Download Institutional Arrangements for Economic Governance

Institutional Arrangements for Economic Governance
J A N UARY 2 , 2 0 1 4
Summary of the basics
Economic growth is a function of …
(i) Factor accumulation
Increase in human capital, physical capital
… depends on saving, investment, schooling decisions
(ii) Productivity change
Improvements in allocative efficiency (including within household!)
Improvements in technical efficiency
… depends on decisions on where to invest, whether and how to adopt new technologies,
etc.
Rates of economic growth determined by whether households, firms, and investors are making
“appropriate” choices—i.e., those that are aligned with social optimality and higher economic
growth.
Markets
… can help by aligning private incentives with social costs and benefits, provided:
(a)
(b)
(c)
they are not missing
they are not distorted by inappropriate policies
they are not malfunctioning due to externalities (e.g., LBD), non-convexities (e.g., IRS),
imperfect/incomplete information (e.g., moral hazard), or incomplete contracting.
When markets work poorly, low levels of accumulation and low productivity are the result.
Institutions of economic governance
Institutions
… shape economic behavior by affecting constraints and incentives that households and investors
face.
They do so both directly, and through their impact on markets. In particular, institutions
determine when markets exist, how well they work, and how long their reach is. Appropriate
market-supporting institutions are those that counter (a), (b), and (c). They enable markets to
exist, restrain governments from inappropriate policy choices, and prevent market failures.
(But not all institutional arrangements are “appropriate” in that sense.)
Definition of institutions:
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 (norms, patterns of behavior, conventions, moral
codes)
As such, they determine not just functioning of markets, but the quality of all social interactions
(e.g., trust, cooperation). We will see examples from a broad cross-section.
Informal versus formal institutions
Relative advantages of self-sustaining agreements versus formal institutions:
The former have low fixed costs, high and rising marginal costs; the latter have high fixed
costs, low marginal costs
As markets grow, number of participants increase, and mobility rises, the relative costs of informal
agreements rise.
Example: traffic and traffic lights
Transitional costs
Outline
• A second-best strategy for institutional reform
• A typology of market-supporting institutions
• Multiplicity of institutional forms
• Where do institutions really come from?
An analogy: contract enforcement
Relational contracting in Vietnam (I)
“The managers we interviewed said they did not believe the courts can
help them. "They normally just create more problems . . . in Vietnam
no one believes we have a good legal system“ … Another said, "The
court is weak and no entrepreneurs use it" … These comments are
corroborated by answers to our questionnaire about how disputes
are managed. Responding to a question about third parties that
can enforce agreements with customers or suppliers, 89% of
managers said, "there is no one." Only 9% said a court or other
government agency could help. Third parties are even less help for
disputes over the quality of goods; only 2% of the managers said
they would take such disputes to court or appeal to local
authorities.”
Relational contracting in Vietnam (II)
“To compensate for the inadequacy of the courts, the firms use
repeated-game incentives. Contracting is supported by the threat of
loss of future business. Interestingly … the managers told us they are
reluctant to sanction trading partners. If a customer reneges on a
debt they often allow payment to be delayed and forgive part of the
debt. As a result the retaliation is not as immediate or predictable as in
the simple repeated-game story and therefore not as effective a
sanction. To ensure compliance, the firms rely on other devices that
supplement the shadow of the future… We find that more elaborate
governance structures are used in transactions with a greater risk of
reneging. Also, firms sometimes scrutinize prospective trading partners
before beginning to transact, checking the firms’ reliability via other
firms in the same line of business or familial connections.”
Relational contracting in Vietnam (III)
So:
• Courts are inefficient, costly to use, and potentially
corruptible
• Firms rarely resort to them
• They rely on relational contracting instead:
• long-term, trust-based relationships with suppliers and
customers
• screen potential business partners by gathering information
• inspect goods on delivery prior to payment
• frequently renegotiate when contract terms are not fulfilled
When intermediate levels of “legality” may not
be an improvement: Former Soviet Union
Relational contracting in Africa
Some initial lessons
1.
We can get a lot of economic activity in very “poor”
institutional environment
2.
Poorly designed institutional reform, following “best
practice,” can do more harm than good
3.
Appropriate reform strategies are inherently context-specific
and may require second-best strategies
•
Working around existing constraints, building on existing
strengths
•
If relational contracting is working decently, the focus of
institutional reform might be not on improving judicial system,
but on
•
•
Improving information gathering and dissemination about “good”
and “bad” firms
Improving formal contract enforcement for specific categories of
firms that do not have access to relational contracting, such as
new entrants and foreign firms
A second-best strategy for institutional
reform
• Additional illustrations
• Property-rights reform
• Entry regulations
• Outward orientation
• Monetary policy regimes
Example 1: Property-rights
reform (1)
• Problem: inadequate protection of property rights
depresses private investment incentives
• Solution: private property-rights legislation and
American-style investor protection rights?
• But what about difficulties of:
• Enforcement?
• Politics?
Example 1: Property-rights reform
(2)
The example of Chinese TVEs
Objective
What is problem?
Institutional
response
Prerequisites
Institutional
complements
provide “property”
rights over profits of
enterprise
courts and legal
system too weak and
corruptible for
property rights and
contract enforcement
through third party
(state) to be effective
Township and Village
Enterprises: a form of
enterprise where
property rights
(“residual rights over
profits”) are formally
vested in local
governments
local governments as
the main threat on
property rights;
expectation of future
profit stream
sufficiently high for
local government not
to want to
“expropriate” private
entrepreneur.
competition among
local authorities for
capital; sufficiently
strong local
governments to stave
off other threats on
property rights; …
Example 2: Entry regulation and
entrepreneurship (1)
• Entry regulations and barriers reduce competition and
generate rents
• Is this good or bad for entrepreneurship?
• World Bank’s Doing Business Surveys based on the presumption
that entry regulations are an unmitigated bad
• Implied strategy of institutional reform: focus on reducing the
regulatory cost of entry
• Reduce licensing requirements and costs, streamline procedures,
speed up bureaucratic processes
• Presumably even if this entails some costs in terms of background
checks, enforcements of regulations and standards, and accuracy
of tax registers.
Example 2: Entry regulation and
entrepreneurship (2)
• Maintained hypothesis: entry barriers are the binding constraint
on entrepreneurship
• But entrepreneurship can also be constrained by other factors
• High costs of contracting environment
• Low private returns
• Low level of public inputs
• When problem lies with low returns, the presence of rents can
play a useful role
Example 2: Entry regulation and
entrepreneurship (3)
• Models where rents are required to stimulate private investment
and entrepreneurship:
• Hausmann and Rodrik (2003): rents as returns to cost discovery
• Hellman, Murdock, and Stiglitz (1997): franchise value for banks as
an incentive device for monitoring borrowers
• Acemoglu, Aghion, and Zilibotti (2006): rent-sustained long-term
relationship to sustain high investment early in the development
process
• In all these models, there are second-best reasons why
maximizing free entry is not optimal
• Minimizing bureaucratic hurdles may not be optimal when
other types of constraints bind as well—e.g., accuracy of tax
registers and fiscal constraints
Example 2: Entry regulation and
entrepreneurship (4)
The example of financial controls in East Asia
Relationship between entry rates
and economic performance
Example 3: Outward orientation
(1)
• Best practice: low and uniform tariffs, no QRs, and
WTO membership
• With few exceptions, successful globalizers have
pursued different strategies
• South Korea and Taiwan: export subsidies
• China: SEZs
• SE Asia and Mauritius: EPZs
• In all cases, discretionary tariff and QR regimes, noncompliance with WTO rules on TRIMS and local-content
regulations
Example 3: Outward orientation
(2)
• What is the advantage of these alternative strategies?
• They generate export-oriented incentives at the margin while
keeping protection in place for pre-existing formal-sector
activities
• With the benefit of
• Managing employment in the transition
• Managing political economy
• The Latin American pattern as the counterfactual
• The lesson: a given economic objective—outward
orientation—can be achieved through different institutional
designs, and sometimes it is worth doing things in an
unorthodox, round-about way if this serves to relax other
constraints elsewhere in the system.
Example 3: Outward orientation (3)
A non-Asian illustration: the Mauritian Export Processing Zone
Objective
What is problem?
Institutional
response
Prerequisites
Institutional
complements
Reduce anti-export
bias
Import-competing
interests are
politically powerful
and opposed to trade
liberalization
export processing
zone (Rodrik 1999)
saving boom and
supply of foreign
investment
Dual labor markets:
segmentation between
male and female labor
force, so that increase
female employment in
the EPZ does not
drive wages up in the
rest of the economy.
Example 4: Monetary policy and
credibility (1)
• When monetary credibility is binding constraint, making central
bank independent and putting monetary policy on automatic
pilot may make sense
• Extreme case: Argentina’s convertibility law
• More broadly, current best-practice of CBI and inflation
targeting is based on first-best thinking which takes the only
function of monetary authorities to be price stability
Example 4: Monetary policy and
credibility (2)
• But monetary credibility need not always remain the binding
constraint
• And in a second-best world there will be always be competing
objectives
• Argentina’s collapse when binding constraint changes from
credibility to competitiveness
• Countries with independent CBs and IT regimes currently face a
similar tradeoff
• Free floats and capital mobility typically produce an “overvalued” currency
from a developmental perspective
• Which independent CBs pursuing IT have little inclination to counteract
• Lesson: binding constraints change over time and no single set
of best-practices will serve all countries well all the time
Caveats
Formal institutions (third-party enforcement)
A typology of formal institutions:
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. Monetary, fiscal and currency arrangements
d. Market-legitimizing institutions
i. Redistribution
ii. Social insurance
iii. Political democracy
Multiplicity of desirable institutional arrangements
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.
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 nontraditional areas?
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.
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 rulebound, 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?
OBJECTIVE
UNIVERSAL PRINCIPLES
PLAUSIBLE DIVERSITY IN
INSTITUTIONAL ARRANGEMENTS
Distributive justice and
poverty alleviation
Targeting: Redistributive
programs should be
targeted as closely as
possible to the intended
beneficiaries.
How progressive should the tax
system be?
Incentive compatibility:
Redistributive programs
should minimize incentive
distortions.
What are the appropriate points of
intervention: educational system?
access to health? access to credit?
labor markets? tax system?
Should pension systems be public or
private?
What is the role of “social funds”?
conditional cash transfers?
Redistribution of endowments? (land
reform, endowments-at-birth)
Organization of labor markets:
decentralized or institutionalized?
Modes of service delivery: NGOs,
participatory arrangements., etc.
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
Bottom line
• “Good” institutions serve similar functions
• All successful countries provide effective property rights protection
and contract enforcement
• maintain macroeconomic stability
• integrate in the world economy
• ensure an appropriate environment for productive diversification
and innovation
• provide effective prudential regulation of financial intermediaries
• maintain social cohesion and political stability
• …
• But these general principles do not map directly and uniquely
into specific policies
• Successful institutional reform is pragmatic and opportunistic
• It focuses on the binding constraints
• And it does not disregard historical legacies