Institutions and Economic Development: Lecture Notes, Study notes of Development Economics

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Lecture 3: Institutions

Readings:

nTodaro: section 2.

nRoland: chapters 7 and 4

Introduction

n Growth models: much remains unexplained

n What gives the incentives to save, invest, educate?

1. Definition of Institutions n The idea that institutions are an important aspect of economic development is far from new n Douglass North: Nobel prize in economics (1990) for his work on institutions n His definition of institutions: q The humanly devised constraints that shape social interaction q The rules of the game

Functions of institutions n Institutions have two main functions: q facilitating cooperation between private actors, gains from trade q restraining powerful actors, especially predatory governments

Economic Institutions

n Security of property rights

n Structures of property rights (communal versus

individualistic)

n Markets

n Trade Unions

n Trade Organizations

n Cartels

n Labour regulations

Political Institutions

n Democracy – pluralism / autocracies

n Extent of centralization

n Electoral system

n Legislative procedures

n Party Systems

n Presidential/parliament: constitution

Legal Institutions

n Courts

n Legal codes (civil law versus common law)

Plan n In this lecture, we will try to look at: q Why would institutions affect aggregate economic performance? q Are there any competing theories? q What does the evidence look like? q How are institutions created? n Attractive theory: explains the role of history, luck, since institutions are slow-changing n But is this a deterministic view of the world?

Example 1: exchange

n Seller S and buyer B want to exchange a good

q S thinks it’s worth 10$ (true private valuation, not first asking

price)

q B thinks it’s worth 30$

q They bargain to a price of 20$

n S has then two strategies:

q Take the money, give the good: strategy H(onest)

q Take the money, keep the good: strategy D(ishonest)

n B also has two strategies:

q Take the good, and pay: strategy H(onest)

q Take the good, and not pay: strategy D(ishonest)

Matrix of payoffs S H D B H Payoff for B?, Payoff for S? D

Matrix of payoffs S H D B

H 10,10 -20,

D 30,-10 0,

n If S does H, what should B do?

Matrix of payoffs S H D B

H 10,10 -20,

D 30,-10 0,

n If S does H: B does D

n If S does D, what should B do?

Matrix of payoffs S H D B

H 10,10 -20,

D 30,-10 0,

n If S does H: B does D

n If S does D: B does D

n If B does H, S does D

n If B does D, what should S do?

Matrix of payoffs S H D B

H 10,10 -20,

D 30,-10 0,

n If S does H: B does D

n If S does D: B does D

n If B does H, S does D

n If B does D, S does D

n Conclusion?