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

Networks of informal relationships between businesses appear to dominate economic activity in several emerging economies. These networks usually involve exchange of favors which make doing business easier for those within the network. Recent empirical studies in the organizational behavior literature 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 will try to advance the understanding of these business networks from both a theoretical and empirical perspective. A simple theoretical framework will be used to show 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 empirical literature on business networks will be reviewed. The objectives of this review are several: to link the sustainability of business networks to the unreliability of the legal system; to examine whether the existence of networks stunts the effectiveness of formal institutions; and to examine whether there is a tendency for informal contract enforcement institutions to wither if formal legal infrastructure develops. The efficiency implications for the overall economy will also be an important issue considered. Policy implications of the theoretical and empirical analyses will be drawn to assist policy-makers who must make choices about which institutions to manipulate