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Institutional Void

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Submitted By iamayushk
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For exclusive use at IMT Nagpur, 2015

9-106-014
REV: AUGUST 24, 2005

TARUN KHANNA
KRISHNA PALEPU

Spotting Institutional Voids in Emerging Markets
1. Introduction
With the demise of communism, many countries in the world today are striving to build their economic activity around markets, and to participate in free trade arrangements, such as the World
Trading Organization (WTO), European Union (EU), & North American Free Trade Agreement
(NAFTA). The first step for most countries in this endeavor is deregulation and liberalization, thus opening their markets to free economic activity by local and international investors and entrepreneurs. However, companies and investors rushing to cash in on these new opportunities learn an important lesson—often through experience—that while these new emerging markets may be liberalized, they do not function in the same way as the more advanced markets of Europe, United
States, Canada, Japan, and Australia.
It is dangerous to equate liberalization and deregulation with building a well functioning market economy. Investors and companies operating in emerging markets quickly realize that these markets do not have all the infrastructure—both physical and institutional—needed for the smooth functioning of markets. The frequent economic crises engulfing many emerging markets—in Mexico and Brazil in the early 90s, Asia in the mid-90s, in Russia soon after, and in Argentina most recently— offer stark reminders of these institutional voids.
The purpose of this note is to address several issues critical to understanding the unique nature of emerging markets relative to their more mature counterparts. What is the fundamental challenge in building well-functioning markets? What sets of institutions do advanced markets rely on to resolve these challenges? What makes building these institutions complex? What

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