Ronald Coase Institute: 2007 Reykjavik Workshop, Abstracts

2007 Reykjavik Workshop: Abstracts

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WORKSHOP ON INSTITUTIONAL ANALYSIS
JUNE 16–21, 2007
REYKJAVIK, ICELAND

ABSTRACTS
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ASSESSMENT OF TRANSACTION COSTS
AND EVOLUTION OF NEW INSTITUTIONS
IN COMMUNITY-MANAGED IRRIGATION SYSTEMS IN NEPAL
Ram Chandra Bhattarai
Tribhuvan University

The overall goal of this study is to analyze factors affecting the evolution of a successfully functioning water users' association in selected mid hills in Kathmandu Valley, Nepal. The study aims to do this by analyzing in detail the nature and structure of transaction costs that would determine or shape the evolution of a formal water users' association in community-managed irrigation systems in Nepal. The irrigation systems will be categorized into four groups: based on formal institutions, informal institutions, lack of institutions, and failed institutions. The study will be conducted mainly with primary information collected from 50 irrigation systems within Kathmandu valley and from about 400 households in 10 irrigation systems selected from those. The factors influencing transaction costs will be analyzed under all four types of institutional settings. The household level characteristics and the characteristics of the systems will be analyzed to understand their impact on transaction costs.

We assume that attributes of the institutional arrangements consist of three sets of variables: functional variables, structural variables, and performance variables. Functional variables include operational rules, incentive structures including fines and penalties. Structural variables refer to the nature of collective choice rules. Performance variables include the size of private benefits from the system, and the nature of access to different categories of users, existing conflicts and resolution mechanisms. We will attempt to find out the private benefits considering crop productivity. We will collect this information for the selected irrigation systems with all types of organizational settings and will analyze it with the help of statistical and econometric models.

PROPERTY RIGHTS AND LAND MANAGEMENT:
A STUDY OF THE EVOLUTION OF LAND TENURE IN BULGARIA
Natalia Boliari
Carleton University

This study investigates the evolution of agricultural land tenure institutions and analyzes the mechanisms of transition between land tenure regimes. The research is based on a single country-case study, and the country of choice is Bulgaria. In a period of about one century, Bulgaria experienced three major shifts in land tenure regimes. In the wake of the radical land reform introduced shortly after the fall of the communist regime in 1990, poorly defined, uncertain and insecure rights to own, use, transfer, and control land property have arisen as important issues which seem to have significant negative effects on land productivity and land market development in the country. Understanding the fundamental causes that led to the ill-functioning current land tenure institutions would create scope for developing policies and help guide policy-makers in the field.

The study identifies two interrelated central research questions. The first question concerns the critical factors that brought the present agricultural land tenure in Bulgaria into being. Examining the periods from the nineteenth century to the present, the question addresses the evolution of both formal and informal property rights to land and stresses the interaction between the two. The implication is that the evolution of formally established property rights to land cannot be fully understood and explained without developing a thorough understanding of the informal institutions governing land relations in the country.

The second question concerns the specific reasons for which a society decides to reallocate property rights to land. Research on this question focuses on providing an account of the actual mechanisms by which transitions between land tenure regimes in Bulgaria occurred. The key hypothesis is that the transitions between land tenure regimes in Bulgaria are products of political processes. The emphasis to be given to the heavily political character of land tenure in this study represents a departure from previous studies which emphasize the desires of interacting economic actors for adjustment to new benefit-cost possibilities to achieve greater efficiency gains as the determining factors for the emergence of property rights.

The study employs historical research and qualitative and quantitative data analysis methodology.

PROPERTY RIGHTS REGIMES AND NATURAL RESOURCES:
INSTITUTIONAL ARRANGEMENTS AT THE JARI RIVER VALLEY REGION, AMAZON FOREST
Priscila Borin de Oliveira Claro, Robson Amancio, Decio Zylbersztajn
UFLA, PENSA/SP, IBMEC-SÃO PAULO

Forest resources are vital to the future of the planet. They are shed and home for almost two-thirds of all known species of plants and animals, and for thousand of aboriginal and traditional populations. Besides, forests play a crucial whole in regulating the local and global climate. However, deforestation is increasing in several less developed countries. The main threats to forest are illegal logging to obtain timber, clearing for agriculture and pasture, clearing for building basic infrastructure, and mining. Moreover, institutional aspects such as property rights regimes can influences deforestation (Alston, Libecap, and Mueller, 2000; Tietenberg, 2000; Ostrom, 1990; North, 1990). Property rights regimes define who and how a resource can be used. In Barzel’s lenses (1997), property rights are composed of legal and economic rights. The legal rights recognized by the state are those of a particular individual or set of individuals. Economic rights reflect the ability, in expected terms, to benefit from a good or service.

Thus, the central question is how different property rights regimes affect deforestation. The legal right is not sufficient to guarantee sustainability of forest resources once there are significant variations in the economic rights (de Soto, 2000). Based on this premise, we hypothesize that the deforestation rate can be high in areas where the legal right is not or poorly defined and enforced; and where agents invest in short gestation activities because they are not certain about capturing the benefits of using the resource in a sustainable way.

In order to test the hypothesis, we relate the deforestation rate to the property regime and characterize the productive arrangements. It is qualitative research with case study methodology. It focuses on two different regimes located in the Amazon Forest in the Jari River Valley Region. In one area, the regime is public with collective use, and the other is a private regime. Data come from secondary and primary sources. At this moment, we are conducting some face-to-face interviews using a semi-structured questionnaire with local agents.

The results of this study highlight valuable information about sustainability to public policy makers, private organizations, and forest-based communities.

EFFICIENCY IMPLICATIONS OF THE LAND REFORM PROGRAM
IN THE PHILIPPINES
Ruth H. Francisco
University of the Philippines

In a developing agricultural economy such as the Philippines, distribution of wealth has important implications to productivity. The agrarian reform programs in the Philippines since the late 30s were intended to benefit the poor mainly by redistributing land to small farmers in rural communities. They aim to promote equitable access to land ownership and other productive resources as well as encouraging greater productivity of agricultural lands. However, the programs restrict ownership of land to a maximum of 5 hectares per individual. Also, the programs provide legal impediments to ex post trading of rights by the farmer beneficiaries for a period of 10 years. Hence, the financially-constrained farmers are awarded rights to hold and till the land but are precluded from using their certificate of land transfers as collateral for credit sourcing.

This paper attempts to establish an empirical case that is contrary to the results of the Fundamental Welfare Theorem and the Coase theorem. It highlights the fact that in a world where agricultural credit markets are incomplete and contracts are not enforceable, institutional design of land redistribution matters. The paper reviews the institutional design of CARP in the Philippines and identifies its drawbacks on the efficiency of (1) property rights allocation, (2) rural land valuation, and (3) credit subsidies.

The paper also provides an empirical case where an informal institution —the secondary land market— arises due to the inefficiencies of the formal institutions and how an informal institution, in turn, may affect exchange in the formal institution.

Lastly, the paper argues that minimal state intervention which does not preclude the functioning of rural land and credit markets is a more sustainable and efficiency-enhancing solution. An alternative decentralized solution to properly align the incentives of landownership is identified.

EARLY MODERN INSTITUTIONAL MATRICES: THE BOMBAY EXPERIENCE
Colin C. Ganley
Oxford University

The English East India Company (EIC) took over Bombay in 1668 and immediately began to provide security to the residents of the island. Before the new security institutions were in place, Bombay was vulnerable to many threats within and surrounding the island.

This paper sheds light on Bombay between 1668 and 1683 with an historical narrative of risks and security. The narrative describes the threats (Dutch, Portuguese, Moguls, Maratha, pirates and natural threats) and specific security institutions which were developed to mitigate the risks that Bombay confronted. In this period, Bombay was run by the EIC for the profit of its shareholders in London. This long-distance agency relationship created unique institutions for its time.

By examining this historical episode, this paper contributes to discussions about the roles, forms, and implications of security institutions. What security policies are best for economic growth? What type of security policy encourages rather than restricts individual freedoms? The construction of security institutions and their ‘fit’ in an institutional matrix are discussed with a focus on the economic outcomes different institutions create.

This paper discusses the specific policy decisions which occurred as economic growth increased dramatically. Large scale immigration was encouraged and fuelled the economic engine. Residents of Bombay at all social positions saw increases to their wealth and incomes.

This paper finds that Bombay’s high risk environment encouraged the development of a new security institution. That institution’s form encouraged immigration, economic growth, and increased personal freedoms. These findings skim the surface of what can be discovered through further research into the early modern period of colonial institutions. By researching the early modern period, economic historians are able to learn more about the impacts of different institutions and policies without the burden of the assumptions which accompany modern societies.

THE DETERMINANTS OF JUDICIAL INDEPENDENCE:
STRATEGIC INTERACTIONS BETWEEN STATE COURTS AND
CHIEF EXECUTIVES IN BRAZILIAN STATES
José Mário W. Gomes Neto
Universidade Católica de Pernambuco

The writ of suspension is a civil procedural instrument established by Brazilian Federal Law # 4.348/64. This action is submitted directly to the Courts of Appeals’ Chief Justices with the purpose of suspending the concrete effects of an injunction, or a judicial sentence, from a single judge which allegedly causes damages to the public interest, particularly to the economy, to health or public safety. Only a few actors have the power of submitting writ of suspension, namely the chief executives (and heads of important bureaus) at the three tiers of government, as well as public prosecutors. This instrument has been an important veto point for executive branches at the local, state and federal level in Brazilian political system (Tsebelis, 2002; Alivizatos, 1995) because of its power to guarantee that public policies that reflect their political preferences remain unaffected despite previous divergent judicial decisions.

This research focuses on the analysis of Chief Justices' role in stopping or preserving public policies of fiscal and economic nature. The research tests a number of hypotheses regarding the strategic interaction between the Executive and Judiciary branches and will seek to identify how political competition and institutional design affect the political transaction costs involved in the delegation of power from the Legislature to the Judiciary. These tests will use information from an original dataset on the writs of suspension that is currently being built for the purpose of this research. It is hypothesized that the instrument will be used more in states with less political competition.

This research paper is part of a larger research project entitled Political institutions, policy-making processes and policy outcomes in the Brazilian states, coordinated by Marcus Melo, Lee Alston, Bernardo Mueller and Carlos Pereira.
References: Tsebelis, George (2002). Veto Players: How Political Institutions Work, New Jersey, Princeton University Press.
Alivizato, Nicos (1995). “Judges as veto players” In: H. Doering. Parliaments and Majority Rule in Western Rule, New York, St. Martin’s Press.

INSTITUTIONAL DISEQUILIBRIUM: FORMAL INSTITUTIONS IN
CULTURAL SPACE. A CASE OF TERRITORIAL REFORM IN POLAND
Lukasz Hardt
Warsaw University

This paper explores the impact of institutional factors on the path of territorial reform in Poland. I argue that the failure of that reform, particularly at the county level, resulted mainly from institutional disequilibrium, namely incoherence between formal institutions (e.g. law promoting decentralized state) and informal ones (e.g. no tradition of self-organized local communities).

In many post communist-countries, informal institutions contradict formal ones, which means that formal law competes with informal norms of conduct, routines, and social norms. Competition between formality and informality often results in institutional disequilibrium, defined as incoherence between formal and informal institutions (North 1990). Incoherent institutional structures produce inefficient outcomes. Moreover, this kind of disequilibrium is often accompanied by cognitive disequilibrium, i.e. incoherence between the external world and agents’ mental models (beliefs) about that world (North 2005).

In order to verify the hypothesis, a simple empirical case study was designed. The pilot research was carried in one county. The empirical investigation was based on the analysis of citizens’ complaints submitted to the chief office of the county. The case study confirmed the existence of a contradiction between decentralized relations among three levels of local authorities and peoples’ mental representations of those relations. It was found that the majority of the complaints concerned poor functioning of the commune, though there was no legal interdependency between the commune and the county. However, people continued to think that the county controlled each activity of the commune, which had been true before the decentralization of pre-existing hierarchical structure of local authorities. The conclusion was that there were present institutional and cognitive disequilibria.

The preliminary empirical findings could serve as some proposition for modifying and further applying more in-depth study on these issues. The results from the extended version of the project could deliver enough interesting information for working out a theoretical framework that could be used in analyses of institutional and cognitive disequilibria.

References: North, D.C. (1990), Institutions, Institutional Change and Economic Performance, Cambridge University Press, Cambridge.
North, D.C. (2005), Understanding the Process of Economic Change, Princeton University Press, Princeton-Oxford.

INSECURE ENTITLEMENT TO WATER IN RURAL TANZANIA:
THE ROLE OF POWER AND INSTITUTIONS
Exploring a new institutional economic framework for analysis
Els Lecoutere
Ghent University

Water insecurity threatens rural livelihoods in Tanzania. Water scarcity is an issue, but equally important are institutional reasons. In rural Tanzania, parallel and competing institutions are in place for securing entitlement to water. The institutional arrangements often result in uncertain and inequitable entitlement to water and open opportunities for ‘forum shopping’, elite capture, and conflicts.

The modified water policy could instigate institutional change potentially resulting in more secure and equitable entitlement to water. Nonetheless, little change is observed. Possibly, the policy is contextually ill-adapted. Unintentional ‘stickiness’ of institutions can be a partial explanation. But the status quo is probably intentional to some extent. Powerful actors, gaining power and benefits under current institutions, are also in a better position to shape institutions and inclined to the status quo. This study will focus on the mechanisms by which powerful agents can influence institutions and institutional change.

An institution is viewed here as a self-sustaining system of shared beliefs about how a game is played, based on a summary representation of the equilibrium path. This governs agents’ strategic interactions and, as such, results in a reproduction of the institution. In this framework, insights in power from sociology and political sciences are integrated.

Power can be exercised by indirectly changing one’s behavior via influencing his beliefs and through constraining possibilities. First, powerful agents able to manipulate others’ cognitive frameworks – or beliefs- about the ‘rules of the game’ and thus the reproduced institution. Secondly, the elite have information advantages on opportunities and different institutional arrangements. Asymmetric information will engender a constrained set of strategies for the less powerful and less knowledgeable.

A second dimension of power is the ability to directly change the behavior of others. In this regard two mechanisms are distinguished. First, agents’ strategies are socially embedded, thus framed in power and dependency relations. Consequently, the ‘water game’ is conditional on a ‘social exchange game’ when powerful agents can punish others in the social domain, making it a rational decision to consent with the powerful. Secondly, decision making procedures and governance structures and thus the game form assign power to the players. As a result, one of the players may be effective for a constrained set of outcomes by directly eliminating other possibilities.

OFFICIAL STANDARDS FOR FRESH PRODUCT IN BRAZIL:
WHY DO AGENTS NOT ADOPT THEM?
Cíntia Retz Lucci, Decio Zylbersztajn
USP – São Paulo

Why are official standards not adopted in the market for fresh food in Brazil? Despite the advantages widely claimed by economic theory, official standards are proposed but not adopted. Agricultural markets include uncertainty derived from inherent characteristics such as variability and perishability. Standards homogenize goods, leading to more competitive markets. It is to be expected that agents will adopt standards to reduce variability.

However in the major Brazilian wholesale markets, the present grade system is unpredictable, and agents have been refusing to accept new official standards. Products are classified according to the quality observed and then the prices are established. Each day a new grade is ascribed. In some cases, not only do prices oscillate daily, but also what is defined as grade “A” today might be considered grade “AA” tomorrow.

Since the official standard is voluntary, we assume the adoption is an organizational decision of each firm. Two hypotheses are made. Agents will face benefits and costs before and after the adoption of a new standard. If the costs are higher than the expected benefits, agents will reject the standard. According to the “governance perspective”, even when net gains are expected, agents tend to resist standard adoption if it requires specific asset investment and safeguards will be required in order to protect quasi rents. The second hypothesis is, according to the “measurement costs approach”, the lower the cost of measuring, the higher will be the chance that the attribute will become standardized. Thus, measurement costs of attributes based on official standards are affecting standard adoption.

Empirical analysis is focused on fresh tomato wholesaler-retailer transactions in the main Brazilian wholesale market. The research integrates analysis of the contractual arrangement and market structure of the agents involved in the transaction with statistical tests of the causal relations between official standard adoption and measurement costs and asset specificity. Data sources are a survey of wholesalers and retailers, and exploratory interviews with wholesale market agents.

Long ago, public administration spent resources trying to introduce unambiguous standards. The results here may contribute to public policy by showing the determinants based on efficiency principles that are confounding the implementation of standards.

COMPARING THE PERFORMANCE OF PUBLIC AND PRIVATE WATER COMPANIES IN RUSSIA
Roman Martusevich
State University - Higher School of Economics

Despite recent improvements (laws on tariffs, on concession agreements), remaining institutional and regulatory weaknesses are key factors explaining why water supply and sanitation infrastructure in Russia is highly deteriorated and inefficient, while the financial state of most municipally-owned water companies is so poor. This includes the ambiguity of responsibility-sharing (and even the absence of contracts as such), inadequate tariff regulation not creating strong incentives for efficiency.

The Russian Government considers private sector participation as the only remedy, assuming that the private sector is always more efficient than the public sector, and giving preferences to concessions.

Domestic private operators entered the water supply and sanitation sector in 2003, now servicing some 10% of urban population under long-term lease contracts. Some of them took investment obligations. The key problems they faced were identified in earlier studies (OECD, 2004).

But the international experience (Tukuman, Buenos Aires, Manila) and new institutional theory (Williamson, Guasch) show that concessions in developing countries, with unstable political environment and weak regulatory capacity, face many problems. The empirical evidence from various surveys suggests that there is no systematic difference in efficiency between public and private operators (Estache & Rossi, 1999). This research aims to identify whether and why the private sector in Russia performs better or worse than the public sector. Performance will be assessed against objectives, and the sector’s averages and trends. The answer why will be found through assessing:

- the competitiveness of the contract award process, criteria for selecting operators, scope of contract obligations, and their implementation in practice;
- regulatory, judicial and other institutions.

So far the author has collected data on key domestic private operators in Russia and the packages of contracts they concluded in several municipalities. Missing data will be collected using special questionnaires.

PATENT RIGHTS INDEX IN COUNTRIES IN TRANSITION
Arina Matvejeva
University of Delaware

How do changes in the institutional environment impact economic performance? How important is the legal framework? In our study, we extend the analysis of the development of intellectual property rights systems to countries of Eastern Europe. To determine whether stronger intellectual property rights protection results in a better diffusion of technology, we calculate patent rights indices for five former socialist countries (Estonia, Hungary, Kazakhstan, Latvia, and Russia) over a period from 1989 through 2005. We then compare the results to the ones obtained for two other developing countries (India and China). The index represents an economic indicator of a given legal system. It includes five different categories that determine the level of patent protection in a country.

The data show big progress made during the 1990s restructuring the old soviet system of intellectual property protection. We also find substantial disparities among the countries studied. The first extension of the work that we would like to pursue would be to link empirically the development of a patent system to economic performance, and the level of innovation (research and development investment expenditure) and foreign direct investment in particular. For the latter purpose, there might be a need for a data collecting survey in the studied countries. We argue that patent right systems should not be analyzed separately from the surrounding economic environment, and the inclusion of such variables as general business climate and educational levels might be helpful in understanding transfers of technology. The second extension would be the inclusion of a greater number of countries and the analysis of their patent systems over a wider time range.

When studying the evolution of intellectual property rights systems, countries in transition constitute a kind of natural laboratory. The results obtained can have implications in law and economics for other countries.

ASSESSING THE ROLE OF LABOR MARKET POLICIES AND
INSTITUTIONAL SETTINGS IN SOUTHEAST EUROPE
Maja Micevska
University of Klagenfurt

The potential incompatibility of employment protection legislation (EPL) with the flexibility required for firms and national economies to prosper today has occasioned much debate and a growing body of research. The central question has been whether excessively strict EPL has been an important contributor to the persistently high unemployment experienced in many OECD countries since the early 1980s. Naturally, empirical research to date has mostly used data on EPL for OECD countries.

This study presents new data that describe the EPL and other labor market institutions and policies prevailing in seven Southeast European countries (Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Macedonia, Romania, and Serbia and Montenegro) in the late 1990s and early 2000s. The main contribution here has been to construct the EPL indices following the methodology used by the OECD. This offers the possibility to extend the international comparative analysis of the strictness and impact of EPL to a wider range of countries.

The new data provide the basis for a reassessment of the links between EPL and labor market performance. The analysis strengthens the conclusion of prior studies that the EPL index has little or no effect on overall unemployment. In addition, the effect of overall EPL index on the demographic composition of unemployment is quite weak. However, both the bivariate and the multivariate analysis support the hypothesis that a stricter regulation of temporary employment leads to higher unemployment for women and younger workers, as well as to lower employment and labor force participation rates. This is a novel result that might be important for informing policy choices when it comes to choosing the best mix of EPL components.

One policy implication is that in the SEE countries the limits of possible deregulation have not yet been reached as far as temporary employment is concerned. As labor market conditions evolve, the focus on initiatives to relax regulation of temporary employment would contribute to eliminating some of the barriers to employment for women, youths and other labor force groups that may face difficulties in gaining access to stable jobs.

CONTRACTUAL CHANGE IN DISTRIBUTION AGREEMENTS
Michelle Mullins
University of Missouri-Columbia

The study of contract use in the wine industry is not new. The relationship between long-term contracts and product quality attributes in the wine is highly documented, but documented strictly in terms of the relationship between a winery and its input markets (Goodhue, et al 2003). There is little analysis on the effective use of contracts between the winery and its distributors, although many of the same product quality characteristics can be said to apply.

Williamson’s Transaction Cost Economics theory suggests that long-term contracts will predominantly be found in environments where there is a medium level of uncertainty, a medium level of asset specificity and a significant level of transactional frequency. The relational agreements between domestic wine suppliers and wine distributors falls within this description, but only because most states have franchise laws that allow for wholesaler exclusivity of winery products once an agreement is reached. In some states those same franchise laws prohibit the supplier from terminating the wholesaler except in the case of “good cause”, which can be extremely difficult to prove. This implies that once a supplier enters a wholesale agreement, it essentially becomes a long-term contract, desired or not. The opposite is not true for wholesalers, which may terminate an agreement at virtually any time and as easily by not re-ordering additional product. These characteristics results in a one-sided long term contract, with the majority of the benefits to the wholesaler.

Wine distribution agreements have historically been oral agreements between the winery and the wholesaler, but given the changing atmosphere of the wine industry and the increasing quality-price attributes of wine and specific brands, we should expect to see a movement away from oral contracts to formal long-term contracts including specific performance evaluation measures that could justify termination on the supplier’s side. This paper attempts to determine whether changing market demand for wine brands and quality and changes in state restrictions on direct shipment of wine to consumers lead to changes in the contractual structure of supplier and wholesale agreements within the wine industry.

INSTITUTIONAL STRUCTURE AND COLLECTIVE ACTION FOR
SUSTAINABLE FOREST MANAGEMENT: A CASE STUDY OF
PARTICIPATORY FOREST MANAGEMENT INSTITUTIONS IN ORISSA
Bibhu Prasad Nayak
Jawaharlal Nehru University

Participatory institutions for the management of natural resources like forests have a long past in India as well as in other part of the world, and this has evolved with a continuous human-natural resource interaction. During colonial rule these resources were nationalized without due importance to traditional common property institutions; this has made these resources de facto open access resources and consequently faced the ‘tragedy of the commons’. Inadequate and inefficient management of state ownership, market failure, increasing dependence between livelihood system and natural resources and the widespread concern for sustainable development have led to the evolution of alternative institutions for management of natural resources. There are two types of participatory institutions in operation for the management of forests in Orissa, a state in the eastern part of India. These are (1) self-initiated management groups called Community Forest Management (CFM) institutions, and (2) forest department initiated Joint Forest Management (JFM) institutions. A certain level of collective action is required for the sustainability of these participatory institutions. The incentives structure and the stakeholder involvement influence the level of collective action significantly and vary across institutional structures.

This paper analyzes the evolution and performance of CFM and JFM in Orissa by using the Institution Analysis and Development (IAD) Framework. The empirical analysis uses data from six forest-protecting communities representing participatory forest management institutions in two forest divisions of Orissa. A conceptual model of the different levels of participation and their linkages is tested through econometric analysis, using data for 370 households across six communities. It is found that CFM institutions are characterized by increased levels of awareness and participation when it comes to the design and implementation of institutional rules. JFM institutions have benefited people in terms of creating employment opportunities and dealing with inter-village boundary conflicts. Both types of institutions have inherent weaknesses that affect the level of collective action for sustainable management of the forest. The weaknesses associated with CFM institutions can mostly be attributed to government policy that does not recognize CFM institutions and hence does not extend the benefits meant for forest- protecting communities.

MARKET DISCIPLINE AND DEPOSIT INSURANCE:
THE CASE OF RUSSIAN MARKET FOR PERSONAL DEPOSITS
Maria Semenova
State University - Higher School of Economics

Like any other financial service market, the market for bank deposits is exposed to information asymmetry problems: all deposits are characterized by some probability that the bank will not be able to repay due to default, but the depositors’ ability to change the characteristics of the deposit supply in response to excessive risk-taking is rather questionable. The deposit insurance institution is aimed to protect small depositors as regulators perform the monitoring more effectively than they do. The main problem related to deposit insurance is a moral hazard one. Even those depositors who have the ability to discipline their banks stop doing so, having the explicit guarantees of repayment. Enjoying the absence of market discipline, banks prefer to invest the accumulated funds into riskier projects which yield more (at a price of higher risks) and to offer higher interest rates. Therefore the tool aimed to provide banking system stability might have an opposite effect, if the introduction of the deposit insurance system removes the incentives to discipline banks.

This paper investigates whether institutions of market discipline exist in the Russian personal deposit market, i.e. whether depositors react to changes in fundamentals, characterizing banks’ additional risk-taking by requiring higher interest rates, withdrawing their deposits, or switching to short-term or on-call deposits. In the end of 2003 mandatory personal deposit insurance was introduced in Russia. August 2006 witnessed a rise in the maximum amount of compensation. Thus the aim is to test whether depositor discipline differs for different groups of banks (state, private, foreign) and whether it disappears with banks’ admission to the deposit insurance system, using panel bank-specific data over the period April 2004 – July 2006.

The analysis reveals that foreign banks’ depositors exert virtually no discipline either by quantity or by price. State banks’ clients use quantity-based discipline mechanism, but the only significant characteristic is bank size (in terms of assets). Maturity shifts exist for time deposits, but the introduction of the deposit insurance system reduced them significantly. Private domestic banks’ depositors exert discipline by quantity (choosing a larger bank), by price, and by switching from on-call to long-term deposits; the deposit insurance system introduction did not remove this discipline.

DID PRIVATIZATION TRIGGER THE PHENOMENAL GROWTH
OF THE ICELANDIC BANKS?
Throstur Olaf Sigurjonsson
Reykjavík University

The growth and international expansion of the Icelandic privatized banks has been striking. The three major players have enjoyed asset growth of about 400% from year 2002 to the end of year 2005. All three banks come from privatization roots. The economy’s growth performance has likewise been impressive. Real GDP has grown by just below 5% per annum over the last decade which is substantially better than OECD growth during that period. The research question to be answered is whether privatization triggered this growth of the Icelandic privatized banks. When performances of foreign privatized banks are analyzed, results are both positive and negative. Privatization alone does not always seem to significantly impact profitability or operating efficiency. When privatization in Iceland is analyzed in general, there can only be seen considerable operating improvements within the banking sector. Other privatized industries do not do better than private comparable companies.

Variables to be analyzed in this study are both internal and external. There was a strong liberalization program in Iceland prior to the privatization that might have delivered major constructive changes in favor of the banking industry. There were also internal parameters such as changed ownership structure, different strategies, management style, strong incentive systems implemented, as well as an aggressive banking culture. Some of these parameters seem to be very specific for the Icelandic case. There was a total generation shift within management teams, unheard of incentive systems were implemented, investment banking culture was brought in, and new strategies were all about aggressive internationalization.

This study aims for concluding what triggered impressive results in post privatized Icelandic banks and whether specific Icelandic key success factors can be identified and exported to other countries. The study also compares privatization success of the banks with other privatized industries.

VERTICAL INTEGRATION TRENDS IN THE BULGARIAN
PHARMACEUTICAL SECTOR: A CASE STUDY
Tamara Todorova
American University in Bulgaria

Some economic explanations of vertical integration stem from monopoly considerations and rent seeking. Others justify integration on the grounds of economies of scale and scope resulting from mergers. A third group of theories maintain that it is technologically determined. While all those might partly be reasons for vertical integration, transaction costs seem to be its major determinant. The paper takes on a transaction cost approach to study integration trends in the newly emerging Bulgarian pharmaceutical sector. We use Oliver Williamson’s definition of asset specificity to explain many of the organizational transformations Bulgarian pharmaceutical companies are undergoing. Having special attributes, their products and assets seem to favor a larger size of the companies. As assets become more specific to a single use and, therefore, less transferable to other uses, parties become more open to opportunism and require the special protection that integration can supply. Extending Williamson’s model we find that that asset specificity increases the profitability of producing to one’s own requirements, while decreasing that of market procurement.

In its second part the paper discusses the tendency of three major pharmaceutical producers in Bulgaria to integrate forward into wholesaling and retailing. These attempts are curtailed by Bulgarian legislature that forbids vertical integration in the sector. We use transaction costs justifications to argue in favor of vertical integration. In particular, we stress that forward integration into wholesaling is observed for products that need coordination of marketing and distribution where branding is practiced. Product differentiation is essential for non-generic medicines for which the need for proper advertising determines ownership of wholesaling. Forward integration into retailing extends the case of ownership of distribution where special handling and proper representation of the product are important to the sales of the product. Nondurable medicines often require such special handling. Medicines require information, special demonstration, and proper display, which also determine the ownership of retail stores. Furthermore, as a low-trust, high-transaction cost economy, the Bulgarian economy dictates that a larger scale of operations be internalized within firms rather than carried out by the market.

INFLUENCE OF ECONOMIC ZONES ON EMPLOYMENT AND WAGE GROWTH IN UKRAINE: REALLOCATION EFFECT OR ALTERNATIVE JOB MARKET
Maria Vyshnya, Olena Nizalova
Kyiv Economics Institute

Economic zones broadly implemented around the world are aimed to create formal institutions necessary to encourage business to locate to depressed areas. Regardless of the optimistic purpose, the existing economic zones (EZ) produce controversial results. For instance, some of the previous studies have emphasized positive impact of EZ on job creation. However, there is no evidence that the employment growth in economic zones is not due to reallocation of labor from other territories of a country. Similarly, EZ impact on wages is hazy as well.

The major reason for the inconsistency of previous findings is methodology. First, previous papers ignored institutional characteristics of the zones and merely concentrated on the presence or absence of the project jurisdiction in a particular time. Second, regional and demographical characteristics of the territories were mainly beyond the scope of the analysis.

This paper seeks to improve the methodology of estimating economic zones’ impact. First, we extend the notion of an economic zone via elaborating a wide range of program treatment variables that consider institutional characteristics (e.g. expected duration of the program, structure of the offered tax incentives bundle, employment and capital investment requirements etc). Second, combination of the difference-in-difference (DID) and the propensity score matching (PMS) technique with the random growth rate approach allows addressing criticism about reallocation of resources as the major source of EZ projects success. The former techniques estimate differences in employment (wage) changes between treatment and control groups. The latter approach emphasizes the overall impact of the project on employment and wage growth. Hence, modest results of the random growth rate model accompanied by positive outcomes of DID and PMS technique presume that the EZ job market absorbs under-utilized labor from other regions of the state. Alternatively, positive results for the entire combination of econometric techniques signal that employment and wages grow since an economic zone job market is created.

Our analysis covers the entire bundle of 21 economic zones in Ukraine and exploits panel data on 693 rayons (small administrative units in 25 regions and the Republic of Crimea) for the period 1995-2005.

LAW, TECHNOLOGY AND ECONOMICS: COMPARATIVE AND ECONOMIC ANALYSIS OF ELECTRONIC SIGNATURES LAW AND ITS IMPLICATION ON THE LAW OF INFORMATION AND COMMUNICATIONS TECHNOLOGY
Minyan Wang
University of London

This research explores how law influences people’s behavior in online transactions and related markets in the area of technology, and how law should be designed to promote technology innovation and economic development. To explore these issues, it investigates the particular technology of electronic signatures (e-signatures) and their related markets such as the certification service market and the e-signatures industry. The main research questions include what is the landscape of current e-signatures laws around the world; whether these laws are “efficient” in achieving their goals; the implication in the design of ICTs law; and how new institutional economic theory can be applied in the situation of China.

It will employ comparative methodology to answer the first question because law is deeply underpinned by the historical, cultural, political, economic and technical development in each jurisdiction. Specifically, it uses four countries with completely different backgrounds as case studies: the US, the UK, Germany and China. It then uses economic analysis to answer the second question. Recognizing different backgrounds in different jurisdictions, it will apply economic theory by seeking the similarities, and then consider whether different backgrounds change the conclusions. The comparative study finds that three key issues are addressed by different jurisdictions. They are (i) promoting the adoption of e-signatures in online transactions by offering legal effects to e-signatures, (ii) the regulation of certification authorities (CAs) in the certification service market, and (iii) technology innovation and market competition. However, different approaches are adopted when addressing these issues. Therefore, it will first address how different levels of legal recognition of e-signatures influence people’s decisions to adopt e-signatures and how they impact on the parties’ behavior during the legal process if a dispute arises. Second, is the regulation of CAs “efficient” in the certification service market? Third, how does the law influence technology innovation and market competition among different e-signatures technologies? Last, it will look for implications for the design of ICTs laws in order to promote economic and technological development.

INTERNATIONAL FLOWER NETWORKS:
TRANSACTION COSTS IN GLOBAL CHAINS OF EMERGING PRODUCERS
Jo H.M. Wijnands, Jos Bijman
Wageningen University

In past decades, developing countries experienced a rapid growth in their exports of highly perishable horticultural products to developed high-income countries, such as the export of flowers from East Africa to Europe. One of the challenges for East African flower producers is to choose a proper international marketing channel. With no domestic market, these producers highly depend on international customers.

This paper describes the structure of international flower chains, using a Transaction Costs Economics (TCE) perspective. It discusses the presence of the classical governance problems of asset specificity and uncertainty (both environmental and behavioral), and how growers deal with these problems. Interesting from a TCE perspective is that growers first choose a marketing channel and then adjust the transactions (by choosing different products) to these governance structures. Basically, flower producers have two options as marketing channel: through the auction in The Netherlands or through contracts with retailers. These channels correspond with the governance structures ‘market’ and ‘contract’ (or hybrid). A significant part of the growers actually use both marketing channels, implying that the governance structure does not fully solve the governance problems.

The description and analysis of the flower chains is based on original empirical data. The dataset consists of two survey samples. In 2005 interviews were held among Kenyan growers. This resulted in a survey of 24 growers, corresponding to 27% of the identified Kenyan growers. Ethiopian growers were interviewed at the end of 2006 which resulted in 35 surveys, 70% of the population. Preliminary results of the Kenyan case showed that the firm organization differs significantly between the two market channels. Auctions provide transparent markets and guarantee buyers for all quantities within the industry standards, thus reducing search, negotiation, and monitoring costs. Higher levels of marketing by auctions result in less personnel involved in these transaction activities. Higher levels of auction marketing also correlate with a smaller number of flower varieties produced per grower. Direct sales to retailers require more varieties of flowers, due to consumer preferences of differentiated products. The paper will elucidate other differences between chain governance structures and between the two countries, Kenya and Ethiopia.

REGULATORY STABILITY AND ORGANIZATIONAL FORM:
AN EXAMINATION OF THE INTERNATIONAL INVESTMENTS
OF A MULTINATIONAL HOTEL FIRM
Nathan Wilson, Francine Lafontaine, Rozenn Perrigot
University of Michigan

Using a large proprietary data set, we explore the impact of regulatory conditions on the organizational form decisions of a large multinational hotel firm. We derive our motivation from a combination of theories from the franchising and institutional economics literatures, which suggest that organizational form decisions will be influenced by the regulatory stability of the host country. To proxy for this factor, the paper uses Witold Henisz’ POLCON variable, which is based on the number of potential vetoes a policy faces before being enacted.

We hypothesize that regulatory instability impacts organizational form decisions in two ways. First, by raising the likelihood of hold-up activities by local officials, an increase in regulatory uncertainty is expected to reduce the desirability of organizational forms in which the firm shoulders the bulk of the financial risk. Second, we argue that a more uncertain policy environment is linked to diminished confidence in the enforceability of contracts. Therefore, if there are important reputational externalities, then greater policy instability should cause the firm to prefer organizational forms in which it retains operational control rather than forms in which local agents are contractually obliged to perform in ways that protect the firm’s intangible assets.

The hotel industry presents an excellent case to test these hypotheses because individual units take one of three different forms, which differ in the extent to which the firm is involved in the financing and operation of the unit. Using a multinomial logit specification, we find considerable support for our hypotheses. In countries with high regulatory uncertainty, the firm overwhelmingly utilizes an organizational form that reduces its financial exposure yet allows it to retain operational control. This result has implications for recent research that has sought to refine the standard principal-agent model of contracting to bring it into greater agreement with the empirical literature in terms of how risk is supposed to impact contracts.

INSTITUTIONAL ANALYSIS OF BANK REGULATION AND SUPERVISION:
TURKEY AND POLAND
Orhan Hilmi Yazar
The University of Sydney

The rise in the number of banking crises since the 1980s has made banking regulation and supervision a crucial and contested element of economic policy making. The objective of banking regulation and supervision is to maintain stability in the banking sector and allow accommodation of savings and investments without interruptions. The debate about the design of banking regulations and the most appropriate tools of supervision has become popular with the East Asian Financial crises in 1997. The unexpected fall of successful East Asian economies altered paradigms about these countries around the world ,especially within the international financial organizations like IMF and WB. The “miracles” have become corrupted and were associated with crony capitalism and bad governance. The blame was put on lack of prudential supervision and regulatory forbearance. This diagnosis led the international community to propose an extensive good governance agenda in the region.

My current research project examines the institutional underpinnings of economic policy-making and implementation in the area of bank regulation and supervision. I investigate the regulatory policies and their application, with a specific notice on supervisory processes, in Turkey and Poland since the liberalization of financial markets within these countries. Turkey, with a record of highly volatile financial sector and its changing regulatory environment over the course of years provides an excellent case to study the role of institutions in this specific policy area. Poland’s experience with its prudential reforms and supervision is the control case for the research findings attained in the Turkish case.

The significance of the issue has increased with greater pressure for harmonization in banking regulation and supervision around the globe. The initial 1988 BASEL Accord setting regulatory best practices for G-10 is now in use in 120 countries. BASEL II initiative, which is to be implemented in 2008, has even now become an inevitable part of the regulatory debate, not only in G10 but also in many developing countries. Understanding the role of institutions in the course of interpretation and importation of ‘best practices’ besides domestic regulatory practices is crucial to assess the impact of the BASEL II in the near future.

COMPENSATORY CONTRACTUAL ARRANGEMENTS:
AN EFFECTIVE APPROACH TO IPR PROTECTION
Yan Zhou
Sun Yat-Sen University

Since China adopted the policy of economic openness and reform in the late 1970s, developed countries have imposed tremendous pressure on Chinese intellectual property issues. In recent years, with the expansion of foreign direct investment and international trade, the pressure becomes stronger. In many reports, such as Special 301, China hasn’t adequate and effective intellectual property protection.

Essentially, Intelligence Property Rights (IPR) are the property rights of ideas. Ideas are a highly valuable and economically significant resource (Cheung, 2005). According to the Coase theorem, if property rights cannot be well protected, the supply of ideas will be inefficient. For the society, investments and innovations become less and less. However, we never find this happen in China. On the contrary, China has become the NO.2 country spending on R&D in 2006.

The situation above results in a question: if China really hasn’t effective IPR protection, what can explain the great flow of FDI and the innovations there? The key point to answer this question is how we measure the protection of IPR. The method to measure IPR protection in the reports must lose something important.

The measurement of IPR has been a concern for many scholars and practitioners. But the scarcity of such research needs more attentions. Almost all the scholars follow this method——Law Measurement and Enforcement Measurement. But legal protection, which is constrained by transaction costs, is not the only way to protect IPR. This paper presents an alternative approach to IPR protection, Compensatory Contractual Arrangement (CCA).

In some industries in China, such as the automobile industry, the equity percentage is restricted to a legal maximum by the government. Under this condition, if compensating payments do not take place to the extent of restoring the resource use, few investors will allocate their resource there. Some adjustments were observed. Specifically, the existence of CCAs, such as patent license, besides the main JV compact, make sure that different forms of arrangements may imply the same effect of resource use. In the contractual arrangement, IPR can be protected well. On the one hand, foreign investors can share the profit JVs make, on the other hand they can get complete license fee, because every product is supervised by them. CCA is an efficient way to protect IPR, though it’s very difficult to be quantitatively measured.

TRANSITIONAL INSTITUTION FOR THE EMERGING LAND MARKET
IN URBAN CHINA
Jieming Zhu
National University of Singapore

Chinese economic reforms since 1978 have been a continuous process of fundamental institutional change. The new institution of ambiguous property rights over state-owned urban land evolves from the socialist people’s landownership. This institutional change is driven by two new organizations – the local developmental state and danwei-enterprises. The new institution facilitates the formation of an emerging land market. The land market, structured by ambiguous property rights, has accounted for the dynamic urban physical growth in many of China’s coastal cities in the 1980s and 1990s. Nevertheless, massive rent dissipation induced by the new institution does not provide market certainty, nor does it offer incentives for optimal development. The cost incurred by the institution is gradually overtaking its benefit (to create a land market). The ambiguous property rights are deemed to be a transitional institution during the development of land markets in urban China. Private zoning emerges to enhance efficiency of land development.