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

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

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

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

The New Comparative Economics The study of the different ways countries design institutions to resolve the conflict between the twin goals of controlling 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?

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

Overview of the Framework Section 2 Overview of the Framework

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

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

Slope and distance from origin determined by “Civic Capital”: Determinants of the IPF Institutional Possibility Frontier (IPF): Slope and distance from origin determined by “Civic Capital”: 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

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

Illustrations of Institutional Design 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

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

(Glaeser and Shleifer 2002) Legal Origins (Glaeser and Shleifer 2002)

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

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

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

Institutions in Transition

Transplantation of Institutions Section 4 Transplantation of Institutions

World Imperialism c.1900

Legal Origins World Imperialism c.1900

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!

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

Legal Systems and the IPF

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

Section 5 Politics

Politics and the IPF Institutional Possibility Frontier (IPF):

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

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

Section 6 Conclusions

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

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

Thank you.