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Joanna Tyrowicz Institutions and growth. Institutional Economics. How to get to the long run?. Two basic building block of a growth strategy: An investment strategy An institution-building strategy => THIS IS NOT NEW STUFF, WE KNEW IT ALL THE WAY
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Joanna Tyrowicz Institutions and growth Institutional Economics
How to get to the long run? • Two basic building block of a growth strategy: • An investment strategy • An institution-building strategy => THIS IS NOT NEW STUFF, WE KNEW IT ALL THE WAY • But examples of successful investment strategies: • Import substituting industrialisation (Brazil, Mexico, Turkey) • Outward orientation (South Korea, Taiwan) • Two track reforms (China, Mauritius)…
solution problem The logic of Washington Consensus Price liberalization Low agricultural productivity Land privatization Private incentives Tax reform Fiscal revenues Corporatization Urban wages Monopoly Trade liberalization Enterprise restructuring Financial sector reform Safety nets Unemployment And so on...
Disappointments of the Washington Consensus • Latin America: Only 3 countries have grown faster during the 1990s than in the 1950-80 period (and one of those 3 was Argentina!) • Countries in transition: Real output below 1990 levels in all but four former socialist economies; poverty rates higher • Sub-Saharan Africa: Results remain very disappointing, and far worse than those obtained prior to the late 1970s • Widening income gaps: • Frequent and painful financial crises: East Asia, Brazil, Russia, Argentina, Turkey.
“Augmented” Washington Consensus the previous 10 items, plus: 1. Fiscal discipline 2. Reorientation of public expenditures 3. Tax reform 4. Financial liberalization 5. Unified and competitive exchange rates 6. Trade liberalization 7. Openness to DFI 8. Privatization 9. Deregulation 10.Secure Property Rights Washington Consensus revival Original Washington Consensus 11. Corporate governance 12. Anti-corruption 13. Flexible labor markets 14. WTO agreements 15. Financial codes and standards 16. “Prudent” capital-account opening 17. Non-intermediate exchange rate regimes 18. Independent central banks/inflation targeting 19. Social safety nets 20. Targeted poverty reduction
Deception of Washington Consensus 1971-1980 1981-1990 1991-2000 Latin America & Caribbean 2.78% 0.97% 2.07% East Asia & Pacific 1.07% 0.86% 1.66% Middle East & North Africa 1.21% 0.69% 0.28% South Asia 0.09% 0.79% 0.85% Source: Calculated from World Development Indicators 2002
Many possible institutional forms… OBJECTIVE Productive efficiency (static and dynamic) 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. 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 public role to stimulate technology absorption and generation? (e.g. IPR “protection”)
Many possible forms … cont’d OBJECTIVE Macroeconomic and Financial Stability 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. 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?
Many possible forms … cont’d OBJECTIVE: Distributive justice and poverty alleviation UNIVERSAL PRINCIPLES: Targeting:Redistributive programs should be targeted as closely as possible to the intended beneficiaries. Incentive compatibility: Redistributive programs should minimize incentive distortions. INSTITUTIONAL ARRANGEMENTS How progressive should the tax system be? Should pension systems be public or private? 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.
Chinese shortcuts • Household responsibility system and township and village enterprises obviate the need for ownership reforms • Two-track pricing insulates public finance from the provision of supply incentives • Federalism, “Chinese-style” generates incentives for policy competition and institutional innovation
Questions • Are there „sole right solutions”? Which? • How can we say if an „old” solution is still a good one? • What does the policy reform serve: more growth or acceptance/adaptation? • What are then „deep determinants” of income levels? • Policy implications: „one way” versus „many ways” • Balance between institutional convergence and diversity?
All of development economics … on one page income endogenous endowments productivity trade institutions partly endogenous Central question of development economics: which are the most important arrows and why? geography exogenous
Geographical determinists claim that… income endowments productivity 4 trade institutions 1, 2 1: natural resources; soil quality 2: public health 3: colonialism, wars, migrations 4: resource curse 3 geography
… trade fundamentalists claim that … income endowments productivity trade institutions Integration convergence geography
…. While the institutionalists prefer income endowments productivity trade institutions One kind versus many? Where do they come from? geography
Determinants of wealth log yi = µ + α INSi + β INTi + γ GEOi + ε i (1) INSi = f + l INTi + ψ GEOi + v INSi (2) INTi = j + q INSi + ω GEOi + v INTi (3)
Some seminal work • Frankel and Romer (1999) • Hall and Jones (1999) • Acemoglu, Johnson, Robinson (2001) • Dollar and Kraay (2002) • Alcala and Ciccone (2002) • Easterly and Levine (2002)
Good instrument versus good theory… Mortality rates of early European settlers as an instrument for institutional quality: the AJR theory settler mortality between 17th and 19th century settlements type of early institutions current institutions current performance
Distance from Equator Figure 4: “Real Openness,” Openness, and Income (Difference between logs of “real openness” and openness on the vertical axis and log per capita PPP GDP on the horizontal axis)
Political trillemma of the modern world Deep economic integration Golden Straitjacket Global Federalism Democratic politics Nation state Bretton Woods compromise Pick two, any two: cannot have deep integration, nation state and democracy simultaneously
Testing in practice • Transitions to high economic growth are typically sparked by a relatively narrow range of policy changes and institutional reforms • South Korea and Taiwan since early 1960s, Mauritius since early 1970s • Brazil, Mexico, Turkey others before 1980, China since 1978 • India since the early 1980s, Chile since mid-1980s • ACTUALLY: REFORM IS SUBSEQUENT TO GROWTH EPISODES IMPULSE • 2. The policy changes that initiate these growth transitions typically combine elements of orthodoxy with unconventional institutional innovations • Outward orientation combined with industrial policies in East Asia; • Partial liberalization combined with household responsibility system • EPZ in Mauritius • Capital controls in Chile
But innovations do not travel too well EPZs work in Mauritius, but not in most other countries (Kenya, Wietnam, Brazil) Gradualism works well in India but not in Ukraine HRS works in China, but not in Russia ISI works in Brazil but not Argentina MAYBE THERE IS SOMETHING SPECIFIC ABOUT „APPROPRIATE” POLICIES? NOT: economic principles work differently in different places Most first-order economic principles come institution-free (incentives,competition, hard-budget constraints, sound money, fiscal sustainability, property rights, etc.) But these principles do not map directly into institutional solutions.
Let’s do a small formal model • Why countries do converge on “consensus” policies even when their circumstances call for different arrangements. • Some countries choose to “experiment” rather than imitate, why? • Plausible pattern of economic performance when a tendency for countries to converge on policies. • Key dilemma faced by policy makers: • the choice of imitating the leader country (and ignoring their private signal) • following their signal (and being perceived as a "corrupt" government, being denied IFI assistance, etc.)
A toy model • countries differ in their underlying characteristics (“state”); • these characteristics are unknown to the public; • policy makers receive a signal about the underlying state, but have no way of costlessly communicating it to their electorate; • when another country (the "leader") stumbles on a policy that works, both the policy and the outcome is observable to all; • policy makers in the "follower" country bear a (private) cost if they pursue a policy that differs from one that worked in the "leader" country.
Toy model solution • yi-outputai-policyzi-country type, yi = -(ai - zi)2 • Country A goes first, chooses policy aA with outcome yA. Country B, the follower. Assume yB is initially low compared to yA. aA and yA are both observed by the public in B. • Government in B observes the country's ideal type, zB. • Determine B's ideal policy, up to a random error term: a'B = zB + , with - N(0, ). • Government has to choose aB, either aA or a'B. If aB does not equal aA, the government pays a fixed cost K (this is a private cost to policy makers, and not a social cost). • Distinguish between output, yB, and government's utility function uB, with uB = yB - K. • yB = -(aA - zB)2 if aB = aA • uB = yB - K = -(a'B - zB)2 - K if aB = a'B • E(uB) = -(aA - zB)2 if aB = aA • = -2 - K if aB = a'B • Mimic the leader as long as zB is in the interval: [aA - (2 + K/)1/2, aA + (2 + K/)1/2]. • Therefore E(y) equals -( aA - zB)2 if aB = aA, and -2 otherwise.
Toy model conclusions • Growth pole, around the successful leading country, A • Countries in the "near periphery" are strictly worse off (compared to a situation where country A did not exist). • Close enough that forced to mimic, but too far tobenefit. • Countries in the "far periphery" are intermediate in terms of average performance, but also exhibit much greater variance in performance. • Similar growth poles are likely to develop sometime down the line in the far periphery--but not in the center or the near periphery.
Early conclusions • Markets require non-market institutions to work well • The institutional basis of market economies is not unique • Institutional diversity creates transaction costs and hampers full economic integration • Neither feasible nor desirable to eliminate these costs, cannot target total integration • „Thin” versus „thick” models of globalization • Within the range of “thin” considerable choice of models. • Each one of these privileges different groups….
Markets require non-market institutions to work well a. Markets are not self-creating i. Property rights ii. Contract enforcement b. Markets are not self-regulating i. Regulatory authorities ii. Correction of market and coordination failures c. Markets are not self-stabilizing i. Monetary, fiscal and currency arrangements d. Markets are not self-legitimating i. Political democracy ii. Social insurance iii. Redistribution
The institutional basis for market economies is not unique • a. Economic principles versus their institutional embodiment • b. Institutional diversity grounded in: • 1. Differences in social preferences (over equity versus opportunity, for example) • 2. Hysteresis and path dependence due to institutional clusters and complementarities (US versus Japan versus various European models) • 3. Context specificity of desirable institutional arrangements to promote economic development (China, India, Latin American examples)
Institutional diversity as a source of transaction costs blocking deep integration a. Despite disappearance of border barriers, border effects remain strong 1. Missing trade 2. Small net capital flows b. Institutional diversity is an important source of market segmentation c. Trade: the role of regulatory & jurisdictional discontinuities, and problems of standards and contract enforcement. d. Capital flows: the problem of “sovereign” risk e. “Deep integration” agenda as a response-but is it wise?
