Public and Private Transactions in the Shadow of Coercive Power
Gani Aldashev (ECARES)
Giorgio Zanarone (CUNEF)

Abstract : We study a simple economy where a seller may either deal with a private buyer or with the state. We show that to induce the seller to transact, the state’s ruler must establish different kinds of reputations in the two governance regimes. Under public contracting, the ruler must credibly commit to compensate the seller. Under private contracting, the ruler must commit not to expropriate the seller and to enforce the buyer’s promise to compensate her. Thus, it is comparatively harder (easier) for the ruler to establish the reputation necessary for private contracting when political constraints on expropriation, and judicial institutions supporting ruler’s enforcement, are weak (strong). This implies that in contrast with the conventional wisdom, contracting with the state creates, rather than destroying, value under weak institutions. Our model provides a theory of the costs and benefits of privatization, the optimal patterns of foreign direct investment, and more generally, the optimal allocation of contracting roles among public and private actors.

Property Rights, Transaction Costs, and the Limits of the Market
Carmine Guerriero (University of Bologna)

Abstract : Although property rights and transaction costs are key, their determinants and interaction are still poorly understood. Within trade interactions, a rise in transaction costs has the marginal effect of inefficiently pushing some high-valuation potential buyers to expropriate the original owners' property and the infra-marginal one of decreasing the social gain from the transfers that are still consensual. Then, it must also reduce the protection of property rights, which gages the probability of unsuccessful expropriation. This pattern holds true regardless of whether transaction costs are driven by frictions outside the control of traders or determined by the mix of the dispersion in their valuation and either the original owners' market power or their privileged information. A similar conclusion applies to an upstream firm's property rights on an ex ante non contractible input necessary to a downstream firm to introduce a new technology. This time, transaction costs rise with the likelihood of a more productive technology. These implications survive if a group of traders/innovators has a larger political influence on institutional design and if the disincentive effect of weak property rights is considered. The model predictions are consistent with the negative effects of proxies for market frictions and failures on measures of the protection of personal, intellectual, and financial property that I document for a panel of 135 countries spanning the 2006-2015 period. This evidence suggests that the negative correlation between weak property rights and economic outcomes might be partly spurious.

Markets, Institutions, and Transaction Costs: the Endogeneity of Governance
Geoffrey R.D. Underhill (University of Amsterdam)

Abstract : Much of the literature contrasts the dynamics of free markets with the ‘political’ dynamics of governance. This dichotomy leaves us blind to the empirical observation central to institutional economics: that complex market systems and institutions of governance cannot be found apart. Even as an analytical distinction, binary market-hierarchy distinctions obscure the ways in which interaction among real-world economic agents is constitutive of the wider processes of formal and informal governance that shape the terms of competition in the first place. Institutional economics has explored the relationship between markets and firms, governance institutions and economic performance, and why societies choose inefficient institutions, among other crucial questions in political economy. Yet we have no theory of the precise relationship between market exchange and patterns of governance, nor of how the change in one is related to change in the other. Building on the seminal insights of Coase, this paper theorises how and why economic interactions generate institutions of governance in the first place. Extending the crucial insights of institutional economics, this paper demonstrates in theoretical terms how the interactive utility-maximising behaviour of economic agents generates both formal and informal institutions and processes of governance from regulation to dispute settlement. Conflict and competition in market interaction combined with transaction cost dynamics lead to mutually beneficial co-ordination mechanisms and the emergence of order essential to the continuity of market exchange. Thus the broader patterns of institutionalised co-ordination we characterise as governance are endogenous to the self-interested and rational utility-maximising behaviour of economic agents in a market setting.