The Economic Theory of Social Institutions

1. The Economic Theory of Social Institutions Sergio Beraldo (University of Naples “Federico II” & ICER) Lectures delivered at the University of Prague (VSE) October 2011 V

2. Outline of the course • I: Institutions • II: Coordination • III: Cooperation 1 • IV: Cooperation 2 • V: Institutional structure and economic performance

3. VLECTURE • Institutions and economic performance

4. Fundamental observation • It is possible to produce more if people cooperate; • everybody specializes in one particular activity • everybody then trades with others to get the goods and services she needs • Adam Smith (The Wealth of Nations, 1776, Book I, Ch. I) → “The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labour.”

5. Smith’s Pin Factory • “To take an example, therefore, from a very trifling manufacture; but one in which the division of labour has been very often taken notice of, the trade of the pin-maker; a workman not educated to this business (which the division of labour has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades... I have seen a small manufactory of this kind where ten men only were employed... Those ten persons...could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day”

6. Institutions • The productivity gains coming from specialization and division of labour can only be reaped if there emerges an institutional structure solving the problem of human cooperation

7. Cross – country investigations • A recent strand of empirical literature investigates whether economic performance depends on the institutional structure; • Cross- country investigation • Two directions: • 1. How the legal system can affect economic development (e.g. works by Andrei Shleifer and co-authours) • 2. How informal institutions can affect economic development

8. Cross- Country Investigations • Informal institutions • Social Capital (Trust, social norms, network density..and whatever you like!) • Putnam (1993) – Differences in economic development between Northern and Southern Italy • E.g. Knack and Keefer (1997) – QJE -- Generally speaking, would you say that most people can be trusted, or that you can’t be too careful in dealing with people? [World Values Survey] • Correlation found between measures of SC and GDP level

9. Cross- Country Investigations • La Porta et al. 1997 found correlations between SC and anything can be deemed as good: low inflation, high GDP and so on [they included also planned economies in the sample] • Real problem: Data from the WVS simply reflect the situation • Trust – ephiphenomen of the institutional environment [Beraldo and Cagliozzi, 2005; Fehr, 2009]

10. Institutions do matter! • Institutions do matter, but as reality is terribly complex, too simplified analysis (providing the recepy for happiness) risks to be both wrong scientifically and socially dangerous!