Thursday, July 5, 2012
Power sharing and institutional stability
July 5, 2012
Institutions are a key determinant of economic development and indeed many developing institutions are deeply dysfunctional. This column presents a new model suggesting that those in power may prefer to keep bad institutions despite their anti-development effects since they alllow the elite to grab a bigger slice of a smaller pie.
Economic activity is influenced by institutions that determine the rules prevailing in a society. Examples include how much income is taxed; what firms can and cannot do; whether contracts are enforced and disputes quickly and correctly resolved; and limits on the arbitrary exercise of government power.
Institutions are considered by many researchers as one of the main determinants of economic development, causing large differences in the cross-country distribution of income (see, e.g., North 1990, and Acemoglu et al. 2005). Besides there being a strong correlation in cross-country data (Hall and Jones 1999), institutions appear to be important in explaining some key historical events, including differences in the pattern of development in North and South America (Engerman and Sokoloff 1997) and the economic success of England from the 18th century onwards (North and Weingast 1989).
Rules that give rise to economic inefficiencies are often attributed to institutions serving the interests of an elite rather than the interests of society as a whole. This explanation is not wholly satisfactory however, because why would an elite have incentives to set up institutions that shrink the total pie? Why can the elite not design policies that maximise output which then allow them to extract more in taxes?
Answering this question requires understanding the institutional choices of an elite in power. One important constraint on their choices is what they must do to remain in power: excessively predatory institutions might prompt rebellions. Hence, in order to analyse the economic consequences of control of institutions by an elite, it is necessary to think about how rulers come to power and what they do to remain there.
Posted by Yulie Foka at 12:48 PM