Transcript Institutional Economics

How to View the East Asian
Economy?
J.D. Han
King’s University College
• In the Classical Economics by Adam Smith,
there is no place for Institutions.
-> Historically, at the time, Institution was
“Ancien Régime” and feudalistic.
-> Institution was by and large a hindrance and
obstacle to human creativity.
Legacy to Neoclassical Economics
• No place for Institution in any production or
utility, or consumption function:
Y = f (K, L; Technology)
U = g(Qx, Qy; Tastes and Preferences)
Institution is not even a conditioning variable or
shift parameter.
Getting relevant to Neo-classical
Economics
• An increase in physical capital leads eventually
to Diminishing Marginal Returns or a
Decreasing MP of Capital
-> Growth rates will gradually come down.
-> “Convergence”
• In the Solow Model of Neo-Classical Growth
Model, the only way of maintaining a high
growth rate or “sustained rapid economic
growth” is to have Technical Innovation.
-> In the Solow Model, the only production
factors are K, L, and T.
• Paul Krugman suggests that the Asian
economic growth is mostly the “Intensive
Growth”; an intense use of labor and capital
inputs can explain the growth
• Eventually there will be a limit to an increase
in K, and L, and a declining growth rate will set
in.
• East Asian economic growth cannot be all attributed to
Growth of Production Factor:
Korean economy keeps going;
Chinese economy has been doing so well for so long a
time;
It may take time but the Japanese economy will
rebound
• There might be another factor that affect
economic growth and performance
-> Human Capital - Revised Neo-classical
Economists’ new tool
-> Institutions/Structural Changes
Social Capital; Government; Socio-economic–
political System
• These ‘New’ or ‘Endogenous’ variables have
the same effect of Technical Innovation on the
Production Function in the Solow Model;
• It shifts up the Production Function (curve)
upwards
Illustration with the Solow Model with
an Increase in Human Capital, and
Positive Institutional Changes
Two questions remain:
1) Can it explain the sustained high rates of
economic growth?
- There has to be a continuous change in these
variables just like technical innovation
- ‘Continuous Reforms’
• Examples of ‘Continuous Reforms’
Japanese Meiji Reforms 明治维新
……..” 周谁旧邦其命维新”
…………Zhou is an old country but its fate is always
new…….
Korean Yousin Regim and New Village Movement
Republican China New Life Movement
Singapore New Country Movement
• 2) Why did some of Structural Changes not work,
such as the Great Leap Forward of the 1950s in
China, or “Ju-Che of the 1980s in North Korea?
Institutional changes may be not a substitution for
technology, but only a conditioning variable
which enhances efficiency.
-> “Vitamins” themselves do not produce calories,
but help calories to better use.
Institutional Economics
• Old School
T Veblen explained the seemingly stupid
behaviors of super-wealthy people with the
concept of “Conspicuous consumption”:
U = f (Qx, Qy; Institutions/societal atmospheres conditioning individual preference)
• New School
Douglas North –Nobel Price 1993
‘Narrow minded’ Contemporary
Institutional Economics
• There are bad, good, better and best
institutions, depending on their contribution
to Technical Innovation.
• Bad ones will eventually evolve towards good
ones as part of the Natural Law.
‘problems’(limitations) of this line of
thought
• Limited idea of the Neo-Classical Economics: Institution
is linked only to Technology, Physical Capital, or Human
Capital, and is to work only through these production
factors.
• It is Dichotomy: ‘Good’ versus ‘Bad’
Bad institutions hinder K,L, and T by increasing
‘Transactions Costs’.
• like ‘Evolution Theory’: move from the Primitive to the
Sophisticated
The Respresentative Scholar:
Douglas North
• North and Fogel were awarded the Nobel
prize "for having renewed research in
economic history by applying economic theory
and quantitative methods in order to explain
economic and institutional change."
His Ideas
• Poverty in the Midst of Plenty
October 2, 2000
by Douglass C. North
“We must create incentives for people to
invest in more efficient technology, increase
their skills, and organize efficient markets.
Such incentives are (to be) embodied in
institutions”
-> What ‘ideal type’ does he have in his mind?
Transaction costs as one of his key
concepts
• Steven N. S. Cheung defines them as any costs
that are not conceivable in a "Robinson Crusoe
economy
or the costs that arise due to the existence of
institutions
or "institutional costs".
-> The worse an institution, the higher the
transactions cost.
• Examples:
Beyond the manufacturing cost , in the imperfect world we are bound
to have:
-Information Cost/Monitoring Cost/Communication Cost
-Marketing Cost
-Bargaining Cost
-Compliance Cost
-Political Cost
-Lobbying Cost
-Litigation Cost
-Insurance Cost
All other non-essential costs
Example 1.
• Bargaining Costs between Employers and Employees
-Through formal collective bargaining: this does not
require any human elements and could be completely
mechanical.
-Through informal harmonization: this works when there
is a shared common norm, and both parties are
reasonable.
‘Open-minded’ Way to Look at the East
Asian Institutions
Institutional/Cultural Relativism is needed:
The East Asian economic institutions are the result
of ‘Optimization’ for the given Socio-EconomicPolitical environment/constraint, and thus the
Rapid Economic Growth proves the point.
-> This ‘optimality’ applied to the pre-take off periods
of the East Asian countries although exogenous and
political factors constrained economic growth.
• They are called ‘Revisionist’, but are in fact ‘Openminded Institutionalist’ and ‘Believer in Cultural
Relativism’ in economic institutions.
• They are still different from Sociologists or other social
scientists in that they believe that the Apparent
Institution is the result of a common Economic
Optimization , not the result of Cultural Determinism of
each specific race or culture.
• The Apparent differences between different ‘optimal’
institutions come from the given different constraints
to each case.
Generalization of this Open-minded
Institutionalist’s View
• Depending on the given different circumstances,
the same optimization process lead to Apparently
Different Institutions.
• No hasty ranking or judging Institutions by the
Conventional (Western) standards
• In other words, seemingly very different
institutions may work for the same goals of
optimization.
Application 1
• Samsung has no Labor Union whatsoever
within the entire conglomerate.
• Hyundai looks plagued with bitter labor strife
by its labor unions all the time.
• Samsung says that
“It does not need Labor Union as it fully takes care of
employees’ welfares.”
The absence of union could save bargaining costs.
In return for fine tuning and controls, Samsung’s salaries are
much higher than other companies’ – “Efficiency Wage”
It argues that it can have a distinct institution that leads to
minimization of transactions-cost-saving institution.
• Some argue that Samsung has been
oppressing the spontaneous labor union
movement.
• Hyundai has different approaches to workers
built on conflicts and checks.
• Hyundai offers relatively low salaries and
bargains very hard with workers.
• Apparently bitter labor strife has no impacts
on the share price of Hyundai
“Wrong Approach/Analysis” says
• Samsung is gentleman. The management is
benign and gentle.
• Hyundai is ‘Nogada’ (manual workers). The
management is coarse and short-tempered.
-Trying to attribute outward difference to innate
differences. “They are doing so differently as
they are different”
It will be also wrong for ‘Narrowminded’ Neo-Classical Economics’
based ‘Narrow-minded Institutional’
economist to think:
• Eventually Hyundai will evolve towards
something like Hyundai.
“Open-minded Institutionalists” say
• Both companies are doing well, meaning that
they are minimizing the costs and maximizing
profits in the different ways that suit their
circumstances best.
-Two companies are given different structures of
core industries.
“They looks as if doing differently, but in fact
underneath they are doing the same
optimization. “
• However, “stress test” shows difference:
There are many whistle blowers in Hyundai.
There are hardly any whistle blower in Samsung.
• The long-run sustainability may be different: it
remains to be seen.
Example 2: Amakudari
• Definition:
• Western Criticism:
• The Advocate:
• Long-run repeated reputational games, it
would work to reduce transactions costs
which could incur involving coordination and
communication between policy makers and
industries.
Expanding it to the East Asian
Countries:
• The Confucian leadership model is shown to
be effective in maximizing economic growth
rates and in minimizing transactions costs.
• Can the East Asian way be more efficient and
more cost-minimizing than the Western Free
Market way?
• The answer was ‘no’ up to the last year.
• Now the answer could be ‘Yes’.
• The East Asian economy will not automatically
gravitate to the Free Market System anymore
because it is the result of its own optimization
and rationality.
• So far the reforms were design to allure more of
investment from the west.
• China will reorganize its economy in the fashion
of the Confucian leadership model.
• Problems will rise when the West do not understand
the fact that China is doing its own optimization for the
given situation and make too harsh criticisms.
ex) 1997 Asian Financial Crisis: Pulling investment out;
Forced Devaluation; Forced Begging for Liquidity
• China will not be pushed, but become assertive.
• China will collide with the U.S. which represents the
Free Market System.
• China will try to build its own economic block.
• The word countries in between will opportunistically
watch which part is performing better.
Example 2
• Amakudari (read Ah-mah-Ku-Da-rih) 天孙制:
Retiring government officials(regulator) become executives of private
companies(regulatee)
-in the Western View, this is the ultimate Conflict of Interests, and the root of
corruption
-in reality, it is not: in the repeated game with reputational values, there is an
incentive against corruption by the incumbent of government officials.
-This system reduces information/coordination cost between government
and industry in the Japanese setting of industrial policies. This is
important in a society where information processing cost is relatively high
(refer to the parallel case in the Western society expounded in “Jews and
Domincans Need not Apply” in J. Carr’s book Cents and Nonsense )
Example 3
• “Not so shameful monetary history of China”
- J.D. Han’s On-going Research on the traditional
Chinese Private Banks up to the 1949
They were different: from the late
1800s to the 1940s in China
Western style Banks
-large scale
-Based on Collateral
- Suitable for ‘arms-lengthdeals’
- Government liked them
Old Chinese Banks
-small/medium scale
-Based on ‘Credit’
-Works well with the
Institutions with good
flows of information
-Government did not like
them
-Prolific during ‘Chaos’
Conventional Wisdom
• Chinese Old Banks are ‘backward and small’;
ustable(no/insufficient collateral);
‘destabilizing’(speculative); and mostly
illegal(underground and not controlled by
government).
Revisionists’ View
• The optimal size is endogenous;
• It was based on Superior Information
Processing;
• Resilient and Quickly Restructuring
• Superior Market Adaptability (high profits)
• Private and free from government controls
J.D. Han’s View
• Chinese old banks operated on Credit basis with
superior information processing organization and
capability in a society where 1)a large amount of credit
was seasonally required for commerce (too large for
collateral backing), 2)information as to the borrower
was flowing rather freely, and3)‘Honor’(credit) was
most important element in commerce.
• The last two were due to uniquely Chinese socioeconomic-political system at the time. Thus Chinese
old banks were the best suited for commerce at the
time.
• I have been arguing that 1) it would be a
mistake even for the contemporary China to
model its banking system after the U.S.
system, and 2) attention should be paid to the
operation of the traditional Chinese bank.