Claude Menard University of Paris (Pantheon-Sorbonne) Centre d’Economie de la Sorbonne A new Institutional economics approach 13th Summer School on Economic History, Philosophy, and History of Economic Thought, Acqui Terme, 1-8 settembre 2010

C. Menard Contracts and conflicts Introduction The complex issue of conflicts in contractual arrangements The case of « UNIMIE »

C. Menard Contracts and conflicts Introduction

Two dominant approaches in New Institutional Economics, identified to two leading figures : Oliver Williamson (Nobel prize in 2009) and Douglass C. North (Nobel prize, 1994).

C. Menard Contracts and conflicts Introduction In Williamson’s view: Conflicts are generated when the potential opportunism of parties to a transaction is activated  because of contractual hazards, or  because of changes in the institutional environment. Limit: breach of contract and/or going to court

C. Menard Contracts and conflicts Introduction In North’s perspective: conflict is inherent to political systems  because violence is embedded in the very nature of the state,  because exerting violence is essential to the actual development of transactions limit: violence transforms into predation

C. Menard Contracts and conflicts Introduction Although operating at a different level, the two approaches are complementary and interdependent: 1) They both involve properties of the institutional environment 2) They both rely on central concepts of NIE: property rights, contracts, transaction costs.

C. Menard Contracts and conflicts Introduction However: *** Williamsonian branch emphasizes primarily economic transaction costs; *** Northian branch extends the concept to political transaction costs.

C. Menard Contracts and conflicts Introduction I will substantiate this view along the following lines: I: Contracts and Conflicts at the Organizational level II: Contracts and conflicts at the Institutional level

Contracts and conflicts: The Organizational level Introduction: Governance at the core => What do we mean by ‘governance’? ¤ Allocation of rights (property & decision -> payoffs) ¤ Mechanisms needed to monitor and adapt them ex post ¤ creating order to mitigate contractual hazards ¤ in order to take advantage of use of these rights

Contracts and conflicts: The Organizational level Introduction: Governance at the core (2) Critical mechanisms of governance : (i) Allocate assets, (ii) delineate control over assets and decisions rights; (iii) monitor payoffs (distribution rules) (iv) define and implement decision-making process; (v) define and implement dispute-resolution devices.

Contracts and conflicts: The Organizational level Central tool (although not the only one): contracts (a) mutual agreements (b) determining rules that organize transfers of rights (c) among well specified economic units (the ‘parties’ to a contract) (d) embedded in institutions in order to be enforceable

Contracts and conflicts: The Organizational level Contracts involve 4 major characteristics:  ‘commitment’ => credibility issue  often on future transactions => time dimension  which requires guarantees  hence a coercive dimension

Contracts and conflicts: The Organizational level What are the source of conflict here? - All needed mechanisms involve costs: TRANSACTION COSTS Ex. of hostage clauses

Contracts and conflicts: The Organizational level Because of these costs, contracts are incomplete -Sources of incompleteness: Bounded rationality Asymmetries of information Problems of measure - Result: contractual hazards

Contracts and conflicts: The Organizational level Filling the blanks of incomplete contracts: - interpretation - domination - Mediation - Arbitration - and ultimately breach of contracts etc.

Contracts and conflicts: The Organizational level All these devices are sources of conflicts and/or generate conflicts. -> Importance of clauses for solving conflicts in contracts. -> More generally importance of « dispute solving devices » (Coase)

Contracts and conflicts: The Organizational level How can conflicts be solved? -> Private ‘order’; see « ethic committee » with UNIMIE -> Courts -> Violence of the State: this is the turf of North

Contracts and conflicts: The Institutional level Introduction: Contracts are deeply embedded in their institutional environment => political system at the core (social organization of contractual arrangements) Case of reform of water system in Cote d’Ivoire

Contracts and conflicts: The Institutional level

Northian approach summarized: Initially heavily influenced by neoclassical economists  cliometrics contracts/transactions as engine of growth (ocean shipping) But incorporating institutions: theory of institutional change (book on American Growth) However, European history shows this is not enough to explain the “fundamental societal change that had characterized European economies”

Contracts and conflicts: The Institutional level Significant role of new arrangements such as written contracts enforced by courts (North and Thomas 1973; North 1990) Problem: Solving conflicts and protecting property rights through formal enforcement (courts) involves high transaction costs  in line with Coase and Williamson More generally, not satisfying answers because: 1) formal contracts concern only small part of economic activity ex. conflict resolution by courts is the exception 2) fundamental role of beliefs and mental models ignored 3) nature and role of the state ignored

Contracts and conflicts: The Institutional level From there, two possible directions: 1) Role of individuals in solving conflicts and adapting institutions 2) Collective action

Contracts and conflicts: The Institutional level 1) Role of individuals (North, 1990 …): Institutional change through “entrepreneurs” (economic and political) who perceive “that they could do better by altering the existing institutional framework”. But: (a) Perception of desirable changes depend on information received and how it is processed. (b) Reforms are “path dependent” -- constrained by the existing set of institutions and mental models. (c) Sticky nature of beliefs and institutions (see underdevelopment)

Contracts and conflicts: The Institutional level => Key issue: how do mental models change? “social contract” tends to be very conservative i) because of high political transaction costs of changes (changing coalitions; changing beliefs) ii) conflicts tend to spread with extension of impersonal transactions. How can individuals, even if they form coalitions, enforced contracts and favor transactions in that context?

Contracts and conflicts: The Institutional level 2) Collective action (a) Contracts enforced and conflicts solved through ‘informal’ collective action based on shared mental models (Greif and the Maghrebi traders in Middle Age) (b) Contracts enforced and conflicts solved through violence of the state (North, 2005; North et al., 2009 …)

Contracts and conflicts: The Institutional level Theory developed in 2009: state violence built on political coalitions. Two possible situations (polar cases) (i) “Limited access orders”: elites become aware of advantages of sharing power rather than fighting. They formed coalitions around specialists in violence who could protect non-military elites (e.g., traders, clergy) and limit outsiders’ access to valuable resources. Violence is “contained” because elites adhere to these agreements by limiting non-elite access to rents: capture (rent seeking behavior). This is the dominant social order.

Contracts and conflicts: The Institutional level (ii) “0pen access societies”: emerged in Europe after the industrial revolution. Political regimes (federalism) and other institutions (powerful judiciary) devised to severely limit rent seeking behavior These are the exception.

Contracts and conflicts: The Institutional level Impact of these theories (Two EXAMPLES) -> Transaction cost approach to regulation: Regulatory institutions based on political coalition (subsets of: government, operators, users) Problems of “commitment” (ex-ante) and enforcement (ex-post) at the core Contracts are not fully self-enforcing. Must be monitored, controlled, with sanctions at stake (hence role of ‘violence’

Contracts and conflicts: The Institutional level -> Development economics Long run economic performance and institutional indicators Organized ‘violence’ How to avoid predatory behavior from the state

Contracts and conflicts: CONCLUSION Key concepts (« golden triangle ») of New Institutional Approach to conflicts: ¤ Property rights (how to protect them) ¤ Contracts (how to enforce them) ¤ Transaction costs (how to minimize them) Contracts are part of governance (but only part of it)

Contracts and conflicts: CONCLUSION A REMAINING (and Central) PROBLEM: HOW TO ARTICULATE PROPERLY THE TWO LEVELS (ORGANIZATIONAL, INSTITUTIONAL) notwithstanding that same concepts are used. Ex. What impact of nature of institutions protecting more or less efficiently property rights on the choice of a mode of organisation of transactions and on development/solution of conflicts?