Transactions cost economics
"Ronald Coase began his 1960 essay by arguing that when it is costless to transact, the efficient neoclassical competitive solution is obtained. This is so because the competitive structure of efficient markets leads the parties to arrive costlessly at the solution that maximizes aggregate income, regardlesss of the institutional arrangements.
This scenario is mimicked in the real world in situations where competition is strong enough via arbitrage and efficient information feedback to approximate the Coase zero-cost transaction conditions and the parties can realize the gains from trade inherent in the neoclassical argument.
In the real world, however, informational and institutional requirements necessary to achieve and realize the gains are stringent:
1. Players must not only have objectives, they must also know the correct way to achieve them, and it is through the instrumental rationality assumption that players know the correct way to achieve their objectives. The assumption states that even though the actors may have diverse and erroneous models, the informational feedback process and arbitraging actors will correct initially incorrect models, punish deviant behavior, and lead surviving players to the correct models.
2. An even more stringent implicit requirement of the discipline-of-the-competitive-market model is that when there are significant transaction costs, the consequent institutions of the market will be designed to induce the actors to acquire the essential information that will lead them to correct models. The implication of this is that not only are institutions designed to achieve efficient outcomes, but they can be ignored in economic analysis because they play an independent role in economic performance.
Both of these discuss stringent requirements that are realized only very exceptionally. The truth is:
1. Individuals typically act on incomplete information.
2. Individuals act with subjectively derived models that are frequently erroneous.
3. The information feedback is typically insufficient to correct individuals' subjective models.
Perhaps more significant, institutions are not necessarily, or even usually, created to be socially efficient. Rather they, or at least the formal rules, are created to serve the interests of those with bargaining power to create new rules.
In a zero-transaction cost world, bargaining strength does not affect the efficiency of outcomes; but in a world of positive-transaction costs, it does. Bargaining strength thus shapes the direction oflong-run economic change."
Economics of political markets
"I is exceptional to find economic markets that approximate the conditions necessary for efficiency. It is impossible to find political markets that do. This is because it is the polity that defines and enforces property rights. It is therefore not surprising that efficient economic and political markets are exceptional; in other words, inefficient markets are common.
Once an economy is on an "inefficient path" that produces stagnation, it can persist (and historically has persisted) because of the natrue of path dependence. Institutional path dependence exists because of the network externalities, economies of scope, and complementaries that exist with a given institutional matrix. The individuals and organizations with bargaining power, as a result of the institutional framework, have a crucual stake in perpetuating the system.
Institutional path dependence do get reveresed, but this reversal is a difficult process about which we know all too little. The reason is that we still know all to little about the dynamics of institutional change and particularly the interplay between economic and political markets."
Source:
Douglass North. 1993. "The new institutional economics and development"