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Institutions - Institutions The Fundamental Question o Why...

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Institutions The Fundamental Question o Why are some countries so much more prosperous than others? o Growth theory / development Factor accumulation (Solow) Endogenous growth (Lucas - Romer) o These are only the proximate causes of growth. o The ultimate causes of economic growth are: Geography Culture Institutions. o AJR argue that institutions is the fundamental cause of longrun growth. Institutions vs. Organizations o A common figure of speech is to refer to organizations as “institutions. ” o For example, banks are often called “financial institutions. ” o Here we need to be precise. When we talk about institutions in this course, we will refer to laws, rules, contracts and other constraints that shape and constrain human interaction. o Entities that performs specific tasks – governments, banks, NGOs – will fall under the label of “organizations. ” The Coase Theorem o Ronald Coase showed that, in the absence of transaction costs, a market economy will produce an efficient outcome irrespective of initial allocations or legal entitlements. o A literal interpretation of the Coase theorem means that governments need not interfere with the allocation of resources. People or companies who are more productive will buy the resources from those who are less productive. o This was the thinking behind the “voucher privatizations ” in the former communist world. Just give away equal shares in state companies to every person in the population, and let them trade. Eventually those who can run them better will acquire the majority of shares. An example o  Imagine an economy with two people, John and Peter. The only resource in this economy is one acre of land. John can produce 200 bushels of wheat per acre. Peter can only produce 100 bushels per acre. Clearly the efficient outcome requires John to farm the acre and produce 200 bushels. The Coase theorem tells us that, from the standpoint of economic efficiency, it doesn’t matter who we give the acre of land to. If we give it to John, he will produce 200 bushels and keep them. If we give it to Peter, John will promise to pay her 101 bushels for the
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acre. He will then produce 200 bushels, give 101 to Peter and keep 99 for himself. In either case, 200 bushes get produced, which is the efficient outcome. Initial allocations, however, matter for distributional outcomes. In the first case above, we have a perfectly unequal distribution, while in the second case the distribution is almost perfectly equal. Transaction costs o The catch with the Coase theorem is that it is costly to transact. Information costs. Negotiation costs. Enforcement costs. o North estimated that, in 1970, over 50% of US GDP was absorbed by transaction costs. Measurement of transaction costs include amounts spent on lawyers, lobbyists, accountants, personnel relations, inspectors, judges, police, etc.
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