Embedddedness & Role of Formal and Informal Institutions in the Economy - Essay Example

Introduction

Embeddedness means to be integrated into or becoming a part of something, in this case, the economy. It also refers to the level in which economic institutions constrain economic activity. Research has shown embeddedness in economy is better portrayed by both informal and informal institutions. They define economical operations starting from social groups, household, villages, firms, to the government. For instance, moral and ethical behavioral (informal) are embedded in institutions such as schools (formal).

The informal sector is at times referred to as the grey economy. Informal sector is rarely taxed or closely monitored by the government in comparison to the formal sector. In many instances, the informal sector is rarely included in the Gross domestic product (GDP) or Gross National product (GNP) of a country. This industry is characterized by ease of entry, lack of job security and small scale operations among other traits. Workers in this sector do not have regular working hours, a structure of command, and at times, they lack a particular workstation location such as street vendors, hawkers among others.

Formal sector relates to a part of the economy where the institutions have regular working hours; regular wages, taxes are paid and is regulated by the government. The employees in this sector have a decent work environment, a job description, health insurance or pension schemes. Banks, government structures, private companies, educational institutions, research organizations, and non-governmental organizations among others make up the formal sector.

Role of formal and informal institutions in stabilizing the economy and their embeddedness

Informal institutions especially in the developing countries play a significant role in the economy, shaping of the formal institutions, and marketing operations. Additionally, informal institutions in most instances emerge as the preponderant rules of interaction when the official institutions and markets fail. The status of economy and development in a country determines the quality of facilities while the quality of these systems determines the level of economy and development. In both formal and informal institutions, economic rules, incentives, and constraints whether written or verbal, are instrumental in the development and growth of the economy.

Informal sector has been seen as an autonomous segment of the economy that benefits mainly the area of its operation and significantly depends on the formal sector. Conversely, this is not the case with the economic institutions. Both informal and formal are linked through production linkages, technological linkages, and consumption linkages. Informal sector traditionally is known to mainly produce consumer products meant for low-income consumers. However, in the modern world, the informal sector provides both consumer and capital goods that serve both the low-income consumers and middle-income consumers. In some instances, these good compete with products produced by the formal sectors. Consumer goods generated by the informal sector are mostly consumed by the people engaged in industries either directly or indirectly.

Although the informal sector is characterized by labor-intensive technologies, it generates more employment opportunities. On the other hand, the formal sector has various regulations and requirements that limit access to formal jobs hence a stagnant economy. However, both are linked together and none can survive without the other. For example, small scale vendors need financial services which they get from banks and other financial institutions in the formal sector.

The formal sector through taxes and other levies contribute to the economy of the country as well by injecting revenue. Both sectors are affected by government decisions and any other factor linked to trade and daily operations. In most developing countries, policies are developed to enhance a more equitable linkage between the formal and informal economies. These policies are mainly aimed at balancing the cost and benefits of working in either the formal and informal sector. The focus in mostly on government and stakeholders involved.

Economic and non-economic spheres in the economy

Economic and non-economic spheres are interlinked; the economic sphere cannot do without the non -economic sphere such as human labour, ethics, politics, and culture. For instance, trading ethical values (non-economic sphere) cannot exist without a market (economic). A good example would be prohibiting exchange of goods from companies that engage in environmental pollution. Do so is thereby introducing values into the economic sphere.

If a distinction was to be drawn between economic and non-economic areas, then values originating in the non-economic sphere such as politics and ethics could be brought to bear on the economic sphere. This shows that economic sphere cannot be isolated from non-economic sphere since values such as ethics, culture, and politics among other, significantly influence the economy, hence the strong bond.

The benefit of non-economic sphere in the economy can be seen in countries where beliefs, culture, ethics, values or religion work in a manner that directly affects operations which in turn stabilizes or destabilizes the economy.

Roles of the state in various aspects in stabilizing the economy and promoting economic growth

The roles of the state in regards to the economy include redistribution, supply of public goods, protecting property rights, providing stability, and economic simulations. The state is the primary supplier of public goods which include; roads, security, street lights, and maintenance of public parks among others. Public goods are divided into merit goods, club goods, and public goods. Public goods are provided by the government as they are necessities and unattractive to the private sector as they do not earn them reasonable profits although they require high investment capital. Public goods are mostly supplied through government monopolies. The government decision as a policy to use a monopoly in the provision of a public good has both positive and negative consequences. For instance, monopolies are in most cases very inefficient which may slow economic growth.

Merit goods under public goods can be provided by both the government and private sector, but they are provided by the government so as to benefit as many citizens as possible. For example, vaccination exercises; when provided by the government, a large number of people are likely to benefit unlike when provided by a private sector which is likely to favor only the able part of the citizen’s population.

Club goods help people involved in economic activities such as athletics and sports. For instance, an individuals interested in sport activities will enjoy amenities built by the government in regards to such activity. Public goods are mainly financed through tax from all tax payers in a country or state. When mismanagement of domestic public goods occurs through monopolies or other authority in place, this is seen as a loss of taxpayers’ money. The state is, therefore, responsible of all public goods by ensuring they are properly used hence stabilizing the economy and promoting economic growth.

The state is in charge of global goods in regards to the economy stability. Global public goods are those that benefit the current generations and generations to come. The challenge in global public goods is the lack of a global government to provide these products or even global tax revenue so as to fund them. In most cases the government is pushed by civil society to provide these goods. In most cases, financing is done by international institutions such as United Nations. In developing countries a problem occurs when funds meant for funding global goods are diverted into provision of other more needy circumstances. In order to stabilize the economy, the state ought to implements treaties that in the long run boost development and economic growth.

Global public goods are also in the form of natural resources; air, lakes, organic and inorganic materials, biodiversity and genetic variability. The term “natural” means act of nature; ownership to no man making them prone to pollution and exploitation by human. Therefore, it is the responsibility of the government to protect these resources. Government through policies, treaties and laws protect the natural commons both at local and international level. These resources can be in the form of minerals which the government benefits from through revenues and taxes. For example, Oil to the producing countries is the major contributor in developing their economy. They can also be used in various industrial productions which is beneficial to the economy at large. Thus, the governments ought to come up with policies that help stabilize and promote economic growth as a result of natural commons.

Lastly, it is the role of the state to promote a skilled labour force to boost economic growth and stabilize the economy. Labour is an essential part of the economy, especially in production. Labour is directly related to the size of the population, education level, and social norms. Government through policies shape the school system and through various factors influences the size of the population. When the government has poor policies, it results into unfavorable working environments such as poor wages and salaries. The economy suffers as the capable part of the population, in this case, the working population, keeps on moving out of the country to look for greener pastures.

Labor supply is at times constrained by formal and informal institutions. The major constraint being imposed by laws and regulations in regards to education. The state should always strive to have favorable policies that protect even the unemployed and monitors the percentage of foreign worker. The work of the state is to avoid this as well as other forms labour discrimination through policies so as to promote equity and fairness in the job market which in the long run has an influence on the economic growth and development.

Methodological Consequences

The methodological consequences of decision making in various economic institutions is taken into consideration as these institutions are embedded. Basic economic institutions such as firms, households, community, and the government are embedded into the larger society. Decision making of any kind must take into consideration all these institutions to avoid economic crisis. For instance, financial crisis in the mortgage sector, directly affects the banking sector which in turn affect the stocks market and in the long run the entire economy. In such times, people loss homes, jobs, businesses, and property. The relationship portrayed here, shows embeddedness of these institutions and how decisions or activities in one sector can affect the other.

Economic stewardship of natural resources

Mindful protection and use of the natural environment otherwise referred to as economic stewardship is a key aspect in any economy. Sustainable growth can only be achieved through very calculative and controlled utilization of natural resources. It is, therefore, the responsibility of all individuals to be stewards of the natural resource by ensuring they live and act in a manner that does minimum or no damage to the environment. However, governance, commitment and responsibility are the major challenges facing economic stewardship in regards to natural resources.

In conclusion, formal and informal institutions in an economy are linked and have been seen to complement each other depending on the market or situation at hand. They both contribute through various ways towards a stable economy. Economic and non-economic spheres are interconnected which positively impact on the economy. Different institutions come into play in stabilizing the economy. For instance, the role played by the government is more pronounced taking into consideration the methodological consequences that result from government decisions. Natural resources also play a major role in stabilizing the economy. This is because through these resources there are industries such as the mining and oil industries hence the need for economic stewardship of the natural resources.