Abstract
All markets need institutions in order to function properly. From the simplest exchange transaction that is governed by the rules of business, cultural norms or traditions to the most complex decision-making procedure that involves strategic uncertainty and limited information, our behavior is shaped by formal and informal institutions that help to facilitate order in daily social and economic interactions and reduce uncertainty in exchange. While an explicit acknowledgement of this fundamental role of institutions in socio-economic life might seem superfluous and obvious to the reader with a non-economics background,188 it is a fact that the prevailing neoclassical theory treats institutions as a highly abstract matter as well as exogenously given, and thus inconsequential, in economic processes. The New Institutional Economics (NIE) attempts to address this shortcoming from an economic science’s point of view. The final part of this chapter will, therefore, review some of the main ideas of this theory, along with complementary, yet different, approaches suggested by two NIE scholars — Douglass North and Oliver Williamson — that are relevant to the analysis at hand. This process will serve to highlight the role and importance of institutions in general as well as their significance for FDI government competition in particular.
Unless the economics scholar is acquainted with the ideas of the German Ordo-Liberalist School which is associated with the writings of Walter Eucken, Alexander Rüstow, Wilhelm Röpke, Franz Böhm, and the Freiburg School. Although the movement was conceived in the late 1920s as a response to the constitutional and economic crisis of the Weimar Republic, its core ideas (i.e., that a certain institutional framework or social and political “order” is essential in achieving economic efficiency to produce individual freedom and liberty) became particularly influential in the founding of West-Germany’s post-World War II “social market economy”.
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References
The term “New Institutional Economics” was coined by Oliver Williamson who first used it in his publication “Markets and Hierarchies: Analysis and Antitrust Implications” (WILLIAMSON, 1975).
KASPER/ STREIT (1998), p. 34.
These include, inter alia, Armen Alchian and Harold Demsetz (property rights approach — ALCHIAN/ DEMSETZ, 1972); Oliver Williamson (transaction cost economics — WILLIAMSON, 1975, 1986); and Douglas North (institutional environment and institutional change — NORTH, 1984, 1990).
See FURUBOTN/ RICHTER, 1997, p. 2. The demarcation between the two fields is not as clear cut, and the intellectual debate whether or not the NIE is part of the neoclassical theory or a separate strand is still underway (see FURUBOTN/ RICHTER, 1997, p. 435).
See NORTH (1992), p. 3.
The concept of bounded rationality was introduced by Herbert Simon (see SIMON, 1957).
NORTH (1992), p. 3.
DAHLMANN (1979), p. 147.
MATTHEWS (1986), p. 903.
An excellent overview on NIE theories can be found in FURUBOTN/ RICHTER (1997); KASPER/ STREIT (1998); and RUTHERFORD (1994).
WILLIAMSON (1998), p. 75.
NORTH (1992), p. 4.
WILLIAMSON (2000), p. 598.
Bounded rationality prevents the existence of “complete contingent contract” (WILLIAMSON, 2000, p. 601).
OSTROM (1995), p. 582.
Man-made is to be understood in Hayek’s sense of “The result of human action but not of human design” (HAYEK, 1967, p. 96).
NORTH (1992), p. 4.
VOIGT (2002), p. 36.
VOIGT (2002), p. 37.
VOIGT (2002) also points out that “social sanctioning” is not costless and, due to the collective action problem, will only happen if the sanctioner expects a repeat situation to occur. The most common effect of “social sanctioning” is on the reputation of the sanctionee.
NORTH (1990), p. 3.
COLEMAN (1974) distinguishes between individual actors, who wish to maximize their individual interests, and corporate actors, who act on the behalf of some group or collectivity.
KASPER/ STREIT (1998), p. 98.
See VOIGT (2002), p. 33.
See WILLIAMSON (2000), p. 596.
See MANTZAVINOS (2001), p. 83.
KASPER/ STREIT (1998), p. 185.
See FURUBOTN/ PEJOVICH (1972), p. 139.
WILLIAMSON (2000), p. 598. He calls this also “first-order economizing”.
WILLIAMSON (2000), p. 599.
This is subsequently called “second-order economizing” (see WILLIAMSON, 2000, p. 599).
See NORTH (1992), p. 4.
See NORTH (1986), p. 231.
See NORTH (1990), p. 84.
North’s efficiency criteria is not the Pareto-Optimum of the Welfare Economics (which explicitly neglects institutional factors) but institutional “adaptive efficiency”, i.e., the “willingness of a society to acquire knowledge and learning, to induce innovation, to undertake risk and creative activity of all sorts, as well as to resolve problems and bottlenecks of the society through time” (NORTH, 1994, p. 1). His choosing of economic growth rates as an efficiency measure is problematic.
See NORTH (1990), p. 8.
Path dependency is a result of increasing returns that reinforce the direction once a path is chosen (see NORTH, 1990, p. 112).
North details the game-theoretic framework using the Prisoner’s Dilemma-Model (see NORTH, 1990, p. 13). A more comprehensive presentation of the game-theoretic logic will be provided in sub-Chapter 4.3.1 of this dissertation.
NORTH (1990), p. 14.
See NORTH (1990), p. 14.
NORTH (1986), p. 233.
COASE (1937), p. 390.
WILLIAMSON (1985), p. 19. Williamson himself only loosely defines transaction costs as “costs of running the system” (WILLIAMSON, 1985, p. 18), which is a reference to ARROWS (1969), p. 48.
See WILLIAMSON (1975), p. 8.
See WILLIAMSON (1985).
SIMON (1957), p. 241.
WILLIAMSON (2000), p. 601.
MEYER (1998), p. 92.
Williamson maintains that opportunism is a necessary condition for internalization to occur. For a discussion of this argument see MEYER (1998), p. 99.
WILLIAMSON (1985), p. 61.
See VOIGT (2002), p. 106.
WILLIAMSON (1985), p. 48.
See WILLIAMSON (1985), p. 79.
WILLIAMSON (2000), p. 601.
WILLIAMSON (2000), p. 601.
See VOIGT (2002), p. 111.
WILLIAMSON (1985), p. 61.
See for example OECD (2002); CHAN-LEE/ AHN (2001); WILHELMS (1998).
See MEYER (1998), pp. 87–88.
See MUDAMBI (2002), p. 5.
See KUHN (1962), p. 36; MEYER (1998), p. 87.
See OMAN (2000), p. 107.
See OMAN (2000), p. 107.
OECD (2002), p. 25.
The presentation in Figure 4 follows the OECD (2002) approach in a sense that it considers only counties with cumulative FDI inflows of less than US$ 60 billion (1995–2000) in order to isolate the effect of top-performing industrialized countries which also ranked the highest on the institutional governance index. For details see Annex Table A-2 and A-3 on country data and correlation matrix. For a similar presentation with different FDI data see OECD (2002).
WILHELMS (1998), in: Abstract.
See WILHELMS (1998), p. 41.
DISDIER/ MAYER (2004), p. 1.
The terminology used in this paragraph as well as in Table 4 is based on an article by CHARLTON/ CHRISTIANSEN/ OMAN (2002) which use these labels in a different context to describe welfare effects in competition between national and subnational levels.
As VOIGT (2002) has rightly pointed out, rational choice is one of the assumptions that the NIE first abandoned, thus, game-theoretic scenarios only have limited compatibility with NIE theories.
The assumptions are that TC(I) involve a certain amount of fixed costs (FC), i.e., costs of setting-up the operation in a foreign country, and increase at a lower rate than TC(E) due to internalization advantages depicted in the above graph through different slopes of the two curves. Project benefits (PB) are thought to occur when project revenues minus the combined production and transaction costs are positive, i.e., R − (TC + PC) > 0. See MEYER (1998), p. 89 for details on this equation.
See also MEYER (1998), p. 100 who identifies five distinct factors that moderate TCs, namely common governance, corporate culture, experience, physical distance and sources of funding.
WILLIAMSON (1998), p. 76.
See MEYER (1998), p. 96. See also WILLIAMSON (1975, 1985).
See MEYER (1998), p. 96.
They also influence external transaction costs in the same direction so the net shift between externalization and internalization is unclear and not further discussed here as the focus is on the potentially FDI expanding effect of government policies. For the discussion of the debate about FDI as substituting or complementing trade see, for example, GRAHAM (1995, 1996).
See DOYLE/ VAN WINJBERGEN (1994), pp. 211–212.
See MUDAMBI (1999), pp. 73–75.
See UNCTAD (1996).
This argument builds on Mudambi’s statement that “governments may prefer support schemes that appear to be more expensive, but have better incentive or risk-sharing implications.” (MUDAMBI, 1999, p. 75).
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(2006). The New Institutional Economics Theory. In: Locational Tournaments in the Context of the EU Competitive Environment. DUV. https://doi.org/10.1007/978-3-8350-9109-2_6
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