When institutions are bad, how much do social networks really help?

Fascinating bit of research by trio of Ulrik Beck, Benedikte Bjerge, Marcel Fafchamps.

Ever since the seminal paper of Coase (1937), economists have known that transactions costs can hinder the efficiency of exchange. If transaction costs are present, some mutually beneficent transactions may not take place.

In developing countries, poor institutions mean that many such transactions are left on the table since transaction costs are too high. For example, property rights are often vaguely defined and contracts hard to enforce legally. Well-functioning institutions support well-functioning markets through low transaction costs. In these contexts, there is increasing evidence that households instead rely on their social networks. One example is how social ties play an important role in informal insurance schemes (Fafchamps and Lund 2003, Mazzocco and Saini 2012). In fact, the importance of social ties shows up in very diverse contexts where they can help to decrease transaction costs; other examples from the economics literature are in the selection of an international trading partner (Granovetter 1995, Topa 2001) and in labour markets where seeking and getting a job is affected by social networks (Rauch 2001, Chaney 2014).

There are good reasons to think that social networks can also reduce barriers to the exchange of production factors. Social connections can increase trust between individuals and important information can be exchanged. Social ties can also reduce the risk of violation of agreements, since the violator risks losing not only the contract but also the social connection. These are some of the ways in which social ties are thought to lower transaction costs. However, the extent to which social ties can offset the negative impacts of high transaction costs for exchange of production factors is an open research question. Earlier papers provide indirect evidence that this may be the case (Sadoulet et al. 1997, Holden and Ghebru 2005, Macours et al. 2010).

So what does their analysis show? Do networks help? Somewhat…

Can social ties offset the negative impact of a limited or non-existing institutional framework? Our answer is a tentative yes.

Interestingly, we find that some of the largest landowners do not perform efficiency-enhancing transfers, but once these are controlled for, the average transfer is efficiency-enhancing. While this can be interpreted as discouraging evidence as to the potential of social networks to offset the limits imposed on transfers by the institutional environment, it is not all bad. One interpretation of our results is that while smaller landowners do use social networks to offset the negative impacts of transaction costs, the largest landowners are not inhibited by the costs of transferring land outside the social networks. In this sense, it is encouraging that the socially marginalised households of the village – those who are not kin-related to or shares ethnicity with the large landowners – are not marginalised when it comes to receiving land.

Our analysis does not attribute any motives as to why households transfer land and labour in the ways that they do. Our method is only concerned with the properties of the factor exchange which occurs in these villages. This column is not concerned with the mechanisms driving the exchanges of land. However, there is some evidence that for the rural farmers in Gambia, factor allocations are at least partly motivated by altruistic behaviour (Beck and Bjerge 2015).

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