The Institutional Organization of the Market Economy Dani Rodrik SW31/PED-233/Law School 2390 Spring...
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Transcript of The Institutional Organization of the Market Economy Dani Rodrik SW31/PED-233/Law School 2390 Spring...
The Institutional Organization of the Market Economy
Dani RodrikSW31/PED-233/Law School 2390
Spring 2013
Richer countries have larger governments– why?
The chart shows the relationship between (the logarithm of) per-capita GDP and the share of government consumption in GDP in 2003, for all countries for which data exist in the World Development Indicators of the World Bank. The estimated slope coefficient is 1.5, and is statistically significant at more than
99%.
More open economies have larger governments – why?
Changing conceptions of market capitalism: capitalism 1.0
Insight: the market is the most creative and dynamic economic engine known to man
Textbook renditions (still common) presume it requires a minimal state National defense, protection of property rights, and the
administration of justice Not necessarily Adam Smith’s own view
Corresponds to the 19th century “liberal” view and today’s libertarian vision “you need small government for markets to flourish”
Changing conceptions of market capitalism: capitalism 2.0
Insight: markets are not self-creating, self-regulating, self-stabilizing, or self-legitimizing
Therefore they need to be embedded in a wide range of institutions Regulatory institutions, redistributive institutions,
monetary and fiscal institutions, institutions of conflict management, …
In practice: Keynes + the welfare state “An extensive government apparatus is needed to render
markets stable, sustainable, and consistent with social values”
Changing conceptions of market capitalism: capitalism 3.0?
Capitalism 2.0 is a national system of capitalism, not a global one Based on national institutions
But national institutions impose transaction costs on economic globalization and hence restrict it
Fully global markets require fully global institutions “global governance”
Questions of feasibility? desirability?
Why markets need states: outline The institutional prerequisites of markets A typology of institutions Sources of institutional divergence
Institutions: definitions Institutions are “the rules of the game in a society”
(Douglass North) Institutions are "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." Lin and Nugent (1995, 2306-2307).
Can be formal (laws, regulations) or informal (patterns of behavior, conventions, moral codes)
Institutional prerequisites for markets (I) Markets are about gainful exchange. Why would they not
exist or perform poorly? Consider potential seller S who has something (a
commodity, labor services, money to lend, an idea …) that is of greater value to potential buyer B.
What is required for the exchange to actually take place? excludability (good is private, not public) ownership (property rights) compliance (enforcement of contracts) information (observability of all relevant attributes of the
good/service) stable and reliable medium of exchange (unless there is “double
coincidence of wants”) a physical (or virtual) marketplace to bring parties together
(transport/communication) adequate peace and security …
Institutional prerequisites for markets (II) When these conditions are not met, there are transaction
costs Direct costs of exchange Costs of disruption of exchange Costs of opportunistic behavior (“cheating,” “free riding”)
Some types of goods/services more prone to such transaction costs: markets for credit, insurance, ideas, differentiated goods, “public
goods” Good (economic) institutions are those that minimize these
“transaction costs” at reasonable cost
Market-supporting institutions (I) Informal institutions
cooperative behavior sustained through reciprocal exchange and repeated interaction
e.g., informal credit markets, village markets, community irrigation schemes
Conditions under which these work? Small setup costs, but rising costs as the number of participants and
geographical scale increase Belief systems
behavior that is driven by internalized ideas about what is right morals, religion, ideology … examples?
Golden rule: “do unto others as you would have them do unto you” Fads and fashions in economic policy
Central planning, free trade
Market-supporting institutions (II) State institutions
Cooperation achieved through “third-party enforcement” of rules and contracts
Implicit force of state punishment Contracting in the “shadow of the law” Costs and benefits
Large setup costs (judiciary, police froce, regulatory insitutions), but smaller marginal costs of expansion
a. Market-creating institutions i. Property rights
incl. corporate governance ii. Contract enforcement
b. Market-regulating institutions
i. Regulatory institutions Anti-trust, prudential regulation, environmental and safety regulations, etc
ii. Labor market institutions iii. Correction of market and coordination failures
“Industrial policies”
c. Market-stabilizing institutions (macroeconomic management) i. Central banks, treasuries and fiscal ministries
d. Market-legitimizing institutions
i. Redistribution (taxes, expenditure systems) ii. Social insurance (health, unemployment, family assistance programs)
iii. Political democracy
A typology of state institutions
Institutional heterogeneity: example of labor market institutions
Variety of institutional arrangements:
Degree of centralization or coordination of wage setting Degree of employment protection Importance of minimum wages Generosity of unemployment benefits Extent of “active” labor market policies? Unionization rates Labor representation/participation in company boards
These refer to differences only among advanced nations!
East Asian institutional “anomalies”Institutional domain Standard ideal “East Asian” pattern
Property rights Private, enforced by the rule of law Private, but govt authority occasionally overrides the law (esp. in Korea).
Corporate governance Shareholder (“outsider”) control, protection of shareholder rights
Insider control
Business-government relations Arms’ length, rule based Close interactions
Industrial organization
Decentralized, competitive markets, with tough anti-trust enforcement
Horizontal and vertical integration in production (chaebol); government-mandated “cartels”
Financial system Deregulated, securities based, with free entry. Prudential supervision through regulatory oversight.
Bank based, restricted entry, heavily controlled by government, directed lending, weak formal regulation.
Labor markets Decentralized, de-institutionalized, “flexible” labor markets
Lifetime employment in core enterprises (Japan)
International capital flows “prudently” free Restricted (until the 1990s)
Public ownership None in productive sectors Plenty in upstream industries.
Institutional “heterodoxy” is a common feature of successful economies
Sources of institutional diversity and divergence Universal institutional functions do not map into unique
institutional designs Security of property rights, market-based incentives,
outward orientation, macroeconomic stability … can all be achieved in diverse institutional settings
Institutional diversity is grounded in: Differences in social preferences (over equity versus
opportunity, for example) Hysteresis and path dependence due to institutional
clusters and complementarities (US versus Japan versus various European models)
Context specificity of desirable institutional arrangements to promote economic development
PLAUSIBLE DIVERSITY IN INSTITUTIONAL ARRANGEMENTS
What type of property rights? Private, public, cooperative?
What type of legal regime? Common law? Civil law? Adopt or innovate?
What is the right balance between decentralized market competition and public intervention?
Which types of financial institutions/corporate governance are most appropriate for mobilizing domestic savings?
Is there a role for “industrial policy” to stimulate investment in non-traditional areas?
UNIVERSAL PRINCIPLES
Property rights: Ensure potential and current investors can retain the returns to their investments
Incentives: Align producer incentives with social costs and benefits.
Rule of law: Provide a transparent, stable and predictable set of rules.
OBJECTIVE
Productive efficiency (static and dynamic)
Multiplicity of desirable institutional arrangements
PLAUSIBLE DIVERSITY IN INSTITUTIONAL ARRANGEMENTS
How independent should the central bank be?
What is the appropriate exchange-rate regime? (dollarization, currency board, adjustable peg, controlled float, pure float)
Should fiscal policy be rule-bound, and if so what are the appropriate rules?
Size of the public economy.
What is the appropriate regulatory apparatus for the financial system?
What is the appropriate regulatory treatment of capital account transactions?
UNIVERSAL PRINCIPLES
Sound money: Do not generate liquidity beyond the increase in nominal money demand at reasonable inflation.
Fiscal sustainability: Ensure public debt remains “reasonable” and stable in relation to national aggregates.
Prudential regulation: Prevent financial system from taking excessive risk.
OBJECTIVE
Macroeconomic and Financial Stability
PLAUSIBLE DIVERSITY IN INSTITUTIONAL ARRANGEMENTS
How progressive should the tax system be?
Should pension systems be public or private?
Should grant schemes be conditional?
What are the appropriate points of intervention: educational system? access to health? access to credit? labor markets? tax system?
What is the role of “social funds”?
Redistribution of endowments? (land reform, endowments-at-birth)
Organization of labor markets: decentralized or institutionalized?
Modes of service delivery: NGOs, participatory arrangements., etc.
UNIVERSAL PRINCIPLES
Targeting: Efficient redistribution entails programs targeted as closely as possible to the intended beneficiaries.
Incentive compatibility: Efficient redistribution minimizes incentive distortions.
OBJECTIVE
Distributive justice and poverty alleviation
Where do institutions come from? Demand-side explanations: institutions are created by
those who stand to benefit from them Colonial origins (Acemoglu, Johnson, Robinson 2001)
Glaeser et al. (2004) critique Initial factor endowments
Type of agriculture: small-holding versus plantation (Engerman and Sokoloff 2002)
Size of educated middle class (Rajan and Zingales 2006) Expanding international economic integration
Benign theories Trade and capital flows increase demand for “good” institutions
Malign theories Increased trade strengthens “regressive” elites (Latin America, U.S.
South) Supply-side explanations
Imposition by foreign powers East Germany, North Korea, Japan(?),..
Adoption of imported legal norms and rules “law and development” school
Institutional innovation and experimentation Chinese example
Institutional hysteresis, lock-in