Wither institutions in economics?

Jan Fałkowski

MADE lecture, 13.11.2009

Outline

• Some historical background on institutions in economics

• What do we really measure?• Hot issues in the debate

Insitutions in economics

American institutionalism

New Institutional Economics

Historical background

• Traditional institutionalism – First 3 decades of XXth century

• Veblen, Commons, Mitchell

– After the 2nd WW• Galbraith, • Myrdal

– Contesting standard assumptions of neoclassical economics– Extending the analysis to include political, moral, etc.

factors– Insitutions – materialised customs and habits

Historical Background

• New Institutional Economics– Incorporating insitutions into neoclassical

framework– Insitutions as rules of the game

• Minimising transaction costs• Competition among instiutions

– Williamson, North– Formal vs informal institutions

6

Williamson’s perception of insitutions

Level Frequency (years) Purpose

Embeddedness:informal insitutions, customs, tradition,

norms, religionL1 102 -103

Often noncalculativespontaneous

Institutional environment

Formal rules of the game esp. property

(judiciary, bureaucracy)

L2 10-102

Get the insitutional environment right

1st order economizing

Governance:Play of the game – esp.

Contract (aligning governance structures

with transactions)L3 1-10

Get the governance structure right

2nd order economizing

Resource allocation and employment(prices & quantities; incentive alignment

L4 continuous

Get the marginal conditions right

3rd order economizing

Washington consensus failure

• The only consensus we have is that there is no consensus

• Recommended policies failed to provide universal remedy for backwardness– Disequilibrium caused by conflict between formal &

informal institutions

• „Insitutions matter” no longer sufficient• What insitutions matter is of importance

Institutional problems in economics?

• Big bang vs. gradualism (Roland & Verdier, 2003)

– What should the pace of reforms?– What should be the sequence of reforms?– Examples of China & Latin America

EBRD index of transformation

0

1

2

3

4

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Albania

Belarus

Bulgaria

Croatia

Czech Republic

Estonia

Hungary

Kazakhstan

Poland

Russia

Slovenia

Tajikistan

Turkmenistan

Ukraine

Uzbekistan

Source: EBRD

Initial elections & reforms

Outcome of initial elections(extent of elite replacement)

Radicalness of initialeconomic reforms

(Non)reformation or(non)marginalization of oldcommunists

(Non)emergence ofnoncommunist politicians

Development of loci ofindependent economic power

Macro-economicperformance

Stability of thepolitical system

Openness of thepolitical system

Extent of economic reformOutcome of initial elections(extent of elite replacement)

Radicalness of initialeconomic reforms

(Non)reformation or(non)marginalization of oldcommunists

(Non)emergence ofnoncommunist politicians

Development of loci ofindependent economic power

Macro-economicperformance

Stability of thepolitical system

Openness of thepolitical system

Extent of economic reform

Source: Fish (1998)

How did economists respond? – theoretical approach

• Three separate pillars– theory of macroeconomic policy

• rationality, micro-foundations, but naive politics

– public choice• agency, constitutions, interest groups, but naive methods

– rational choice (political science)• collective choice procedures, but naive approach to policy

• Gradual improvements on theoretical front: combining best of three approaches

How did economists respond? – empirical approach

• Early work suffered from two problems– tests of theory not very precise– lack of institutional detail

• Gradual improvements on empirical front– more solid theoretical foundations– better data– concern with identifying causal effects: micro-

econometrics– appreciation of findings in empirical political science

Hot issue in the debate: democracy

• Does democracy promote growth?• In more general terms, the dispute between:

– Modernisation hypothesis (Lipset, 1954)

– Critical junctures hypothesis (Moore, 1966)

• Is it a necessary condition for growth?– Autocratic govt is not always a disaster!

• Modern China• British industrial revolution before free & fair elections

Hot issue in the debate: democracy

• Theory– Downs (1957) and median voter theorem

• Acemoglu & Robinson predict redistribution from the elite to the citizens after an extension of voting rights

• Olson & McGuirre argue that autocracies tend to tax more and spend less for general public goods than democracies

– Chicago school (Stigler, Becker, Peltzman)• key determinants of the policy-making are economic and

demographic factors, such as interest group structure, urban location and the technology of tax collection

Hot issue in the debate: democracy

• Empirical findings– Income & democracy highly correlated– De Hann & Sturm (2003) greater political freedom

furthers economic freedom– Giavazzi & Tabellini (2005) economic liberalisation

precedes political liberalisation– Persson (2005) it is not democracy per se that

matters but its specific form

Acemoglu, Robinson, Johnson, Yared (2009)

• Existing studies support the modernisation hypothesis because they fail to control for the presence of omitted variables

• fxed effects in a linear model or parameterized random effects in non-linear double hazard model removes the correlation btw income & democracy

• POLITY IV database, Freedom House Political Rights Index

Gundlach & Paldam (2009) - EJPE

• Resarch Question– Does income promote demoracy?

• UGT: present income differences have roots in prehistoric past

• Prehistoric measures of biogeography as instruments for modern income level

• Find long run casual effect of income on democracy

G&P (2009)• Biological variables measure the conditions that prevailed in

various regions of the world at the time of the Neolithic Revolution about 10,000 years ago– number of domesticable big mammals that are believed to have

existed in prehistory– number of annual perennial wild grasses (plants) known to have

existed in prehistory

• Geographic variables measure the specific conditions that have constrained or enabled the spread of the Neolithic innovations to neighboring regions– a ranking of climates according to how favorable they are to

agriculture

G&P (2009)

• Two approaches– An OLS estimate explaining the pattern by present

income. – A two stage IV estimate, where

• stage one instruments the income pattern with the biogeography variables, and

• stage two explains the democracy pattern by the generated institution free incomes

Main conclusion

• Does income favour democracy?

• We do not know

• What we know is that:

• Economists should be creative!

Thank you for you attention!

Democracy• Democracy is conceived as three essential, interdependent

elements:– the presence of institutions and procedures through which citizens can

express effective preferences about alternative policies and leaders. – the existence of institutionalized constraints on the exercise of power

by the executive. – the guarantee of civil liberties to all citizens in their daily lives and in

acts of political participation.

• Other aspects of plural democracy, such as the rule of law, systems of checks and balances, freedom of the press, and so on are means to, or specific manifestations of, these general principles.