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Chapter 8. Institutional analysis of trade liberalization and agriculture[131]

8.1 Introduction

Mainstream analysis of agricultural trade liberalization has tended to focus on the effects of trade reform and other policy instruments on the volumes and location of production, consumption and resulting trade flows. Insofar as institutional change is a change in the rules of the game, trade policy liberalization can be thought of as a bundle of institutional changes. In this sense, mainstream analysis of trade liberalization is a form of institutional analysis. A number of gaps in the treatment of institutions are discussed in this chapter.

8.2 The need for improved institutional analysis

The nation, or an alternative aggregation such as a region, can be considered as a system with a particular historical institutional endowment. The institutions of its political economy must be examined from a perspective that recognizes there are different routes to the achievement of effective coordination. The liberal market economy (LME) institutional set is effective in some regards, but unsatisfactory in others. Thus, when liberalization policies are proposed for a particular nation or region, it is necessary to consider these as developments of that nation’s systemic approach to dealing with coordination problems. Radical changes may be damaging, as they amount to new institutional models which are not rooted in accepted ways of solving coordination problems. They risk damaging existing sources of “comparative institutional advantage” while failing to find new ones.

LME institutions are probably not appropriate for the development of smallholder agriculture in pre-Green Revolution areas of the poorer countries, although this conclusion is tempered by the fact that transactions challenges differ by crop, and generally are at their most difficult for semi-tradable staples. Thus the institutional changes required by liberalization measures within the Washington Consensus on Agriculture (WCA) (described in Chapter 6) may be taking poor farmers down a blind alley. For poor farmers, the key challenge is to devise institutional arrangements which are able to reduce transactions costs and also induce a much stronger strategic commitment to investing in needed specific (and co-specific) assets. The characteristics of poor smallholder agriculture are such that LME institutions are unable to solve the very particular coordination problems that arise. As yet there is little in terms of detailed alternative policy proposals or policy experiments to find alternative paths for trade liberalization to support growing rural welfare and food security.

Whether poor farmers do benefit from liberalization, and enhanced food security, will be partly a matter of the appropriateness of national institutions, rural institutions and the particular institutional arrangements that can be developed to support the transactions of smallholder farming. From this it follows that it is critical that policy be developed on the basis of an understanding of what are likely to be broad outlines of appropriate institutional arrangements, i.e., arrangements that will be transaction cost-reducing and specific asset investment-inducing.

While the increasing institutionalist emphasis in World Bank work[132] is welcome, it focuses mainly on property rights. Well defined, accessible and easily tradable property rights are, essential for modern economies, whether they follow the LME route, or the alternatives sketched out below. However, for some LME economists, a framework of strong property rights and competitive markets are most of what there is to worry about. If institutional arrangements evolve within this framework, these will be broadly satisfactory. From this point of view, institutional arrangements are interesting matters, worthy of study, but in policy terms second order in comparison to property rights and competition. Here an alternative line is taken, which argues that institutions such as non-market coordination and deliberative mechanisms, and institutional arrangements such as competitive coordination, interlocking and regulated monopolies need to be central to any analysis of the effects of trade liberalization on the poor.

8.3 Coordination and deliberative mechanisms

Following in the tradition of North[133] and Williamson[134], Hall and Soskice[135] construe the key relationships in the political economy in game theory terms, and focus on the kinds of institutions that alter the outcomes of strategic interactions. They see an economy as being populated by different actors seeking to advance their interests in a rational way through strategic interaction with others.

National political economies can be compared in terms of the means by which firms within these economies solve coordination problems. Hall and Soskice distinguish two ideal types, at opposite poles of a spectrum.

Hall and Soskice argue that in LMEs, the principal institutions on which firms rely for coordination are markets and hierarchies (firms), together with vertical hybrid arrangements between firms in a supply chain. CMEs differ because they draw on a further set of organizations and institutions, those supporting more horizontal strategic interaction, both across and within supply chains. Strategic interaction is dependent on informal rules based on experience with a familiar set of actors; the shared understandings that accumulate from this experience; and a set of shared understandings of available “strategies for action” developed from experience of operating in a particular environment. This shared set of understandings is evolutionary and fragile. Hall and Soskice conclude that institutions of the political economy need constant reinforcement by the active endeavours of the participants. In general, CMEs are institutions which reduce the uncertainty that actors have about the behaviour of others and will allow them to make credible commitments to each other, providing capacity for exchange of information, monitoring of behaviour, and sanctioning defection from cooperative endeavour.

Particularly relevant to developing country agriculture, is the role in CMEs of deliberative institutions. These are institutions within which actors engage in collective discussions which, when successful, endow participants with a strategic capacity which they would not otherwise enjoy, because it facilitates cooperation. More specifically, deliberative institutions achieve cooperation by increasing and sharing knowledge and increasing confidence in the strategies likely to be taken by others, facilitating agreement about what may constitute a broadly acceptable distributive outcome, which is often a pre-requisite for effective cooperation, and enhancing the ability of actors to take strategic action in the face of shocks, through common diagnosis and common action.

The key competitive advantage for CMEs, which results from effective non-market coordination, is that firms and other actors are willing to invest in specific and co-specific assets, i.e. assets which cannot readily be turned into another use, and assets the returns to which depend heavily on the active cooperation of others. In contrast, in LMEs there is a greater interest in switchable assets, such as general skills or multipurpose technologies.

Hall and Soskice argue that the two types of political economy have distinctly different capacities for innovation, and have different income distributions. These different capacities for innovation are the basis for a theory of comparative institutional advantage. For these authors, the institutional structures of a particular political economy provide firms with advantages for engaging with specific types of activity. A key distinction is between: radical innovation, which requires substantial shifts in product lines, entirely new goods or major changes in the production process; and incremental innovation, the continuous small improvements to product lines and processes. In general, CMEs can be thought of as being specialized in activities characterized by continuous technical innovation, and the LMEs characterized as those more fully engaged in areas of radical innovation.

8.4 Implications of comparative institutional advantage

The key policy challenge is to induce economic actors to cooperate with each other. In some cases, markets can be used to secure this coordination, so the task of policy-makers is simply to improve the functioning of markets. In other cases, the challenge is to improve coordination in the context of strategic interactions. Much less is known about how to accomplish this, but as Hall and Soskice state, “It entails persuading private actors to share information, improving their ability to make credible commitments, and altering their expectations about what others will do.”

Hall and Soskice see the “strong state” as a potential source of disadvantage. States cannot simply tell economic actors what to do, as they lack the information needed to specify appropriate strategies. States can establish agencies, but what these can do is limited. Only where appropriate social organizations” exist, is it possible to work with them to improve their cooperation, for example, if the state improves the way in which it regulates.

8.5 Institutional pre-requisites for agricultural in poor countries

As set out in Chapter 6, the agriculture sector’s contribution to poverty reduction will be made, principally, where broad-based growth is achieved in smallholder farming communities. Important historical examples of the strategic contribution of agriculture to development are the Green Revolution areas of India and China. Both of these occurred within specific and well-defined institutional frameworks, including strong state intervention in irrigation infrastructure and in delivery systems that influenced prices, transaction costs and transaction risks in inputs, finance and output markets.

In contemporary India and China, the emerging challenges are to find means to modify the institutions which underpinned the Green Revolution to support urbanization and a diversifying rural economy. In contrast, in much of sub-Saharan Africa, and some parts of South Asia, sustainable broad-based agricultural intensification has yet to occur and agriculture has not yet made its strategic contribution to economic development.

The following institutional aspects of the challenge of smallholder development need to be noted.

The results have, by and large, been unsatisfactory, and a debate has been joined between:

Interventions by the state are often associated with encouraging rent-seeking behaviour, inadequate deliberation, and a certain lack of dynamism. At the same time, however, as in the achievement of India’s and China’s Green Revolutions, a degree of success may be achieved which is difficult to imagine under a pure LME model, due to inadequate strategic commitment to asset-specific investment and, possibly, an unwillingness to support non-standard contractual arrangements, such as interlocking.

8.6 Conclusion

The way forward is likely to involve a rethinking of the role of the state (at sub-national, national and international levels) and of the roles of producer organizations and other stakeholder (including trader) associations. The aim must be to find a way in which the state and other powerful actors can initiate deliberative processes and take a lead in encouraging appropriate asset-specific investments, while at the same time planning to become less involved in direct intervention in the agriculture sector as initial success is achieved. The second stage of a successful path of institutional development will have the state and other stakeholder (prominent among these producers) acting as equal partners.

Research on liberalization and poverty needs to be “institutionally informed”. The challenge to institutional specialists is to provide insights, ideally quantifiable, into the consequences of liberalization policies driving changes in such features as “non-standard institutional arrangements”, non-market coordination and the role of the government. Those engaged in institutional analysis are still far from meeting these challenges.

Box 8.1 An institutional view of liberalization in poor rural areas: Sub-Saharan Africa

The development of effective deliberative mechanisms is highly problematic for several reasons: the spatial dispersion of smallholders, their smallness, poverty, low levels of education, large cultural variation (e.g. in language and inheritance traditions) and weak information (in terms of access to reliable media, and farmers’ understanding of the roles of other actors in the supply chain). Thus non-market coordination to induce asset-specific investment is very difficult to achieve.

In Africa, there has been little choice but for the state to take the lead in efforts at non-market coordination. Except in cases where private processors were present on a large scale (mainly in cash crops and with a degree of monopsony), there were few alternatives to a state-led approach. The alternative, feasible for certain cash crops only, of coordination being led by a dominant private interlocker, was politically unpalatable, and perhaps had nearly as much scope for rent-seeking.

Rolling back the state does eliminate organizations and a policy framework which have created scope for rent-seeking, while being technologically and managerially slothful. However, what has been largely ignored in the liberalization literature was that the state was involved in the first place because:

- coordination to encourage asset-specific investment was vital, and frequently the state was the only actor available for this;

- the state itself made asset-specific investments that, generally, independent private businesses would not have made;

- the state sometimes overcame market failure, particularly the near pervasive issue of credit market failure, though practising a form of interlocking, based on area monopolies and state power.

The current predicament in liberalized smallholder farming areas of Africa is the assumption that policy reform has created space for the flourishing of LME-type institutions, markets and hierarchies, with little non-market coordination. This is largely illusory, as neither the demand nor supply conditions nor the infrastructural or informational prerequisites are in place for a self-sustaining LME growth path to be attained. Players (farms and input and output marketers) are typically small, lacking in effective loan collateral and subject to high climatic and price risk. Transport costs are high and other forms of communication are underdeveloped. There is widespread market failure in smallholder finance, leading to weak use of inputs and failure to make much headway in intensifying production. This is a discouraging market for processors to invest in. The result is a low level equilibrium trap, arguably aggravated by the “institutional naivety” of liberalization policies.

[131] This chapter is based on a paper by J. Kydd, (Centre for Development and Poverty Reduction, Imperial College Wye), presented at the Expert Consultation on Trade and Food Security: Conceptualizing the Linkages. 11-12 July 2002, Rome.
[132] World Bank. 2002. World Development Report Globalization, growth and poverty: building an inclusive world economy?
[133] North, DC. 1990. Insitutions, institutional change and economic performance. Cambridge, Cambridge University Press.
[134] Williamson, O.E. 1985. The economic institutions of capitalism. New York, The Free Press.
[135] Hall, P.A. & Soskice, D. (eds.) Varieties of capitalism: the institutional foundations of comparative advantage, Oxford University Press, 2001
[136] For example research at the Centre for Development and Poverty Reduction, Imperial College Wye, available at

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