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Appropriate Institutions

Author: S Djankov, R La Porta, F Lopez de Silanes and A Shleifer
Date: 2002
Size: 26 pages (55 KB)

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Summary

The transition from socialism, the Asian financial crisis and European economic and political integration have challenged our understanding of how capitalism works. The inevitable lesson from these events is that institutions vary significantly among capitalist economies, and that these variations influence the most important economic changes. This raises the question of what institutions are appropriate for what countries. If the observed institutions are not appropriate, what forces have shaped them? Finally, can institutions be reformed?

This conference paper by a group of scholars from the World Bank, Harvard University and Yale University discusses the historical evolution and the current conditions shaping institutions. The first section of the paper deals with the three major economic changes of the final decades of the 20th century. The second section deals with the institutions that secure property rights against private expropriation, or what the authors refer to as “law and order”. Broadly speaking, “law and order” delineate the scope of government: What services the government should provide, how and what it should tax, what it should own, what and how it should regulate, how it should deal with social harms and externalities, which contracts it should enforce and how. The third section focuses on the institutions that secure property rights against expropriation by the state, also known as “rule of law”. “Rule of law” shapes trust in government: How politicians are chosen, what mechanisms exist to keep them in check, how policies are selected, how powers are allocated among different branches and levels of government, how judges and regulators are controlled. The final section considers policy reform. The authors conclude that there is nothing inevitable about the institutions that already exist. Although some are efficient and appropriate, many are not. In the years ahead, institutional reform may become one of the principal strategies for improving human welfare.

The key source of inefficiency is the fact that many institutions are designed to serve the interests of the incumbent rulers and the political interests that support them as well as the crucial role of colonial transplantation. Other conclusions from the study are that:

• Understanding the historical evolution and the current conditions shaping institutions is central to explaining the differences in economic performance, as well as to the design of economic and political reforms
• Although colonial heritage has been historically important, it should not hinder change
• Nearly all the available evidence identifies the inefficiencies of excessive government intervention in the economy of developing countries
• The incumbent governments and the political groups they favour are the beneficiaries of existing institutional arrangements and are responsible for the persistence of inefficient institutions.

Identifying the appropriate institutions, and designing politically feasible reform strategies for introducing them is both the challenge and the hope of the new comparative economics. The policy implications from the paper make it clear that:

• Colonial legacy should not stop reform
• Government intervention into the economy should be limited
• The reformers should identify the forces opposing change and either destroy or co-opt them.

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Source: Djankov, S., La Porta, R., Lopez-de-Silanes, F. and Shleifer, A. 2002, 'Appropriate Institutions', paper presented at the World Bank conference on Appropriate Institutions for Growth, Washington, D.C., September 13
Author: Rafael La Porta , rafael_laporta@harvard.edu