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Climbing the Hierarchical Ladders of RulesThe
Dynamic of Institutional Frameworks

• Eric BROUSSEAU
• (EconomiX, U. Paris X IUF)
• Emmanuel RAYNAUD
• (INRA SADAPT ATOM, U. Paris I)

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Motivation
Two main views of institutions in economicsand
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
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Motivation
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)
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Our contribution

• We provide an endogenous justification for
  contrasted paces of change across institutional
  levels of order provision
• We explain how and why institutions at one level
  might climb the institutional ladders

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Outline

• Logic of collective order formation gt
  Sponsored Orders
• Incentives to climb the institutional ladder
• gt Competition among Orders
• Strategic Interplay among Sponsors
• gt Coopetition among kernels

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Functions of governance levelProvision of an
order
Governance Managing interactions through the
definition of property rights
Rules enforcement
Rules setting
Provision of an economic order
Rules setting
measurement cost
Enforcement costs
Transaction costs
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Analytical Framework

• Assumptions
• Heterogeneity of agents
• Coordination Trade and Provision of Collective
  Resources
• Distance/Proximity territorial, preferences,
  agents characteristics, etc.
• Minimization of Private Transaction Costs (mix of
  seek for efficiency and rent seeking)
• Process of Emergence Collective Governance

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Convergence/Divergence of Interests
Coordination Game Rule 1 Rule 2
Rule 1 (2, 2) (10,10)
Rule 2 (10,10) (2, 2)
Battle of Sexes Rule 1 Rule 2
Rule 1 (3, 6) (8 , 10)
Rule 2 (8 , 10) (5, 1)
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The Evolution of the Bargaining Game
Battle of Sexes Rule 1 Rule 2
Rule 1 (3, 6) (8 , 10)
Rule 2 (8 , 10) (5, 1)
Battle of Sexes Rule 1 Rule 2
Rule 1 (2, 5) (7 , 12)
Rule 2 (7 , 12) (5, 1)
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Dynamics of the Evolution of Institutions

• Insight Alternative governance levels pertain to
  a common life-cycle model of institutional
  evolution
• Main argument Like lava, some local institutions
  spread and froze and become generic

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Dynamic of Institutions
Mandatory
Generic institution
Local
Global
Intermediate institutions
Negotiable
Bilateral institutions of governance
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Benefits/Costs of Collective of Governance
The Centralization Tradeoff

• Static Mal-adaptation(Increasing heterogeneity
  of Individual Preferences)
• Dynamic Mal-adaptation (Reduced Renegotiability)
• Information costs (Increasing Information
  Asymetries)
• Enforcement Requirements (Increasing Incentives
  to Free Ride)
• Private Capture(Increasing Incentives to distort
  coll. Gov. in favor of a minority)

• Scale Scope Effects
• Learning and Specialization Benefits
• Reduction of Collective Welfare Losses(Increased
  consistency among local rules, Internalization of
  externalities, Positive network effects in the
  use of common standards of interactions, )

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The Emergence and Evolution of Institutions 0
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The Emergence and Evolution of Institutions 1
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The Emergence and Evolution of Institutions 2
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The Emergence and Evolution of Institutions 3
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The Emergence and Evolution of Institutions 4
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Local orders become generic

• Why is there incentives for local institutions to
  grow?
• Direct positive network externalities
• Expansion widens the scope of low TCs deals
• Indirect positive network externalities
• New adopters reinforce the attractiveness of a
  given institution
• ? Competition among local institutions
  // standard race

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Negotiable orders become rigid

• Local institutions are voluntary devices
  ? exit is always possible
• Quality of the collective rules has to be
  enhanced to meet external optionsRules that are
  initially rough become more efficiently designed
  and more tailored to particular needs
• Exit options reduce and disappear
• ? At the end of such process, there is no longer
  margins of negotiations

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Incentives to climb the institutional ladders

• To sum up with the passing of times
• Incentives to expand Winning local
  institutions become more attractive and face less
  competitive pressure
• Incentives to enhance efficiency initial rules
  become more complete and broader in scope
• ?
• Reductions of both outside options and margins
  for negotiations
• The individual benefits of membership increase
  and the outside options decrease Emerging
  institutions shift
• from local to global
• from negotiable to mandatory
• They become frozen

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Horizontal Competition
Main enabling ConditionNature of the
Instit. Informal formal
Main Causal FactorStruct of Rel.
Network Distant Intertwined

• Competitive Decisions by kernels
• Improving Efficiency (Uniform
  Reduction of TCs)
• Switching Cost Manipulation (Rising
  acquisition costs)
• Poaching of Go-Betweens
• Explicit Merger
• gtKernels members drivers of formalization
• while Formalization make their position
  contestable

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Vertical Competition as the Driver of
Institutional Change and Efficiency Gains
A cross section view
Step 0 Step 1 Step 2 Step 3 Step 4
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Vertical Competition
Available Decisions by kernels of Frozen Institutions Available Decisions by kernels of Frozen Institutions
External Competition of Successful Local Institutions Internal Competition to take Control of the Formal Levers of the Generic Instit
Eradication/Confinement Substitution Recognition Strengthening Power Allowing negotiations and Compromises
Doomed to failure Cognitive boundaries Increase internal competition (while mutual recognition) Increasing amount of resources dedicated to a zero-sum 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