NIE and Development Theory.docx
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NIEandDevelopmentTheory
TheNewInstitutionalEconomicsandDevelopmentTheory:
ABriefCriticalAssessment
PRANABBARDHAN
UniversityofCalifornia,Berkeley
Summary.–Inthispaperwediscussstrengthsandweaknessesoftransaction-costandimperfect-informationapproachestotheeconomictheoryofinstitutions,particularlywithreferencestoproblemsrelevanttoeconomicdevelopment.
1.ALTERNATIVETHEORLES
Inrecentyearstwostrandsofnon–Walrasianeconomicliteraturehavedevelopedwell-articulatedendogenoustheoriesofinstitutions,andtheyarebothgettingtobeprominentinthenewmicroeconomicsofdevelopmentOneisthetransactioncostschoolflowingoutofthefamouspaperbyCoase(1960),followedbythewritingsofAlchian,Demsetz,Williamson,Northandothers;theotherschoolisassociatedwiththetheoryofimperfectinformationasintheworkofAkerlof,Stiglitz,Spenceandothers.Althoughthereissomefamilyresemblancebetweenthetwostrands,thereareimportantdifferencesintheirpointsofemphasis.Buttheybothdenythevalidityofsomeoftheprincipal–resultsofmainstreameconomics.Forexample,oneofthemainpillarsofWalrasianneoclassicaleconomicstheseparabilityofequityandefficiency---breaksdownwhentransactioncostsandefficiency;thetermsandconditionsofcontractsinvarioustransactions,whichdirectlyaffecttheefficiencyofresourceallocation,nowcruciallydependonownershipstructuresandpropertyrelations.Developmenteconomics,whichdealswithcaseswheremarketfailureandincompletemarkets(oftentheresultofthesubstantivepresenceoftransactioncostsandinformationproblems)arepredominant,clearlyprovideshospitableterritoryforsuchinstitutionalanalysis.
Accordingtothetransactioncostsschool,institutionsthatevolvetolowerthesecostsarethekeytotheperformanceofeconomies.Thesecostsincludethoseofinformation,negotiation,negotiation,monitoring,coordinationandenforcementofcontracts.Whentransactioncostsareabsent,theinitialassignmentofpropertyrightsdoesnotmatterfromthepointofviewofefficiency,becauserightscanbevoluntarilyadjustedandexchangedtopromoteincreasedproduction.Butwhentransactioncostsaresubstantial,asisusuallythecase,theallocationofpropertyrightsiscritical.Inthehistoricalgrowthprocessthereisatradeoffbetweeneconomiesofscaleandspecializationontheonehandandtransactioncostsontheother.Inasmall,closed,face-to-facepeasantcommunity,forexample,transactioncostsarelow,buttheproductioncostsarehigh,becausespecializationanddivisionoflaborareseverelylimitedbytheextentofmarketdefinedbythepersonalizedexchangeprocessofthesmallcommunity.Inalarge-scalecomplexeconomy,asthenetworkofinterdependencewidenstheimpersonalexchangeprocessgivesconsiderablescopeforallkindsofopportunisticbehavior(cheating,shirking,moralhazard)andthecostsoftransactingcanbehigh.InWesternsocietiesovertime,complexinstitutionalstructureshavebeendevised(elaboratelydefinedandeffectivelyenforcedpropertyrights,formalcontractsandguarantees,corporatehierarchy,verticalintegration,limitedliability,bankruptcylawsandsoon)toconstraintheparticipants,toreducetheuncertaintyofsocialinteraction,ingeneraltopreventthetransactionsfrombeingtoocostlyandthustoallowtheproductivitygainsoflargerscaleandimprovedtechnologytoberealized.NorthandThomas(1973)haveexplainedeconomicgrowthofWesternEuropebetweenthe10thandthe18thcenturiesprimarilyintermsofinnovationsintheinstitutionalrulesthatgovernedpropertyrights.Inthisview,asinMarxisthistory,propertyrelationswhichweresociallyusefulatonetimebecome“fetters”onthefurtherdevelopmentoftheforcesofproduction,andanappropriateredefinitionofpropertyrightsbecomesnecessary.Newpropertyrightsemergethatallowanincreaseingainsfromtradebyeconomizingontransactioncosts(includinggainsfromnewproductionorearlierhightransactioncostsandtheconsequent“marketfailure”).Northandmanyotherneoclassicalinstitutionaleconomistsbelievethatthebasicsourceofinstitutionalchangeisfundamentalandpersistentchangesinrelativeprices,whichleadoneofbothpartiesinatransactiontoperceivethattheycouldbebetteroffunderalternativecontractualandinstitutionalarrangements.Historically,populationchangeisjudgedtohavebeenthesinglemostimportantsourceofrelativepricechanges,thoughtechnologicalchange(includingthatinmilitarytechnology)andchangesinthecostsofinformationarealsodeemedasmajorsources.
Theimperfect-informationtheoryofinstitutionsiscloselyrelatedtothatoftransactioncosts,sinceinformationcostsconstituteanimportantpartoftransactioncosts.Buttheformertheoryisusuallycastinamorerigorousframeworkclearlyspellingoutassumptionsandequilibriumsolutionconcepts,drawingoutmorefullytheimplicationsofstrategicbehaviorunderasymmetricinformationandsharplydifferentiatingtheimpactofdifferenttypesofinformationproblems.Imperfect-informationtheoryyieldssomewhatmoreconcreteandspecificpredictionsaboutthedesignofcontracts,withmoreattentiontothedetailsoftermsandconditionsofvaryingcontractualarrangementsundervaryingcircumstances,thantheusualpresentationsoftransactioncosttheory.ExceptionsinthelatterareprovidedbyWilliamson’stheoryoftransaction-specificassetsandhistheoryofincompletecontractsasfurtherdevelopedbyHartandHolmstrom(1987).Thelatterfocusonadaptivesequentialdecision-makingratherthanthecomprehensivecontingentclaimscontractsoftheimperfect-informationliterature.Theimperfect-informationtheoristsgivemoreemphasistoexantemechanismdesignincontractsandlesstomaladaptationcostsincurredwhentransactionsdriftoutofalignmentexpostinaworldofboundedrationalitywherecontractsarenecessarilyincomplete(i.e.cannotpossiblytakeintoaccountallcontingencies).Inparticular,oncerelation-specificinvestments(i.e.wheretheinvestmentsthepartiesmakehaveamuchgreateruseinsidetherelationshipthanoutside)aremade,thereisscopeforpost-contractualopportunisticbehavior.Institutionaldevicestoreducethisconsistusuallyoflong-timecontractualrelationsorintegrationoffirms(convertinganarm-lengthtransactionintoaninternaloneanddefiningpropertyrightsasthedefaultoptioninincompletecontracts).Long–termimplicitcontractsandpersonalized,less-than-arms-lengthtransactionsare,ofcourse,quitecommonindevelopingcountries,althoughWilliamson’simmediateconcerniswiththecorporatestructureandpracticesinindustriallyadvancedcountries.
Theimperfect-informationtheoryhasbeenfruitfullyusedinmodelingmanykeyagrarianinstitutions,whichareseentoemergeassubstitutesformissingcredit,insurance,andfuturesmarketsinanenvironmentofpervasiverisks,informationasymmetry,andmoralhazard.Itstartedwiththeliteratureonsharecropping,thenoninterlockingoftransactionsinlabor,creditandlandlease,onlabortying,oncreditrationingandsoon.Radicaleconomistshaveoftencitedsomeoftheseproductionrelationsasinstitutionalobstaclestodevelopmentinapooragrarianeconomy,overlookingthemicroeconomicrationaleoftheformationoftheseinstitutions.Underasetofinformationalconstraintsandmissingmarkets,agivenagrarianinstitution(say,sharecroppingofinterlockingofcontracts)maybeservingarealeconomicfunctionItssimpleabolition,asisoftendemandedonaradicalplatform,withouttakingcareofthefactorsthatgaverisetotheinstitutioninthefirstplace,maynotnecessarilyimprovetheconditionsoftheintendedbeneficiariesoftheabolitionprogram.Theremaybesomeimportantpoliticallessonsherefromwhatcanbecalledtheeconomicsofsecond-bestreformism.
2.FUNCTIONALISMANDOTHERLIMITATIONS
Thetransaction-costandimperfect-informationtheoriesareequallymurkyonthemechanismthroughwhichnewinstitutionsandpropertyrightsemerge.Onegetstheimpressionthatmoreefficientinstitutionsandgovernancestructuresevolveasthepartiesinvolvedcometoappreciatethenewbenefit-costpossibilities.TheliteratureismarkedbyacertainahistoricalfunctionalismandevenvulgarDarwinismonthispointAninstitution’smerefunctionofservingtheinterestsofpotentialbeneficiariesisclearlyinadequateinexplainingit,justasitisanincompetentdetectivewhotriestoexplainamurdermysteryonlybylookingforthebeneficiaryand,onthatbasisalone,proceedstoarresttheheirofthemurderedrichmanOnecannotgetawayfromtheenormityofthecollectiveactionproblemthatlimitstheabilityofpotentialgainerstogettheiracttogetherinbringingaboutinstitutionalchanges.Therearetwokindsofcollectiveactionproblemsinvolvedhere;oneisthewellknownfree-riderproblemaboutsharingthecostsofbringingaboutchangetheotherisabargainingproblemwheredisputesaboutsharingthepotentialbenefitsfromthechangemayleadtoabreakdownofthenecessarycoordination
Wehavenotedbeforetheneoclassicalinstitutionaleconomists'strongbeliefthatrelativepricechangesfuelthemainmotiveforceforinstitutionalchangesinhistory(primarilybyinducingthedevelopmentofpropertyrightstothebenefitoftheownersofthemoreexpensivefactorofproduction).Inparticular,demographicchangesalteringtherelativepriceoflabortolandleadtotheincentiveforredefinitionofpropertyrightsonlandandarearrangementoflaborrelations:
North(l981)andHayamiandRuttan(1985)givesev