““Climbing the Hierarchical Climbing the Hierarchical Ladders of Rules”:Ladders of Rules”:The Dynamic of The Dynamic of

Institutional FrameworksInstitutional FrameworksEric BROUSSEAU Eric BROUSSEAU

(EconomiX, U. Paris X & IUF)(EconomiX, U. Paris X & IUF)

Emmanuel RAYNAUD Emmanuel RAYNAUD (INRA SADAPT & ATOM, U. Paris I)(INRA SADAPT & ATOM, U. Paris I)

MotivationMotivation Two main views of institutions in economics

and two visions of Institutional Changes

Institutions as (designed) rules of the game

Institutional Framework:Political Competition

Institutional Arrangements:Economic Competition

Institutions as (self-enforced) equilibrium of

games

Destabilization of a prevailing equilibrium

…and processes of convergence toward a new set of shared beliefs

MotivationMotivation

Alternative layers are distinguished according to their ability to quickly change (or costs of changing them)

“slow” vs “fast-moving” institutions (Roland, 2004)

Williamson (2000, JEL)

Our contributionOur contribution We provide an We provide an endogenousendogenous justification for justification for

contrasted paces of change across contrasted paces of change across institutional levels of order provisioninstitutional levels of order provision

We explain how and why institutions at one We explain how and why institutions at one level might level might climb the “institutional ladders”climb the “institutional ladders”

Multiples bilateral orders (bilateral GS)

Sets of collective & “local” orders (“intermediate institutions”)

Uniform & generic order (“generic institutions”)

OutlineOutline

Logic of collective order formationLogic of collective order formation => Sponsored Orders=> Sponsored Orders

Incentives to climb the institutional ladderIncentives to climb the institutional ladder => Competition among => Competition among

OrdersOrders

Strategic Interplay among Sponsors Strategic Interplay among Sponsors => Coopetition among => Coopetition among

kernelskernels

Functions of governance level:Functions of governance level:Provision of an orderProvision of an order

GovernanceGovernance

Managing interactions through the definition of

“property rights”

Rules setting

“measurement cost”

Enforcement costs

Transaction Transaction costscosts

Rules setting

Rules enforcement

Provision of an Provision of an economic “order”economic “order”

Analytical Analytical FrameworkFramework

AssumptionsAssumptions Heterogeneity of agentsHeterogeneity of agents Coordination: Trade and Provision of Collective Coordination: Trade and Provision of Collective

ResourcesResources Distance/Proximity: territorial, preferences, Distance/Proximity: territorial, preferences,

agents’ characteristics, etc.agents’ characteristics, etc. Minimization of Private Transaction Costs (mix of Minimization of Private Transaction Costs (mix of

seek for efficiency and rent seeking)seek for efficiency and rent seeking) Process of Emergence Collective GovernanceProcess of Emergence Collective Governance

ConvergenceConvergence/Divergence /Divergence of Interestsof Interests

CoordinatioCoordination Gamen Game Rule 1Rule 1 Rule 2Rule 2

Rule 1Rule 1 (2, 2)(2, 2) (10,10)(10,10)

Rule 2Rule 2 (10,10)(10,10) (2, 2)(2, 2)

Battle of Battle of SexesSexes Rule 1Rule 1 Rule 2Rule 2

Rule 1Rule 1 (3, 6)(3, 6) (8 , 10)(8 , 10)

Rule 2Rule 2 (8 , 10)(8 , 10) (5, 1)(5, 1)

The Evolution of the The Evolution of the Bargaining GameBargaining Game

Battle of Battle of SexesSexes Rule 1Rule 1 Rule 2Rule 2

Rule 1Rule 1 (2, 5)(2, 5) (7 , 12)(7 , 12)

Rule 2Rule 2 (7 , 12)(7 , 12) (5, 1)(5, 1)

Battle of Battle of SexesSexes Rule 1Rule 1 Rule 2Rule 2

Rule 1Rule 1 (3, 6)(3, 6) (8 , 10)(8 , 10)

Rule 2Rule 2 (8 , 10)(8 , 10) (5, 1)(5, 1)

Dynamics of the Evolution of Dynamics of the Evolution of InstitutionsInstitutions

InsightInsight: Alternative governance levels pertain to : Alternative governance levels pertain to a a common life-cycle modelcommon life-cycle model of institutional of institutional evolutionevolution

Main argumentMain argument: Like lava, some : Like lava, some local local institutions spread and “froze”institutions spread and “froze” and become and become genericgeneric

Dynamic of InstitutionsDynamic of Institutions

Local Global

Negotiable

Mandatory

Bilateral institutions of governance

Intermediate institutions

Generic

institution

Benefits/Costs of Collective of Benefits/Costs of Collective of GovernanceGovernance

The Centralization Tradeoff

Scale & ScopeScale & Scope Effects Effects LearningLearning and and

SpecializationSpecialization Benefits Benefits Reduction of Collective Reduction of Collective

Welfare LossesWelfare Losses(Increased consistency (Increased consistency among local rules, among local rules, Internalization of Internalization of externalities, Positive network externalities, Positive network effects in the use of common effects in the use of common standards of interactions, …)standards of interactions, …)

Static Mal-adaptationStatic Mal-adaptation(Increasing heterogeneity of (Increasing heterogeneity of Individual Preferences)Individual Preferences)

Dynamic Mal-Dynamic Mal-adaptationadaptation (Reduced (Reduced Renegotiability)Renegotiability)

Information costs Information costs (Increasing Information (Increasing Information Asymetries)Asymetries)

Enforcement Enforcement RequirementsRequirements (Increasing Incentives to Free (Increasing Incentives to Free Ride)Ride)

Private CapturePrivate Capture(Increasing Incentives to (Increasing Incentives to distort coll. Gov. in favor of a distort coll. Gov. in favor of a minority)minority)

The Emergence and Evolution of The Emergence and Evolution of Institutions 0Institutions 0

The Emergence and Evolution of The Emergence and Evolution of Institutions 1Institutions 1

The Emergence and Evolution of The Emergence and Evolution of Institutions 2Institutions 2

The Emergence and Evolution of The Emergence and Evolution of Institutions 3Institutions 3

The Emergence and Evolution of The Emergence and Evolution of Institutions 4Institutions 4

Local orders become Local orders become genericgeneric

Why is there Why is there incentivesincentives for local institutions to for local institutions to grow?grow? DirectDirect positive network externalities positive network externalities

Expansion widens the scope of low TC’s dealsExpansion widens the scope of low TC’s deals IndirectIndirect positive network externalities positive network externalities

New adopters reinforce the attractiveness of a given New adopters reinforce the attractiveness of a given institutioninstitution

Competition among local institutionsCompetition among local institutions // standard race// standard race

Negotiable orders become Negotiable orders become rigidrigid

Local institutions are voluntary devices Local institutions are voluntary devices exit is always exit is always possiblepossible QualityQuality of the collective rules has to be of the collective rules has to be

enhancedenhanced to meet external options to meet external optionsRules that are initially rough become more Rules that are initially rough become more efficiently designed and more tailored to efficiently designed and more tailored to particular needsparticular needs

Exit optionsExit options reduce and reduce and disappeardisappear

At the end of such process, there is At the end of such process, there is no no longer margins of negotiationslonger margins of negotiations

Incentives to climb the Incentives to climb the institutional laddersinstitutional ladders

To sum up: with the passing of timesTo sum up: with the passing of times Incentives to expandIncentives to expand: “Winning” local institutions become : “Winning” local institutions become

more attractivemore attractive and face and face less competitive pressureless competitive pressure Incentives to enhance efficiencyIncentives to enhance efficiency: initial : initial rules rules become become

more more completecomplete and and broader in scopebroader in scope

Reductions of both outside options and margins for Reductions of both outside options and margins for

negotiationsnegotiations

The individual benefits of membership increase and the The individual benefits of membership increase and the outside options decrease: Emerging institutions shift outside options decrease: Emerging institutions shift

from local to globalfrom local to global from negotiable to mandatoryfrom negotiable to mandatory

They become “frozen”They become “frozen”

Horizontal CompetitionHorizontal Competition

Competitive Decisions by “kernels”Competitive Decisions by “kernels” Improving EfficiencyImproving Efficiency

(Uniform Reduction of TCs) (Uniform Reduction of TCs) Switching Cost Manipulation Switching Cost Manipulation

(Rising acquisition costs) (Rising acquisition costs) Poaching of “Go-Betweens”Poaching of “Go-Betweens” Explicit MergerExplicit Merger

=>Kernel’s members drivers of =>Kernel’s members drivers of formalizationformalization

… … while Formalization make their while Formalization make their position contestableposition contestable

Main enabling ConditionNature of the Instit.

Informal

+ formal

Main Causal FactorStruct of Rel. Network

Distant

Intertwined

Vertical Competition as Vertical Competition as the Driver of Institutional the Driver of Institutional

Change and Efficiency Change and Efficiency GainsGains

Step 0

Step 1

Step 2

Step 3

Step 4

A cross section view

Vertical CompetitionVertical CompetitionAvailable Decisions by “kernels” of “Frozen” Available Decisions by “kernels” of “Frozen”

InstitutionsInstitutions

““External” Competition of External” Competition of Successful Local Successful Local

InstitutionsInstitutions

““Internal” Competition to Internal” Competition to take Control of the take Control of the Formal Levers of the Formal Levers of the

Generic InstitGeneric Instit1.1. Eradication/ConfinementEradication/Confinement

2.2. SubstitutionSubstitution

3.3. Recognition*Recognition*

1.1. Strengthening PowerStrengthening Power

2.2. Allowing negotiations and Allowing negotiations and CompromisesCompromises

1.1. Doomed to failureDoomed to failure

2.2. Cognitive boundariesCognitive boundaries

3.3. Increase internal competition Increase internal competition (while mutual recognition)(while mutual recognition)

Increasing amount of Increasing amount of resources dedicated to a zero-resources dedicated to a zero-sum political competition gamesum political competition game

*Driving Factors:

Generic Instit : Degree of Competition among (more) generic institutions; Heterogeneity, Pace of needed evolution

Local Instit: Degree of horizontal competition