Comparative Economic Systems and the New Comparative Economics

Dallago, Bruno, The European Journal of Comparative Economics

Abstract

The field of comparative economic systems has been recently enriched by the arrival of the new comparative economics. This approach is in the line of the law and finance tradition and presents an important contribution under different perspectives. In the paper I present the most important propositions of this new approach and I evaluate them in the light of the problems that the comparative study of economic systems traditionally considers. The conclusion is that this new approach can give important contributions to the development of the discipline in particular fields, but falls short of its pretended general validity.

JEL Classification: P10, P50, P51

Keywords: Comparative Economic Systems, Comparative Economics, New Comparative Economics

1. Introduction

The changes that took place since late Eighties, particularly globalisation and transition, have had profound consequences for economics. These consequences were particularly dramatic for fields that have traditionally dealt with economic systems that have disappeared or have been deeply changed. Comparative economic systems is certainly among the first in the list of affected fields.

This situation has prompted many, particularly in the academic world, to raise the crucial question: "is comparative economic systems (comparative economics) dead?" (2) The most recent answer given to this question has been advanced by a group of well-known authors, mostly based in Harvard and at the World Bank, (3) who are usually in the line of the rapidly growing field of law and finance. These authors have applied their peculiar approach to analysing an extensive database having mostly to do with such important institutions as ownership, finance, law, government, and regulation "around the world".

The answer that these authors give to the above question is a straightforward one: NO. This simple answer in itself makes this line of research particularly interesting and important for the scholars in the more traditional field of comparative economic systems (CES). The motivation that the above authors give to their answer is presented as follows:

"Traditional comparative economics has evolved into a new field. This field shares with its predecessor the notion that by comparing alternative economic systems, we can understand better what makes each of them work. But it sees the key comparisons as being those of alternative capitalist models that prevail in different countries. Each capitalist economy has many public and private institutions. These institutions function to choose political leaders, to secure property rights, to redistribute wealth, to resolve disputes, to govern firms, to allocate credit, and so on. Political economy over the last two centuries, as well as recent empirical research, demonstrate that these institutions differ tremendously and systematically among countries, with significant consequences for economic performance. The analysis of these differences is the subject of the new comparative economics." (Djankov et al. 2003a., p. 1)

This quotation offers some food for thought. That CES has to evolve, and possibly refocus, few in the field would doubt. Is the new comparative economics (NCE) the good and correct answer? Are the topics it examines, the methods it uses and the analysis it performs really contributing new ideas and new solutions to the field? And if so, in which sense? Which are these ideas, methods and solutions? In which sense do they differ from more traditional ones? Are they compatible or are they antagonistic with those more deeply established in the discipline?

There are at least three other reasons beyond its novelty and aim why careful attention should be paid to this contribution. First, law and economics is part of the broad field of institutional economics and therefore comparative economists should devote particular attention to it, since institutional economics is akin CES both methodologically and in the field of study. The second reason for devoting particular attention to the NCE is the name of the authors. Third, the important approach of relative efficiency, that the NCE places at the heart of its explanation, is a serious candidate for fruitful analysis of intersystemic differences and an important contribution to reform drawing, planning and implementation.

In the above quotation, the proponents of the NCE make three important statements that are worth examining in some depth. First, they write that the NCE shares with its predecessor the notion that by comparing alternative economic systems, we can understand better what makes each of them work. (4) Since we are all convinced that this is so, there is no need to investigate this issue any further.

Second, the NCE sees the key comparisons as being those of alternative capitalist models that prevail in different countries. This is presented in an ostensible contradiction with CES, which is considered to be concerned only, or at least in large part, with non capitalistic systems. Although there is much truth in the statement that CES scholars have at first given priority to socialist systems and later to transition issues, the statement is at least imprecise. There is therefore a need to devote some effort to clarifying this issue. Since this issue is not central in the NCE analysis, I will postpone its discussion to section 9.

Third, there is a stress on the fact that institutions differ tremendously and systematically among countries, with significant consequences for economic performance. The NCE states that the analysis of these differences is its subject of research. This implies that the correct benchmark of comparison is (institutional) efficiency. (5) This is, in my view, the most interesting and important contribution of the NCE to the field. Much of this paper will be devoted to a discussion of this issue, since the apparent outcome of the exercise is an appealing theoretical explanation which hides the risk of excessive analytical simplification and may produce a justificationist and rationalising interpretation of the data. In doing so, I will make reference primarily to the two papers that present directly the authors' effort at establishing the NCE (Djankov et al. 2003a, Shleifer 2002). However, since these papers are in a sense the summary of a broad and long lasting research program, due attention will also be paid to other contributions by this group of authors.

Most of this paper illustrates and examines critically the NCE contribution to this third issue. In section 2 I introduce the New Comparative Economics and highlight its main features. Each of the following sections focuses on a particular aspect of the NCE and presents my analysis of its strengths and weaknesses. Section 3 presents the basic NCE idea of comparative institutional efficiency and the following section 4 outlines the premises of the comparative institutional efficiency analysis. In section 5 the institutional possibility frontier (IPF) is introduced as the basic NCE instrument to represent and analyse comparative institutional efficiency. Civic capital as the basis of the IPF is discussed in section 6, together with the role of the legal system. Section 7 looks at the consequences of this approach for institutional reform and section 8 discusses the role of legal origin. Section 9 considers earlier contributions to the idea of a "new" comparative economics and discusses the overall situation of CES to assess whether the NCE criticism of CES is well taken. Section ten concludes by considering the relation of the NCE with CES.

2. The New Comparative Economics

The basic message of the NCE can be divided into two steps. In the first step the NCE organises what one could define as the core variables. Since these are insufficient to clarify all the issues that the NCE intends to explain, in a second step the complementary variable of civic capital is introduced.

The starting point is human nature, i.e. the individuals' inclination to subvert social institutions to their personal gain. Since this threatens to create disorder, which would jeopardise economic activity, state intervention is necessary. However, the latter creates the danger of dictatorship.

The trade-off between disorder and dictatorship is affected by the legal system, although it is also true that the "law and order" endowment of a particular economy determines which legal regime is efficient. In particular, a pure liability regime is efficient in conditions of law and order. When the latter does not hold, a regulatory regime is the only possibility. The trade-off between disorder and regulation, under the influence of the legal system, determines institutional efficiency, i.e. which institutions are the most efficient in securing property rights. These in turn determine economic performance.

This description is insufficient to explain why institutional efficiency is different in diverse economies. This depends on the absolute level and mix of disorder and dictatorship that exists and is tolerable in a given society, which in turn depends on civic capital. Civic capital, then, explains the actual possibilities of a particular economy. This element is corroborated by the role of technology, which further refines the issue of disorder and dictatorship.

Considering all these elements and with some simplification, the overall explanation advanced by the NCE is outlined in the following Chart 1.

[ILLUSTRATION OMITTED]

3. Comparative institutional efficiency

The core of the NCE lies in the concept of institutional efficiency. Similarly to Coase (1960), the NCE intends to identify which institutional arrangements are more efficient in securing property rights. Glaeser and Shleifer (2003) consider three plus one alternative institutional arrangements: private litigation, government regulation, a combination of the two, and doing nothing. In a following work, intended to establish the NCE (Djankov et al. 2003a), socialism is added to the previous three arrangements.

The importance of the law enforcement strategy that society chooses comes from the fact that private individuals are considered naturally self-interested. They will seek to subvert the law workings to benefit themselves. This creates a threat of disorder that jeopardizes property rights and consequently business and economic life. (6) Disorder must be put under control in some way, either privately or by the state or in any intermediate mixed way. However, the intervention of the state opens the way to dictatorship, of which socialism is the extreme form.

The NCE sees (formal) institutions in a narrow functional perspective, whereby their role is to control the twin dangers of dictatorship and disorder. Moreover, no mention is made of the role of informal institutions except in the case of transplantation, but then only in an implicit way. A dynamic element is introduced by considering that institutions are vulnerable to subversion by the potential violator making use of a number of both legal and illegal strategies. (7) However, as long as institutions work properly, "[t]he theory leads to predictions as to what institutions are appropriate under what circumstances." (Glaeser and Shleifer, 2003, p. 401). This is clearly an ambitious research program, which has the explicit goal of replacing the traditional CES framework with a new paradigm. In this new perspective, comparative economics would become a simple, although important, chapter of (a particular brand of) the property rights interpretation of the world.

After this summary description, in order to evaluate this program of re-founding CES it is useful to assess how the NCE answers two crucial questions. First, in which sense and in which ways are different legal regimes vulnerable to subversion? That is, in which sense can we speak of comparative (in)efficiency of alternative legal regimes? Second, how can efficient institutions evolve, particularly so if we consider the role of subversion?

The NCE answer to the first question reveals an important similarity with the CES approach. In fact, the NCE answer is based on the features of the context in which the legal regime is embedded. However, this NCE context is rather thin, since it is reduced to the issue of law and order, however important this may be. To understand this point, we can follow the proponents by considering the two opposite legal regimes: (8) a pure liability regime and a regulatory regime.

According to the NCE, pure liability regimes entail the risk of having to make large payments with a small probability. Particularly in environments lacking law and order, such regimes are more vulnerable to ex post subversion than regulatory regimes. Therefore, when law and order hold, pure liability regimes are efficient. However, in the absence of law and order a regulatory regime is more efficient than a pure liability regime. In intermediate cases mixed solutions prevail. This explanation is complemented with other variables that the literature has shown to be important, such as stronger incentives and greater specialization of regulators compared to judges (for a contribution on this point by the same group of authors see Glaeser et al. 2001).

In a later contribution (Djankov et al. 2003a) a framework is presented that describes the tradeoff between dictatorship and disorder and also introduces the extreme case of socialism (the purest case of dictatorship with very low level of disorder). This framework is then applied to the problem of social control of business. It is worth noting that the authors do not support the view that efficient institutions eliminate the dangers of disorder and dictatorship. These are simply reduced to the minimum possible level, given the features of the society--to be discussed in section 6. This is, I believe, one of the most important statements of the NCE, which identifies an interesting point of possible cooperation with CES. (9)

The answer to the second question introduces an interesting evolutionary element, that is however restricted and remains undeveloped: "Efficient institutions could evolve from democratic pressures (...), from the influence of growth-seeking interest groups such as merchants (...), from a Coasian negotiation among the members of the elite, such as the Magna Carta or the American Constitutional bargain (...), or from a long term evolutionary process described by Hayek (...)." (Djankov et al. 2003a, p. 9) The authors also criticize the special interest group theory and do not support it as a convincing explanation of comparative …

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Publication information: Article title: Comparative Economic Systems and the New Comparative Economics. Contributors: Dallago, Bruno - Author. Journal title: The European Journal of Comparative Economics. Volume: 1. Issue: 1 Publication date: June 2004. Page number: 59+. © 2008 Mario Rostoni Library - Universita Carlo Cattaneo- LIUC. COPYRIGHT 2004 Gale Group.

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