Cronyism

Neoclassical economic theory assumes that the institutional framework - the legal, political, and informational aspects of an economy -  is given. In a neoclassical world contracts are costlessly and immediately enforced, property rights are secure, and any initial distribution of resources can be voluntarily bargained over and exchange in order to maximaze efficiency. Thus built into the model is the idea that any government intervention must be deleterious, since it involves a move away from a perfect market. However, once the idea of an undistorted initial period is questioned, much of the distinction between profit and rent-seeking may involve fights over the distribution of rents and may not necessarily involve inefficient dissipation.

In contrast, transaction cost economics emphasizes that the creation, monitoring, and enforcement of long-term agreements are inherently impossible and therefore long-term or iterated exchange is risky. Transaction cost analysis thus examines the search for institutions that reduce the costs of exchange, since institutions evolve to minimize transaction costs. Closely related themes are property rights, informational asymmetries, and principal-agent models. In this world, a high performance economy is one in which institutions minimize transaction costs, property rights are secure, information is common or at least relatively public, and judicial and political rights are immutable. These conditions are not met in most developing countries. Coercion and uncertainly are both central to politics and economics and also intensify an actor's fear regarding potential expropriation, opportunism, and shirking. The scarch for institutions and methods by which actors can credibly engage in cooperative behavior is thus central aim of the new institutional economics.

Cronyism

The perspective of the new institutional economics is particularly useful in understanding cronysim, a blanket term that refers to a number of related concepts: family and personal realtions, bribery and corruption, patron-client relations, and collusion. In some cases cronysim involves political factions, groups, or informal networks, while in others it involves clans, families, or social groups. Cronyism is often seen as deleterious to economic growth because it implies decisions based on nonmarket principles, increases transaction costs, impedes efficiency, involves rent-seeking, distorts economic incentives, and makes exchange between actors more difficult. In most instances reliance on personal relations is detrimental to economic efficiency.

However, personal realtions sometimes enhance efficiency. Where legal, political, and economic institutions are weak, as in most developing countries, information about market conditions and possibilities is both scarce and difficult to obtain, and investments and property rights may be insecure. Long-term commitments of any sort are more difficult, because political and economic conditions and actors can change rapidly. Capital markets do not function as effectively in developing countries, and political and economic decision making is subject to greater uncertainty than in developed systems. For businessmen and politicians, the transaction costs of making and keeping agreements and securing property rights can be prohibitively high. Absent some enforcement mechanism, parties may be reluctant to enter into long-term relationship.

Under these conditions, cronysim can reduce transaction costs, because actors have deep and enduring contact with and knowledge of each other and are able to make nuanced judgments about each other's credibility and integrity. Monitoring is also easier, because all parties know each other and actors with long-term, close, and overlapping personal ties can sanction each other and spread information more easily. It is not true that, if long-run gains are uncertain, actors look myopically to the short run. Rather, they attempt to craft alternatives that will add some predictability and stability, often by relying on personal relations. In addition, bribes are marely tranfers. The relevant question is whether the resources will be put to more productive use by the bribe giver or the bribe taker.

Thus, cronyism can lead to better information, monitoring, and sanctioning, can strengthen property rights, and can provide alternative means of reciprocity and side payments. Within a well-defined set of actors cronyism may reduce transaction costs across the broad. Since institutions are weak and property rights fluid, confidence in exchange and agreements can be imbued only through other relationships. Under what conditions does cronyism lower rather than raise transaction costs?

reference:
David C. Kang, Transaction Costs and Crony Capitalism in East Asia, Comparative Poltics Vol. 35 No. 4 (July, 2003)