How Important Are Formal and Informal Institutions in Mediating Economic Activity - Case Study Example

Name : xxxxxx Tutor : xxxxxxx Title : HOW IMPORTANT ARE INSTITUTIONS, BOTH FORMAL & INFORMAL IN MEDIATING ECONOMIC ACTIVITY? Institution : xxxxxxx @2009 How important are institutions, both formal and informal, in mediating economic activity? Abstract This paper examines how both formal and informal institutions are involved at various levels in the mobilization of economic activities. This is in line with the argument that the configuration of an institution in the securing of developmental approval lies with the implicated history of the respective developers. This according to the argument is in line with the relations of the developers with both the government and the private sector. This paper thus gives an outline of the involvement of both the formal and informal institutions in spear heading economic projects and activities at various levels. It is clear that local developers are more likely to initiate arrangements with various informal institutions. These arrangements are initiated for the purpose of securing the approval for any development. Foreign developers on the other hand are more likely to liaise with formal institutions to attain the approval for initiating any form of developmental economic activity. Introduction Institutions are known to affect the rate of economic development in a number of ways. The impact of which can not be successfully attributed to one aspect. Development is measured by the level of growth and poverty reduction. Institutions are simply various constraints that have been formulated by human beings to govern or shape their own interaction. Such constrains are known to set the standards for what can be done and how it is to be done and what is not supposed to be done. Human beings are thus permitted to uphold some activities and at the same time prohibited from upholding others by these constraints. These institutions form the basis for all forms of human related activity. They basically consist of various formal rules that appear in written and outlined codes of conduct that are not necessarily documented. Informal institutions are outlined behavioral regulations that are common to human beings in simple forms that are not documented. Such regulations are known to be upheld and communicated within structures that are not within official jurisdiction. These regulations are thus contrary to formal regulations that are governed by official legal entities including courts. These regulations are normally not coded but have wide acceptance. Formal institutions on the other hand are defined regulations that are under the governance of legal frame works. Such regulations are made up of constitutional laws, charters, and outlined property rights alongside by laws. Such regulations unlike the case of informal regulations are codified and their application if officially accepted. These regulations both formal and informal are known to either foster development or reduce development in various ways. Discussion It emerges that both formal and informal institutions are dynamic and very diverse. Most of the involvement of these institutions lies with the constitutional code and majorly with the implicated behavioral changes. It is established that the constitutional order at any one point governs the making of laws and the entire governing framework. The arrangement at organizational level is however under governance of the institutional code which is entirely regulated by by-laws. It is established that institutions keep changing and this change process happens to drive societies in to adopting mechanisms to fit in the changes. As indicated in a certain research study, societies have a four level mechanism of adopting this change process (Williams et al 1999). The first level of the mechanism is centered at social embeddings which translate in to customs and religions. This level is characterized by very gradual economic change. The second level of the mechanism revolves around the institutional involvement of a society that translates in to formal regulations and implicated rights to property. At the third level of the mechanism, issues related to the governance of other two levels of the mechanism emerge. The fourth level encompasses the allocation of available resources with regard to the prevailing and the expected economic standards. How formal and informal institutions mobilize economic planning Instutionalisation at both formal and informal levels revolves around the recurring behavioral changes at various institutions. To the broader extent, both formal and informal institutions are known to define a number of actions in any economic development. These actions defined by the institutions both formal and informal include; the type of developers, the action plan, and the type of economic activity to be embarked on. With regard to initiating development, the role of institutions can not be overstated. Informal institutions in particular form the basis for extensions and clarification of the expected code of conduct. These institutions are known to limit the available alternatives for the development of formal institutions. These institutions are known to be more resilient to change and evidently affect the asymmetries of power implicated in the allocation of available resources (Isham 2002). Owing to the fact that the structures governing informal institutions are not within the government jurisdiction, this institution tends to form the basis for all forms of decision making and negotiations. The structures governed by informal institutions are very vital to all forms of residential development. Formal institutions on the other hand form legal regulations that govern the operations of market related activities (Coyne 2007). The impact of formal institutions is more felt in matters that revolve around the economic constrains that are bound to be shared socially. These institutions seem to provide a large proportion of the foundation for any form of economic interaction. With regard to residential development for instance, these regulations define the expected forms of land use and ownership. These regulations will thus either foster or limit the number of land use activities that can be upheld by the owners of the land, developers or investors in various capacities (Isham 2002). The role of both formal and informal institutions in defining economic development Institutions are thought to impact on the behavior or conduct of human beings through the provision of incentives that drive people to involve themselves in various economic activities. Institutions can at the same time limit the economic development through defining restrictions that prevent people from indulging in a number of economic activities. Both informal and formal institutions are known to foster the level of economic development through two major mechanisms. The first mechanism revolves around the reduction of the implicated cost of indulging in any business related activity. This mechanism is geared at fostering competitive processes (Menard 2000). The second mechanism is centered at fostering the efficiency with which the competitive processes may initiate development of various economic sectors. All forms of development are centered on the growth of the economy. This is measured by the degree with which individuals will be willing to involve themselves in various business related transactions. It emerges that if the existing regulations are such that foster a high cost of transacting, the implicated economic activity at that time would be heavily constrained. Institutions are very influential in easing the cost of various business activities by enhancing the effectiveness with which business transactions occur (Chandra 2006). With regard to Muslim nations around the world, the impact of both formal and informal institutions has been very influential in defining economic activities. Genovese businessmen for instance managed to successfully expand a number of their economic activities owing to the existing institutions. Such institutions built on individualist ethos fostered the emergence of well enabled transactions (Fischer 2006). This situation was thought to be similar to that of Muslim businessmen that seemed to have been constrained by a number of communal ethos. The transactions among the Genovese traders were done at arms length unlike the case of Muslim traders whose transactions were conducted at intercommunal levels encompassing one on one encounter. Such encounters were under a number of sanctions. This illustration depicts how the prevailing cultural norms and regulations define the level and nature of the emerging economic development (Chandra 2006). Institutions foster competitive processes that are bound to initiate the development of various economic activities through fostering efficiency. Owing to the fact that institutions influence the incentives that are bound to drive both individuals and groups of people in to engaging in various activities, the existing regulations on the market are known to influence the level of competition in any market. Both formal and informal institutions are known to define how industries are to be regulated, outline the laws that govern the taxation process and the overall economic change process measured through the acquisition of various technologies (Joachim 2002).A number of countries have formulated laws and regulations relating to graft. Such regulations define what graft is all about and how the same is dealt with measures the level to which formal regulations on graft are effective. Both informal and formal institutions are very influential in shaping the prevailing economy. By outlining the regulations that govern the interplay of activities in social, economic and political organizations, institutions may either foster economic development or hinder any form of economic growth (Watson & Anthony 2003). With the dynamic nature of both formal and informal institutions, both foreign and domestic investment is bound to be affected by the changing institutions. The impact of both formal and informal institutions is known to affect the development of the economy in various ways depending on the governance of a country. This explains why the impact of institutions on the economic development differs in developing and developed countries. In majority of the least developed countries, the existing formal institutions are known to limit the development of businesses in the private sector. In such countries, the change process in the existing institutions is relatively very slow (Ruming 2009). Both formal and informal institutions are known to co-exist with each other. The change process in either of the institutions must be such that is consistent. This co-existence with regard to the economic change process may limit the overall economic reform process as implicated in the case of post Soviet Union (Welter et al 2005). The same co-existence can foster the development of private economic activities as was the case of Vietnam and China in the twelfth century. The complexity and quality of the institutions in place is very vital at defining the level of economic growth. There are a number of institutions that have slowed the level of economic development especially in least developed countries where a number of reform processes are now being initiated (Soya 2009). For both informal and formal institutions to effectively foster economic development, the following recommendations need to be fostered: Developing countries and the various development agencies need to put in place informal institutions that effectively support the development of private businesses. Countries that are still lagging behind in economic development need to foster open networks of business activities and not kinship networks. This is because kinship forms of networks are very inferior. Informal institutions that effectively support the development of the private sector are known to foster the change process for formal institutions as well. It should be understood that informal institutions that slow down the development of the private sector also hinder the reformation of formal institutions and thus slow down the growth of the economy (Rodriguez 2009). There is need for development agencies in various countries to replace economic growth slowing informal institutions with institutions that can foster economic growth. Such a task may not be effectively upheld by the least developed countries themselves. In the initiation of such reform processes, there is need for development agencies to understand that the institutions that are to be put in place would compete with institutions put in place by developed countries. This should be done in line with the prevailing institutions in mind. This is because introduction of new institutions in any country depends on the prevailing social and political institutions (Dhillon 2005). For informal institutions to successfully foster economic growth there is need to change the prevailing political institutions. The authority of the government is equally vital in fostering the reformation of both formal and informal institutions. There is need to understand that some political elites have in the past resisted institutions that are effective in fostering economic growth. There is need for both foreign investors and development agencies to ascertain the feasibility of existing political systems in any country before initiating any economic development. The move to initiate new institutions in any country may not be ideal. It is better to initiate the reformation of existing institutions. Directly exporting policies from developed countries in to least developed countries may not successfully foster the rapid development of the economy (Johannes 2007). Conclusion Both formal and informal institutions are very vital determinants of economic development. These institutions define regulations that may be written as in the case of formal institutions or not written as in the case of informal institutions. These regulations influence the development of the economy either positively or negatively. The outlined regulations can form the basis of incentives provision for both individuals and groups to indulge in to economic activities. At the same time the regulations can slow down the economic development by putting in place very harsh economic regulations. Such harsh regulations tend to put off potential investors in any economy. Reference Chandra, R 2006, Institutions, globalization, and empowerment, Edward Elgar Publishing, Washington. 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