Lecture 5
Institutions and growth
Issues discussed today
• What do Institutions do?
• Are persistent ,long-lived institutions
necessarily efficient?
• How do institutions emerge?
• Which are the necessary instutions for
economic progress.
The function of institutions
• Good institutions tend to stimulate growth
because they improve the allocation of
resources,for example
• markets stimulate division of labour
• money stimulates exchange
• banks solve information assymetries
between savers and investors
• private property rights are a barrier to
overexploitation of resources
The peculiarity of institutional
explanations
• Explanations of the emergence and
persistence of institutions often stress the
beneficial effect of an institution.
• Standard causal explanations have a timelag between cause and effect.
• Consequence explanations reverse that
order: the effect is the cause
• A selection mechanism is needed:
competitive selection or design.
The essential institutions in a
modern economy
• Markets for labour,commodities and
capital.
• Contract enforcement institutions.
• Law and order.
• Accountable government.
• Trust, commitment and social capital.
Market performance has improved
over time
• Thin vs. thick markets.
• The institutionalization of markets and
fairs: Champagne in the medieval era.
• Information speed is the key to market
efficiency.
• Transparency and collusion.
The law of one price comes with a
time lag
Price
110
108
Pisa - Ruremonde
17th century
106
Chicago-Liverpool
1850’s
Chicago-Liverpool
1880’s
104
102
100
-1
0
6
12
18
24
Months
The persistence of inefficient
institutions: slaverey and serfdom
• Institutions do have distributional consequences
and can survive when they serve powerful
vested interests.
• Serfdom emerged because landholders could
not get a rent from peasants leasing their land
when there was free fertile land at the frontier.
• Serfdom was disappearing when population
pressure drove down opportunity income of the
landless.
Was open field agriculture
efficient?
• Peasant households had their land scattered in
narrow strips in different parts of the village:
insurance against local harvest shocks?
• In agriculture where shocks can bring you down
to subsistence ; maximum efforts of all were
essential: open field lay-out helped peer
monitoring.
• Conclusion: sceptics have the right to remain
sceptic.
Firms vs.farms
• Why are firms not labour-managed as most
farms.Farms are run by those who work the
land, while firms are run by those who own the
capital?
• Economies of scale.
• Monitoring cost.
• Risk aversion and low risk diversification.
• Time horizon and firm objectives.
• Path dependence and competitive selection
Share-cropping: persistent but inefficient
Co-operatives vs. capitalist firms
• Vertical integration is a solution when firms face
suppliers with hold-up power or suppliers who
do not honour contracts.
• Suppliers are residual claimants in co-operatives
and have an interest in peer montoring.
• Being residual claimants suppliers to cooperatives are willing to enter long-term
contracts.
• Selection mechanism: competitive markets.
Why do ethnic groups often form
commercial networks?
• Lombard Street and Rue Juif.
• Information asymmetries generate
principal agent problems.
• Ethnic groups share common beliefs and a
code of conduct and can sanction
members by exclusion: reputation matters.
• Information about misconduct of an agent
is swiftly transmitted within the group.
•
Conclusion
• Persistence of an institution is not
necessarily a sign of efficiency.
• Institutions often emerge to solve
problems linked to
• risk (the limited liability corporation),
• information asymmetries (banks)
• incomplete contracts (trust and
commitment),
• exchange (money and markets).