Abstract
In many low-income transition countries, where formal institutions such as courts do not function effectively, informal institutions are often used by firms to minimize transaction risks. We examine the role of informal institutions, in the forms of relational contracting and social networks, in determining the risks that firms are willing to bear in their transactions with their suppliers and customers, and whether firms that bear such risks have higher productivity. Our country context is Myanmar, a country which is making a transition from a socialist to market-oriented economy. Using a unique dataset of 2496 micro, small, and medium firms, we find that firms that engage in risk taking are significantly more productive than firms that do not, and such firms are more likely to utilize informal institutions, such as acquiring information from informal interaction with customers, and social networks, including information received from business networks by firms, talking to other suppliers of customers, and being a member of a business association. Our findings suggest that informal institutions can be effective substitutes for formal institutions that are often absent or not effective in low-income transition economies.
Highlights
What explains the productivity of firms in developing countries? Several studies have examined the role of factors internal to the firm such as technology, human capital, research and development investment, and managerial practices, as well as external factors such as trade reforms, competition, and foreign direct investment (Syverson 2011)
We examine the role of informal institutions in determining firm productivity in a low-income country which has made the move recently from a socialist economy to a market-based economy
We draw from the Transactions Cost Economics (TCE) framework pioneered by Oliver Williamson (1985, 1996) to posit a relationship between assumed risk and firm productivity
Summary
What explains the productivity of firms in developing countries? Several studies have examined the role of factors internal to the firm such as technology, human capital, research and development investment, and managerial practices, as well as external factors such as trade reforms, competition, and foreign direct investment (Syverson 2011). Since the laws of contracts are often inadequate, informal institutions can substitute for formal institutions in allowing firms in these economies to undertake crucial economic exchanges that are necessary for their survival and growth (Grief 2006; McMillan 1997; McMillan and Woodruff 1999). Relatively little is known about the role of informal institutions, such as social networks and relational contracting, in determining firm productivity in low-income country contexts where formal institutions either do not exist or function poorly. We examine the role of informal institutions in determining firm productivity in a low-income country which has made the move recently from a socialist economy to a market-based economy. For private firms in Myanmar, formal contracting institutions are weak, and firms need to rely on informal institutions when engaging in transactions with their suppliers and customers.
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