2004 Tucson Workshop: Abstracts

SEPTEMBER 25–30, 2004


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Property Rights in Irrigation: What Difference Does It Make?
Eduardo K. ARARAL, Jr.
Indiana University

The broad theoretical question that the study will address is: what are the conditions that facilitate or impede collective action among a large group of poor farmers in large-scale public irrigation systems in developing countries?  This research question is important in at least 25 developing countries currently in the process of redefining property rights in their public irrigation systems.  It has also long term consequences to the livelihoods of 1.94B largely poor people in these countries directly or indirectly dependent on irrigated farming.  The core assumption behind this policy reform is that farmers will act collectively to advance their interests when given control of decisions, resources and property rights and when working in partnership with responsive support organizations.

The study will test, among others, the hypothesis that variation in property rights over an irrigation system makes a significant difference in terms of the ability of a large group of poor farmers to overcome collective action problems.  The study will also test the significance of various types of property rights in terms of the productivity, equity and financial sustainability of irrigated farming. Contending hypothesis such as water scarcity, access to markets, social capital and history of irrigated farming will also be examined.

The study will be organized around the Institutional Analysis and Development Framework developed at the Workshop in Political Theory and Policy Analysis at Indiana University.  The study will review methodological issues in social science research, institutional analysis, common pool resources and irrigation institutions.  It will examine 2,054 irrigation associations in the Philippines using 85 data sets and will employ cross sectional analysis using maximum likelihood estimation and other statistical tests.  This will be supplemented with a historical analysis of the evolution of irrigation institutions in the Philippines with focus on how political regimes shape the evolution of formal property rights in irrigation. 

Fisheries Policy Learning:
The Interplay of Information, Institutions, and Interests

Betsi E. BEEM
University of Washington

In the development of policies for the environment, policymakers are called upon to make decisions based on highly technical information--often fraught with varying degrees of uncertainty and conflict, sophisticated assessments of the environment, and limited understandings of the distribution of costs and benefits.  Creating and disseminating policy relevant information are members of the policy community: which includes scientists, lay experts, interest groups, and administrative agencies.  Discerning the degree to which learning occurs within this subsystem and what factors contribute to or frustrate learning can help us design processes that lead to better policies.

This research develops an analytic framework that provides a basis for examining factors that enhance or limit opportunities for various forms of learning in calling attention to the roles of information, institutions, and interests.  Institutions are central to the framework as they shape who gets involved and how they are involved. This draws attention to the complexities of multiple venues and their concomitant variations in decision-making and participation rules, the degree to which different types or sources of information are privileged in different contexts, the structure of the relationship of the scientific community to the policy process, and how interests shape and are shaped by diverse sets of rules.

This framework is used to compare decision processes and learning in the development of fishery management plans for blue crab (Callinectes sapidus) fisheries in North Carolina, Georgia, Virginia, and Maryland.  These settings provide a basis for systematic comparison—through content analysis, interview data, and personal observation-- of differences in variables that are central to propositions about policy learning being examined in this research.

I will have completed the majority of data collection and will have begun preliminary analysis and comparisons prior to the workshop.  It therefore comes at an important stage of the research process where interaction with established and emerging scholars will be most beneficial.

New Institutional Economics
and the Brazilian Correctional System
Federal University of Bahia

The Brazilian correctional system is near collapse. Various alternatives have been discussed, including the privatization of penitentiary facilities as is done in the United States, where 6% of the 2 million inmates are held in privately operated facilities. In general, this research seeks to answer the following question: What are the likely outcomes of privatizing correctional services in Brazil?

In Brazil, there are currently only 180,000 beds for a population of 308,000 inmates, as of end of 2003. Approximately an additional 200,000 warrants are due to be enforced by Brazilian justice officers. Riots, escapes, corruption, high recidivism rates and public agencies' failure to observe penal legislation  – all these are common.

Those who support private participation in correctional services management offer several arguments, generally resting on ideological and non-utilitarian grounds. On the other hand those who criticize the private participation often have arguments on the same basis as well. This research tries to analyze the feasibility of the different governance structures in the Brazilian correctional system from the perspective of efficiency and performance, taking in consideration the incentive structure and the legal and ethical limits of correctional services outsourcing.  New Institutional Economics is proposed as the theoretical background of this research.

To answer the central question, I will compare private and public performance in Brazil, where private provision began in 2000. The analysis of foreigner experiences may bring some insights to the Brazilian analysis. For example, the French experience in private correctional management is important to my research because its model is very similar to the adopted in Brazil.

The next step is to compare performance indicators of the existing private-managed facilities in Brazil with public-managed ones (cost-effectiveness, riots, escapes, internal violence, etc.). The contracts between government and private companies should also be examined. The research samples must to have similar characteristics, such as unit localization, number of inmates and  inmates criminal profile. In this way, I expect to know: what are the conditions the private sector is more feasible than public sector, the economic impact of private correctional management and the eventual benefits that can be obtained.

Dictators and Their Viziers:
Agency Problems in Dictatorships
Centre for Economic and Financial Research, Moscow

Dictatorship is one of the oldest forms of government.  Human history is replete with examples of unconstrained rulers, most exhibiting poor governance.  Despite the enormous successes of democracies on every count, there is no sure sign that dictatorship is vanishing as a form of governance today.  While the number of democratic countries increased significantly during the last decades of the 20th century, there are also a significant number of emerging dictatorships, especially in countries of the former Soviet Union.  If in countries like Cuba, Burma, Egypt, Libya, North Korea, Zimbabwe the regimes have already reached some sort of maturity, the situation is very different from the newly emerging dictatorships in the countries of the former Soviet Union such as Uzbekistan, Turkmenistan, or Belorussia.

In this paper, we do not study why dictatorships emerge. Instead, we focus on the internal structure of dictatorships. When a dictator faces threats both inside and outside their countries, one limit on his power is the incompetence of his ministers and advisors. At the same time, the possibility of a treason by a close associate has been a nightmare of most dictators throughout the history.  Better informed viziers are also better able to discriminate among potential plotters, and this makes them more risky subordinates for the dictator.  To avoid this, dictators, especially which are weak and vulnerable, sacrifice the competence of their viziers, hiring mediocre but loyal subordinates.  If a ruler expects a high loss of utility (e.g. a capital punishment) conditional on being thrown out of the office, he needs more loyal and less able viziers than a dictator that face lesser threats.  One reason why democracies generally witness more talented people in the government, is the dictator's inability to commit to the optimal (less than the capital) punishment for those who unsuccessfully plotted to remove him from power.

The Relationship Between Assemblers and Suppliers
in the Automotive Industry in Brazil: an Exploratory Study Using the Focus of Transaction Cost Economics
Fundaçao de Pesquisas, Estudios Sociais e de Politicas Públicas,
Paulinia, São Paulo

From the 1990's onward, with the institutional changes occurring in Brazil, not only the automotive industry but also its parts suppliers' net were submitted to structural modifications, adjusting their processes to comply with a globalized market as much in the technological aspect as in the commercial one. The combination of those factors induced a process of drastic reduction in the number of parts suppliers, who in turn searched for alternative ways to increase their efficiency and efficacy, with the concurrent demand of the assemblers to reduce their costs. A complex governance relationship emerged between the parts suppliers and the assemblers in the automotive industry. This complex relationship may be characterized by uncertainty, limited rationality, and opportunism, among other factors.

The objective of this exploratory study is to suggest some hypotheses, based on Transaction Costs Economics, concerning the dynamic of the current relationship between these agents.  Based on a case study of one assembler and some of its suppliers, some considerations of the governance structure are brought up, here characterized by the contents, duration, and type of supply contracts.

The Impact of Institutional Change on Internet Diffusion
in Small Transition Economies
University of Massachusetts - Amherst

Recent research in economics, political science and public policy has outlined the factors that determine Internet diffusion from a broad, global perspective. Usually wealth and the level of infrastructure development are given as key factors in explaining outcomes in per capita Internet penetration rates. While such findings may provide a valid view of global trends, these factors fail to explain outcomes in the Internet penetration rates of several transition economies in Central and Eastern Europe (CEE).

This research uses new institutional economic and political theory to investigate the impact of institutional change on Internet penetration rates in Estonia, Latvia, Slovakia and Slovenia. Of the four cases studied, Estonia and Slovenia have substantially different institutional settings and paths of transition but the same Internet penetration rates. Latvia's institutions and path of transition are similar to that of Estonia but the Internet penetration rate is significantly different. Slovakia's institutions and path of transition are closer to Slovenia than Estonia, but its outcome in Internet diffusion is different from that of Slovenia.

Hence, substantially different settings of institutions and paths of transition can lead to similar outcomes in Internet penetration rates, while similar institutional frameworks and paths of transition have led to significantly different outcomes in Internet diffusion. However, once the initial institutional setting of countries before the transition from socialism to a market economy is taken into account, it becomes clear that institutional change that has encouraged openness throughout the economy is also crucial for increasing Internet diffusion.

Based on the case studies, this paper argues that the Internet diffusion in transition and developing economies is encouraged through the privatization of the incumbent telecom company and the opening of the telecom market.  This requires that the telecom regulators be independent and stay free of political interventions, in order to secure maximum openness and fair play in the telecom sector. For this to be successful, this paper finds that these sector specific rules of the game have to be combined with a liberal trade and foreign direct investment regime.

Getting the Institutions Right:
Reforms of Banking Sectors in the Czech Republic and Romania
Central European University

The institutions framing banking sectors of transition economies were prone to support crony capitalism rather than competitive one. They sustained incentives for financial repression and rent-seeking and constrained those for prudential banking based on fiduciary duty until major institutional reforms were implemented.

This paper aims to understand how countries broke out of the vicious circle of predatory institutions and managed to transplant the current best practices of bank governance. Further, I formulate some lessons for governance reforms in emerging markets and for the role of international organisations.

Drawing on various strands of literature including political economy of policy reforms, codes of best practices proposed by Financial Stability Forum, law and finance literature, and new institutional economics, I formulate and test by comparative case study the following hypotheses.

1. Sequencing hypothesis: successful banking sector reforms in the transitive economies aspiring to the EU membership proceed in four steps:

(i) creation of a regulator whose capacities were initially inadequate but which formed a constituency for reform; (ii) gradual introduction of the international regulatory standards; (iii) dealing with the vested interests opposing reforms; and (iv) creating constituency for further implementation of evolving best practices (typically by privatization to foreign strategic owners).

I focus predominantly on dealing with vested interests, as it can provide important lessons. Moreover, I address the question of what triggers and helps to sustain institutional reform by the following:

2. Sustainability hypothesis: two factors play a major role in overcoming the opposition of vested interests:

 (i) Increasing awareness about the unsustainability of high and growing proportion of non-performing assets (threat of banking crisis) and

 (ii) Pressure from the European Union and the World Bank for implementation of reforms.

3. The trigger puzzle: the literature failed to come up with a theory of reform triggers. Given the inherent complexity it remains an empirical question.

To gather necessary information I conducted a tightly structured comparative case study, tracing the banking sector reforms in the Czech Republic and Romania. The former is advanced reformer, whereas the latter is a case of a "laggard" which is yet to finish major reforms. Findings are concurrent to hypotheses and the project will be broadened by including three more country cases.

The Demand for Democratic Institutions:
The Independent Mass Media
Andrey KUNOV
Institute for Open Economy, Russia

The general goal of our research project was to assess the demand for democratic institutions in modern Russia and across a wide panel of countries. Specifically, we attempted to address the question: how do the national wealth and its distribution among the population affect the freedom of press? In the research, we used the data on the national incomes from the World Bank and the data on independence of mass media from the "Freedom House" for the 1994-2001 period.

Our preliminary findings indicate that there exists a statistically significant link between the national prosperity (national income per capita) and independence of mass media. More wealthy countries tend to have more independent media.

We have also discovered that within a sample of more autocratic regimes there exists a negative relationship between social inequality and freedom of press: the increasing income inequality (measured by the Gini coefficient) tends to be associated with lower levels of independent mass media. Yet, within the sample of countries that had the elements of democracy a hundred years ago, there exists now a positive relationship between freedom of press and social equality, i.e. the increase in inequality is associated with more freedom of press.

After examining a full sample of countries (123 states), we identified a certain level of income that best explains the existence of independent mass media. According to our preliminary results, the freedom of press can be best explained by the size of the population group that has an annual income of $7,300 (GNI, PPP, 2001). All countries that had more than two thirds of their population enjoying such or higher income could also afford the independent mass media (except for Singapore). Over the 1994-2001 period, this threshold income, which best explains the free press, has not changed over time (when adjusted for the US inflation rate).

For Russia, considering the purchasing power parity, this threshold income was 48,000 Rub per annum. Currently only a third of all population enjoys such or higher income. This leads us to conclude that there is an insufficient demand for the independent mass media in Russia. If, however, Russia will continue to grow as it does now, we would expect the emergence of a sufficient group of middle class in 2010 or so with a strong demand for the free press.

Institutions of Civil Society:
Cross-National Studies in Russia and Kyrgyzstan
University of Bonn

This study examines and compares the impact of social discrimination (indicators and clusters of social structure), corruption (power structure) and public engagement in politics (political behavior) on development of civil society institutions in Russia and Kyrgyzstan. The inquiry also aims at revealing the relationship between these variables in terms of institutional analysis. Three major research strategies are: (1) a qualitative and quantitative analysis of country-level data, (2) cross-national case studies and 3) survey in the form of interviews and questionnaires (field research). Data is collected from archives, published reports, newspapers and other primary and secondary sources. The major focus is on the units of an analysis such as non-governmental organizations and political parties.

Research Question

The major research question is to identify the factors that influence the level of civil society institutions development. The emphasis is principally on socio-political, economic and cultural features of civil society institutions. The concept of civil society is operationalized in terms of the Social Capital and Good Governance approaches.

Research Objectives

Objectives of the study are to digest the relevant literature and distil a conceptual framework, which is useful for research purpose. The purpose of this study is to give a theoretically informed diagnosis of Russia and Kyrgyzstan with respect to the development of civil society: the respective state of affairs; the path to this state; the assessment of stability, problems etc.; and the prospects.

Research Hypothesis

The hypothesis is that strong collective sense of social justice, widespread citizen participation in policy influence the level of development of civil society institutions. These variables are best measured by the absence of oppression of minorities (social discrimination), level of corruption and wide participation of citizenry in policy formation and execution. Respective levels of the dependent variable are high and low meanings.

Research Methods

The research design is based on combination of quantitative and qualitative design. Both kinds of methods are necessary to justify the operationalization of the dependent variables. Those methods are: Sampling of Subjects/Participants, Instrumentation/Measures, Data collection procedures (interviews, questionnaires, focus-groups, participant and direct observation), Statistical/Data Analysis in SPSS, Excel, etc.

The Russian Market for Household Savings 1992–2004: Paradoxes of Trust And Credence Goods
New Economic School, Moscow

The financial market of household savings in Russia has been created again after more than seventy years' break in 1992, and hence it is a very interesting case for analyzing institutions and institutional changes. Personal interest to this theme is based also on the author's work during 1995–2000 at the special department of the largest consumer organization in Russia (KonfOP) whose mission was to protect consumers in the market of household savings.

The main puzzle highlighted in the given project is the extraordinary level of trust that people feel to their counterparts on this market within several years, despite on previous losses. It directly confirms by KonfOP's empirical materials and indirectly by statistic data measured the amount of money that households gave to the financial organizations. (Note, it was the period of macroeconomic liberalization with its negative impact on people's income.)  It is especially interesting because the general level of impersonal trust in Russia measured by various surveys was not high.

The author argues that the market of household savings is the market of credence goods, and hence the consumer's past experience does not play a big role and does not cut the level of trust dramatically. Vice-versa, when the level of trust on the market is low, the previous good news also does not affect much people's behavior, as it was demonstrated during the bank crises in Russia in the summer 2004. To prove this theoretically the author uses papers on the role of asymmetric information on the Russian market of household savings; the papers on credence goods and Mussa and Rosen's-kind model of variation in product quality and quantity under asymmetric information. To prove it empirically the author uses the materials collected by KonfOP and describes in the paper the phases of the market development that characterized by predominance of different sellers (three types of non-bank financial institutions, banks and the state in case of GKO), different behavior of market agents before and after defaults, and different policy of state regulation.

How Should Standards Be Set and Met?
An Incomplete Contracting Approach
to Delegation in Regulation
C.-Y. Cynthia LIN
Harvard University

I examine the optimality of delegating regulatory power when neither input levels nor output levels are contractible. The key trade-off is that while the federal (or central) government is able to internalize externalities, the state (or local) governments have preferences that are better aligned with local welfare.  Because of this trade-off, it is possible that some form of partial decentralization, in which the federal government has control but delegates some of its decisions to the states, may be more efficient than either extreme of complete centralization or complete decentralization.

I model regulation as a two-stage decision-making process.  In the first stage, a target output level is set for each state.  In the second stage, input levels are chosen for each state in order to meet the output levels chosen in stage one.  There are externalities involved in both stages of the regulatory decision-making process.

A primary contribution of this paper is that it exploits novel synergies between the two erstwhile separate literatures on incomplete contracts and on federalism.  I define "power" as the right to make decisions; there are thus two types of power in my model, one for each of the two stages. Power matters because neither input nor output is contractible. I compare four decentralization scenarios, each corresponding to a different allocation of input power and output power between the federal and state governments. The research question I pursue is the following: when is delegation the most efficient distribution of power and in what form should it take?

The central finding is that "conjoint federalism" (the federal government chooses output while the states choose input), which is the regulatory structure often used in federations such as the United States and the European Union, tends to be least efficient, while a reverse form of delegation tends to be most efficient.

My results therefore suggest that social welfare may be increased by reversing the form of delegation often used in regulatory decision making.  The implications of my model are generalizable to other public goods and, even more generally, to any problem of organizational choice in the presence of interjurisdictional externalities.

Evaluation of Mergers and Acquisitions Efficiency:
Ex Ante Approach
Novosibirsk State University

During past several years the processes of mergers and acquisitions (M&A) in Russia have quantitatively and qualitatively changed. Russia has become leader of M&A among transition countries. However, outcomes of significant part of mergers do not fully comply with demands of initiators and have little impact on economy. For example, according to investigation of Mergers & Acquisitions Journal (1998), 61 % of all mergers do not compensate the invested capitals. In this connection, the problem of defining the expedience of merger itself and selection of appropriate partner is of highest importance for many Russian companies.

The main stages of corporative strategy in realization of the merger process are: definition of merger goals (stage 1), quest for target company (stage 2), evaluation of the target company (stage 3), negotiations and determination of the form of payment (stage 4), integration procedures (stage 5), and evaluation of the outcomes from the deal (stage 6).

Most of the researchers explore the effects from M&A ex post, and ex ante phase seems to be less specified. At the same time, it is worthwhile to model the process of decision-making itself and quantitatively estimate, what kind of forces and factors play crucial role, who are the most influencing figures in the transaction.

It is the methods of evaluation of multi-objective alternatives, that can be adjusted to modeling the stages 1 and 2 at the ex ante phase of merger. They are the following: method of analytical hierarchy, multi-objective utility theory and ELECTRE methods. On the basis of conducted comparative analysis, method of analytical hierarchy was chosen for modeling the M&A processes.

This approach was empirically tested on the example of Russian companies of ferrous metallurgy. It gave us an opportunity to develop this approach into a universal method of decision-making by mergers that can be applied to other industries. The importance of recommendation aspect in modeling the functioning of a corporation ex ante is hard to overestimate: integral assessment of merger's expediency and criteria, that have decisive weight in this case, can substantially reduce the number of unjustified mergers and increase the efficiency of such investments.

Non-Transparency of Formal Institutions
as a Source of Transaction Costs: The Case of Ukraine
National Technical University, Kharkov

The quality of institutions a society develops over time is a critical factor of economic growth. One of the important characteristics of quality as applied to institutions is their transparency. In particular, the problem of transparency is very acute in case of institutions regulating business activities in a society. Non-transparency of the formal procedures endows state agents with a high discretionary, and consequently, bargaining power, which makes compliance with regulation costlier for entrepreneurs.

An entrepreneur first comes to grips with formal institutions regulating business activities when starting his or her business. The quality of formal procedures of business legalization determines the costs of starting a new business and thus influences the decision whether to launch business or not, and, if yes, whether to go official or to stay in shadow.

Our research project is devoted to measuring and analyzing the costs of small business legalization in Ukraine. The research is conducted within the framework of a cross-country study of the costs of exchange incurred by small businesses in the garment industry. Case studies and a survey of small business owners through personal interviewing using a standardized questionnaire are the main methods of research.

We study in detail the entire process of business legalization and analyze the sources of discretionary power inherent in separate formal procedures, and consequently the corruption capacity of these procedures. Using the concept of opportunity cost, we determine costs associated with different steps in the legalization process and estimate the overall cost of business legalization. The degree of transparency of the formal procedures is closely related to the accessibility of the information on the requirements to be met during these procedures. In this connection we pay special attention to the informational problem, i.e. how easily accessible, accurate and exhaustive the information on the business legalization procedures is. It is in terms of transparency that we draw a dividing line between the procedures of business registration and obtaining permits. We also show that non-transparency of formal procedures raises not only the costs of compliance with these procedures but also the costs of measuring the compliance costs.

Why Do Informal Small-Scale Enterprises Stay Informal? Estimating and Comparing Transaction Costs
Estomih J. NKYA
Mzumbe University, Tanzania

Why do informal small-scale enterprises choose to stay informal? The purpose of this ongoing study is to answer this question through estimating and comparing cost of doing business in food vending ventures in informal and formal sectors in Tanzania. The aim is to determine the extent to which transaction costs constrain formalization of the informal sector. Frame of analysis for the study is informed by the New Institutional Economics in which institutional arrangements, as humanly devised constraints, shape human interaction and determine cost of doing business. Cost of exchange consists of cost of measuring attributes of the object of exchange arising from information asymmetry between exchanging individuals, cost of monitoring and protecting property rights, and cost of enforcing agreements.

Informal enterprises are units engaged in the production of goods and services that are not constituted as separate legal entities independent of the individuals or households that own them. Formal and informal Small-Scale Enterprises in countries like Tanzania are important because they create more jobs at lower costs, meet local demand of appropriate goods at affordable prices, require less sophisticated managerial skills, and their widespread ownership structure provides for more equitable distribution of income.

Case study methodology is adopted in order to capture the actor's viewpoint, societal contexts and dynamics in regard to nature and levels of costs of exchange. Case study method provides possibility of combining a variety of sources of evidence in an in-depth inquiry into a social phenomenon in which research interest involves a large number of variables and limited number of cases.

During the current phase of the study, purposive sampling is employed to select twenty cases of small-scale formal and informal food vending enterprises in Morogoro and Ilala Municipalities in Tanzania. Systematic within-case and cross-case analysis is employed to estimate average values of resources (time, money and energy) deployed in business operations.

Expected results include cross-case summary of common determinant elements of transaction costs, average values of resources deployed, and barriers to formalization of the informal enterprises. The expected results will lead to policy-relevant conclusions that provide discriminating explanations to fit specific local government policy settings in Tanzania.

Sovereignty, Credible Commitment, and the Wealth of Indian Nations
Terry L. Anderson and Dominic P. PARKER
Property & Environment Research Center (PERC), Bozeman, Montana

American Indian reservations are well known for their impoverished conditions. Some Indian economies, however, perform significantly better than others. Aside from lucrative gambling activity, what factors explain the relative success of certain tribes? Just as a growing number of studies show that a consistent rule of law is crucial for encouraging investment in the developing world, we argue the same holds for reservations. Tribes that can credibly commit to not expropriate private wealth will have a comparative advantage in attracting investments and generating commerce. Consistent with this notion, we find a robust positive relationship between state court (as opposed to tribal court) adjudication of contractual disputes and economic growth across reservations. Our findings underscore the importance of credible commitment and highlight a cost of tribal sovereignty.

The reservation setting provides a natural experiment for social scientists interested in the effects of legal institutions on economic performance. In contrast to empirical studies linking good institutions with prosperity across countries, we are not forced to rank the legal institutions of disparate nations. More importantly, our results are less exposed to allegations of endogeneity. Whereas wealth in a country might cause, rather than result from, differences in legal institutions, this reverse causation is unlikely on Indian reservations. Tribes did not choose state court adjudication. The U.S. government superimposed it over certain reservations when Congress passed Public Law 280 in 1953. There appears to be no selection bias, with regard to wealth or incipient wealth, in Congress's choice of which reservations are subject to P.L. 280 and which are not. Thus, this experiment with binding tribes to a more stable rule of law makes the empirical findings even more robust.

Firm Size and Market Structure: Transaction Cost Approach
Irina Sokolova and Kaire PÕDER
Estonian Business School

Estonia presents one of the most successful transition stories of the last decade. Within more than 10 years Estonia has accomplished rather successful transfer from central planning to the market system.  We may say that Estonia belongs to one of the most liberal market economies in the world. At the same time Estonia managed to "arm" itself with modern information and currently Estonia is faced by the new challenge – EU accession.  The "new transition" has definite benefits, but it also incurs costs. Part of these costs is related to abolishing a "portion" of economic freedom, and compliance with the EU institutions. As Estonia has gone through these three (or at leas two) stages rapidly, we are considering Estonia's experiment is a valuable object for economic analysis. 

We are exploring how the transaction cost in Estonia have changed and will continue to change because of EU enlargement. We are regarding transaction cost analysis important because of mainly two facts. First, calculations of transaction cost for Estonia are generally absent, while they exist for other economies (including Latvia and Lithuania).  So, for purposes of novelty of such data and the possibility of future comparison to related countries this analysis seems plausible. Second, the received data will help us to make estimation on possible changes in business environment caused by EU accession, and predict major obstacles firms will face in the transition period in overall economy, as well as in particular industries. We are also exploring how firms' size and market structure will be affected from the forcoming changes. We are quite confident, that the outcome of the research will be of interest of businesses as well as politicians and academia in general.

For measuring transaction costs we are mostly relying on the World Bank's methodology. To get country specific information, we have to rely also on questionnaires (developed for businessmen), which enable us to modify and collect information about institutions what we consider to be at the most interest in the case of Estonian "success story"

Capital Flows and Domestic Market Integration in China
Columbia University

The torrent of reports about the inadequacies of the Chinese financial system, accompanied by studies claiming product and capital market segmentation (Boyreau-Debray and Wei 2002, Young 2001, and Poncet 2002) argues that two decades of reforms in China failed to change the behavior of the financial system.  But I believe this conclusion overlooks real achievements due to its failure to distinguish the behavior of the official sector and commercial sector by examining only aggregate level data.  My unique data set on provincial savings and investment allows me to examine components as well as aggregates in appraising domestic capital market integration in China. While my aggregate results parallel those of Boyreau-Debray and Wei and others, I am able to assess the impact of reforms on capital flows outside the government allocation mechanism. Stripping out foreign funds, government appropriations, and officially influenced bank loans, I discover that inter-provincial commercial capital flows start to behave like interstate flows in the US and other advanced nations. I also provide evidence of institutional development, government policies and actual channels for commercial funds transfers to show the existence of a large commercial sector with important elements of integration.  This result undercuts the widespread view of China's economy as lacking in domestic integration. 

I am also expanding this approach to new topics:

1. Examine returns on capital with both aggregate and component level data to determine whether conventional findings of widespread misallocation of investment resources are truly an economy-wide phenomenon or they are confined to the official sector only.

2. The coincidence of the weak financial systems and tremendous growth spurts in many East Asian economies puzzles people who believe that finance is essential to development.  Perhaps this puzzle in the standard growth story exaggerates the role and problems of government and government-dominated financial institutions.  If informal finance is important and avoids many of the traps that have hobbled major financial institutions, then maybe we can start a new explanation of growth spurts that includes finance.  My discovery of commercial sector's impact on real economic activities suggests that one possible approach is to disaggregate data to concentrate on the impact of unofficial, commercial financing.

Bank Ties' Effect on Corporate Governance
in Transition Economies
Agnieszka SLOMKA
Warsaw School of Economics

Financial policy makers in transition economies emphasize the role of banks in corporate governance, as banks can foster a long-term relationship with industrial firms and hence ensure economic growth and development.  The process of banks' engagement in corporate governance involves a wide range of politics, from regulation to policy-related to corporate financing.  However, certain political issues have proved central to the process, such as banks' privatization, restructuring of corporate debts, and reform of both bankruptcy and foreclosure procedures. Some of the issues have been just implemented, and the early results are mixed.  Nevertheless, it is suggested that banks in Poland can play a significant role in corporate governance.

In this paper I will analyze the institutional environment to better understand the constraints and opportunities of banks in the corporate governance system in Poland. However, the primary purpose of the study is specifically to examine evidence that active banks' control over debtors in transition economies contributes - by promoting effective investments - to firms' better performance. Empirical analysis will focus on the issue whether firms with bank ties are less financially constrained in comparison to the firms without bank ties, and invest in projects with good prospects.

Corruption and Foreign Direct Investment:
An Empirical Analysis
Munich Graduate School of Economics

Defined as "misuse of public power for private benefit" corruption is best conceptualised as an institutional failure. Specifically, the relationship between corruption and growth has been subject to both theoretical and empirical analyses so far, with the resulting conclusion that corruption deters growth. Having this in mind, it should be said that an analysis of the channels through which the above-mentioned impact takes place is still on the agenda of the present day economist. One potential channel through which corruption hinders growth is its negative impact on capital flows in general, foreign direct investments in particular.

This paper adds a further link to the chain of studies on corruption and capital flows. Using data from Global Competitiveness report of the World Economic Forum, the corruption variable is decomposed into its subcomponents. It is argued here that not only does corruption reduce foreign direct investment inflows to a country, but also different forms of corruption have separately identifiable effects on the variable in question. In contrast to the studies using aggregated measures of corruption such as the Transparency International's Corruption Perceptions Index, the present study is the first attempt to analyse corruption in this level of detail concerning its different manifestations.

To summarise the results, it is concluded in a cross sectional setting that (i) corruption has a negative and significant impact on the foreign direct investment inflows, and (ii) corruption in the field of import/export permits has a positive and significant impact on FDI inflows, whereas corruption in the fields of annual tax payments, access to public utilities and judicial decisions are strong deterrents against FDI. The negative association between corruption and FDI Inflows is robust and withstands the use of instrumental variables technique. The results of the study should be read as policy proposals for developing countries, by pointing a finger to the areas that should be given priority concerning reform issues. 

The Costs of Business Legalization in Ukraine:
Implications for Entrepreneurs and for Researchers
Kharkov University of Humanities

A successful economic development of a society depends on the costliness of doing business in that society. Overall costs of doing business include both the costs of exchange between economic agents and the costs of compliance with regulation. The latter is the price economic agents pay for the permission to engage in the economic activities and for the access to formal institutions supporting these activities. The higher this price is, the more potential entrepreneurs will be deterred from entering business, the more detrimental effect it will have on the economic development of a society.

Our current research project is concerned with studying the costs of business legalization, which constitute an important part of the overall costs of doing business. This project is a part of a larger cross-country comparative study of the costs of legalization of small businesses in the garment industry. Our project is carried out in Kharkov, a large industrial city in Eastern Ukraine. The research methodology involves case studies and a survey of a sample of small garment business owners. The concept of opportunity cost is used for the assessment of the costs of business legalization.

We determine and compare the costs associated with two different ways of small business legalization –as a private entrepreneur (physical person) and as a legal entity. In general, the process of business legalization can be divided into two stages: business registration and obtaining permits. Unlike the registration procedure the current permit system in Ukraine is opaque and complex, which gives rise to corruption practices and informalization of relations with local officials. The costs of getting permits are much higher than the registration costs and can vary significantly for different entrepreneurs depending on their bargaining power, connections, perceptions of unofficial prices of permits, and finally, attitudes to corruption practices (ideology). Empirical research on these costs encounters significant problems. A high variance reduces the accuracy of estimates and lowers the meaningfulness of the mean values. The reluctance of entrepreneurs to divulge their illegal practices poses problems with sampling procedures; in particular, it urges to give up probability sampling in favor of non-probability techniques.

The Butterfly Effect: Economic Impacts of the Evolution
of Institutional Structures in England and Spain
Alexandar Dimitrov TOKAREV
Southern Illinois University – Carbondale

This comparative historical study makes three contributions in establishing a new causal link between religion, government structures, and economic performance in England and Spain. First, it explains the causes for the evolution of pyramidal and decentralized church organizations. Second, it explores the influence of ecclesiastical structures on the evolution of government structures. Third, it offers a new answer to the question: "Why are some so rich and some so poor".

As in living organisms, the structure of any organization determines its functions by setting limits as powerful as natural constraints. Structural constraints influence the rules in the organization that concern crucial elements such as distribution of power and responsibilities. Through informing all individual actors about the payoffs for certain kinds of behavior, rules determine incentives, which in turn affect all entrepreneurial activities. Entrepreneurs either promote the sustainable development of their societies by investing in innovation, thus taking the narrow road to success, or put their talents into rent-seeking and even destructive activities, thus slowing economic growth and pushing their nations down the highway of failure.

The paper shows that institutions with very different structures, and thus limits, were transplanted in the New World by the major colonial powers – England and Spain. I explore why the two biggest empires evolved with different political structures and find, surprisingly, that government institutions in England and Spain have followed the evolutionary paths of their churches. Once discovering this phenomenon, it seems impossible not to ask the next question: "Why did the churches in England and Spain develop different structures?" The paper finds the answer in the different conditions under which Christianity grew and spread on the British islands and on the Iberian peninsula. I find in short that economic outcomes are often not a matter of conscious choices but depend to a large extent on institutionally predetermined social behavior. Human actions are influenced by slowly changing attitudes, which are embedded in institutional structures established in the past. Thus, in order to understand better the "why" of today's economic divergence, we need to focus on the processes of institutional evolution.