Business Networks in Transition Economies: Norms, Contracts and Legal Institutions

Raja Kali

Networks of informal relationships between businesses dominate economic activity in many emerging economies. These networks usually involve exchange of favors which make doing business easier for those within the network. Recent empirical studies suggest that these networks are a response to inadequate institutional support, essentially in terms of legal infrastructure that guarantees written contracts and private property.  This paper advances the understanding of these business networks from both a theoretical and empirical perspective.

A simple theoretical framework is used to argue that while such networks benefit the participants, who thus have a vested interest in their preservation, from a general equilibrium perspective these networks retard the efficient functioning of the economy.  The recent empirical literature on business networks is examined for evidence on the following issues: the link between the sustainability of business networks and the unreliability of the legal system, whether the existence of networks stunts the effectiveness of formal institutions and if there is a tendency for informal contract enforcement institutions to wither if formal legal infrastructure develops. Policy implications of the theoretical and empirical analyses are drawn to assist policy-makers who must make choices about which institutions to manipulate.