How to Make Institutional Economics Policy-Relevant: Theoretical Considerations and an Application to Rural Credit Markets in Developing Countries

Welfare economics as the traditional, prescriptive theory framework used in agricultural economics has been criticised by institutional economists as being largely irrelevant to real-world policy issues. We therefore ask how normative statements are possible within an economic theory framework that does recognise the importance of institutional arrangements. Instead of applying established outcome-oriented criteria of social welfare, we examine whether the rules of economic interaction allow the acquisition of gains from cooperation. We suggest to reconstruct any interaction as an existing or repealed social dilemma. This approach helps to identify common rule interests which create room for improvement of all parties involved, and to suggest desirable institutional reforms. An application to credit markets in developing countries demonstrates the insufficiency of welfare economic arguments and the potential insights generated by a social dilemma heuristic. The latter sheds new light on the role of various forms of collateral and informal arrangements to overcome credit rationing.