the ronald coase institute institutions and development mary m. shirley presentation to esnie, may...
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The Ronald Coase Institute
Institutions and Development
Mary M. Shirley
Presentation to ESNIE, May 2004
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The Ronald Coase Institute
Overview of talk
• What causes underdevelopment?
• Why have so few countries been able to create institutions to foster development?
• Which institutions are needed for development?
• How can countries get these institutions?
• How can we fill the gaps in knowledge?
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The Ronald Coase Institute
What causes underdevelopment?
• Institution-free explanations
• It’s the institutions.
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The Ronald Coase Institute
Institution-free explanations for underdevelopment
1. Under-investment
2. Lack of technological innovation
3. Lack of education
4. Geography; resource curse
5. Poor macroeconomic policies
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The Ronald Coase Institute
Institution-free explanations for underdevelopment
William Easterly, The Elusive Quest for Growth, Cambridge: The MIT Press, 2001
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The Ronald Coase Institute
Institution-free explanations for underdevelopment
1. Under-investment because of lack of financing.
Harrod-Domar: this year’s growth will be proportional to last year’s share of investment in GDP.
Arthur Lewis: underdeveloped countries have surplus labor but too few machines because of a financing gap
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The Ronald Coase Institute
Investment did not lead to growthGDP Growth and Lagged
Investment/GDP, 4-year averages
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
0 10 20 30 40 50
Investment/GDP at world prices
GD
P g
row
th
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The Ronald Coase Institute
Institution-free explanations for underdevelopment
2. Lack of technological innovation
Technological progress causes growth (Solow).
Countries are underdeveloped because of initial small capital base.
Capital should flow to countries where capital is scarce and increase their technological progress. Poorer countries should grow faster than richer ones.
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The Ronald Coase Institute
Poor did not grow faster
• Poorest three fifths of countries have had zero growth of income per person since 1981
• 70% of poor countries grew more slowly than median growth per capita of richer countries
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The Ronald Coase Institute
Increase in capital stock did not necessarily eliminate underdevelopment
• Nigeria & Hong Kong increased physical capital stock per worker by 250% from 1960-1985
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The Ronald Coase Institute
Increase in capital stock did not necessarily eliminate underdevelopment
• Nigeria & Hong Kong increased physical capital stock per worker by 250% from 1960-1985
• Gambia & Japan increased physical capital stock per worker by 500% from 1960-1985
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The Ronald Coase Institute
Increase in capital stock did not necessarily eliminate underdevelopment
• Nigeria & Hong Kong increased physical capital stock per worker by 250% from 1960-1985
• Increase in output per worker:– Nigeria: 12%
– Hong Kong: 328%
• Gambia & Japan increased physical capital stock per worker by 500% from 1960-1985
• Increase in output per worker:– Gambia: 2%
– Japan: 260%
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The Ronald Coase Institute
Rich got richer, poor stagnated(Maximum & minimum per capita income in richest and poorest 20% of 58 countries)
0
5000
10000
15000
20000
25000
1950 1960 1970 1980 1990 1998
maxmin
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The Ronald Coase Institute
Institution free explanations for underdevelopment
3. Lack of education.
Inadequate schooling leads to less skilled labor force, low productivity and low growth.
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The Ronald Coase Institute
Increased schooling of labor force did not lead to growth in developing countries
-1.0%
0.0%
1.0%
2.0%
3.0%
1960s 1970s 1980s 1990s
2
2.5
3
3.5
4
4.5
GrowthInititial Schooling
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The Ronald Coase Institute
Institution free explanations for underdevelopment
4. Geography: • Resource curse: Countries with abundant
natural resources may invest too little in more promising sectors or have more corruption, weaker governance.
• Geography raises costs of transport & communication, lowers agricultural productivity, increases population density, raises risks of dangerous diseases, etc. (Sachs)
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The Ronald Coase Institute
Geography explanation doesn’t hold up
• Resource curse ignores US, Australia, or Norway; e.g 60 years of fast growth in Australia.
• Geography used to be an explanation for wealth.
• Factor endowments cannot explain changes over time: many developing countries were rich in earlier ages.
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The Ronald Coase Institute
Crude Oil Production, 1857-1997 (Gavin Wright & Jesse Czelusta, Mineral Resources and Economic Development, SCID working paper, November, 2003)
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The Ronald Coase Institute
Institution free explanations for underdevelopment
5. Countries chose macro-economic policies that retard growth, such as high fiscal deficits, price controls, public ownership, high barriers to trade, etc.
• Begs the question: where do bad policies come from?
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The Ronald Coase Institute
It’s the institutions
• Shortage of capital because of failure to protect property rights.
• Misdirection of investment because of high transaction costs, distorted incentives, corruption, lack of trust.
• Where governance is weak, highest returns to skills may be in less productive activities, e.g. lobbying government for favors.
• Rodrik finds that institutions trump geography and trade in growth regressions.
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The Ronald Coase Institute
If it’s institutions, then
1. Why have so few countries been able to create and sustain the institutions that foster growth and social progress?
2. Which institutions must function effectively if countries are to develop?
3. How can poorer countries attain well functioning institutions?
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The Ronald Coase Institute
If it’s institutions, then:
1. Why have so few countries been able to create and sustain the institutions that foster growth and social progress?
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The Ronald Coase Institute
Two Kinds of Institutions Needed for Development
Encourage trade by promoting trust & lowering transaction costs
• For example, contract laws & enforcement, norms favoring trust
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The Ronald Coase Institute
Two Kinds of Institutions Needed for Development
Encourage trade by promoting trust & lowering transaction costs
• For example, contract laws & enforcement, norms favoring trust
Direct the power of the state toward protecting property, not exploiting it
• For example, separation of powers, federalism, norms against corruption
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The Ronald Coase Institute
Colonial heritage
Colonial heritage plus
Political conflict
Beliefs & norms
Why do countries have underdeveloped institutions?
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The Ronald Coase Institute
Colonial heritage
North (1990) La Porta, Lopez-de-Silanes, Shleifer, & Vishny (1997, 1998, 1999)
Colonial heritage plus
Acemoglu, Johnson, & Robinson (2001a&b) Engermann & Sokoloff (1998, 2000, 2002)
Political conflict North & Wiengast (1989) Bates(2001), Herbst (2000) Nugent & Robinson (2002)
Beliefs & norms North (1994, 2002) Greif (1994) Knack & Keefer(1997)
Why do countries have underdeveloped institutions?
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The Ronald Coase Institute
Colonial heritage
Countries inherited poor institutions from colonial masters. Legal origins important.
Why do countries have underdeveloped institutions?
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The Ronald Coase Institute
Colonial heritage
Countries inherited poor institutions from colonial masters. Legal origins important.
Why do countries have underdeveloped institutions?
• Spain brought centralized, despotic state, large bureaucracy, & tradition of elite privileges to colonies; Britain brought decentralized, limited government.
• Common law heritage countries have better protection for investors and property rights, more flexibility in face of change, greater independence of judiciary, limited state power,than countries with civil law heritage.
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The Ronald Coase Institute
Colonial heritage
Countries inherited poor institutions from colonial masters. Legal origins important.
Colonial heritage plus
Countries had valuable resources/people and colonizers designed institutions to exploit
Why do countries have underdeveloped institutions?
• Large population that could be enslaved & climate suited to plantation agriculture led to low settlement from mother countryand exploitative institutions
• Factor endowments interacted with colonizers’ institutions that created persistent inequality in wealth, human capital & politicalpower in some places
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The Ronald Coase Institute
Colonial heritage plus
Countries had valuable resources/people and colonizers designed institutions to exploit
Why do countries have underdeveloped institutions?
• Large population that could be enslaved & climate suited to plantation agriculture led to low settlement from mother countryand exploitative institutions
• Factor endowments interacted with colonizers’ institutions and created persistent inequality in wealth, human capital & politicalpower in some places. Slavery, plantation agriculture.
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The Ronald Coase Institute
Colonial heritage
Countries inherited poor institutions from colonial masters. Legal origins important.
Colonial heritage plus
Countries had valuable resources/people and colonizers designed institutions to exploit
Political conflict Countries had too little political competition over borders or between elites; allowed rulers to build institutions to serve selfish interests
Why do countries have underdeveloped institutions?
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The Ronald Coase Institute
Political conflict Countries had too little political competition over borders or between elites; allowed rulers to build institutions to serve selfish interests
Why do countries have underdeveloped institutions?
•Geography & Cold War prevented border conflicts in Africa. Elites did not have to grant concessions to citizens.
• Competition among merchant elites led them to grant property rights & franchise to smallholder farmers in Colombia & Costa Rica. Versus cooperation among landowning elites in El Salvador & Guatemala.
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The Ronald Coase Institute
Colonial heritage
Countries inherited poor institutions from colonial masters. Legal origins important.
Colonial heritage plus
Countries had valuable resources/people and colonizers designed institutions to exploit
Political conflict Countries had too little political competition over borders or between elites; allowed rulers to build institutions to serve selfish interests
Beliefs & norms Countries had beliefs & norms inhospitable to markets or trust; prevented them from building institutions to encourage trade & investment
Why do countries have underdeveloped institutions?
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The Ronald Coase Institute
Beliefs & norms Countries had beliefs & norms inhospitable to markets or trust; prevented them from building institutions to encourage trade & investment
Why do countries have underdeveloped institutions?
• Collectivist enforcement among Maghribi traders led them to rely on partnerships, community ties, ostracism to enforce bargains. Versus Genoa which relied on formal contracts, courts – and traded outside network ties.
• Norms that support cooperation even when people have no family or business or other ties reduces the cost of securing agreements. Trust correlates with growth & development.
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The Ronald Coase Institute
Colonial heritage
Countries with same colonial master but different outcomes. Common law has no growth effect. Large differences in enforcement.
Colonial heritage plus
Ignores differences among colonial powers. No test of casual effects of institutions. Africa?
Political conflict Ignore other factors in Glorious Revolution. Case specific arguments hard to generalize.
Beliefs & norms Hard to falsify. Advice?
These explanations are not sufficient
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The Ronald Coase Institute
Common themes
Institutions are critical to development
Some institutions endure for centuries
Greater equality and some political
competition led to institutions to secure
bargains and limit government
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The Ronald Coase Institute
If it’s institutions, then:
1. Why have so few countries been able to create and sustain the institutions that foster growth and social progress?
2. Which institutions must function effectively if countries are to develop?
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The Ronald Coase Institute
Which institutions matter for development?
Significant Variables in Growth Regressions:
Number of Studies
Protection of property rights & enforcement of contracts
7
Civil liberties 10
Political rights & democracy 10
Political instability 15
Institutions supporting cooperation (trust, religion, social clubs, etc.
4
Adapted from Aron, 2000
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The Ronald Coase Institute
Which institutions matter?
Many variables are not institutions, they are:
• Outcomes (secure property rights, instability)
• Socio-economic conditions (ethnic fragmentation)
• Policies (trade barriers, black market premium)
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The Ronald Coase Institute
Which institutions matter?
• Large number of institutional variables are significant (nine winners in Roll & Talbott (2001) horse race)
• Institutional variables are broad aggregates or indices (rule of law)
• Rodrik: econometrically successful, but little progress in identifying underlying causal variables with precision
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The Ronald Coase Institute
Common Themes
• Strong statistical evidence that institutions are significantly correlated with growth.
• Some institutions can be very long lived
• Development is associated with institutions that limit government & allow some civil liberties
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The Ronald Coase Institute
Which Institutions Matter?
Past success no guarantee of future success.
Environment that allows experimentation & adaptation may be key to emergence of market supporting institutionsSome political competition and liberties, but not
necessarily democracy?
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The Ronald Coase Institute
If it’s institutions, then:
1. Why have so few countries been able to create and sustain the institutions that foster growth and social progress?
2. Which institutions must function effectively if countries are to develop?
3. How can poorer countries attain well functioning institutions?
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The Ronald Coase Institute
How Can Countries Change their Institutions?
• Most change is at the margin, framework stable because of:– path dependency
– norms and beliefs
• Context matters -- Imported institutions often fail:– Latin American constitutions, francophone African
educational systems, transitional economies commercial codes
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The Ronald Coase Institute
How can countries change their institutions?
Experimentation & adaptation: China’s “Market Supporting Federalism” (Weingast); TVEs; goodness of fit (Levy & Spiller)
Hard for outsiders to judge success:• How supportive is institutional innovation
of movement towards an efficient market economy over long term?
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The Ronald Coase Institute
Can Foreign Aid Help Countries Improve their Institutions?
Institutional economics suggests pessimism:– Fundamental institutions are long lived & path
dependent– Norms and beliefs unlikely to change because
of aid– Aid agencies support best practice, not
experimentation & adaptation – Imported institutions often fail
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The Ronald Coase Institute
Aid is a poor tool for institutional reform
• Projects last for four years or less
• Measurable changes preferred
• Staff rotated every +/- every 3 years
• Staff rewarded for project approval & disbursement, not outcomes
• Counterpart is government officials
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The Ronald Coase Institute
What are the effects of aid?
• Aid leads to Reforms: e.g. privatization, regulation of telecoms & electricity (Henisz, Zelner, & Guillen 2003)
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The Ronald Coase Institute
What are the effects of aid?
• Aid leads to Reforms: e.g. privatization, regulation of telecoms & electricity (Henisz, Zelner, & Guillen 2003)
• Aid doesn’t lead to Growth: Aid has no impact on growth in poor policy environments & no impact on policy (Burnside & Dollar, 2000) or no effect period (Boone 1994,1996; Easterly, Levine & Roodman, 2003)
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The Ronald Coase Institute
Aid & conditionality in weak institutional settings
• Laws without mechanisms for their enforcement;
• Agencies without adequate staffing, budget or mandate;
• Privatized state enterprises without competition or competent corporate governance.
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The Ronald Coase Institute
Performance contracts an example of pro forma reform
• Aid disbursed in exchange for signed contract between government & SOE
• Governments failed to negotiate tough targets, demand necessary information, pay promised bonuses for good performance, impose promised punishments for bad performance, or provide promised autonomy to lay off workers or close plants
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The Ronald Coase Institute
Performance Changes After the Introduction of Contracts
Return on assets
No change
Deteriorated0
4
8
12
Number of state-owned enterprises
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The Ronald Coase Institute
Performance Changes After the Introduction of Contracts
Labor productivity
Improved
No change0
4
8
12
Number of state-owned enterprises
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The Ronald Coase Institute
Performance Changes After the Introduction of Contracts
Total factor productivity
0
4
8
12
Number of state-owned enterprises
Improved
Deteriorated
No change
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The Ronald Coase Institute
Institutions matter
• Institutions affect incentives and thus determine – how investment, technological innovation or
education are used, – which policies are chosen, – how factors are used.
• Countries have poor institutions because of historical factors.
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The Ronald Coase Institute
Which institutions matter?
• Depends on country’s circumstances.
• Limited government, political competition, norms that support cooperation are consistently important.
• Experimentation and innovation key.
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The Ronald Coase Institute
How can countries change their institutions? - Recap
• Successful institutional changes may defy best practice or conventional wisdom
• Successful institutional changes result from experimentation by insiders
• Sustained institutional change depends on changes in beliefs
• Foreign aid seems ill suited to promote institutional innovations or change beliefs
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The Ronald Coase Institute
How can we fill the gap in our knowledge?
Institutions matter, butNone of the three questions I posed can be fully
answered:1. Why have so few countries been able to create and
sustain the institutions that foster growth and social progress?
2. Which institutions must function effectively if countries are to develop?
3. How can poorer countries attain well functioning institutions?
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The Ronald Coase Institute
How can we fill the gap in our knowledge?
Fill the gap with a pincer movement?• Cross country studies that move from
aggregation to specificity (Keefer 2001)
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The Ronald Coase Institute
How can we fill the gap in our knowledge?
Fill the gap with a pincer movement?• Analytical narratives: case studies that test
hypotheses with methodological rigor and also describe historical context, norms and beliefs and institutional adaptations (Bates, et al. 1998)
• Move from sui generis to comparative• E.g. Levy & Spiller 1995 on telecom; Ostrom
1999 on common pool resources; Shirley 2002 on urban water
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The Ronald Coase Institute
How can we fill the gap in our knowledge?
Deeper analysis of institutions within developing countries (Spiller & Tomassi study of Argentina)
Critical mass of local researchers: prerequisite for understanding institutions fully, stimulating informed debate, and fostering changes in belief systems