Joanna Tyrowicz Institutions and growth Institutional Economics.

Joanna Tyrowicz

Institutions and growth

Institutional Economics

2

Two basic building block of a growth strategy: An investment strategy An institution-building strategy=> THIS IS NOT NEW STUFF, WE KNEW IT ALL THE WAY

But examples of successful investment strategies: Import substituting industrialisation (Brazil, Mexico,

Turkey) Outward orientation (South Korea, Taiwan) Two track reforms (China, Mauritius)…

How to get to the long run?

3

solutionproblem

Low agricultural productivity

Price liberalization

Private incentives Land privatization

Fiscal revenues Tax reform

Urban wages Corporatization

Monopoly Trade liberalization

Unemployment Safety nets

Enterprise restructuring

Financial sector reform

And so on...

The logic of Washington Consensus

4

Disappointments of the Washington Consensus

Latin America: Only 3 countries have grown faster during the 1990s than in the 1950-80 period (and one of those 3 was Argentina!)

Countries in transition: Real output below 1990 levels in all but four former socialist economies; poverty rates higher

Sub-Saharan Africa: Results remain very disappointing, and far worse than those obtained prior to the late 1970s

Widening income gaps:

Frequent and painful financial crises: East Asia, Brazil, Russia, Argentina, Turkey.

5

“Augmented” Washington Consensus the previous 10 items, plus:

1. Fiscal discipline2. Reorientation of public expenditures3. Tax reform4. Financial liberalization5. Unified and competitive exchange rates6. Trade liberalization7. Openness to DFI8. Privatization9. Deregulation10.Secure Property Rights 

11. Corporate governance 12. Anti-corruption13. Flexible labor markets14. WTO agreements15. Financial codes and standards16. “Prudent” capital-account opening 17. Non-intermediate exchange rate regimes18. Independent central banks/inflation targeting19. Social safety nets20. Targeted poverty reduction 

Original Washington Consensus

Washington Consensus revival

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 Latin America & Caribbean 2.78% 0.97% 2.07%

East Asia & Pacific 1.07% 0.86% 1.66%Middle East & North Africa 1.21% 0.69% 0.28%

South Asia 0.09% 0.79% 0.85%

       Source: Calculated from World Development Indicators 2002

1971-1980

1981-1990

1991-2000

Deception of Washington Consensus

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Deception of Washington Consensus

8

INSTITUTIONAL ARRANGEMENTS

What type of property rights? Private, public, cooperative?

What type of legal regime? Common law? Civil law? Adopt or innovate?

What is the right balance between decentralized market competition and public intervention?

Which types of financial institutions/corporate governance are most appropriate for mobilizing domestic savings?

Is there a public role to stimulate technology absorption and generation? (e.g. IPR “protection”)

UNIVERSAL PRINCIPLES

Property rights: Ensure potential and current investors can retain the returns to their investments

Incentives: Align producer incentives with social costs and benefits.

Rule of law: Provide a transparent, stable and predictable set of rules.

OBJECTIVE

Productive efficiency (static and dynamic)

Many possible institutional forms…

9

INSTITUTIONAL ARRANGEMENTS

How independent should the central bank be?

What is the appropriate exchange-rate regime? (dollarization, currency board, adjustable peg, controlled float, pure float)

Should fiscal policy be rule-bound, and if so what are the appropriate rules?

Size of the public economy.

What is the appropriate regulatory apparatus for the financial system?

What is the appropriate regulatory treatment of capital account transactions?

UNIVERSAL PRINCIPLES

Sound money: Do not generate liquidity beyond the increase in nominal money demand at reasonable inflation.

Fiscal sustainability: Ensure public debt remains “reasonable” and stable in relation to national aggregates.

Prudential regulation: Prevent financial system from taking excessive risk.

OBJECTIVE

Macroeconomic and Financial Stability

Many possible forms … cont’d

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INSTITUTIONAL ARRANGEMENTS

How progressive should the tax system be?

Should pension systems be public or private?

What are the appropriate points of intervention: educational system? access to health? access to credit? labor markets? tax system?

What is the role of “social funds”?

Redistribution of endowments? (land reform, endowments-at-birth)

Organization of labor markets: decentralized or institutionalized?

Modes of service delivery: NGOs, participatory arrangements., etc.

UNIVERSAL PRINCIPLES:

Targeting: Redistributive programs should be targeted as closely as possible to the intended beneficiaries.

Incentive compatibility: Redistributive programs should minimize incentive distortions.

OBJECTIVE:

Distributive justice and poverty alleviation

Many possible forms … cont’d

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Chinese shortcuts

Household responsibility system and township and village enterprises obviate the need for ownership reforms

Two-track pricing insulates public finance from the provision of supply incentives

Federalism, “Chinese-style” generates incentives for policy competition and institutional innovation

12

Questions

Are there „sole right solutions”? Which?

How can we say if an „old” solution is still a good

one?

What does the policy reform serve: more growth or

acceptance/adaptation?

What are then „deep determinants” of income

levels?

Policy implications: „one way” versus „many ways”

Balance between institutional convergence and

diversity?

13

income

institutionstrade

geographyexogenous

partlyendogenous

endogenous endowments productivity

Central question of development economics: which are the most important arrows and why?

All of development economics … on one page

14

income

institutionstrade

geography

endowments productivity

1, 2

4

31: natural resources; soil quality

2: public health

3: colonialism, wars, migrations

4: resource curse

Geographical determinists claim that…

15

income

institutionstrade

geography

endowments productivity

Integration convergence

… trade fundamentalists claim that …

16

income

institutionstrade

geography

endowments productivity

One kind versus many?

Where do they come from?

…. While the institutionalists prefer

17

log yi = µ + α INSi + β INTi + γ GEOi + ε i (1)

INSi = + INTi + ψ GEOi + v INSi (2)

INTi = + INSi + ω GEOi + v INTi (3)

Determinants of wealth

18

Some seminal work

Frankel and Romer (1999) Hall and Jones (1999) Acemoglu, Johnson, Robinson (2001) Dollar and Kraay (2002) Alcala and Ciccone (2002) Easterly and Levine (2002)

19

settler mortality between 17th and 19th century

settlements

type of early institutions

current institutions

current performance

Mortality rates of early European settlers as an instrument for institutional quality: the AJR theory

Good instrument versus good theory…

20

theoretical concept

empirical proxy instrument

geography distance from equator, mean temperature, etc.

--

integration trade/GDP ratio predicted trade share constructed from a bilateral gravity equation (Frankel and Romer, 1999)

institutional quality

survey of investor perceptions regarding protection of property rights, rule of law, etc.

mortality rates among 19th century European settlers (Acemoglu et al., 2001)

Basic implementations into empirics

21

exp

rop

ria

tion

ris

k, 1

98

5-9

5

Log settler mortality2.14593 7.98617

3.5

10

AGO

ARG

AUS

BFA

BGD

BHS

BOL

BRA

CAN

CHL

CIV

CMR

COG

COL

CRI

DOM

DZAECUEGY

ETH

GAB

GHA

GIN

GMB

GNB

GTM

GUY

HKG

HND

HTI

IDN

IND

JAM

KENLKA

MAR

MDG

MEX

MLI

MLT

MMR

MYS

NER

NGA

NIC

NZL

PAKPAN

PER

PNG

PRY

SDN

SEN

SGP

SLE

SLV

SUR

TGO

TTO

TUNTZA

UGA

URY

USA

VEN

VNM

ZAF

ZAR

Instruments and theories…

22

lcg

dp

95

Log settler mortality2.14593 7.98617

5.77144

10.2414

AGO

ARG

AUS

BDI

BENBFA

BGD

BHS

BLZ

BOL

BRA

BRB

CAF

CAN

CHL

CIVCMR

COG

COLCRI

DJI

DOMDZA

ECUEGY

ETH

FJI

GAB

GHA

GIN

GMB

GNB

GTM

GUY

HKG

HND

HTI

IDN

IND

JAM

KEN

LAO

LKAMAR

MDG

MEX

MLI

MLT

MMR

MRT

MUS

MYS

NERNGA

NIC

NZL

PAK

PAN

PER

PNG

PRY

RWA

SDNSEN

SGP

SLE

SLV

SUR

TCDTGO

TTO

TUN

TZA

UGA

URY

USA

VEN

VNM

ZAF

ZAR

Instruments and theories … cont’d

23

Extended AJR sample

Dependent variable

log GDP per

capita 1995

log GDP per

capita 1995

log GDP per

capita 1995

log GDP per

capita 1995

log GDP per

capita 1995

log GDP per

capita 1995

log GDP per

capita 1995

log GDP per

capita 1995

log GDP per

capita 1995 RULE LCOPEN

(10) (11)

Geography (DISTEQ) 0.74 0.20 0.32 0.81 0.25 0.36 0.76 0.21 0.24 0.82 -0.72(4.48) * (1.34) (1.85) ** (5.35) * (1.85) *** (2.37) ** (10.59) * (2.75) * (2.9) (5.71) * (-3.47) *

Institutions ( RULE) 0.78 0.69 0.79 0.70 0.80 0.77 0.57(7.56) * (6.07) * (8.96) * (6.86) * (12.41) * (10.71) * (4.14) *

Integration (LCOPEN) 0.16 0.15 0.08 0.34(1.48) (1.61) (1.31) (3.37) *

Geography (DISTEQ) 0.74 -0.42 -0.56 0.81 -0.44 -0.70 0.76 -0.05 -0.14 0.78 -0.86(4.48) * (-1.19) (-1.23) (5.35) * (-1.22) (-1.34) (10.59) * (-0.4) (-0.91) (5.64) * (-3.09) *

Institutions ( RULE) 1.67 1.78 1.76 2.00 1.19 1.32 0.77(4.29) * (3.78) * (4.4) * (3.55) * (7.91) * (6.77) * (2.33) **

Integration (LCOPEN) -0.18 -0.302 -0.17 0.23(-1.23) (-1.07) (-1.35) (2.04) **

No. of observations 64 64 64 80 80 80 140 140 140 80 80R-square 0.25 0.54 0.562 0.264 0.51 0.52 0.417 0.50 0.55 0.54 0.38Test for over-identifying restrictions (p-value) (0.0071) (0.0365)

Dependent variable LCOPEN RULE

Geography (DISTEQ) 0.41 0.47 -0.25 0.46 0.53 -0.19 0.65 0.64 -0.04 0.01 0.46(2.8) * (3.21) * (-1.99) *** (3.25) * (3.76) * (-1.42) (10.35) * (10.92) * (-0.75) (0.09) (3.25) *

Settler mortality (LOGEM4) -0.39 -0.40 -0.30 -0.34 -0.34 -0.27 -0.28(-3.87) * (-4.1) * (-3.49) * (-3.63) * (-3.75) * (-3.2) * (-3.63) *

Population speaking 0.19 0.18 0.17English (ENGFRAC) (2.69) * (2.69) * (2.66) *

Population speaking other 0.12 0.16 -0.11European langages (EURFRAC) (1.74) *** (2.43) ** (-1.65)

Constructed openness 0.20 0.90 0.19 0.80 0.25 0.70 0.80(LOGFRANKROM) (1.95) ** (10.28) * (2.16) ** (9.68) * (4.37) * (12.4) * (9.10) *

F-statistic n.a. 22.9 17.2 41.7 n.a. 23.3 17.8 37.2 n.a. 46.3 44 42 45.0 23.3

R-square 0.41 0.44 0.66 0.36 0.39 0.58 0.49 0.55 0.54 0.53 0.36

Table 2: Determinants of Development: Core Specifications

AJR sample Extended AJR sample

(3) (9)(7)(6)(5)(4) (8)

Large sample

(2)(1)

RULE RULE

Panel A. Ordinary least squares

Panel B. Two-stage least squares

Panel C: First Stage for Endogenous Variables (Institutions (RULE) and Integration (LCOPEN))RULELCOPEN LCOPENRULE LCOPEN RULE RULE

Bottom line results

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Figure 4: “Real Openness,” Openness, and Income(Difference between logs of “real openness” and openness on the vertical axis and log per

capita PPP GDP on the horizontal axis)

Distance from Equator

25

e( lc

gdp9

5 | X

,dis

teq

) + b

*dis

teq

(f) Distance from Equator

Residuals Linear prediction

0 64

-1.75562

2.65895

GAB

UGA

ECU

RWA

KENSTP

SGP

CMR

BDI

GNQ

MYS

SYC

COG

COL

ZAR

CAF

CIV

SURGHA

IDN

GUYBEN

TZATGO

LKA

AGO

PAN

SLE

ETH

NGA

CRIGIN

PNG

TTO

VEN

GNB

KHM

DJICOM

MLI

NIC

BFATCD

PER

THA

BRB

MWI

SLV

NERVCT

GMB

GTM

SEN

PHL

CPV

HND

BRA

SDN

ZMBYEM

MMRBOL

BLZ

ZWE

LAO

MDG

MRT

HTI

DOM

FJI

JAM

MEXMUS

VNM

NAM

HKG

BGD

CUB

OMN

BWA

SAUQAT

MOZ

ZAF

BHS

PRY

TWN

SWZ

BHR

NPL

IND

KWT

EGY

LSO

JOR

ISR

PAK

LBN

CHL

MAR

SYR

URY

ARG

CYP

JPN

MLT

IRN

AUS

DZATUN

GRC

KORUSA

PRTTUR

CHN

ESP

ALB

ITA

NZLBGR

ROM

CANCHE

HUN

MNG

AUT

FRA

LUX

BELCZE

GBR

DEU

POL

NLD

IRL

RUS

DNKSWENOR

FIN

ISL

Predicted (fitted) distance measure

26

Lo

g R

ea

l GD

P p

er

cap

ita in

19

95

(e) Log Openness

Log Real GDP per capita in 1995 Linear prediction

2.55341 5.77982

5.77144

10.4544

AGO

ALB

ARG

AUS AUT

BDI

BEL

BENBFA

BGD

BGR

BHR

BHS

BLZ

BOL

BRA

BRB

BWA

CAF

CANCHE

CHL

CHN

CIVCMRCOG

COL

COM

CPV

CRICUB

CYPCZE

DEU

DJI

DNK

DOMDZA

ECUEGY

ESP

ETH

FIN

FJI

FRA

GAB

GBR

GHA

GIN

GMB

GNB

GNQ

GRC

GTM

GUY

HKG

HND

HTI

HUN

IDN

IND

IRL

IRN

ISL

ISR

ITA

JAMJOR

JPN

KENKHM

KOR

KWT

LAO

LBN

LKA

LSO

LUX

MAR

MDG

MEX

MLI

MLT

MMR

MNG

MOZ

MRT

MUS

MWI

MYS

NAM

NERNGA

NIC

NLDNOR

NPL

NZL OMN

PAK

PAN

PER

PHLPNG

POL

PRT

PRY

QAT

ROM

RUS

RWA

SAU

SDNSEN

SGP

SLE

SLV

SUR

SWE

SWZ

SYC

SYR

TCDTGO

THA

TTO

TUNTUR

TWN

TZA

UGA

URY

USA

VEN

VNM

YEM

ZAF

ZAR

ZMB

ZWE

Opennes

27

e(

lcg

dp

95

| X

,Lo

gO

pe

nH

at )

+ b

*Lo

gO

pe

nH

at

(e) Predicted Log Openness

Residuals Linear prediction

2.919 5.37554

-2.99292

1.35991

CHN

BRA

INDRUS

MEXUSA

ARG

IDN

JPN

CHLCAN

AUS

COL

PERVEN

BOL

PAK

ETH

CUB

NGA

PHL

ZAF

ZAR

VNM

IRN

THA

ESP

MDG

PRY

BGD

ECUPNG

TURMMR

MOZ

FRA

SDN

EGY

TZA

ZWE

AGONZLMAR

TCD

POL

MNG

NER

URY

MWINPL

ITA

MLI

KEN

DZADEU

KOR

UGA

PRT

ZMB

BFA

LKA

SAU

CAF

SWECMR

YEM

CIV

ROM

TWN

MYS

DOM

FJI

CZEFINGTM

CRI

GHA

GBRLSO

HTISENNIC

NOR

KHM

NAM

PAN

TUN

HNDMRT

SLV

BWACHEGIN

HUN

GRC

BDI

AUTCOG

MUS

LAORWA

DNK

SLE

ISLBGR

GAB

SUR

NLD

OMN

JAM

HKG

SYR

CPV

GUY

KWT

ALB

TGO

GNB

BEN

BEL

IRL

COM

TTO

CYPISR

GMB

SGP

SWZBHS

LBNGNQJOR

QAT

BHR

DJI

STP

SYC

MLT

BRB

BLZVCT

LUX

Predicted (fitted) Opennes

28

Lo

g R

ea

l GD

P p

er

cap

ita in

19

95

(d) Rule of Law

Log Real GDP per capita in 1995 Linear prediction

-2.08859 1.90945

5.77144

10.4544

AGO

ALB

ARG

AUSAUT

BDI

BEL

BENBFA

BGD

BGR

BHR

BHS

BLZ

BOL

BRA

BRB

BWA

CAF

CANCHE

CHL

CHN

CIVCMRCOG

COL

COM

CPV

CRICUB

CYPCZE

DEU

DJI

DNK

DOMDZA

ECU EGY

ESP

ETH

FIN

FJI

FRA

GAB

GBR

GHA

GIN

GMB

GNB

GNQ

GRC

GTM

GUY

HKG

HND

HTI

HUN

IDN

IND

IRL

IRN

ISL

ISR

ITA

JAMJOR

JPN

KEN KHM

KOR

KWT

LAO

LBN

LKA

LSO

LUX

MAR

MDG

MEX

MLI

MLT

MMR

MNG

MOZ

MRT

MUS

MWI

MYS

NAM

NERNGA

NIC

NLDNOR

NPL

NZLOMN

PAK

PAN

PER

PHLPNG

POL

PRT

PRY

QAT

ROM

RUS

RWA

SAU

SDNSEN

SGP

SLE

SLV

SUR

SWE

SWZ

SYC

SYR

TCDTGO

THA

TTO

TUNTUR

TWN

TZA

UGA

URY

USA

VEN

VNM

YEM

ZAF

ZAR

ZMB

ZWE

Rule of Law

29

e(

lcg

dp

95

| X

,Ru

leL

aw

Ha

t ) +

b*R

ule

La

wH

at

(d) Predicted Rule of Law

Residuals Linear prediction

-1.18734 1.92975

-2.59633

2.42011

IDN

UGA

ZAR

KEN

TZAETH

NGA

CMR

CAF

MYS

AGO

PNGLKA

CIV

RWA

GHA

THA

BDI

GAB

PHLECU

COG

TCDMLINER

MWI

BFA

SDN

IND

MMRSUR

COL

PER

MDG

GIN

ZMB

KHM

SLE

BRA

BOL

VNM

YEMTGO

SGP

ZWE

BENSENGNQ

STP

BGD

CHN

VENFJIMEX

GNB

PRY

MOZ

HTIMRT

COM

ZAF

LAO

SYCSAU

JPN

NPLGMB

EGY

PAK

TWN

NIC

GTM

DJI

NAMCRIPANBWA

IRN

HKG

MAR

OMN

LSOHND

SLVCUBDZA

TUR

DOM

KOR

CPV

MUS

ARG

KWT

SWZ

RUS

ITA

CHL

TUN

QAT

GUY

BHR

SYR

GRC

ISR

MNG

ROMJORLBN

CYP

BGR

ESP

URY

POL

TTO

ALB

HUN

USA

CZEMLT

AUS

PRT

JAM

CANSWENLDDNK

BLZ

NOR

FINBRBFRABHS

VCT

CHE

NZL

BELDEUISLAUT

LUX

GBRIRL

Predicted (fitted) Rule of Law

30

Lo

g R

ea

l GD

P p

er

cap

ita in

19

95

colonized by Europeans 0 1

5.83834

10.3875

Instruments and theories … cont’d

31

(3) (4) (5)

Geography (DISTEQ) -0.70 -1.34 -0.66 -0.90 -0.58 -0.14 -0.14 0.02 -0.36 -0.96 -0.67 -0.81(-1.34) (-1.08) (-1.38) (-1.14) (-0.81) (-0.91) (-0.91) (0.17) (-2.12) ** (-1.45) (-0.98) (-1.27)

Institutions (RULE) 2.00 2.68 1.82 2.82 1.97 1.32 1.32 0.90 1.69 2.43 2.22 2.13(3.55) * (3.03) * (3.31) * (2.43) ** (1.67) *** (6.77) * (6.77) * (8.47) * (4.87) * (3.09) * (2.56) * (2.97) *

Integration (LCOPEN) -0.302 -0.44 -0.31 -0.75 -0.42 -0.17 -0.17 0.03 -0.36 -0.41 -0.23 -0.32(-1.07) (-1.68) (-1.23) (-1.30) (-0.81) (-1.35) (-1.35) (0.25) (-1.46) (-1.50) (-0.79) (-1.12)

REGIONAL DUMMIES Latin America (LAAM) 0.44 0.17 0.25

(1.25) (0.33) (1.655) ***

Sub-Saharan Africa (SAFRICA) -0.19 -0.43 -0.63(-0.51) (-1.11) (-3.79) *

East Asia (ASIAE) 0.24 0.07 0.12(0.56) (0.14) (0.62)

Legal origin [0.133]

Identity of colonizer [0.058] ***

Religion [0.019] **

R-square 0.52 0.56 0.65 0.44 0.63 0.55 0.55 0.67 0.55 0.53 0.56 0.59No. of observations 80 78 79 76 76 140 140 137 136 80 80 80

Omitted observations Singapore Ethiopia Australia Australia Cuba Australia None None NoneEthiopia Canada Canada Czech Rep. Canada

New Zealand New Zealand Germany New ZealandUSA USA USA

Table 4. Determinants of Development: Robustness to "Influential" Observations, Neoeuropes, Legal Systems, Origin of Colonizer, and Religion

None None None

Baseline 2 (2)*Baseline 1 (1)** (1)***(1)* (2)**

Two-stage least squares: Dependent variable is log GDP per capita in 1995

(2)***(1)****

Decomposition of wealth…

32

Deep economic integration

Democratic politics

Nation state

Golden Straitjacket

Pick two, any two: cannot have deep integration, nation state and democracy simultaneously

Global Federalism

Bretton Woods compromise

Political trillemma of the modern world

33

1. Transitions to high economic growth are typically sparked by a relatively narrow range of policy changes and institutional reforms

South Korea and Taiwan since early 1960s, Mauritius since early 1970s

Brazil, Mexico, Turkey others before 1980, China since 1978

India since the early 1980s, Chile since mid-1980s

ACTUALLY: REFORM IS SUBSEQUENT TO GROWTH EPISODES IMPULSE

2. The policy changes that initiate these growth transitions typically combine elements of orthodoxy with unconventional institutional innovationsOutward orientation combined with industrial policies in East Asia;

Partial liberalization combined with household responsibility system

EPZ in Mauritius

Capital controls in Chile

Testing in practice

34

EPZs work in Mauritius, but not in most other countries (Kenya, Wietnam, Brazil)

Gradualism works well in India but not in Ukraine

HRS works in China, but not in Russia

ISI works in Brazil but not Argentina

MAYBE THERE IS SOMETHING SPECIFIC ABOUT „APPROPRIATE” POLICIES?

NOT: economic principles work differently in different placesMost first-order economic principles come institution-free (incentives,

competition, hard-budget constraints, sound money, fiscal sustainability, property rights, etc.)

But these principles do not map directly into institutional solutions.

But innovations do not travel too well

35

Let’s do a small formal model Why countries do converge on “consensus” policies even

when their circumstances call for different arrangements.

Some countries choose to “experiment” rather than imitate, why?  

Plausible pattern of economic performance when a tendency for countries to converge on policies.

Key dilemma faced by policy makers: the choice of imitating the leader country (and ignoring their

private signal) following their signal (and being perceived as a "corrupt"

government, being denied IFI assistance, etc.)

36

1. countries differ in their underlying characteristics (“state”);

2. these characteristics are unknown to the public;

3. policy makers receive a signal about the underlying state,

but have no way of costlessly communicating it to their

electorate;

4. when another country (the "leader") stumbles on a policy

that works, both the policy and the outcome is observable

to all;

5. policy makers in the "follower" country bear a (private) cost

if they pursue a policy that differs from one that worked in

the "leader" country.

A toy model

37

yi-output ai-policy zi-country type, yi = -(ai - zi)2

Country A goes first, chooses policy aA with outcome yA. Country B, the follower. Assume yB is initially low compared to yA. aA and yA are both observed by the public in B.

Government in B observes the country's ideal type, zB. Determine B's ideal policy, up to a random error term: a'B = zB + , with - N (0, ).  Government has to choose aB, either aA or a'B. If aB does not equal aA, the government pays a fixed cost K (this is a private cost to policy makers, and not a social cost). Distinguish between output, yB, and government's utility function uB, with uB = yB - K.

yB = -(aA - zB)2 if aB = aA

uB = yB - K = -(a'B - zB)2 - K if aB = a'B

E(uB) = -(aA - zB)2 if aB = aA = -2 - K if aB = a'B

 Mimic the leader as long as zB is in the interval: [aA - (2 + K/)1/2, aA + (2 +

K/)1/2].  Therefore E(y) equals -( aA - zB)2 if aB = aA, and -2 otherwise.

Toy model solution

38

zh* zeff zc* z1=1=a1

z1=1=a1

ANeighbors

C B Periphery`Far' 'Near'

ExpectedNationalIncome

Follower government’s type

0

Income of `Leader’

Toy model solution

39

1. Growth pole, around the successful leading country, A

2. Countries in the "near periphery" are strictly worse off (compared to a situation where country A did not exist). Close enough that forced to mimic, but too far to benefit.

3. Countries in the "far periphery" are intermediate in terms of average performance, but also exhibit much greater variance in performance.

4. Similar growth poles are likely to develop sometime down the line in the far periphery--but not in the center or the near periphery.

Toy model conclusions

40

41

Growth and distance from Brussels

42distance from Brussels (miles)

growth since onset of reform Fitted values

448 4225

-.10982

.03399

CZE

SVN

SVK

HRV

HUN

POL

LVALTU

ALB

EST

BLR

MKD

BGR

ROM

MDA

UKR

RUS

GEO

ARM

AZE

TKM

UZB

TJK

KGZ

KAZ

MNG

Growth and distance from Brussels

43

Growth and distance from Brussels

44

„Reform” and distance from Brussels

45

Voice and accountability and distance from Brussels

46

Control of corruption and distance from Brussels

47

1. Markets require non-market institutions to work well

2. The institutional basis of market economies is not unique

3. Institutional diversity creates transaction costs and hampers full economic integration

4. Neither feasible nor desirable to eliminate these costs, cannot target total integration„Thin” versus „thick” models of globalization

5. Within the range of “thin” considerable choice of models.Each one of these privileges different groups….

Early conclusions

48

a. Markets are not self-creatingi. Property rightsii. Contract enforcement

b. Markets are not self-regulatingi. Regulatory authoritiesii. Correction of market and coordination failures

c. Markets are not self-stabilizingi. Monetary, fiscal and currency arrangements

d. Markets are not self-legitimatingi. Political democracyii. Social insuranceiii. Redistribution

Markets require non-market institutions to work well

49

a. Economic principles versus their institutional embodiment

b. Institutional diversity grounded in:

1. Differences in social preferences (over equity versus opportunity, for example)

2. Hysteresis and path dependence due to institutional clusters and complementarities (US versus Japan versus various European models)

3. Context specificity of desirable institutional arrangements to promote economic development (China, India, Latin American examples)

The institutional basis for market economies is not unique

50

a. Despite disappearance of border barriers, border effects remain strong

1. Missing trade

2. Small net capital flows

b. Institutional diversity is an important source of market segmentation

c. Trade: the role of regulatory & jurisdictional discontinuities, and problems of standards and contract enforcement.

d. Capital flows: the problem of “sovereign” risk

e. “Deep integration” agenda as a response - but is it wise?

Institutional diversity as a source of transaction costs blocking deep

integration

51

Key Standards According to the Financial Stability Forum

Subject Area Key Standard IssuingBody

Macroeconomic Policyand Data TransparencyMonetary and financialpolicy transparency

Code of Good Practices on Transparency in Monetary andFinancial Policies

IMF

Fiscal policy transparency Code of Good Practices in Fiscal Transparency IMFData dissemination Special Data Dissemination Standard/

General Data Dissemination SystemIMF

Institutional and MarketInfrastructureInsolvency World BankCorporate governance Principles of Corporate Governance OECDAccounting International Accounting Standards (IAS)3 IASCAuditing International Standards on Auditing (ISA) IFACPayment and settlement Core Principles for Systemically Important Payment

SystemsCPSS

Market integrity The Forty Recommendations of the Financial Action TaskForce

FATF

Financial Regulation andSupervisionBanking supervision Core Principles for Effective Banking Supervision BCBSSecurities regulation Objectives and Principles of Securities Regulation IOSCOInsurance supervision Insurance Supervisory Principles IAIS

Source: FSF

There is just about 64 standards….

52

foreign reserves

(mil $, 2000:I)

reserves in

months of

imports

"excess" reserves

(% of GDP)

annual social cost of excess reserves

(% of GDP)*

South Korea 83,581 7.0 0.12 0.70Peru 9,041 12.2 0.12 0.72

* Assuming a 6% spread between the yield on foreign reserves and themarginal cost of public borrowing.

… and even if you comply…

53

Institution-building via integration: has opportunity costs,

when human resources, administrative capabilities, and political capital are limited;

does not necessarily yield appropriate institutions nor necessarily an appropriate sequencing thereof;

presumes imported blueprints can be made effective

… some costs…

54

Education: bank auditors or teachers?

Corruption: “grand” or “petty’?

Legal reform: import or evolve?

Public health: cheap medicines or TRIPs?

Industrial strategy: South Korea of 60s/70s or Argentina of the 90s?

Labor relations: encourage centralized bargaining or de-

institutionalize labor markets?

Social protection: use fiscal resources for social programs or for

building war chests against financial crises?

Exchange rate regimes: avoid corners or manage the ER for growth?

Some illustrative trade-offs