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Readings Comparative Economics & Business Systems:Lecture 1:
Djankov et al. (2003) – The new comparative economics:
In recent years, the field of comparative economics refocused on the comparison of capitalist
economies. The theme of the new research is that institutions exert a profound influence on
economic development. We argue that, to understand capitalist institutions, one needs to
understand the basic tradeoff between the costs of disorder and those of dictatorship. We apply
this logic to study the structure of efficient institutions, the consequences of colonial
transplantation, and the politics of institutional choice.
The traditional field of comparative economics dealt mostly with the comparison of socialism
and capitalism. Traditional comparative economics studies under what circumstances either the
plan (socialism) or the market (capitalism) delivers greater economic efficiency. Capitalism is
the winner, but comparative economics is not dead: it is evolving into a new field. The key
comparisons are those of alternative capitalist models prevailing in different countries.
Institutions differ tremendously and systematically among countries. These differences and
their consequences for economic performance are the subject of the new comparative
economics.
There are two sides to the security of property rights. On the one hand, investment must be
secured, typically by the government, from the expropriation by thieves, competitors, or tort-
feasors. On the other hand, a government capable of protecting property against private
infringement can itself become the violator and the thief. A crucial risk to property rights is
taking by the government, which we call dictatorship.
A fundamental problem of institutional design is the conflict between the twin goals of
controlling disorder and dictatorship. Fearful of disorder favored absolutism.
On the one hand, there is the objective of controlling disorder, which pushes toward greater
dictatorship. On the other hand, there is the goal of controlling the abuses of state intervention,
which pushes against dictatorship.
The four common strategies of control (private orderings, private litigation, regulation and state
ownership) can be viewed as points on the institutional possibility frontier, ranked in terms of
increasing state powers. These strategies are associated with progressively diminishing social
costs of disorder and progressively rising social costs of dictatorship.
Disorder refers to the risk to individuals and
their property of private expropriation in
such forms as banditry, murder, theft,
violation of agreements, torts, or monopoly
pricing. Dictatorship refers to the risk to
individuals and their property of
expropriation by the state and its agents in
such forms as murder, taxation, or violation of
property. Institutions function to control
these twin dangers of dictatorship and
disorder.
Figure: Institutional Possibility Frontier (IPF).
On the x-axis, the social losses from
dictatorship, are measured relative to a world
with perfect property right. On the y-axis, the
social losses from disorder are measures
relative to a perfect property rights benchmark. The IPF shows how much disorder can be
reduced with an incremental increase in the power of the state, knowing that disorder cannot be
,reduced without increasing dictatorship. No institutions fully eliminates the transaction costs of
dictatorship and disorder.
The downward sloping 45 degree line holds constant the total social costs of dictatorship and
disorder. Its point of tangency with the IPF is the efficient institutional choice for a given society
or a sector within a society. The location and the shape of the IPF, and hence the efficient choice,
are determined by a number of factors and the location of the IPF varies most dramatically
across societies. The location of the IPF is dependent on the civic capital. Societies with more
such capital, and an IPF closer to the origin, are more capable of achieving cooperation among
their members. Civic capital is a constraint rather than a choice, and optimally is determined by
the shape of the IPF.
The four basic strategies differ in the degree of public control: private orderings, independent
judges, regulatory state, state ownership. No public involvement is required with competition
and private orderings. Courts employ impartial judges enforcing the rules of good behavior.
These rules do not even need to come from legislation; rather, they may derive from custom or
from judge-made common law. Even in this case, the judge is a public agent with decision-
making authority. With regulators, the state writes the rules, inspects the product before it is
sold, and penalizes sellers for delivering a bad product. Both the scope of government activity
and its centralization are increased relative to independent courts. Finally, with state ownership,
the government takes complete control over an activity. The question is how much of a
reduction in disorder is bought by more dictatorship.
In summary, our framework enables us to discuss systematically the alternative forms of
social control of business. The efficient choice is determined by the slope of the IPF, which
varies across countries and industries. In places with more effective government, greater
transparency, and greater freedom of the press, for example, an increase in the scope of
government to control disorder leads to fewer social losses. In such places, the slope will
be steeper, allowing for more state intervention at the efficient choice. In sectors with more
effective market discipline, lower inequality of resources among participants, and weaker
tendency toward monopoly, increasing dictatorship will yield smaller reductions in disorder. In
these sectors, the slope of the IPF will be flatter, and less intervention will be consistent with
efficiency. Ultimately, efficient institutional design depends on specific characteristics of
countries and sectors, which can only be ascertained empirically.
To counter disorder, it was efficient for France to
adopt a legal system with more dictatorship than
England’s, even at the cost of greater scope for
sovereign abuse of the law.
The IPF in France is steeper because greater
inequality and constant warfare increased the
ability of some private citizens to expropriate
other without being punished. So the choice of
legal rules is shaped by the costs of enforcement
that vary across both jurisdictions and the rules
themselves.
The pre-Civil-War US was a relatively stable
country, without great inequality. In this
environment, private litigation was an efficient
strategy of social control of business. After the
War, there was increased disorder. The growth in
disorder shifted the IPF outward, rendering the reliance
on courts inefficient. See figure below.
technological change shifted the IPF outward and also
changed its slope so that the reduction in disorder from a
,marginal rise in dictatorship increased. The efficient institutional choice required more
regulation to provide the countervailing power to big business.
Russia’s experience with the collapse of communism can be described as a sharp move along its
IPF: disorder increased.
The general point is that economic and social change in each country should be considered in
light of its own institutional possibilities, rather than some idealized view of a rich capitalist
democracy.
As European powers conquered much of the world
in the 19th century, they brought with them their
institutions, including their laws. A significant
portion of the institutional variation among
countries, especially with regard to legal systems,
can be accounted for by transplantation. The fact
that colonial transplantation is such a significant
determinant of institutional design suggests that the
observed institutional choices may be inefficient.
Because the developing countries often lack
government transparency, press freedom, and
bureaucratic efficiency, the marginal productivity of
dictatorship in reducing disorder is lower than in
developed countries. As a consequence, developing
countries efficiently need relatively less dictatorship.
Transplantation leads to excessive intervention and
regulation, and relatively more so in civic than in
common law countries. The transplanted regulatory systems appear excessive for the countries
that use them. Deregulation is likely to diminish the costs of dictatorship without a significant
increase in disorder.
Politics often moves societies toward institutional efficiency rather than away from it:
1. Some institutions evolve over time into more efficient forms as they confront new
circumstances
2. Governments are often captured by interests groups that favor efficiency
3. Bargaining often leads to efficient institutional choice
4. Voting is often a powerful force toward more efficient institutions
Lecture 2:
Acemoglu et al. (2001) – Institutions as a fundamental cause of long-run growth:
This paper develops the empirical and theoretical case that differences in economic institutions
are the fundamental cause of differences in economic development. We first document the
empirical importance of institutions by focusing on two "quasi-natural experiments" in history,
the division of Korea into two parts with very different economic institutions and the
colonization of much of the world by European powers starting in the fifteenth century. We then
develop the basic outline of a framework for thinking about why economic institutions differ
across countries. Economic institutions determine the incentives of and the constraints on
economic actors, and shape economic outcomes. As such, they are social decisions, chosen for
their consequences. Because different groups and individuals typically benefit from different
economic institutions, there is generally a conflict over these social choices, ultimately resolved
in favor of groups with greater political power. The distribution of political power in society is in
turn determined by political institutions and the distribution of resources. Political institutions
allocate de jure political power, while groups with greater economic might typically possess
, greater de facto political power. We therefore view the appropriate theoretical framework as a
dynamic one with political institutions and the distribution of resources as the state variables.
These variables themselves change over time because prevailing economic institutions affect the
distribution of resources, and because groups with de facto political power today strive to
change political institutions in order to increase their de jure political power in the future.
Economic institutions encouraging economic growth emerge when political institutions allocate
power to groups with interests in broad-based property rights enforcement, when they create
effective constraints on power-holders, and when there are relatively few rents to be captured
by power-holders. We illustrate the assumptions, the workings and the implications of this
framework using a number of historical examples.
The fundamental explanation of comparative growth is differences in institutions. Institutions
are the rules of the game in a society, the humanly devised constraints that shape human
interaction. In consequence they structure incentives in human exchange, whether political,
social or economic. While we have good reason to believe that economic institutions matter for
economic growth, we lack the crucial comparative static results which will allow us to explain
why equilibrium economic institutions differ.
1. Economic institutions matter for economic growth, because they shape the incentives of
key economic actors in society, in particular, they influence investments in physical and
human capital and technology, and the organization of production. They do not only
determine the aggregate economic growth potential of the economy, but also an array of
economic outcomes, including the distribution of resources in the future.
2. Economic institutions are endogenous. They are determined as collective choices of the
society, in large part for their economic consequences. Whichever group has more
political power is likely to secure the set of economic institutions that it prefers.
3. There are conflicting interests over the distribution of resources and therefore indirectly
over the set of economic institutions.
4. The distribution of political power in society is also endogenous. There are two
components of political power: institutional and de facto political power. The first refers
to power that originates from the political institutions in society.
5. A group of individuals, even if they are not allocated power by political institutions, may
nonetheless possess political power. This is de facto political power. First, this depends
on the ability of the group to solve its collective action problem. Second, the de facto
power of a group depends on its economic resources.
6. Political institutions and the distribution of resources are the state variables in the
dynamic system because they typically change relatively slowly and they determine
economic institutions and economic performance both directly and indirectly.
Putting this all together, you get the following framework:
The two state variables are political institutions and the distribution of resources and the
knowledge of these two variables at time t is sufficient to determine all the other variables in the
system. While political institutions determine the distribution of de jure political power in
society, the distribution of resources influences the distribution of de facto political power at
time t. These two sources of political power, in turn, affect the choice of economic institutions
and influence the future evolution of political institutions. Economic institutions determine
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