Transcript Growth and Institutions

Institutions and Economic
Development
Sources: Economics Network & other
Guest Lecture
• Raji Rajan, Coffey International
– A development consultancy
– Will talk about Markets for the poor (I think!)
• Time: Monday, 24 Feb, 2-4 p.m.
• G11, HBS
Definition
• ‘Institutions are a set of rules, compliance procedures and
moral and ethical behavioural norms designed to constrain
the behaviour of individuals in the interests of maximising
the wealth or utility of the principals’ (North, 1981, p.201-2).
• “Institutions are the rules of the game in a society or, more
formally, are the humanly devised constraints that shape
human interaction.” (North, 1990)
– “In consequence they structure incentives in human exchange,
whether political, social, or economic.” (North, 1990)
• Lin and Nugent (1995) "a set of humanly devised behavioral
rules that govern and shape the interactions of human
beings, in part by helping them to form expectations of what
other people will do.
• Pande and Udry (2005) contest the notion of
‘agency’ embodied in the North definition by
arguing that institutions are often not ‘designed’
and even when they are, their operation may be
different to what was originally intended. They
therefore argue that we should concentrate on de
facto institutions rather than de jure ones.
• North’s ‘moral and ethical behavioural norms’ are
often embodied in informal institutions like
religion and caste that determine the quality and
sustainability of formal institutions like schools,
labour markets and the rules and regulations
governing economic activity.
• Standard Neo-Classical economic framework assumes a well-defined
set of property rights with a full set of complete and contingent
markets. It also assumes that contracts are signed with no fear that
they will be revoked when it suits one of the parties.
• In the background of this model, there exist institutions that establish
and protect property rights and enforce contracts - a system of laws
and courts.
– Laws imply a legislator and a police force. The legislator's authority may derive
from religion, family lineage, or access to superior violence or alternatively, may be
provided by popular support (in a democracy).
• This implies the beginnings of a governmental structure that goes well
beyond the narrow needs of the market.
– One implication of all this is that the market economy is necessarily "embedded" in
a set of non-market institutions.
– Another is that not all of these institutions are there to serve the needs of the
market economy first and foremost, even if their presence is required by the
internal logic of private property and contract enforcement.
(Rodrik, 2000)
Institutions
• Contractarian perspective: historically institutions emerged through a
social contract between citizens and the state which delegated the
use of violence to the latter in exchange for protection and social
order.
– defence, political institutions esp those relating to governance.
– Over time, these institutions were supplemented by economic institutions
like private property rights and markets, all of which stimulate economic
growth (see Rodrik (2000, 2005) and Savoia et al (2010)).
• For development, we need growth igniting institutions but also growth
sustaining institutions which will reinforce long term economic
development (as opposed to growth alone) and conflict management
institutions, which will relieve social conflict.
• How are formal institutions formed?
– informal institutions (gender, class, caste and social capital) shape formal
ones (e.g. the law).
– informal institutions (customs) gradually change the actions and
interactions of agents in all sorts of social organisations (households,
groups, villages, as well as firms and governments).
Formation of Institutions
• North’s theory of institutional change explains that formal institutions
are a crystallisation of informal ones (North, 1990), and that both coevolve through the operation of organisations (informal and formal
social groups, from households and villages to networks, firms,
parties and governments).
– Institutions affect economic outcomes but will society choose those institutions that
maximise social surplus (North and Thomas, Demsetz)?
– Institutions are not always chosen by all of society but instead by the few, hence
not efficient. Coase Theorem does not apply, i.e. the winners do not fully
compensate the losers.
– North (1981) argues that institutions act to constrain the individual in order to
enhance the welfare of the ‘principals’.
• Informal institutions in developing countries play a very significant
role in shaping formal institutions and the operation of markets, and
can emerge as the preponderant rules of interaction when formal
institutions and markets fail.
– Eg. caste, religion or tribe can influence access to schools, credit etc.
– They can influence the outcomes of elections and therefore the benefits derived
from them.
Acemoglu, Johnson and Robinson (AJR, 2004) provide the
following framework for understanding the formation of
institutions.
1. Economic institutions influence growth because they
shape incentives and affect investment in physical and
human capital
– Institutions  incentives investment  growth
2. Economic institutions are endogenous – determined as
collective choices of society – mostly for their economic
consequences.
– Some conflict of interests amongst individuals and groups.
– Equilibrium institutions determined by groups with political power
3. Distribution of power in society is also endogenous. It
is determined by political institutions. Two types of
institutions – de jure and de facto political institutions.
– Political institutions determine de jure political power.
4. De facto political power arises from the ability to co-ordinate and
‘band’ together to solve problems (e.g. Arab Spring) or military strength
or economic strength.
– Distribution of resources leads to de facto political power
5. Two state (exogenous) variables – political institutions and
distribution of resources.
– Both change very slowly and knowledge of these variables sufficient to
determine all other variables [de jure and de facto political power,
economic institutions, future political institutions, economic performance
and distribution of resources in future].
Acemoglu, Johnson and Robinson, 2004
• the way that humans themselves decide to organize their societies
determines whether or not they prosper. Some ways of organizing
societies encourage people to innovate, to take risks, to save for the
future, to find better ways of doing things, to learn and educate
themselves, solve problems of collective action and provide public
goods. Others do not. (AJR, 2004)
• Jean Phillipe Platteau argues that economic specialization requires
well-defined property rights, which must evolve over time.
– Practices and rules as well as the public agencies and moral
environment which sustain trust are determined at least in part, if not
largely, by the cultural endowment of societies as they have developed
over their particular histories (Platteau, 1994).
• an individual’s position vis a vis others and therefore their ability to
access resources depends on historically and culturally determined
power relations, which are continuously changed by people pushing
the boundaries of what is feasible (empowerment processes, but
also social and economic entrepreneurship).
Adam Smith and J.S. Mill argued that good institutions include:
Enforcement of property rights so that individuals have incentives to
invest.
Equality of opportunity so that those with opportunities can take
advantage of them.
Why do institutions differ across countries?
• Efficient Institutions View
– Societies will choose the economic institutions that are socially efficient.
It does not matter how the surplus is distributed across the groups
because as surplus is produced, all externalities will be internalised and
new distributions will emerge (Coase Theorem).
• Ideology View
– Societies choose different institutions because they or their leaders
disagree about what would be good for society.
• Incidental Institutions View
– Popular amongst political scientists and sociologists
– Downplays the role of choice in institution building and thinks of
institutions as by products of other societal interactions or historical
accidents.
• Social Conflict View
– Economic and social institutions are chosen not by whole society but by
groups who control power
– These groups choose institutions to maximise their rents and this may
not be the same as maximising social benefits.
Institutions and Growth
•
Relationship between institutions and economic growth widely studied (AJR,
2001, 2004; Hall and Jones, 1999; Knack and Keefer, 1995;).
•
Findings of this literature are ‘of fundamental importance for development
economists and policy practitioners in that they suggest that institutional quality
may cause poor countries and people to stay poor,’ (Pande and Udry, 2005,
p.2)
•
Glaeser et al (2004) argue that measures of institutional quality such as risk of
expropriation (used in Acemoglu et al 2001), government effectiveness and
constraints on the executive are ‘outcomes’ and do not represent ‘deep’
institutions. They estimate the following equation:
Institutions and Growth
Institutions and Growth
Interpretation of Glaeser’s results
Coefficient on Initial level of schooling is always +ve and
significant.
So also the coefficients on Initial GDP per capita (-ve and
significant) and Share of Population living in Temperate
Zone (+ve and significant).
The beta coefficients are only significant when the
institutional proxies stand for outcomes (expropriation
risk (82-90) or government effectiveness (98-2000).
Other proxies for institutions such as judicial independence
or constitutional review are insignificant.
Institutions and Growth – Empirical Estimation
2 Problems:
1. Endogeneity: Institutions affect growth but the latter in turn influences the
kind of institutions that exist.
• The solution is for us to try and find a variable or a factor that
meaningfully can affect institutions but does not directly affect
economic growth.
• Acemoglu, Johnson and Robinson (American Economic Review, 2001)
addressed this point by including baseline settler mortality in colonial
period.
2. Most institutional variables that are available in datasets tend to be
outcome variables rather than deep institutional variables.
1.
2.
For instance, these measures do not code dictators who choose to respect
property rights any differently than democratically elected leaders who have no
choice but to respect them. Since these measures confound constraints on
government with dictatorial choices, they do not proxy for institutions, which in
their essence are constraints (North 1981).
To use the latter, we need to concentrate on a single country within which
changes in institutions can be traced, rather than study institutions across
countries.
Measuring institutions is difficult because popular measures are (i) ‘outcomes’
rather than anything ‘deep’ (ii) they are mostly subjective (iii) when nonoutcome proxies for institutions are used they are insignificant.
Variables used
Common proxies for institutions are:
• Voice and accountability
• Political Stability/No violence
• Government Effectiveness
• Regulatory Quality
• Rule of Law
• Control of Corruption
• Corporate Ethics
• Corporate Corruption
• Judicial Effectiveness
• Corporate Governance etc.
•
Problem is that all of these variables are related to the level of development.
So, more developed economies are likely to have better institutions. How
then can we identify whether these institutions influence the level of growth or
development?
•
Also, these variables are not ‘deep’ institutions. Instead, they denote
‘outcome’ institutions (or quality of secondary institutions) and the question is
what determined these institutions.
Institutions & Development
• So far, have concentrated on institutions relating
to growth.
• However, almost all aspects of development are
influenced by institutions e.g. levels of equality
(income as well as social equity), urbanisation,
education, health, sustainability etc.
• As mentioned earlier, a lot of literature on growth
and institutions. Less so on development and
institutions though fast growing literature on it.
• Paper by Crost & Kambhampati (2010) one
example of this literature.
• The existing literature on institutions and development is limited in
three ways:
1. It does not precisely define the respective roles of formal and informal
institutions in development processes.
– Institutions are seen in very broad terms as relating to certain political or
economic rules of behaviour (eg. protection against expropriation risk or
government anti-diversion policies or country’s openness or bureaucratic
efficiency.
– Very few authors consider informal institutions like caste, ethnicity or trust.
2. It concentrates on the impact that institutions have on growth, rather
than on development in broader terms.
– Thus, most of the existing papers are concerned with the impact on log
GDP per capita or output per worker. They concentrate on growth igniting
institutions rather than growth sustaining or conflict management
institutions.
3. reverse causality i.e. from development to the quality of institutions
within a country makes it hard to identify the impact of institutions on
development or growth.
Institutions and Economic Development
Institutions can be (i) developmental or (ii) predatory
1.
Developmental Institutions – encourage investment, growth and
productivity.
2.
Predatory – extractive institutions that favour the few.
•
•
Problem: institutional quality itself is determined by lack of equity
in a society: inequitable economies develop exploitative and
inefficient institutions.
–
Unfair wealth distributions can block the emergence of effective
democracy because it makes redistribution too costly for the
elites in power. Inequality shapes, and is shaped by, political
institutions.
Initial conditions matter and change is very slow and difficult to
initiate.
Institutions influencing Schooling
Crost & Kambhampati, 2010
• Analyse the factors that influence the availability of schools in India.
• Include a range of formal (political) and informal (caste, religion,
ethnicity) institutions.
• The political variables include:
– extent of political competition in the district (as reflected in the margin of victory of the
incumbent party,
– the extent of party fractionalization,
– the probability that an incumbent party loses an election;
– political awareness of inhabitants of the village (as reflected in turnout at elections)
– empowerment of minority communities (as reflected in reservation of seats for such
communities in assembly elections).
• ethnic diversity: caste fractionalization index constructed using upper
caste, middle caste, SC, backward agricultural & other castes, Muslims.
Crost and Kambhampati, 2010
• When seats are reserved for certain minority groups (political
reservation), then the number of primary schools decreases.
– Implying that minority politicians are less bothered about getting schools
built?
• When there are a large number of small parties (party
fractionalisation) and when parties are often overthrown at elections
(party turnover), then more primary schools built.
• Number of middle schools is not affected by any political variable
except the margin of victory – higher this is, smaller the number of
middle schools.
– If schools are to be used as election winners, then primary schools easier
to set up……also see that they are very tangible. Less likely to see
quality of schools being improved.
• Informal institutions eg. caste, religion etc.
– Upper caste villages have more primary schools and also more teachers
per school.
– SC districts have fewer primary schools.