The New Comparative Economics

1. The New Comparative Economics Simeon Djankov, World Bank Edward Glaeser, Harvard University Rafael La Porta, Dartmouth College Florencio Lopez-de-Silanes, Yale University Andrew Shleifer, Harvard University Economics 980l: Macroeconomics and Politics Tuesday, October 30, 2007

2. “Is comparative economics dead?” • Comparative economics historically: socialism vs. capitalism • Comparative economics today: differences among capitalist economies → How institutions affect economic performance

3. Historical Background • Enlightenment Economists: Good economic institutions make for good economic growth • Good institutions… Secure property rights, enforce contracts, resolve disputes, protect investment returns • Problem with property rights: Government that secures property may also take it away

4. Two Challenges to Property Rights • On Security of Property: Hobbes v. Montesquieu “War of all against all” vs. “Nation in slavery labors more to preserve than to acquire” • Two challenges: Disorder and Dictatorship Either your neighbor may steal your property, or your government • Institutions designed to control both – at once Success varies, affecting economic performance

5. The New Comparative Economics The study of the differentways countries design institutions to resolve the conflict between the twin goals ofcontrolling disorder and dictatorship at once. The Study of Questions, such as… How much government ownership is desirable? How much should governments regulate? How hard should the government fight disorder? Is democracy or authoritarianism better for reform? In democracies, do economies do better under divided or consolidated government? Is a federal structure better for economic transformation?

6. The Purpose of this Paper To provide a framework for considering the dictatorship-disorder tradeoff, as well as its implications and application The rest of the presentation will therefore go as follows: • Part 2: Overview of the Framework • Part 3: Three Illustrations • Part 4: Transplantation – legacies of colonial policies • Part 5: Politics • Part 6: Conclusion

7. Section 2 Overview of the Framework

8. Basic Framework Risk to individuals and their property comes from… Disorder Dictatorship Expropriation by the state via: Murder, Taxation Violation of property Artificial barriers to market entry, competition Corruption • Private expropriation by: • Banditry, Murder, Theft • Violation of contracts, torts • Monopoly pricing • Private subversion of public institutions by: • Bribes and threats → Institutions function to control these twin dangers of disorder and dictatorship…

9. The Tradeoff Institutional Possibility Frontier (IPF): The efficient institutional choice for a given society or sector within society

10. Determinants of the IPF Slope and distance from origin determined by “Civic Capital”: Institutional Possibility Frontier (IPF): • Culture • Ethnic heterogeneity/strife • Factor endowments, geography • Social capital (e.g. history of cooperation in pursuit of public goods) • Technology of production • Efficiency of taxation • Human capital

11. An Example: Social Control of Businesses Institutional Possibility Frontier (IPF): Objective: Reduce disorder from… Monopoly pricing Torts (e.g. breaches of contract) Predatory Tactics Alternatives: Degree of public control… Individual market discipline Litigation State regulation State ownership Constraints: Institutional capacity… Civic Capital Other state-specific characteristics

12. Section 3 Illustrations of Institutional Design 3.1 — Twelfth/Thirteenth Century Legal Systems: France and England 3.2 — Progressive era rise of the regulatory state: United States 3.3 — Post-communist transition: Eastern Europe

13. Legal Origins (Glaeser and Shleifer 2002) England: Common Law France: Civil Law Fact finding by state-employed judges Decisions automatically reviewed Judges bound by procedural and substantive codes, rather than discretion • Fact-finding juries • Independent judges • Infrequent appeals • Reliance on precedent Strong King, Weak Nobles Weak King, Strong Nobles

14. Legal Origins (Glaeser and Shleifer 2002)

15. The Rise of the Regulatory State (Glaeser and Shleifer 2003) • Before 1900, commercial disputes in the U.S. resolved by private litigation Before the Civil War, this worked – litigants were of relatively equal status • Disorder increases with Post-Civil War industrialization Monopolies, Unsafe conditions for workers/passengers, Increased inequality, litigation less effective – robber barons hire better lawyers and bribe judges • Progressive movement calls for more regulation

16. The Rise of the Regulatory State (Glaeser and Shleifer 2003)

17. Institutions in Transition → Communism falls… • Russia: Dictatorship drops, disorder spikes End communist control, entrepreneurship, unofficial economy reaches 40% economic activity • Belarus: Dictatorship same, disorder same Personal dictatorship replaces communists, structures of controls kept intact • East Europe: IPF near origin, disorder increases IPFs already closer to origin, end communist control, increased capitalist activity

18. Institutions in Transition

19. Section 4 Transplantation of Institutions

20. World Imperialism c.1900

21. Legal Origins World Imperialism c.1900

22. Some Prior Work on Transplantation • La Porta et al. (1997, 1998) Legal origin affected investor protections, and thus affected financial development • Djankov et al. (2002, 2003), Botero et al. (2003) Countries’ control of businesses related to origin of laws • La Porta et al. (2004) Judicial independence associated with common law independence; good for business • Acemoglu et al. (2001) Quality of institutions today related to whether colony was a settlement and cultivated or an outpost and exploited → All of these legacies affect the present IPF!

23. Transplantation and the IPF • Different colonial legal systems led to different present business environments • Legal origin and investor protection correlated with aspects of financial development • Transplantation profoundly influenced present social control of business • Observed institutional choices may be inefficient

24. Legal Systems and the IPF

25. Legal Systems and the IPF Transplantation leads to… • Higher dictator-disorder equilibrium • Excessive state intervention and regulation – especially in civil law countries • Developing countries need less regulation for efficiency

26. Section 5 Politics

27. Politics and the IPF Institutional Possibility Frontier (IPF):

28. Politics Can Increase Inst’l Efficiency • Institutions evolve and become more efficient as they face new circumstances • Pro-efficiency interest groups capture government • Coasean bargaining leads to efficient institutional choice • Voting leads to more efficient institutions

29. Influence of Politics on Institutions • Politics: a negotiation between interests • Success of negotiations depends in part on civic capital • Location of IPF and political choice of a point on the IPF are not entirely independent • Not all poor institutional outcomes can be blamed on politics

30. Section 6 Conclusions

31. General Conclusions • Different institutions will be appropriate for different circumstances • The diversity in institutional arrangements can be understood as a tradeoff between dictatorship and disorder • An inefficient – or more efficient – tradeoff may arise from political forces • Reforms in each country must be evaluated relative to its own institutional opportunities

32. Looking Forward • Recent history has called new attention to the role of institutions in macroeconomics • This framework offers a systematic way to compare different countries’ different institutions, and different economic outcomes • It is this type of comparative perspective of institutions that is at the heart of the new comparative economics

33. Thank you.