between demand price and supply price.

• Market control arises when buyers or sellers are able

to exert influence over the price of a goods.

• The ability to control the market, especially the

market price, prevents a market from equating
demand price and supply price.
 3. Competition/ Market Control…cntd
• An extreme example of market control on the supply
side exists with monopoly, a market with a single
seller.
• example, oligopoly, a market with a small number of
large sellers.
• Market control on the demand side allows buyers to
set a supply price

• An extreme example of market control on the demand

side exists with monopsony, a market with a single
buyer.
• example is oligopsony, a market with a small number
of large buyers
 New Market Failure
4) Missing markets (absence of markets)
• Markets may fail to meet a need for public goods, such
as defence, street lighting, and highways.
• Market failure is the failure to produce some goods
and services, despite being needed or wanted.
• The most extreme case of a missing market is the case
of pure public goods.
• Pure public goods clearly provide a benefit to the
consumer, but, for several reasons, are unlikely to exist
in a market economy.
• E.g national defense, police service,& street lighting.
• Because markets for these goods are not likely to form
they are called missing markets and are considered a
special case where demand exists, but supply is absent.
 5. Imperfection Information

• The lack of information among buyers or sellers

• demand price does not reflect all benefits of a good or the
supply price does not reflect all opportunity costs of
production.
• In many cases, sellers have better information about a good
than buyers.
• If there are defects or problems with the good, they are
likely to know.
• Buyers have less familiarity with a good, perhaps only
knowing the information provided by the sellers.
• In this case, buyers are likely to have a different demand
price than the value of the good produced, a value based on
more complete information.
 Reasons for market failure

• Positive and negative externalities:

• externality is an effect on a third party that is caused by
the consumption or production of a good or service .

• A positive externality is a positive spillover that results from

the consumption or production of a good or service.
• E.g although public education may only directly affect
students and schools, an educated population may provide
positive effects on society as a whole.

• A negative externality is a negative spillover effect on third

parties.
• E.g the effects of environmental pollution, secondhand smoke
may negatively impact the health of people, even if they do
not directly engage in smoking.
 Reasons for market failure..cntd

• Environmental concerns: effects on the environment as

important considerations as well
as sustainable development.

• Lack of public goods:

• goods where the total cost of production does not
increase with the number of consumers.

• causes inefficiency because non-payers cannot be

excluded from consumption

• This problem - someone benefiting from resources or

goods and services without paying for the cost of the
benefit - is known as the free rider problem.
 Reasons for market failure..cntd
• Underproduction of merit goods:
• a merit good is a private good that society believes is under
consumed, often with positive externalities.
• For example, education, healthcare, and sports centers are
considered merit goods.
• Overprovision of demerit goods:
• a demerit good is a private good that society believes is over
consumed, often with negative externalities.
• For example, cigarettes, alcohol
• monopoly power:
• imperfect markets restrict output in an attempt to maximize
profit.
• Market dominance by monopolies can lead to under-
production and higher prices.
• When a market fails, the government usually intervenes
depending on the reason for the failure.
 Institutions to deal with Market Failure in
Rural Development
• This is a means of addressing the market failure
• Market efficiency is achieved if the value of goods
produced is equal to the value of foregone production.
• Markets fail when this efficiency condition is not
achieved.
• Such failures can only be corrected by government
intervention.

• There are several ways a governments can do this:

• Direct Provision
• Regulation
• Taxes
 Direct Provision
• Production of public goods and distribution to the
public.
• Planning, funding and operation of public goods like
defence, policing and street lighting
• The national government hires military personnel,
purchases armaments and equipment, maintains
military bases, and generally oversees the operations of
military actions.
• Provide public utilities include water distribution,
electricity generation, and trash collection.
• Regarding to transport services, government can fund
the building and maintaining infrastructure: bridges,
tunnels, motorways, and airports
 Regulation
• regulation of production, consumption, and exchange
decisions undertaken by the private sector
• set the rules of the game, a task they undertaken for
society,
• Also used to address the market failures of market
control, externalities, and imperfect information.

• For example, the price of a firm with significant

market control might be regulated by government.

• Government might restrict the amount of pollution

emissions from a particular productive activity.
• Regulations requiring sellers to provide information
to buyers
 Taxes
• Use of coercive government taxes.
• Impose general taxes to pay for services
• Discourage undesirable activities.
• Taxes are well-suited for controlling externalities or
encouraging the provision of information.
• For example, an industry the creates a pollution
externality can be encouraged to efficiency if
government imposes a tax equal to the external cost.
 Market regulating institutions
• This include telecommunication, transport, financial service
regulatory agencies are required to deal with externalities,
economies of scale, and imperfect information
• Market stabilizing institutions:
• Those that ensure low inflation, minimize macroeconomic
volatility, and avert financial crises.
• E.g national banks, exchange rate regimes, and budgetary
& fiscal rules
• Social Protection & Insurance Providers:
• involve redistribution, and manage conflict.
• These include pension systems, unemployment insurance
schemes, and other social protection funds like Productive
Safety Nets (PSN)
Reasons for Government Intervention in Agriculture
and Rural Development
1) Efficiency increase of agricultural production
• For example, efficient functioning of land market.
• transferring land towards those owners who are able to
use it in the most efficient way, just like modern
country.
• high transaction costs exist in conditions of outdated
land registries and non-functioning of lease institution.

2) Protection of farmers’ income:

• This is provision of support to sectors that produce
inputs for agriculture
 Government Intervention in Agric. & RD…
3) National food safety and security:
• self-sufficiency in food production.
• produce sufficient amounts of agricultural products
for the needs of domestic population, in accordance
with climate and resources in the specific region.

4) Correct market failures in the agricultural sector:

• for example, strengthen rural credit markets by,
providing information on alternative lending and
borrowing opportunities
• Encouraging formal lending institutions that can
mobilize savings.
 Government Intervention in Agric. & RD…
5) Provide public goods
• infrastructural development (roads, schools,
health facilities)

6) Accelerate the rate of income growth

7) Stabilize price in agriculture

 State Failure
• State failure refers to the pervasive inefficiency and
impropriety of state institutions in many LDCs.
• includes mismanagement, malpractice, overstaffing,
nepotism, bribery, corruption etc

• Consisting of both errors of omission and errors of

commission ,
• Errors of omission: when the state fails to do things
that could have improved economic performance
• E.g the failure to provide good infrastructure
• Errors of commission: when the state does things
that worsen economic performance.
• E.g. creation of monopolies
 The Service Delivery State
• providing law and order
• providing essential public goods
• correcting market failures
 Three theoretical components on how a liberal market
economy works.

• 1) efficient markets are rent free and have stable property

rights.
• rents exist if next-best activities are prevented from
acquiring access to particular resources or opportunities.
• This could be protected rights over information, monopoly
rights to supply particular markets, rights over subsidies
 2. Rent-seeking
• This creates rents and destabilizes property rights.
• It consists of such activities as lobbying and
corruption that seek to persuade states to create rents.
• Corruption is illegal rent-seeking whereby the rent-
seeker uses bribes to influence public officials.
• One of the most damaging effects of rent-seeking is
the destabilization of property rights
Absence of democracy and a weak bureaucracy
• This allow rent-seeking to continue.
• damaging rent-seeking continues even when the majority is hurt by
it, due to a number of factors:

 absence of democracy increases the chances that small groups can

continue with their socially damaging rent-seeking.

 low bureaucratic salaries, a politically appointed bureaucracy, and a

weak judiciary can all reduce the expected cost to public officials
of accepting bribes, thereby making rent-seeking more likely.

• Figure 1 shows how these three core components of the liberal

market consensus interact to explain how developing countries can
become locked into persistent state failure, defined as poor service
delivery which in turn affect growth.
 Institution of Property Right
• Property rights are:
• fundamental institution governing who can do what
with resources.
• can be viewed as an attribute of an economic good.
• This attribute has four broad components and is
referred to as a bundle of rights: These rights include:

• Use rights : controlling the use of the property;

• Extraction rights: the right to capture the benefits or
earn income from it;
• Transfer rights: the right to sell or lease the property to
someone else;
• Exclusion right: the right to exclude someone from the
property;
 Open-access property
• It is not owned, managed and controlled by anyone.
• It is non-excludable (no one can exclude anyone else
from using it)

• rival (one person's use of it reduces the quantity

available to other users).

• Examples:
 upper atmosphere (navigable airspace)
 ocean fisheries (navigable waterways).

• The government can sometimes convert open access

property into private, common or public property
 Public Property
• also known as state property
• property that is owned by all, but its access and use
are controlled by the state or community.

• An example is a national park or a state-owned

enterprise.

• Private property:

• both excludable and rival.

• access, use, exclusion and management are controlled

by the private owner or a group of legal owners.
 Common property
• Also known as collective property
• property that is owned by a group of individuals.
• Access, use, and exclusion are controlled by the joint
owners.
• owners have greater ability to manage conflicts through
shared benefits and enforcement unlike open-access
property
• free to use because it is too expensive, or physically
impossible, to establish legal boundaries.

• E.g oceans, rivers and canals; beaches; air; roads

• effectiveness of markets in terms of the allocation, pricing
and rationing of these resources is substantially reduced.