Economic Comparative Systems
Djankov et al.'s: "The New Comparative Economics"
Grand Valley State University
Dr. Daniel Giedeman
Basic Idea
Traditional comparative economics dealt mostly with the comparison of socialism and capitalism. Now, the key comparisons are between alternative capitalist models that prevail in different countries. Particularly, new comparative economics analyses the institutional differences across countries:
how political leaders are chosen property rights wealth redistribution resolution of disputes how firms are governed credit allocation etc.
Motivation
Questions arising from transition:
How much government ownership is desirable? How much should governments regulate? How much should the government fight disorder at all? Is democracy the best political system for economic reform or is dictatorship efficient when radical change is required? Within democracies, do reforms proceed better under divided or consolidated governments? Is a federal structure desirable from the viewpoint of economic transformation?
Motivation
What can one make of these questions?
First, the standard economic questions of market failure, and inefficiencies associated with it, have played virtually no role in the central debates of transition.
Rather, the central issues have all dealt with property rights: how these rights can best be secured against both public and private expropriation?
Second, we see in all these questions a common tradeoff.
On the one hand, there is the objective of controlling disorder, that pushes toward greater state intervention. On the other hand, there is the goal of controlling dictatorship, that pushes against state power. In the rest of the paper, we explore this tradeoff.
Limiting Losses from Disorder & Dictatorship
The four common strategies of such control:
private orderings private litigation regulation state ownership
can be thought of as points on the institutional possibility frontier, ranked in terms of increasing powers of the state. These strategies are associated with progressively diminishing social costs of disorder, and progressively rising social costs of dictatorship.
Limiting Losses from Disorder & Dictatorship
The two central dangers that any society faces are disorder and dictatorship.
Disorder: the risk to individuals and their property of private expropriation in the form of murder, theft, violation of agreements, torts, monopoly pricing, etc.
Disorder is also reflected in private subversion of public institutions, such as courts, through bribes and threats, which allows private violators to escape penalties.
Dictatorship: the risk to individuals and their property of expropriation by the state and its agents in the form of murder, taxation, violation of property, etc.
Dictatorship is also reflected in expropriation through rather than just by the state, as with the use of regulators to eliminate entry by competitors.
Institutional Possibilities Frontier
They focus on the efficient institutional choice for a given IPF. Efficient institutions could evolve from:
democratic pressures the influence of growth-seeking interest groups
such as merchants
a Coasian negotiation among the elite
such as the Magna Carta the American Constitutional bargain
a long term evolutionary process
Institutional Possibilities Frontier
Even if it selects an efficient institutional choice, society cannot eliminate the problems of disorder and dictatorship Consistent with Coase (1960), even the most efficient institutional structure retains residual levels of both dictatorship and disorder.
Institutional Possibilities Frontier
The shape and the location of the IPF -- and hence the efficient choice -- varies across:
activities within a society across societies. An activity that involves repeated interactions among participants of roughly similar resources, and with little technological change, can achieve order with little dictatorship
e.g. diamond trading
An activity involving players with few repeated interactions and massive inequalities of power, is vulnerable to much more disorder for a given level of police
e.g. security issuance
Institutional Possibilities Frontier
The location of the IPF can be viewed as measuring Civic Capital
Considers things like:
culture ethnic homogeneity factor endowments Inequality long-run history of cooperation
Examples:
Sweden Congo Yugoslavia or Iraq
Institutional Possibilities Frontier
Civic Capital is also determined:
technology of production technology of government repression
efficiency of collecting taxes monopoly on power
human capital
Disorder
How can a society stop disorder?
Caused by things like:
deception monopoly pricing predatory tactics outright theft
1) 2) 3) 4)
Market discipline Private legal action through courts Public enforcement through regulation State ownership
Market Discipline
Market Discipline occurs when the market forces people/firms to behave properly
Competition will force firms to sell good products
e.g. I will go out of business if I sell salmonella-infected peanut butter
Market Discipline
Strength of Market Discipline as an enforcement mechanism:
It is free of public enforcers
Hence, there is no possibility of:
politicization of rules of conduct political corruption costly and delayed enforcement of rules random or compromised of choice one competitor over another.
Market Discipline
Weaknesses of Market Discipline as an enforcement mechanism:
Market participants use their economic, political, or social resources to damage their customers and rivals
Deception predatory pricing monopoly pricing social exclusion outright theft violence.
"One mans peaceful private orderings become another mans death in the hands of the mafia."
Market Discipline
When market discipline can successfully control disorder and avoid Hobbesian anarchy, it works best because it minimizes the social costs of dictatorship.
As a corollary, any case for public intervention relies crucially on the presumptive failure of market discipline to control disorder.
To the extent that market discipline can control disorder, regulation, or even courts, are unnecessary.
But this is far from always being the case.
Private Litigation
Judges would recognize quickly whether parties have been misled, and compel the counterparty to compensate the victims for their losses.
e.g. If you get sick from eating salmonella-infected peanut butter, you can sue the peanut company for your losses Firms, knowing that they could be successfully sued if they engage in improper behavior (i.e. create disorder), will have an incentive to behave properly
Private Litigation
Advantages of private litigation:
In principle, such litigation is of no special interest to the government, and hence disputes can be resolved apolitically, with no favors to influential parties. Judges may also develop expertise in contract enforcement (as well as in handling tort cases), and hence address problems efficiently and expeditiously.
Private Litigation
Weaknesses of private litigation:
The powerful and not the just often get their way in court
Legal mechanisms of influencing courts:
hiring good lawyers delaying proceedings seeking political help (in some cases)
Illegal mechanisms of influencing courts
bribing judges, juries and/or witnesses threatening judges, juries and/or witnesses
When the rich and the politically connected influence the path of justice, litigation over contracts and torts cannot be counted on for enforcing socially desirable conduct
Regulation
A third strategy of limiting disorder is government regulation.
The government can (potentially) force people/firms to behave in a proper manner.
e.g. The government can pass a regulation that says firms must test their peanut butter for salmonella contamination before they sell it to consumers.
Regulation
Strengths of regulation
regulations describe exactly what facts need to be established to prove a case subversion of judges becomes more difficult when they lose discretion
(regulations set down the rules they are supposed to follow)
regulators can become experts and motivated to pursue social objectives regulators are empowered to complete the law
(they can act pro-actively, where-as judges/courts must react after the fact)
regulators are less likely to be subverted since they can get incentives from the state to pursue social objectives
Regulation
Weakness of regulation
Raises risks of dictatorship
rules can be used to expropriate politically weak & favor politically strong regulators can be captured by a particular group or industry
Nationalization
Disorder caused by private ownership could be reduced if the government owned the firms
Government monopolies could allocate the proper amount of a good or resource The government would have no incentive to trick taxpayers concerning the quality of a product Government can care about overall societal welfare and not just profit maximization. e.g. The government could own peanut butter factories and since it be trying to optimize societal welfare, it would have a strong incentive to test peanut butter for salmonella, even if it reduced the factory's profitability.
Nationalization
Weakness of Government Ownership:
state ownership has the obvious problems of dictatorship
Consider the miserable performance record of public enterprises and the benefits of privatization.
The failure of state socialism as an economic system reveals most dramatically the consequences of dictatorship taken to an extreme, in which all economic problems are solved to maintain political control by the communist party
Examples
England and France in the 12th and 13th centuries
France was more disorderly than England
Hence, France chose a legal system with greater centralization (government control).
The authors claim that both England and France's institutional choices were efficient.
Examples
The United States in the Gilded Age
(the rise of the regulatory state) Authors claim that prior to the civil war, private litigation worked
(since there was not too much inequality).
After the Civil War, massive industrialization and commercialization of the economy undermined courts as the sole institution securing property rights. Hence there was a shift the efficient institutional set
(represented by the IPF shifting out and tilting)
Examples
Transition Economies in the 1990s
Examples
The transplantation of institutions to developing (or nondeveloping) countries
Conclusion
"Economics can move further, and recognize that different institutions are appropriate in different circumstances." "This, we believe, is the goal of the new comparative economics."