ABSTRACT
This chapter explores that some of the lessons development agencies can learn from countries that have experienced state failure or collapse and from attempts to rebuild those countries. It focuses on selected literature dealing with the new institutional economics (NIE) and the phenomenon of state failure. A major contribution of NIE has been the elaboration and application of the concept of transaction costs. Two recent extensions of the transaction-costs approach to political processes are relevant to the analysis of failed states. These are: transaction-cost economics, and transaction-cost politics. Robert Picciotto presents development projects as "instruments of policy reform and institutional change" that aim to overcome market failures. He describes three basic institutional design parameters that vary in dominance depending on the nature of the goods to be delivered by a project. The three parameters are hierarchy, or the state sector; the market, or the private sector; and participation, or the voluntary sector.
