New Institutional Economics: its theory and practical

implications for environmental research

What is science?

“…a state or fact of knowing ” (Oxford Encyclopedia)

Puzzle solving within an unquestioned “paradigm” (set of assumptions, values, practices) (T. Kuhn 1931).

“…knowledge infused on conscience”.

Science (especially social science) is not value-free

What is science? Limitations...

Humans are subject of science and therefore there are following limitations:

• cognitive

•high complexity of reality

•non-effectiveness of reductionism

Science has got limits

Paradigm dilemma of social science: 2 approaches to reality

Institutionalism, constructivism individuals are constrained by social rules (which are

of primary interest), and individual behavior is secondary

Behaviorism/ rational choice/neo-classical economics

individuals are self-interested (primary value) and this brings in the societal order - social rules (secondary value)

Institutions defined

“Institutions are the rules of the game in a society; more formally, they are the humanly devised constraints that shape human interaction. In consequence they structure incentives in exchange, whether political, social, or economic.”

D.C. North (1997)

Features of institutions

Institutions are a structural feature of the society or polity. They are created with the only reason: decrease uncertainty.

Stable over time.They must pose constraints and affect

individual behavior of its members.

Challenges for institutional analysis

Confusion with definitionInstitutions are invisibleMultiple inputs from different disciplines are

neededGiven multiple disciplines and concepts a

coherent institutional framework is needed.Multiple level of analysisConfigural analysis rather that additive

Why institutions matter in economics?

Adam Smith said that the productivity of an economic system depends on specialization.

Specialization will be useful only if there is an exchange, and the lower the costs of exchange (transaction costs) the more specialization there will be and the higher economic productivity will be.

Level of transaction costs however depend on institutions, its legal system, its political system, its culture etc.

Existence of Transaction Costs

TC are the costs that an actor bears in order to engage in exchange (political, economic, social etc.).

TC exist because info is costly to obtain as well as due to “bound rationality”, cognitive limits and the opportunism (self-interested individuals will not readily disclose the information about their preferences).

Institutional change 2 (D. North)

Path dependence (when the institutional framework poses certain

constraints for the downstream institutional choices and therefore influence the whole process of institutional change)

Power (institutional change is the result of the power

circles action in their own interest)

Old Institutional economics. What is that?

Emerged as the protest against methodological individualism of the mainstream Neo-classical Economics.

Emphasized importance of institutions but lacked rigorous and systematic theoretical foundations, as well as empirical support. Often it was country specific or even case specific.

Concerned more with description of institutions.

New Institutional Economics (NIE)

The purpose of NIE is two-fold:1) Explain (opposed to describe) the

determinants of institutions and analyze the institutional change;

2) Evaluate impact on economic efficiency and distribution.

New Institutional Economics

Coase R. (1937) “The Nature of the Firm” Coase R. (1960) “The theory of

social cost”. Williamson O. (1971) coins the

term “New Institutional Economics”.

North D. (1990) “Institutions”. International Society for NIE

(ISNIE) established in 1997.

Coase R. and North D.

Williamson’s framework: 4 level of social analysis

Level 1: Embeddedness. Informal institutions, customs, traditions, norms and religion; Frequency of change is 100 - 1000 y.

Level 2: Institutional environment. Formal rules of the game: property, bureaucracy. Frequency of change is 10 - 100 y.

Level 3: Governance: play of the game - contract. Frequency of change is 1- 10

Level 4: Resource allocation and employment (prices and quantities; incentive alignment). Continuos.

NIE as a scientific “umbrella”

NIE

New Economic History (North, Fogel)

Public Choice and Political Economy (Buchanan, Olson)

New Social Economics

Transaction Costs Economics (Coase, North, Williamson)

Theory of Collective Action (Ostrom, Hardin)

Law and Economics

Social Capital

Property rights literature

Economics of information(Akerlof, Stiglitz, Stigler)

How good is NIE? NIE is the framework for social scientists that puts

institutions and transactions costs on the forefront of analysis.

NIE is evolutionary and rapidly developing being focused on institutional change (dynamics).

NIE is very good in empirical testing and analysis; however: Is the forum for scientists with different background to “de-

isolate” knowledge. Major weaknesses are associated with methodologies and

thinness of empirical application

PART II: NIE AND THE ENVIRONMENTAL RESEARCH

Theoretical framework of NIE for environmental research

Case study of Forestry in GhanaConclusions

Theoretical framework for environmental research informed by

NIEFrom neoclassical “externality” to institutional

“interdependence”

Transaction Cost Economics

Rejection of Cost-Benefit Analysis

Focus on implementation rather than policy formulation ( different from NCE)

Interdependence broadens Externality

“Interdependence prevails when a choice of one agent influences that of another. Interdependent agents cannot simultaneously realize their incompatible interests in scarce environmental resources and their conflict should be resolved by defining or redefining the initial endowment” (Coase 1960).

Rejection of CBA

Due to TC and methodological pluralism the choices of an actor does not reveal his/her preferences and the CBA (Contingent valuation) cannot be applied effectively.

Case Study: NIE and Forestry in Ghana

NIE helps to illuminate how private interests interact with public interest

Rent-seeking, Public Choice, Rational Choice theories.

Forestry in Ghana

Capital: Accra

Population: 18,8 mln

Rain Forest covers area: 35%

Forestry is the 3rd export item;

Many Ghanaians depend on forest for firewood and cooking;

Reduction in forest cover from 8.2 mln ha in 1900 to 1.6 mln. in 2003. Reduced by 75%!

Participants in the forestry on Ghana

Logging firms – primary treatment Timber millers – secondary treatment Furniture workers – tertiary treatment Ghana Timber Association (IO) Ghana Timber Millers’ Organization (IO) Furniture and Woodworkers Association of Ghana

(IO) Small-scale Carpenters Association (IO)

Chainsaw operators

Technological change triggered socio-political change.

Chainsaw operation is very mobile and 2 people are enough and they are difficult to be controlled.

They competed with millers by: converting wood into lumber and by offering loggers better price than millers.

Timber Management Resources Act (1997)

Adopted in 1997 as the action to fight de-forestation Prohibits timber harvesting without Timber Utilization

Contract (TUC), which is the ecological contract. Holders of TUC have to pay stumpage fee to the

Administration of Stool Lands. Holders of TUC have to:

Submit proposal for reforestation of at least 10 ha from km2 Submit Social Responsibility Agreement (not more than 5% of

annual royalty) Implement obligations promptly

Chainsaw operators were forbidden to convert felled trees into lumber for sale.

Implications for chainsaw operators

1. Pushed out from the lumber processing industry and restored monopoly of timber millers

2. TUC created interest for local community as the beneficiary of the legal logging.

3. TUC created interest for environmental bureaucrats to enforce compliance with the TMRC.

Implication for deforestation

TRMA controlled chainsaw operators from entering the market, but did not restrict loggers (by restricting the season or the amount of timber to be harvested). Moreover, it had worse implications for deforestation as it forced loggers to engage in TUC and pay fees, and given oligopoly of millers to harvest more than previously. More timber on the market means decrease in price and a new incentive posed for loggers to increase logging.

Why did TRMA fail? The NIE perspective

Because the true rationale for TRMA was not the environmental protection (in line with “multiple streams theory” by Zahariadis) but to protect timber for mill owners – which it did successfully.

Looking at the incentives of the participants and the dynamics of institutional change the NIE allowed us to spot the main reason for failure of TRMA and these insight would have value if applied prior to developing new policies.

NIE and Environment

NIE is relatively well advanced in local CPR problems (Ostrom) and International Environmental Governance (Young)

NIE has not been applied to environmental research in the consistent way on the national level: there is a niche

IAD framework (Ostrom) can be interesting for analysis on any level as a universal framework.

The mandate of NIE

“There is no greater challenge facing today’s social scientist than the development of a dynamic theory of social change that will fill in many of the gaps in the foregoing analysis and give us an understanding of adaptive efficiency”.

(D. North 1993)

Organizations actively involved in NIE research

1) International Society for New Institutional Economics; 2) Ronald Coase Institute 3) European School on New Institutional Economics 4) Garrett Hardin’s Society 5) Center for new institutional social sciences 6) University of Paris (Sorbonne) 7) University of Chicago 8) MIT 9) Indiana University 10) University of California, Berkeley 11) University of Cambridge