Our Perspective

“Adam Smith said, and he was right, that the productivity of an economic system depends on specialization. But specialization is only possible if there is exchange. And the lower the costs of exchange (transaction costs as they have come to be called) the more specialization there will be, the greater the productivity of the economy and the higher the standard of living of people in that economy.

However, the level of transaction costs depends on the institutions in a country, its legal system, its political system, its culture and so on. This is why we must include the influence of these institutions in our study of the working of an economic system.”

Ronald Coase
(Newsletter of The International Society for New Institutional Economics,
Spring 1998)


Our Challenge

Obstacles that impede the formation of efficient markets rob people of opportunities to improve their standards of living.

These obstacles include weak enforcement of contracts and laws, insecure property rights, corrupt or inefficient bureaucracies, and societal norms that discourage cooperation. They result in high transaction costs, which reduce exchange, employment, and growth.

High transaction costs are hard to overcome. Rules and norms often allow those who have a stake in maintaining these costs to thwart reforms. Even without active opponents to change, habits and long-standing alliances may impede efforts to reduce high transaction costs.

Institutions such as laws, customs, and social norms profoundly affect the level of transaction costs. Because these institutions vary from one country to the next, policies that have worked in some countries often produce disappointing outcomes when imported into other settings. Economic models that ignore institutions fail to take into account the many real barriers to market exchanges.

Institutions are not well understood. While local scholars have a comparative advantage in understanding and affecting the institutions in their own countries, they often lack the tools, training, incentives, and funding to analyze institutions and their effects on economic performance.

Thorough knowledge of institutions is crucial to designing good policies.

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