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Markets and Institutions: A Transactions Cost Approach

Markets and Institutions: A Transactions Cost Approach Evolution of Markets and Institutions: A Study of an Emerging Economy by Murali Patibandla; Routledge, London and New York, 2006; pp x-xvi + 345,


inventories over time in both raw material and finished product holdings and attributes

Markets and Institutions:

this reduction of inventory holdings to a reduction in transaction costs. Likewise it also shows a decline in transaction costs

A Transactions

Cost Approach

Evolution of Markets and Institutions: A Study of an Emerging Economy

by Murali Patibandla; Routledge, London and New York, 2006; pp x-xvi + 345, £ 80.


his interesting book is published by Routledge under their “Studies in Development Economics” series. However, this study is atypical as it does not follow the standard development economics framework, but pursues instead the framework of “new institutional economics” in general and “transactions costs” in particular. As stated in the introductory chapter, ‘the new institutional economics emphasises the importance of institutions of capitalism, such as the rule of law, social and economic norms, property and contractual rights and transaction costs of enforcement in determining the economic prosperity of societies’ (p 2). Patibandla emphasises the importance of the interaction between institutional environment and governance mechanisms in determining economic efficiency.

The introductory chapter gives a brief background about India and then goes on to raise some issues relating to comparative economic organisation in the context of the Chinese and Indian experiences. The author argues that India has evolved its capitalist forces from the ground-up while China has been pursuing a top-down approach. Towards the end the chapter discusses some methodological issues. Chapter 2 is devoted to developing a conceptual framework. The author takes the stand that policy reforms entail parameter and qualitative shifts in the institutional environment that change transaction costs. In the light of the analytical framework developed in Chapter 2, Patibandla discusses in Chapter 3 the initial conditions and economic policy reforms in India. The chapter begins with a brief description of British India and the institutions created by the British. This is followed by a brief discussion of independent India and in particular, the product, labour and capital markets. The chapter also deals with regional inequalities, market structure, and the behaviour of the public and private sectors. The author is critical of the pre-reform regime and considers the government’s act of going to the aid of banks with taxpayers’ money to rescue them from non-performing assets, as a case of redistribution of wealth from the public to loan defaulters. He also disapproves India’s dependence on indirect taxes, which he considers regressive and equal to the poor subsidising the wealthy. He also deprecates the policies followed in the 1960s and 1970s that enabled building of family empires with taxpayers’ money without undertaking investments from their own resources. These policies resulted in the creation of monopolistic and monopsonistic market structures in most of the product markets, low productivity, underutilisation of manpower and a creation of a large industrial base that was inefficient and that operated below international technological frontiers.

Chapter 4 analyses the Indian economic reforms and their impact using the transaction costs framework. It attempts to demonstrate a sharp decline in transaction costs in dealing with the government in response to reforms. After discussing the decline in transaction costs with regard to government transactions, the chapter proceeds to consider transaction costs of business organisations. It presents evidence of a sharp decline in the level of in capital and labour markets consequent to liberalisation. The significant increase in labour productivity and decline in wage/ capital cost in the post-reform period is attributed to micro level technological and organisational change and a fall in transaction costs in the labour market.

The chapter provides interesting case studies of several industries that include IT software, pharmaceuticals, textiles and garments. It also examines differences in growth rates and income distribution and concludes with the differences in regional distribution of growth. The birth of the Indian software industry is attributed to the closed-door policy and licensing controls that restricted the growth of the hardware industry. After the birth of the software industry the evolution of institutions that enforce copyrights and intellectual property rights further strengthened the industry and placed it on a faster growth path. The chapter also discusses the crucial role of intellectual property rights in promoting the pharmaceutical sector. In Patibandla’s view, the modifications of the patent regime, the endowment of a large pool of scientific manpower, the complementary industries and the vast biodiversity in India provided incentives for firms to grow. While examining the effects of reforms on the textiles and garments sector, special emphasis is laid on reductions in tariffs and restrictions on yarn imports and the consequent reduction of raw material prices that generated a market for manmade fibres from the low income groups. Furthermore, the large mill sector that “lost out in the prereform period, was able to restructure itself through integrated production and realise high cost-efficiency”. All these helped Indian firms to export.

Technological and Organisational Change

In Chapter 5 (Competitive Dynamics), based on an econometric exercise of firm level panel data for a set of industries covering the post-reform period, the author

Economic and Political Weekly January 20, 2007 shows that the market share of firms is positively associated with relative production efficiency (technical efficiency). The earlier studies conducted for the preliberalisation sample did not indicate a positive relationship between market share and efficiency of firms. This result is interpreted to imply that markets have become competitive, with more efficient firms gaining at the cost of the less efficient ones in the post liberalisation era. The chapter also presents several case studies of joint ventures – Maruti-Suzuki, TVS-Suzuki (its break-up and the later better performance of TVS), and Hero-Honda. It also presents case studies of joint ventures in the financial sector – State Bank of India (SBI) and GE in the credit cards market, SBI and Cardiff joint venture in the insurance market.

Chapter 6 is on technological change. It provides evidence, both qualitative and quantitative, on the adoption of new technology by Indian industry. It emphasises the market and institutional conditions in determining the process of adoption of technology. It also considers the evolution of the national innovative system. The section on the micro-level processes of technology adoption and adaptation, provides case studies of the auto sector – TELCO, Maruti-Suzuki, Hyundai, Bajaj, TVS, and Honda. Towards the end, the role of venture capital is also examined.

The focus of Chapter 7 is on the underlying mechanisms of organisational change at the micro-level of firms and industries. In the first part the change in the ownership structure from family groups to more professional ones is discussed. It also presents the emergence of stand-alone companies in the post-reform era, organisational innovations in software and BPO industries in India. The chapter has a whole section on corporate governance. It covers the emergence and role of foreign institutional investors and their influence on corporate governance. It also discusses the dominance of the first generation enterprises or professionally run businesses in recent years. Under corporate governance, the governance of partnership (joint ventures), and fully owned subsidiaries is also highlighted. The author perceives a distinct improvement in corporate governance practices in recent years.

Furthermore, for the first time since Indian independence, stand-alone companies, especially those started by entrepreneurs from the middle class, have emerged in skill intensive and globalised industries.

Institutional Reforms

The book argues in favour of significant institutional change relating to both public and private sectors to solve the problem of poverty and income inequality. It suggests that the problem is not merely one of allocation of resources “but building the institutional conditions that enable the services to reach the targeted groups with low transaction costs” (p 288). For example, it cites the case of semi and unskilled labour facing high transaction costs because of the lack of institutions for formal certification of semi-skilled persons like carpenters, plumbers, etc. This lowers the bargaining position of these workers with contractors. The book, while acknowledging the contribution of the institutional reforms that have already taken place, argues in favour of several other reforms that would drastically reduce transaction costs.

Economic and Political Weekly January 20, 2007

The principal distinguishing feature of this book is its analytical framework, namely, a neo-institutional and transaction costs framework, to analyse the dynamic Indian developmental scene. Most works on development economics tend to ignore the institutional aspect in general and transaction costs in particular. Having said this, it is equally important to bear in mind that economic development is a multi-disciplinary phenomenon and its understanding requires an eclectic approach.

In this context, sole reliance on transaction costs to the possible exclusion of others could be misleading. Nevertheless, in this case the emphasis on transaction costs could be excused as the earlier works have totally ignored this dimension. To sum up, this book is a welcome addition to the literature and will enrich our understanding of the Indian development scene.



Economic and Political Weekly January 20, 2007

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