Abstract
Till today, the policies of the Washington Consensus, just as their neoclassical foundations, are still a vital part of development economics. Since the late 1990s, there was, however, a growing recognition that economic policy reforms will remain ineffective if they are not complemented by a similar effort to improve a country’s underlying institutional environment. For instance, trade liberalisation requires, among other things, effective fiscal institutions that are able to compensate for lost trade revenue. Capital markets, an efficient banking system, or labour market institutions that can reduce transitional unemployment are just some of the institutional preconditions for the effective implementation of mass privatisation programmes. Nobel Laureate Douglass C. North was among the first to caution that free markets do not in themselves mean efficient markets, as the latter require a well-specified legal system with effective enforcement mechanisms and a set of attitudes towards contracting and trading that would encourage people to engage in trade and production at low costs (North 1986).
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Notes
- 1.
See also the analysis of alternative institutions for contract enforcement in low-income countries in Sect. 4.2.
- 2.
This relates to the question of whether the New Institutional Economics adheres to the precept of methodological individualism. If the unit on analysis in modern institutional theory is the transaction between two or more individuals, methodological individualism, in a narrow sense, would not persist. Yet, North seems to disagree when he states that “institutions are a creation of human beings, they evolve and are altered by human beings, hence our theory must begin with the individual” (North 1990, p. 5).
- 3.
By remaining tied to neoclassical economics, the New Institutional Economics is yet not as successful in explaining the dynamic process of institutional change as its predecessor, the old institutional economics of Veblen and Commons has already been more than a century ago. See Sect. 12.4 on their contributions to institutional theory.
- 4.
The view of institutions as efficient solutions to problems of organisation in a competitive framework has in particular been advanced by Williamson (1975, 1979, 1990). See also Chap. 3.
- 5.
See especially North (1990, 1992, 1995a). Menard and Shirley (2008) provide a good overview of the New Institutional Economics literature.
- 6.
The ability of societies to adapt to altered conditions can be described by the concept of adaptive efficiency (North 1995a). Unlike allocative efficiency, which is a static concept valid only within a given set of institutions, adaptive efficiency can serve as a criterion to evaluate an economy’s performance in terms of the flexibility of its institutions to adjust to evolving technological, social, political and demographic changes or shocks to the system.
- 7.
The implications of considering cultural influences on economic behaviour are further discussed in Sect. 13.1.4.
- 8.
This argument will further be developed in Sect. 13.2.2.
- 9.
In this context, North (1984) also refers to informal institutions as the “ideological superstructure” of a society, an expression which has, albeit in a different context, already been used by Karl Marx in his critique of morality.
- 10.
Note that the term “informal” in connection with economic arrangements and activities in the informal sector is meant in a narrower sense here than the concept of informal institutions of the previous analysis. In the present context, “informal” refers to the extralegal nature of an arrangement in the sense that it is outside the reach of formal law.
- 11.
Note that these culturally-derived influences on economic behaviour can only be analysed in a meaningful way if research is tied to context. The enormous range of possible cultural adaptations to similar economic situations implies not only that the informal influences on individual choices and institutional change vary with the decision-maker’s cultural background, but also that, for this very reason, a given stimulus for institutional change can lead to very different, context-specific outcomes. The argument in favour of context-specific analysis in development economics is further developed in Sect. 9.2. For a further discussion of the influences of cultural factors on economic outcomes in low-income countries see Sect. 13.2.1.
- 12.
See, for instance, Nabli and Nugent (1986, 1989), Bardhan (1989), North (1995a), and Olson (1996).
- 13.
See, for instance, Borner (1998), Burki and Perry (1998), and Zattler (2004).
- 14.
The World Bank devoted its 2002 World Development Report to the subject of institution-building for growth and poverty reduction (World Bank 2001b). The IMF made growth and institutions the subject of its flagship publication, the World Economic Outlook, in 2003 (IMF 2003).
- 15.
Bardhan (2005) observes that nearly 90% of the papers presented in Development Seminars in the U.S. are now mainly empirical.
- 16.
Especially Barro and Sala-i-Martin (1992), and Mankiw et al. (1992). For a further discussion of neoclassical growth theory see Sect. 7.1.
- 17.
This problem besets as well many other assertions of causality in development economics that will be further discussed in Sect. 9.2.1. In econometric terms, the problem is one of endogeneity of explanatory variables which occurs when the independent and dependent variables in a regression model are jointly determined, i.e. when they affect each other in such a way that the direction of causal effects between them is ambiguous. Endogeneity means that the independent variable is correlated with the error term in a regression model (i.e. Cov(x,ε) ≠ 0), which has the effect that the coefficients in an OLS regression are biased and inconsistent. The usual solution to this problem, the use of an instrumental variable instead of an OLS regressor, is an accurate one from an econometric standpoint, but tends to be conceptionally problematic as the theoretical link between the instrument and the independent variable that it replaces is often vague and seldom credible.
- 18.
An alternative approach, which allows for a larger sample of countries, is the use of instruments based on language use, namely, the fraction of the population that speaks English or other European languages (see, for instance, IMF 2003). However, Glaeser et al. (2004), who revisit the institutions-cum-growth literature, find that most indicators of institutional quality used to establish the proposition that institutions cause growth are constructed to be conceptually unsuitable for that purpose. Moreover, Glaeser et al. show that some of the instrumental variable techniques used in the literature are flawed.
- 19.
See, for instance, Gallup et al. (1999), Henderson et al. (2000), and Sachs (2003).
- 20.
Basu even maintains that “causality lies in the eyes of the beholder” (2005, p, 36), with which he means that economists are often so used to thinking in terms of causality that they see causal relation even if they do not exist. For a detailed discussion on the implications of reverse causality problems for the policy-relevance of development theories see Sect. 9.2.1.
- 21.
- 22.
Note that even if all relevant factors could be expressed in quantifiable data, the attempt to endogenise all of them in empirical analyses would lead to impossible infinite regressions. Retreat to partial analyses does hardly solve this problem as those variables of the institutional environment that are held constant are still likely to be determinants of the dependent variable, and may, at the same time, be correlated with the model’s endogenous variables.
- 23.
For instance, the World Bank devoted its 1997 World Development Report to the theme “The State in a Changing World” (World Bank 1997).
- 24.
The most comprehensive attempt at measuring governance more narrowly defined is the World Bank’s Worldwide Governance Indicators project. It gathers data on more than 60 indicators that are based on several hundred individual variables measuring perceptions of governance covering 212 countries and territories. The dimensions of governance measured by aggregate governance indicators include voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law, and control of corruption.
- 25.
According to Bandura (2008), the performance of national governments is continuously being assessed and ranked against more than 175 composite indices, many of which measure attributes of governance like, for instance, the United Nations Economic Commission for Africa’s African Governance Indicators, the Bertelsmann Transformation Index, the Corruption Perceptions Index by Transparency International, the World Bank’s Country Policy and Institutional Assessment and the International Development Association’s Country Performance Ratings, the Fraser Institute’s Economic Freedom of the Word Index, the Index of Economic Freedom by the Heritage Foundation and the Wall Street Journal, the Millennium Challenge Account country rankings by the U.S. Government Millennium Challenge Corporation, PriceWaterhouseCoopers’ Opacity Index, or Deutsche Bank’s Stability Index.
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Altmann, M.P. (2011). The Third Generation: Institutional Turn and the “New Development Economics”. In: Contextual Development Economics. The European Heritage in Economics and the Social Sciences, vol 8. Springer, New York, NY. https://doi.org/10.1007/978-1-4419-7231-6_8
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