In 1984, I set out to investigate whether my demand for institutional analysis had created its own supply, whether the thesis of institution-free economics had created its antithesis. My working rule was to limit the study to contributions that did not alter the core of the economic approach, particularly the rational-choice model, and to seek a new synthesis of neoclassical and institutional economics. Neoinstitutional Economics is the term I use.
In general terms, transactions costs are the costs that arise when individuals exchange ownership rights to economic assets and enforce their exclusive rights. A clear definition of transactions costs does not exist, but neither are the costs of production in the neoclassical model well defined.
The concept of state ownership is particularly ambiguous. In a democratic society, state property may have some of the characteristics of common property; for instance, the citizens usually do not have the right to sell their individual titles to public property, whereas under dictatorship, state ownership can approach the system of private property with the economy resembling a huge corporation.
Let us define institutions as sets of rules governing interpersonal relations, noting that we are talking about formal political and organizational practices.
Without the state, its institutions, and supportive framework of property rights, high transaction costs will paralyze complex production systems, and specific investments involving long-term exchange relationships will not be forthcoming.
Adam Smith began his Wealth of Nations with an examination of the internal works of a pin factory, but he soon turned his attention to other things: the coordination of a market system and the economics of growth and development. For more than a century and a half following the publication of Smith's masterpiece, the nature and internal organization of the firm received little attention in mainstream economic theory.
When analyzing the nature of the firm, the new literature tends to emphasize two aspects: A firm involves a set of long-term contracts between input owners, and a firm replaces the product market with a factor market where price signals play a relatively small role (as output is not measured continuously and sold for a price) and, typically, hierarchical relationships are substituted for market exchange.
We begin by introducing what we refer to as the naive theory of property rights and its application in several areas. The naive theory looks at the emergence or nonemergence of exclusive rights in terms of the costs and benefits of exclusion and the cost of internal governance when individuals share property rights.
North's (1979) theory of the state,... is based on the modern theory of the firm... and emphasizes how transaction costs and agency problems affect political behavior and the structure of property rights.