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Formal and Informal Market Institutions: Embeddedness Revisited

Mar 2017
SCID Working Paper
By  Marcel Fafchamps

Market exchange involves many cognitive and non-cognitive processes -- e.g., search, inference, prediction, negotiation. Much attention has been devoted to these issues both in theory and in experimental economics. I focus on the enforcement of market transactions against opportunistic behavior. I first discuss the different mechanisms that can deter opportunistic breach of contract. Some of these mechanisms rely on rational thought and self-interest; others rely on intrinsic motivation, including emotions. Implications for institutional design are summarized. I then discuss the different types of social norms that are needed to support different mechanisms for the assignment of individuals to task, either within a family and a hierarchical organization, or by the market. This framework provides insights on the normative content that is most conducive to economic efficiency. In the last and central part of the paper, I examine how behavioral tendencies interact with norms, incentives, and assignment mechanisms to support or undermine market institutions. I start by discussing how altruism and rivalry feed into the competitive process. Next we examine the relationship between mate selection and market matching. Breach deterrence is introduced next, first from the point of view of risk attitudes and excusable default. This leads to a discussion of morality and preferences over process. The paper ends with a brief discussion of individualism and agency. Implications are drawn regarding knowledge gaps. Investigation is needed on how different cultures view different types of incentives and deterrence mechanisms.