Elaboración de Notas Técnicas Universitarias

Acemoglu & Johnson (2005), commenting on the work of North (1981) distinguish between contract theory and predatory theory of the state. They argue that in the contract theory, the state and associated institutions provide a legal framework to

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enable private contracts, which facilitate economic transactions (reduce transaction costs), whereas in the predatory theory, the state act as an instrument for resources transfer from one group to another. The contract theory literature underscores the importance of contracting institutions, hence theorist argue that organisations and societies are able to work better depending on what type of contracts can be written and enforced (Grossman & Hart, 1986; Hart & Moore, 1990). Contract enforcement institutions such as legal institutions are essential for impersonal transactions (Lee et al., 2007; Williamson, 1991). However an argument has been raised that judicial inefficiency causes high transaction costs for litigations and deters potentially valuable impersonal exchanges (Peng & Zhou, 2005). Hence, Zhou et al., (2008) argue that a weak legal system favors strong personal ties and relational contracting as viable substitutes for formal legal contracts, which may restrict business opportunities and weaken competition. For example, empirical studies of manufacturing firms in Africa demonstrate that the absence of effective legal institutions in enforcing contracts has limited trade and market development (Collier & Gunning, 1999). An effective judicial system increases confidence in the likelihood of exchange partners’ fulfilling legal obligations, thus enhancing the willingness to reach out to new exchange partners (Johnson et al., 2002). Hence, other scholars opine that credible assurance from effective legal institutions can foster confidence over exchanges with strangers (Johnson et al., 2002), and make firms willing to explore new exchange opportunities outside relational networks (Zhou & Peng, 2010). The implication could be that under such circumstances, individual may face fewer barriers in becoming self-employed, and existing firms may have the opportunity to access resources required for the expansion of their businesses.

Other authors emphasise the importance of private property rights, especially their protection against government expropriation (Jones, 1981; De Long & Shleifer, 1993). Acemoglu and Johnson (2003. p. 4) argue that contracting institutions affect private transactions and create ex-post transfers between parties. They further argue that although private contracts or other reputation-based mechanisms can be used to alleviate these problems, yet in societies where it is more difficult for lenders to collect on their loans, interest rates increase, hence increasing the transaction cost of doing business. In contrast, protection of private property rights relates to the

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relationship between the state and the citizens. When there are few checks on the state, on politicians, and on elites, private citizens do not have the security of property rights necessary for investment. In this case, they are also unable to enter into private arrangements to circumvent these problems; it is impossible to write credible contracts with the state to prevent future expropriation, since the state, with its monopoly of legitimate violence, is the ultimate arbiter of contracts (Acemoglu & Johnson, 2005, p. 4). This perception could serve as a barrier to the entrepreneurial process; and consequently result in start-up failures, and inadequate firm growth. As Lippman & Rumelt (2003, p. 924) argue, entrepreneurial energy is starkly biased towards the creation of those surpluses which can be appropriated by the innovator. Since in such situations, there may be no safeguards protecting contracting party from expropriation (Williamson, 1991), which may de-motivate individuals from investing. Nkya’s (2003, p. 17) highlights three main elements of transaction cost: cost of measuring the valuable 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. The magnitude of measurement and enforcement costs can be figured in institutional arrangements such as guarantees, warranties, bonding of agents, trademarks, arbitration, mediation and judicial system. Enforcement can come from second party retaliation, internally enforced codes of conduct, societal sanctions, or a coercive third party (the state) (North, 1990, p. 31- 33). Djankov et al.’s, (2003) suggest that countries with greater legal formalism have higher costs of enforcing simple contracts, longer delays in courts, and lower perceived fairness and efficiency of the judiciary system. Also, Narayanan & Fahey (2005) argue that transaction costs in emerging economies are too high because of inadequate or lack of formal institutional structures and enforcement mechanisms that underpin efficient markets. For example, Nkya notes that institutional structures in countries like Tanzania lack effective formal institutional structures and enforcement, which are important for markets to be efficient by creating an enabling environment for entrepreneurs. Consequently, transaction cost per exchange in such economies is higher than in developed economies (Nkya, 2003). Therefore, it could be said that depending on the nature of institutions in a specific context, transaction cost of entrepreneurship may be higher or lower. To wit, higher transaction cost of

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entrepreneurship may potentially pose a threat to firm entry and growth. This will be one of the investigatory themes of this research.

Moreover, Hoskisson et al. (2005) argue that under-developed capital market institutions result in high transaction costs in emerging economies. However, it has been argued that in developed capital markets, the institutional framework contain rules, which improve credit-worthiness, rules effecting credit-transactions (payments on account) and capital-transfers (loans). It has also been argued that the legal framework that supports and enables borrowing depends primarily on reliable authorities who provide subjects with legal security. The implication could be that capital market is closely connected with legal security. Therefore capital transfers beyond the small circle of friends and relatives clearly require a legal framework supported by institutions, in particular government institutions. Thus, the development of the capital market is closely connected to state-formation. Consequently, when authorities take an interest in the capital market and improve the institutional framework, information costs and transaction costs on the capital market will be lower, thus allowing interest rates to drop (Zuijderduijn, 2005). Therefore, the improvement of legal protection for transactions and availability of capital to the local firms lead to the decline of overall transaction costs (Hoskisson et al., 2005), for entrepreneurship.

In deepening understanding between institutions, the capital market and transaction cost for entrepreneurship, Pagano (1993) argues that in modern economies, economic growth hinges on an efficient financial sector that pools domestic savings and mobilises foreign capital for productive investments. Nevertheless, the challenge has been that underdeveloped or poorly functioning capital markets, which are typically of developing economies, are typically illiquid and expensive, hence deters investors. Pagano further argues that there are three main ways5 by which capital markets and economic growth are linked, through whose compliance the capital markets link net savers (households) to net investors (entrepreneurs). The effect is a reduction in the

5 _{Firstly, capital market development increases the proportion of savings that is funnelled to}

investments. Secondly, capital market development may change the savings rate and hence, affect investments; Third, capital market development increases the efficiency of capital allocation (Pagano, 1993).

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transactions costs associated with funneling savings, making the household savings highly liquid, enabling selection of efficient investments by gathering information on investment returns efficiently and providing markets for diversification of risks by households and corporate (Mishra et al., 2010). The implications could be that, in the presence of inefficient financial institutions, productive projects may remain unexploited, while productive investments will be taxed, (Bekaert & Harvey, 1998), increasing the transaction cost for entrepreneurship and limiting enterprise.

Furthermore, Blewett & Farley (1998) argues that in developing economies, transaction cost of entrepreneurship is high because of poor infrastructure, high cost of screening, monitoring and enforcement problems of potential customers for credit facilities. In addition, Khanna & Palepu (2000) argue that an institutional void makes accessibility to information very difficult hence imposing high costs for firms unless they overcome this through their networks. North (1990) argues that institutional infrastructure facilitate economic exchange, the absence of which increases the cost per exchange. In effect, Peng (2003) notes that institutional complexity6 increases the occurrence of arms length transactions, which Okun (1981) suggests as very costly because the other firm or party may become opportunistic and try to capture all the gains from investment or entrepreneurship may be subjected to the other party’s hold- up problems (Kulakowski & Chronister, 2006). The effects of arms length transactions and second party hold-up could decrease the speed with which for instance entrepreneurs access resources (meaning it will require more efforts and resources before accessing resources), as well as increasing the cost of accessing such resources. Consequently, such situations could affect the transaction cost of entrepreneurship, which could eventually suppress entrepreneurship.

While institutions have been considered as a means to create the structure necessary for reducing transaction cost, Olson (2000) argues that formal institutions are created by people with their own private interest in play, but not necessarily the interest of social well-being. Similarly, Johnson et al., (1997) writing about politics and entrepreneurship in transition economies give account of the use of certain rights by politicians over firms. The politicians rights include rights over the use of land and

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real estate that businesses occupy, regulatory powers over privatised and private firms, rights over determination and collection of taxes that businesses pay, the ability to regulate and restrict entry, rights of inspection and closure if regulations are violated, rights to control international trade that firms engage in as well as foreign exchange transactions (Johnson et al., 1997). Shleifer & Vishny (1993) point out that, politicians may use those rights to pursue political goals such as support of politically friendly and punishment of politically unfriendly entrepreneurs as well as enrich themselves by offering firms relief from regulations in exchange for bribes. To this end, Johnson et al., (1997) argue that the generic effect is to reduce profitability of doing business, which adversely influence entrepreneurship and economic growth. Drawing on the above, an argument seems to emerge that in societies with underdeveloped institutions or institutional void, transaction cost of entrepreneurship is high while in societies with developed institutions, transaction cost is low. Transaction cost economists view economic activities as ongoing process of discovery, in which agents’ (entrepreneurs) plans are based on incomplete, imperfect, and subjectively held knowledge about the plans of other agents (O’Driscoll et al., 1985; Littlechild, 1986; Foss & Foss, 2006). Nonetheless, institutions have been argued as assisting in reducing uncertainty by providing stability for entrepreneurship, as discussed in section 4.2.3.

4.1.3 How institutions assist in reducing uncertainty by creating stability for