Analysis of the potential and problems of new institutional economics for third world development

Purpose - The aim of this paper is to provide a critical evaluation of the potential of new institutional economics (NIE) in third world development. Design/methodology/approach - The paper reviews various theories under NIE from both conceptual and empirical perspectives. It then reviews the various definitions of institutions and show that institutions are essential to overcome problems of information and uncertainty. Findings - The review finds that weak institutions can undermine development and hence governments in developing countries should strengthen their institutions to provide greater scope for efficient functioning of markets. Where the market does not work owing to high transactions costs, traditional institutions of collective action and group decision making can work and hence need to be recognised. Research limitations/implications - The major implications of the paper is that in developing countries, a clear understanding of various institutions such as user groups, inter‐linked credit markets, rotational irrigation etc. is needed before they are replaced or modified by other institutions. The main limitations of NIE are that there can be capture by elites of various institutional innovations in rural areas, and that it does not explicitly consider income distribution and uncertainty which are glossed over and hence remain areas for future research. Originality/value - This paper critically reviews the various institutional environments that developing countries face in addressing development issues.