1Karla Hoff ABCDE Conference, 4-18-00, Revised 9-16-00 Beyond Rosenstein-Rodan: The Modern Theory of Coordination Problems in DevelopmentKarla HoffABCDE Conference, , Revised
2A coordination failure can occur if: Agents' behavior creates externalitiesthatraise the relative return to each agent of those behaviorsby an amount large enough thatthere are multiple equilibria, and some are better for everyone
3Early 1970s: Externalities are a “fable,” say Coase’s followers Cheung (1973) Contracts between beekeepers and orchard owners resolve the market failure of "unpaid" servicesCoase (1974) British history suggests that market arrangements (once property rights are defined) can efficiently provide for lighthouses.
4Old and modern views of externalities and public goods Old view:“Atomistic”New view:“Ecological"Systematic, diffuse externalitiesSearch costsCorruptionSpillovers in technologySocial and political interactionsRole model effectsExternalitiesBeekeeperPrice vector (if there are multipleequilibrium price vectors)Group reputationKnowledgePublic goodsLighthouse
5Are coordination failures important? In theory?In empirical investigations?For policy?
6Example 1. Training and innovation A central difference between advanced andless developed economies is the extent oftraining and innovation.Can we explain a low level oftraining and innovationas a coordination failure?
7Training and innovation Worker’s decision treeDo not trainTrainInnovateDo not innovateFirm’s decision treeSuppose that there is perfect contracting between a firm and its employee.How can a “coordination failure” then occur?
8Joint decisions are made by a single worker and his employer Train and innovateDo neitherStay togetherSeparate- C + B-C + [B • probability of a good match]Period 1Period 2Decisions over investment in innovation and trainingoutput is producedSeparation with probability sSource: Acemoglu Note: The pink node is a chance node, reflecting exogenous risk of separation.
9Example 2. Rent-seekingDC’s and LDCs differ in the extent to which economic activity is directed at rent-seeking, rather than output enhancement.Can we explain a high proportion of rent-seekers in the population as a coordination failure?
10Agent’s decision tree Cash crop producer Subsistence producer Rent seeker10if there are no rent-seekers58if producers do notretreat to subsistence
11Multiple equilibria may exist $10High-income equilibrium8payoff to rent-seekerLow-income equilibriumpayoff to cash-crop producer5ratio of rent-seekers to cash crop producersSource: Murphy-Shleifer-Vishny 1993Acemoglu 1994
12Example 3. Social organization Some neighborhoods are characterized by low civic participation and crime, and also low maintenance of property.Can we explain that as a coordination failure?
13Household’s decision tree in residential community Buy home equity and expend effort in home and community improvementDo not buyhome equity anddo not expend effortPayoff to homeownership - cost of borrowing- cost of effortPayoff to renting3 assumptions: (1) Price appreciation depends on fraction (x) of households who are homeowners;(2) There are capital market imperfections; and (3) “Home improvement effort” can’t be contracted for.These assumptions imply that a homeowner’s payoff increases with income and with x.
14Multiple equilibria may exist Income, yincome of the richest xth percentile of householdsBlightedneighborhoodNeighborhood with high civic activismcritical value of y at which homeownership becomes the preferred strategy1x, fraction of homeownersSource: Hoff and Sen 1999
15Unresolved QuestionHow important are local interaction effects in explaining divergent fortunes of countries and communities?
16Ex. 4. Transition Economies and the Emergence of the Rule of Law There is a debate about two alternative strategies in the transition process:regulation followed by privatizationversusprivatization without prior regulation
17Two Views“Privatization offers an enormous political benefit for the creation of institutions supporting private property because it creates the very private owners who then begin lobbying the government...for institutions that support property rights.” Murphy-Shleifer-Vishny 1998“[The owner typically] doesn’t pay wages to the employees, doesn’t pay taxes, is not interested in the enterprise’s development, establishes subsidiaries in order to ‘pump out’ the assets while leaving only the legal shell of the company, etc.” Radygin 1999
18Decision tree of agent with controlling interest in a firm, after privatization Tunnel value outMaximize firm valuetState captureRule of lawVSVLIf VL > t > VS , the “efficient owner” is acreature of his environmentNote: The pink node is a chance node.
19A “partial reform” trap is possible Tunneling value for the richest xth percentile of ownersRule of lawState captureCritical value of t at which tunneling becomes the preferred strategyt*1fraction of owners who tunnelShift up to pink curve depicts the effect of an increase in the entrepreneurial ability of those with control rights, or greater confidence in the emergence of the rule of lawSource: Hoff 2000
20Summary of the ecological/social interactions perspective depend on,shape & ultimatelymay make traps ofAgents’ decisionsTrain/innovate or notRent-seek or produceOwn or rentTunnel or invest productivelythe environmentsearch costsreturns to productionlocal civic participationstate capture or rule of law
21Role for Policy Experiments "The task of ... finding out which combination of activities should be coordinated is not unlike the problem of hundreds of people, scattered in a dense, foggy forest, trying to locate one another. ..even the market mechanism cannot solve it ...” Matsuyama 1995There may be great scope for improvement through experimentation.