Understanding Underdevelopment: Challenges for Institutional Economics from the Point of View of Poor Countries

I In the development literature two recent strands of institutional economics have been influential. One is associated with the theory of imperfect information: the underlying rationale of institutional arrangements and contracts (formal or informal) are explained in terms of strategic behavior under asymmetric information among the different parties involved. This theory has been fruitfully used in modeling many key agrarian and other institutions in poor countries, which are seen to emerge as substitutes for missing credit, insurance and futures markets in an environment of pervasive risks, information asymmetry, and moral hazard. It started with the literature on sharecropping, then on interlocking of transactions in labor, credit, marketing, and land lease, on labor tying, on credit rationing, on joint liability in group lending schemes, and so on. For examples and overviews of the models, see the edited volumes by Bardhan [1989a], by Nabli, concentrates on comparative historical analysis of development processes (mainly in Western Europe and North America). North has pointed to the inevitable tradeoff in the historical growth process between economies of 2 scale and specialization on the one hand, and transaction costs on the other. In a small, closed, face-to-face peasant community, for example, transaction costs are low, but the production costs are high, because specialization and division of labor are severely limited by the extent of market defined by the personalized exchange process of the small community. In a large-scale complex economy, as the network of interdependence widens the impersonal exchange process gives considerable scope for all kinds of opportunistic behavior and the costs of transacting can be high. Greif examined the self-enforcing institutions of collective punishment for malfeasance in long-distance trade in the late medieval period and in a comparative study of the Maghribi and the Genoese traders explored the institutional foundations of commercial development. In Western societies over time complex institutional (legal and corporate) structures have been devised to constrain the participants, to reduce the uncertainty of social interaction, in general to prevent the transactions from being too costly and thus to allow the productivity gains of larger scale and improved technology to be realized. These institutions include elaborately defined and effectively enforced property rights, formal contracts and guarantees, trademarks, limited liability, bankruptcy laws, large corporate organizations with governance structures to limit problems of agency, and, what Williamson [1985] has called ex post opportunism. Some of these institutional structures are non-existent or weak or poorly devised …