Markets or Hierarchies? Transaction Costs, Institutional Environment and the Foreign Collaboration Decision in India

Abstract

Over the past few years, a growing volume of literature has analysed the forms of foreign investment to developing countries from the perspective of institutional economics, following their attempts to shift from centralised planning to a market oriented system of exchange. This article carries forward this literature and examines the relevance of the institutional factors—transaction cost theory and institutional environment—in empirically determining the modes of foreign investment and technology transfer (or foreign collaborations in India) in India. The results of this exercise show that market institutional factors like transaction costs and government policies (institutional environment) play a significant role in influencing the forms of foreign collaborations in India. However, the pattern of foreign collaborations also show a trend for higher control modes, refuting the basic hypothesis of transaction costs theory that posits a low level of ownership, unless proven otherwise. These observations can be linked to considerable market imperfections, like weak conditions relating to contract enforcement, property rights protection and ease of exit and also foreign monopoly power that hinder the market mechanism, and call for the need for strengthening the role of supporting institutions required for facilitating market exchange of transactions. JEL Classification: L22