NN42, June 2009
A Safari Towards Aid Effectiveness?
New Institutional Economics and New Conditionalities?
By Richard Ashford and Shampa Biswas, Whitman College, Walla Walla, Washington State.
Email: ashforr@whitman.edu and biswassa@whitman.eduKeywords
Institutional economics; conditionality
Summary
This piece discusses how ?transaction cost economics? can be used as an analytical tool to better understand the issue of aid conditionality.
The topic of conditionality has received considerable attention within the development literature. Typically, the literature describes the conditions attached to aid by donors in either technical terms as safeguards which facilitate the achievement of certain goals or in political terms ascribing power to one (typically the donor) agent in the aid relationship. By applying a more micro-analytic tool such as ?transaction cost economics? to the issue of conditionality, we might be able to reveal certain insights not found in the other types of analyses.
The application of transaction costs analyses to the complexity of production within the development industry makes an interesting and germane topic. Indeed, transaction costs are frequently mentioned within development discourse and the reduction of transaction costs are a central feature of most broad policy statements such as the Paris Declaration. However, rather than using concepts developed by the vast body of research and literature in transaction cost economics, transaction costs are relegated to another entry in an accounting ledger. Until we accurately portray transaction costs in terms of a comparative institutional analysis and begin to apply the already well developed conceptual framework to the development industry, key aid effectiveness goals may not be met.
As part of New Institutional Economics, transaction cost economics provides a number of interesting concepts that may clarify some problems with the way in which we frequently view conditionality. Williamson (1996) defines seven features of transaction cost economics: 1) the transaction is the basic unit of analysis, 2) transactions differ by several key dimensions, 3) modes of governance differ in their dimensions, 4)modes of governance are supported by separate types of contact law, 5) transactions, which differ in attributes will align with a (mainly) transaction cost-economizing governance structure, 6) the institutional environment impacts transaction costs and 7) transaction cost economics is an exercise in comparative institutional analysis. Although the contracting or agreement to transact is central to transaction cost economics, all contracts are assumed incomplete due to a lack of complete information (bounded rationality) and the potential for ex-post opportunism (Noorderhaven, 1996).
In terms of how we might better understand aid conditionality through a transaction costs lens, two concepts prove useful: asset specificity and path dependence. Asset specificity refers to the extent to which an investment (in a transaction) is readily redeployable for some other purpose. In a similar vein, path dependence, referring to the production process more generally, indicates that once productive technologies are created, the costs of creating new technologies to replace old ones (even if they may be inefficient) may prohibit innovation and change. Conditions placed on governments and ministries are investments which relative to other projects, organizational structures, human resources, etc. create a high level of asset specificity. The production of educational services and outcomes, for example, becomes entrenched within a path dependent production process or contingent on the organizational structure.
Although conditions may appear rational in the short run to donors, they may not be part of the preferred contractual arrangements of the country or ministry. Conditionality creates an environment where the donor may act opportunistically and establish a quasi-rent stream because once investments are made on the part of the government, additional conditions subject to the loan or grant contract may be added since there is a cost to forgoing the investments in the initial contract, to search for (and secure) alternative contracts, and to potentially lose the trust built up under the contract and thus future contracting. Although some research indicates that frequent contractual obligations unfulfilled by recipient governments are not punished, transaction cost analyses can still reveal the extent to which conditionality creates certain kinds of long term fixed costs that may impact aid effectiveness.
Within the post-Paris Declaration aid effectiveness trend and the push for cooperative and collaborative development efforts, the coordination of development initiatives has become a central component of this trend and unfortunately its Achilles heel as well. For this article, I am not as interested in major overt policy conditionality as I am in the organizational and human resource reforms that the policies imply, using several examples to support this. Not only do organizational reforms represent an externality borne by the aid recipient in the name of ownership, but they also represent an investment in the aid package (sometimes agreed upon by several donors and sometimes not). The environment/market within which countries acquire development aid (education in this case) is continually in flux. What transaction costs economics may help to unpack is the complexity of multiparty agreements (contracts) and cooperative behavior within the aid effectiveness trend.
Given little to no measurement of transaction costs, poor understanding of transaction costs analyses in the development field, and the argument that changing institutions is a costly enterprise (North, 1990), it is not surprising that conditions continue to be attached to aid contracts and that the aid effectiveness trend continues to suffer from a lack of coordination. The recent decision by the FTI to forgo costly ?harmonization? efforts is another reason why we need to conduct more applied research in transaction cost economics to the development industry.
References
Noorderhaven, (1996) Opportunism and trust in transaction cost economics. In J. Groenewegen (ed) Transaction Cost Economics and Beyond. Kluwer Academic Publishers. Boston. p105-128
North, D. (1990) A transaction cost theory of politics. Journal of Theoretical Politics. 2(4) p355-367.
Williamson, O. (1996) Efficiency, power, authority and economic organization. In J. Groenewegen (ed) Transaction Cost Economics and Beyond. Kluwer Academic Publishers. Boston. p11-42
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