Mind Map Gallery Mind Map Of Political Economy Analysis
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Mind Map Of Political Economy Analysis
This is a Mind Map Of Political Economy Analysis. Political economy analysis (PEA) tries to place development interventions in the context of society's prevalent political and economic processes, specifically the incentives, linkages, and power distribution and contestation among various groups and individuals. By establishing realistic expectations of what can be accomplished, over what timeframe and the dangers associated, such an analysis might promote more politically feasible and thus more effective development programs. PEA is a formal process, but it's also a technique for figuring out why things are changing (or not happening). To think politically, one must first comprehend the political economy environment at the national level, i.e., the change drivers–structure, institutions, and agency. In EdrawMind community, you can get more templates related to Economics or other topics in study, work and life.
Edited at 2022-04-12 08:00:27
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Political Economy Analysis of Institutions
Session 1: Introductions
Why Incomes Differ
Importance of Institutions in Economics
Session 2: Institutions
Definitions
Formal vs Informal
How do Institutions emerge
Session 3: Evolution of Political Institutions
Historical Examples
Simple Model
Session 4: Co-Evolution Model
Model Setup: Economy
Political System
Developmental Paths: Analysis
Dynamic Compatibility of Economic and Political Development
Session 9: A Model of Educational Change
Motivation and Evidence
Model Intuitions
Basic Results
Extensions
Historical Evidence
Session 8: Education and Human Capital
Purpose of Education
Vocational vs General Education
Human Capital Theory
Institutions of Human Capital
Liberties and Virtue
Session 7: Property Rights
Introduction
Property Rights in English History
Dynamic Commitment Problems
A Model on Property Rights Security
Main Results and Evidence
Session 6: Contract Enforcement - Model of Legal Development
Usage of Informal vs Legal Contracts
Litigiousness and Declining Social Capital in the US
A Model of Legal Development: Institutions
Model Analysis and New Insights
Session 5: Contract Enforcement
Risk of Default in Transactions
First-Party Enforcement: Trust
Second-Party Enforcement: Relation
Third-Party Enforcement: Law
Culture: Individualism vs Collectivism
Introduction to Institutions
Difference in GDP
Hypothesis 1: Institutions and government policies differ
Determine economic environment - individuals accumulate skills - firms accumulate capital and produce output
Good Institutions get the incetives and prices right - individuals capture social returns to their actions as private returns
Invisible Hand works in the First Welfare Theorem
Hypothesis 2: Bad Institutions create divergences between social and private returns
Give rise to rent-seeking activities
Private Diversion - Thievery, Squatting, Mafia Protection undertaken by private agents
Public Diversion - Expropriation, corruption by public agents
From government
Evidence
Hall and Jones (1999)
Close association between output per worker and measures of institutions
Long-standing policies favourable to productive activities rather than diversion
Difference in social infrastructure between Niger and US
Instituional Measures
Government Anti-Diversion Policies (GADP)
2 Ways Government role in protecting agaisnt private diversion
1. Law and Order 2. Bureaucratic Quality
3 Ways Government role in protecting against public diversion
1. Corruption 2. Risk of expropriation 3. Goverment reupidation of contracts
Openness to trade index
Productivity
Remaining difference is from the productivity residual - Calcualted by (3.1*1.5*7.7)
Physical Capital
Captial Intensitiy - Factor of 1.5
Human Capital
Educational Attainment - Factor of 3.1
Basis of Differences
Differences in GDP
1988: Output per worker in US 35x more than Niger
In 10 Days, US worker produced what Niger would produce in an entire year
GDP in 2018: Niger 414; US 62,795, different by 151 times Afghanistan 521; Singapore 64,582; Malaysia 11,373
Hall and Jones (1999)
Found variation in level of the Solow Residual Across Countries
We document that the differences in capital accumulation, productivity, and therefore output per worker are driven by differences in institutions and government policies, which we call social infrastructure
Not just physical capital and educational attainment
Institutions
Definition
Rules of the game in society, humanly devised constraints that shape human interaction
Political Institutions
Legal Instituions
Economic Institutions
Good vs Bad Institutions
Developmental Institutions
Permit or Encourage growth
Predatory Institutions
Hinder Investment and Economic Development
Leads to rent-seeking activity
Can be initially good but turn bad
Eg. Free market compettion among firms is a good institution if properly constrained but can become predatory if firms get too much market power over others and consumers
Eg. Strong government can be effective in providing public goods but can also become predatory against private sectors
Formal and Informal Institutions
Formal
Written laws, regulations, legal agreements, contracts and constitutions that are enforced by third parties
Informal
Unwritten norms, procedures, conventions and traditions that are often embedded in culture
Institutions come inclusters
There is a need for consistency, if not the less deeply rooted ones will be changed
Formal instituions need to be supported by informal institutions that are more fundemental and harder to change
Example
Argentina
Perón had been secretary of labor in the previous military Junta which had ruled since 1943. The labor movement was a key pillar of the Peronist movement. He introduced social programs that benefited the working class, supported labor unions, and called for additional involvement of the state in the economy. When Perón was first democratically elected president in 1946, the Supreme Court had ruled unconstitutional an attempt to create a new national labor relations board. Perón sought the impeachment of 4 of the 5 members of the Court.
Peron's decision was passed
3 members of the Court were impeached, Chamber of Deputies and Senate supported this
Set the precedece for future political transitions
Incoming regime replaced entire exisiting Supreme Court or impeaching most of them
1990 democratic political transition from Alfonsin to Menem allowed him to expand 5 to 9, letting him name 4 extra judges
USA
In the first term of President Roosevelt (FDR), the Supreme Court starting in 1935 - New Deal Policies such as the National Industrial Recovery Act was unconstitutional. - Roosevelt proposed that all judges over the age of 70 should be retired (the ones that opposed him) - Which in effect would give him the right to nominate 6 new judges (there were 9 at the time) and ensure a majority
FDR's bill was not passed
Public regarded it as an attack on the independce of court
Public still supported FDR hence Supreme Court made compromises 1. Social Security Act 2. National Labour Relations
Importance of Check and Balances Political Institutions
Prevent actions by othre branches and are induced to share powers
Legislative, Executive, Judicial
De Jure and De Facto Political Power
De Jure
Allocated by formal political institutions such as electoral systsm
De Facto
Emerges from ability to engage in collective action, brute force, paramilitaries, lobbying or bribery
Useful to understand why formal institutions function differently indifferent environments
Creates equilibrium outcomes, composition of the 2 courses of power
How do Institutions Emerge
4 Views (IBEE)
1. Incidental Institutions View
Institutions emerge as a by product of interactions eg. historical accidents
2. Idealogy / Beliefs View
Different institutions chosen as a result of different beliefs
3. Efficient Institutions View
Institutions that maximise the toal welfare in society will prevail
4. Equilibrium Outcome View
Cluster of institutions prevailing is an equilibrium outcome of relevant game Agents cooperate, compete and bargain to maximise gains
Evolution of Political Institutions
Demcroatisation Process in the West
Bourgeoisie or Working Class
Moore 1966
Getting rid of agriculture as a major social activity --> essential for successful democracy
Supports capitalist development and hence strengthen working class
Concluded that the bourgeoisie were the primary agent of democracy
Rueschemeyer 1992
Key actor of full democracy us not capitalists but organised working class
Forced or Voluntary
Acemoglu and Robinson 2000
Franchise expansion is forced on the ruling elites to mitigate revolutionary threat
Lee, Persico, Jack
Suffrage extension suggests that elites might do it voluentarily in their best interest
Both views are supported by historical evidence - Different countries and Different Times
Institutions or Factor Endowmnet
Acemoglu 2005
Institutions are the fundemental cause of long run growth
Glaeser 2004
Level of human capital is more fundemental than institutions
Other views such as - Geography, resource endowment - Culture, religion - Geopolitics - Education
Simple Model Evolution
Dynaminc Interactions between - Economic activities leading to increase in aggregate wealth - Political conflicts over its distribution
Main production factor shifts from Land --> Physical Captial --> Human Captial
Relative economic and hence coercive power shifts
Induces the transition of political system from Monarchy to Oligarchy to Democracy with full sufferage Land owners to Capitalists
New political regime extends power to owners of new form of capital Therefore increaseing future economic gains and speeding up economic progress
Smooth Transition or Repression
Smooth Expansion
Smooth expansion of political power from Owners of land --> Owners of Captial --> Owners of labour facilities
Smooth transition and allocation in Investment in phyiscal captal --> Investment in human captial
Repression
Inability to expand political power to support expanding investment
Retarding of Economic Development Political Repression and Future Revolution
Driving Forces of the Model
1. Economic Development
Technical features of land, physical captial, human capital and complimentaries
2. Political Development
Conflicts between factor owners on income distribution
3. Dynamic Links
Might is Right
Economic Strength --> Coercive Power --> Political Power
Future economic strength <-- Poltiical Power
Incumbents Advantage
De Facto Power --> De Jure Power --> Future De Facto Power
Sequence of events
1. Factor Composition
Land --> Physical Capital --> Human Capital
2. Income Distribution
Unequal --> Equal
3. Coercive Power
Unequal --> Equal
4. Political Power
Landlords --> Capitalist --> Workers
5. Political Regime
Monarchy --> Oligarchy --> Democracy
6. Investment
Unequal --> Equal
7. Back to Factor Composition
Western Europe
Example
Consistent with historical evidence in Western Europe (England and France) where the model is realised through autonomous transitions
Olson 1993
Spontaneous and autonomous transitions from autocracy to democracy
England
France
Germany
Land, Anarchy and Monarchy
Introduction of Feudalism
Emerge from anaychy and develop a political-economic structure to produce sufficient order and stability
Nobility held lands from the Crown - Peasants were obliged to live on lord's lands - In exchange for protection
Lords, Nobles held land
Vassal was Knight / Baron
Feudal landlords directed efforts to maintenance and expandion of inherited lands
Territory rulers were winners in the free for all control over the sparse surpluses of the relatively unproductice agricultural economy, Blockmands 1998
Commerce and Oligarchy or Landowners and Capitalists
Surpluses from agriculture became available
Princes benefeited through extra revenues from the cities
Economic development strengthened the business and profession classes
Citizens strive for autonomy and independence
Development of parliamentary democracy in England
Weak repressive apparatus compared to monarchies
Joint force of land owners and bourgeoisie
Glorious Revolution in 1688
Parliament more sympathetic and accessible to aspirations, manufacturers, farmers and land ownders O'Brien 1994
Industrial Revolution in 18th Century
Brought economic and political changes across Europe
Propertied Class had acquired substantial political powers
Transformation from absolute monarchy to oligarchial rule of land owners and capitalists
Demand for Skilled Workers, Public Education, Suffrage Expansion
Industrial Revolution created a large working class
Demand for skilled workers was driven up
Massive education reforms
Workers would expend high levels of effort if they received a fair share of returns
Employers became more receptive to sharing power with workers organisations
Less fighting of unionisation
Opening the way for Political Transformation
Agrarian Societies turned into Industrialsed Societies
Agrarian means economy is based on producing and maintaining crops and farmland.
Oligarchial rule was replaced by democractic institutions will full suffrage
England
Best fits into the benchmark case of smooth development
National monarchy was established early
Provide stable and peaceful environment
Political compromises achieved in relatively peaceful and timely manner
Economic development was greatly facilitated
First nation to start industrialisation and democratisation process
Glorious Revoluion in 1688
Political transition from monarchy to parliamentary rule of landowners and bourgeois
Suffrage Extension
1867 Better paid workers
1918 Men
1928 Women
France
Less Smooth and Less Clear Cut
Monarchy established at around 1450
Transition from Monarchy to Oligarchy more violent and accompanied by more revolutions from 1789
Full Suffrage in 1871
High represive capacity the main difference from England
Necessity of a strong army to establish a central monarchy
Repression and economic stagnation
Germany
Modern nation state in 1871
Long term fragmentation of states
Democratisation process was interwoven with nation building
Shaping distinct conservative modernisation path led by authoritarian governents
Stable Democracy realised AFTER WWII
The later a country develops, a more complex developmental path is followed due to influences by other advanced countries
Why do we need to talk about it
Mr Ho does not want people to sleep walk into the next generation With a group think mentality
Co-Evolution Model
Model Setup: The Economy
OLG Model
Over Lapping Generational Model
Savings
Bequests
One individual lives for 2 periods 2 Generations
Endowment
Overlapping generations w/ Fixed Popn Size
Land
Capitalists
Workers
Preferences
Utility Function
Budget Constraint
Consumption
Suppose in country A people care a lot more about their offspring than those in country B. How can this be reflected in this model?
Suppose country A is very cold and hence they need to spend more resources on getting warm in order to survive. How may this affect bequests?
How will this affect the consumption decisions of individuals? In other words, which country will tend to leave more bequests?
Bequests
Optimal Bequest
Proof Of Bequest
Optimal Saving and Bequest
0
When poor
Positive
When income is higher than threshold Z
Higher if people care more about offspring
Final Output Production
L: Land
Quantity is fixed over time
Kt: Physical Capital
Ht: Human Capital
Depreciates fully after one period about 20 to 30 Years
At: Knowledge stock
Grows exogenously and very slowly
Capital Investment
Individual may invest in physical or human capital for the next generation
Capitalist borrows at a rate to produce physical capital, rent it to final output producers for a return
Human Capital is financed by public education through tax revenues by the ruler
Maximise its own benefit, optimal tax rate imposed on individual's bequest
Individuals then invest disposable savings into capital market
Physical Capital Investment
With material resources phyiscal capital is generated
Aggregate physical capital
Human Capital Investment
Education expenditure --> Human capital is generated by
The Political System
Coercive Capability
Group's organising efficiency increases with the group average capability to coordinate BUT decreases with increasing individuals due to free-riding and information problems
Political Regime
Initial regime is established by might-is-right
Dominant group becomes first ruler + imposes tax
Highest possible tax rate is determined by ability to hide income
Political Transition
Revolt
Challenging group becomes new ruler
Not Revolt
Group decides when facing incumbent ruler
Repress
Maintain current regime Repressed group pays extra fighting cost
Compromise
Ruler extends political power to challenging group, who will not need to pay eploitative tax anymore
Ruler decides when there is a revolt
Outcome is stochastic in an open fight
Winning probability is proportianal to group's coercive power
Subgame Perfect Equilibrium (SPE)
Smooth transition more likely when xt becomes higher
Outcomes
1. Cost of fighting is high, politial transition is peaceful and timely
Compromise between ruler and challenging group is equilibrium outcome
Smooth transition is achieved by extending political power to the challenging group
Change of coercive power OR Change of De Facto Political Power is consolidated by Change of De Jure Political Power
Economic development is not interrupted
2. Cost of fighting is low, transition is slow and may involve violence
Engage in open fight for political power
Ruler wins
Old regime continues by repressing revolt
Challenging group wins
Revolution occurs that leads to a violent transition
3. Transition is more likely to occur when challenging group relative coercive power is higher
Developmental Paths: Analysis
Passive Laborers
Do not contribute to any changes
Lack coercive power to gain political rights
Large size, Low Coordination Skills Reduce coercive capability of groups that include them
Not be invited challenging groups
Production Factors
Technical Features
Land
Exogenously endowned by nature
Hard to destroy
Physical Capital
Endogenous effort to produce
Cannot be produced without investment
Easy to be destroyed
Human Capital
Basic unit endowned by nature Further investment needs endogenous effort
Usage cannot be easily forced
Land is initially dominant Physical Captial Investment starts with enough surplus Human Captial investment of the masses start when physical capital stock is enough
Physical Capital less easily centralised, less easily controlled through coercion
Dispersed among capitalists
Factories and machines may be confiscated
But most important assets of capitalists are intagible and difficult to capture by coercion
Entrepreneurial skills
Technical Know-How
Business Networks
Not everyone has these talents
Human Capital
Read, Write, Calculate
Can be acquired through education
Land under Monarchy
Land is initial dominant factor, hence owner becomes monarch and allows him to enforce stablic political order without challenge
Inequality of land ownership shorterns time for society to start capital investment
Monarchy facilititates economic development
Physical Captial under Monarchy
Endogenous supply of physical captial differentiates it from land
With sufficient surplus, capitalist use special skill set to produce physical capital
Induces change in political system
Capitalists do not emerge from landowners
Doepeke and Zilibotti 2008
Characteristics such as patience and work ethic cultivated in working families
Increasing the Coercive Power of Capitalists
Increase stock of physical captial induces faster growth in total output
Monarch benefits from capital accumulation + tax revenues
Economic Development causes joint income of elites to grow faster than monarch
Driving force of the increasing coercive power is due to the inreasing physical capital
Public Education Under Oligarchy
Under elite rule, workers are still raw labour, after-tax wages are not high enough to have bequests
Elites may find it beneficial to start investing into human capital through public education when investment in physical captial is inefficient
Tax rate for public education is optimally chosen by the ruling elites to balance the marginal returns of investing in physical and human capital
Expendture in public education increases over time Increasing human capital level and coordination effectiveness
Coercive power of powers eventually reaches threshhold Trigger equilibrium outcome
Oligarchy To Democracy
Similar to transition from monarchy to oligarchy
Mutual compromise is reached between elites and workers when too costly to figt
Poliical power extended to workers
No tax is imposed on wages, each factor erans competitive return Exploitative tax disappears
If not, open fight occurs ending in repression or revolution
Dynamic Compatibility of Economic and Political Development
Co-Evolution Path
Path with Repression or Revolution
Smooth Transition Path Is Benchmark, fighting is too costly
If fighting is less costly --> Open fight occurs
Repression
Same political game is played in following period
Revolution
Monarchy to Oligarchy
Results not much difference from compromise
Oligarchy to Democracy
Workers become new ruler and impose tax on Land and Physical Capital
Economic development slower than smooth path
Resources are wasted in tax collection and social unrest
Main sequence of developmental stages is still the same
Reverses could hapen if stochastic shocks are allowed BUT will be temporary
Subtopic
Contract Enforcement
Risk of Default in Transactions
Voluntary Exchange
Sequential therefore implies opportunity to renege
Commitment Problem
Ex-ante
That his partner will fulfil his contractual oligation
Ex-post
What his partner can gain from reneging
Prisoners Dilemma
Growing specialisation in the economy generates more frequent and complex economic changes
Contract Enforcement Importance
Arrow 1972
Every transaction has an element of trust
Economic backwardness can be explained by the lack of mutual confidence
Cocercion - Constraining Institutions
Political Institutions
Legal Institutions
Secture the rights for markets to prevail
Security is not free lunch Price can be a sub-optimal organisation of the economy
Scope of exchange is determined by prevailing contract-enformcement institutions
First - Party Enforcement: TRUST
Keep promise by self-enforcement, derived from intrinsic interests
Actor who imposes rules and sactions on himself
Derived from intrinsic interests
Moral Values
Exhibiting Trustworthiness
Integrity
Conscientiousness
Useful Indicator is level of Social Trust
Example
Ji Zha Hanging Sword
Social Attitudes
Civic Attitude and Trust
Accounts for differences in economic and government performances
Social Captial
Fukuyama
Set of infomal values or norms shared among members of a group that permits them to cooperate with one another
Propensity to trust each other is likely to be key for fostering mutual cooperation and growth
Example: Trust
Empirical
Average trust level is associated with economic growth
Large Positive effects on performance of organisations
Experimental
Documentation of substantial amounts of trust
Real Life examples
Wallets were placed onto side walks in NYC
More than half were returned w/ Cash intact
Extensive research
Industrial and Organsation psychology
Individuals conscientiousness relates strongly to job performance across diff type sof jobs
Effect of Trust on Growth
Algan and Cahuc
Casual link between trust and economic development
Social Trust
Global comparisons of trust attitudes suggest time persistent cross country heterogeniety
Second - Party Enforcement: RELATION
Keep promise due to external incentives imposed by the other party in the transaction
Person acted upon in a specific transaction administers rewards and punishments depending on whether the promisor adheres to the promised course of behaviour
Collatera, bail, bond, hostage
Example
Pied Piper in 1284
Piper promised to rid the town of rats in return of payment but the villagers reneged on the promise
Relational Contracts
Repeated interactions generate future stream of benefits to prevent short sighted cheating
Engaging in a long-term personal relationship where both sides have ample opportunities and stakes to reward cooperation and punish cheating
Cooperation may fail when people are not sufficiently patient or when future is uncertain
Third - Party Enforcement: LAW
Keep Promises due to external incentives imposed by others not involved in the specific transaction
Parties not in the primary interaction carry out the rewards/punishments according to
Social Norms
Conventions
Rules
Law
Credible Information can be circulated to develop individual reputations
Community and Law
Cost of litiation + Difficulty of proving information
Reliance on other contract enforcement methods
If there are repeated interactions between diff members --> refrain from trade with a member who has behaved opportunistically
Multilateral punishment means that opportunism has a long term cost
Example: The Maghribi Traders Coalition (1993)
Role of social networks in circulating information About breach of contracts
Enabling businesses to penalise and exclude cheaters
Group of Jewish Traders in the Muslim Mediterranean
Maghribi trader in one location could reduce his cost by using another Maghribi trader as an agent to sell the goods
Form a non-anonymous framework where relations are established between agents and merchants
Cheaters are identified and will not work with them anymore
Satisfies the conditions of a well-defined group
Good information flows
Incentives to punish cheating
Common religious-ethnic origin of traders provided the boundaries for the coalition
Collectivist cultural beliefs
Culture: Individualism vs Collectivism
Hofstede's Work Related Cultural Dimensions
1. Power Distance
2. Uncertaintiy Avoidance
3. Individualism
4. Masculinity
Examples
Individualism
High in the US, Australia,Great Britain
Low in Hong Kong, Serbia, Malaysia, Portugal
Long Term Orientation
High in East Asia
Low in Anglo Countries, Africa and Latin America
Indulgence
Highest in Latin America
Restraint is mostly found in East Asia
Uncertaintiy Avoidance
Society's tolerance for ambiguity
Higher means stiff codes of behaviour, laws etc
Lower means more acceptance
Individualsim
People act as individuals rather than members of a group
Individual Goals and Rights of Individual Persoin
Individualism holds that every person is an end in himself and that no person should be sacrificed for the sake of another
Collectivism
Collective culture people are integrated in strong, cohesive in-groups
Group Goals, Long Term R/s is important
Such as a nation, a community, or a race is the primary unit of reality and the ultimate standard of value The needs and goals of the individual must be subordinate to those of the group.
Example
England individualism is intense The death of a parent may be private information not willing to share
Korea is less intense Firms would congratulate employeed when their children marry, condolences whose grandparents died
Relative Measure
Pure versions are seen as undesirable
Pure individualism is a "war of all against all"
Pure collectivism is intergroup hostility, oppression of human rights
Related Attributes
Individualism related to low power distance
Society accepts inequality in power
People should have control over their own destiny and expect authority figures to consult them
History is more important to collectivists than individualists
Collectivists see themselves as links in a long chain that consists of ancestors and descendants .
Rarely occurs among individualists. The individualist is in the center of the stage what comes before and after is more or less irrelevant .
Ingroups
Groups of individuals about whose welfare a person is concerned, with whom that person is willing to cooperate without demanding equitable returns
Collectivists
Want ingroups to be monolithic and homogenous
Individualists
Emphasize homogeneity less and arguments are better
Contract Enforcement: A Model of Legal Development
Usage of Informal Vs Legal Contracts
Cross Sectional Differences
Different comparative advantages therefore coexisting in societies
Prevelance of legal contracts is associated with well-developed economies
Exhibit high quality legal systems and democracy
In comparison developing countries have a heavier reliance on informal relationships
Such as kinship and social communiteis
Collective Vs Individualistic Culture
Collective culture is prone to usage of relational contracts
Reason for both Low Legal Quality and Slow Economic Growth
Example
Latin America
1. Culture is more collective
2.Usage of informal contracts that rely on personal R/S is higher
3.Legal quality - Degree of institutionalised democracy per capita GDP - Average schooling level is much lower
4. Income Inequality is highest
Counter-Example
East Asia
Difficult to reconcile with East Asian Economies under Confucian Culture
Network of interpersonal r/s significant role in East Asia's Economic Development
Cultural stress on collectivism, communitarian values and practices rather than individualism
High economic growth and low income inequality are achieved despite low reliance on legal contracts
Litigiousness and Declining Social Capital In the US
Heavy Dependence on Law Not Efficient
Magge (1989) and Murphy (1991)
Large proportion of Lawyers in white collar labour force leads to declines in economic performance
Litigious Society
US has the largest proportion of lawyers
Spend 2x as much on civil ligtigation compared to new automobiles more than any other industrialised economy
Litigiousness and Individualism
Americans are litigious people
Changes in US cutlure
Emphasis on individual rights and neglect of common good
Chosen to litigate rather than tolerate discomforts or settle disputes amicably
Communal spirit and stoic temper that kept Americans out of court has withered
Litigiousness and Declining Social Captial
Bowling Alone, Putnam (1995)
US undergone collapse in
Civic
Social
Associational
Social Capital
Social captial is participatory potential, civic orientation, and trust in others available to cities, states, or nations.
People trust each other much less than 40 years ago
Anti-Litigation Reforms
Profusion of bills to limit lawsuits
Has become part of political debate BUT reformers confrton powerful forces in American culture and politics
Resistance to Reforms
Alexis de Tocqueville
Politcal questions will turn into a Judicial One
Public Policy Style
Litigious (Judicial)
Fundemental features of constituional tradition
Combines distrust of centralised government power + set of structures
Structures could be
Federalism
Separation of powers
Independent Judiciary
Political (Government)
Courts prevent policies from being captured
Preventing abuse of power, literally preventing agencies from capturing the policiy
Trade off between law and politics
Separation of powers
Protect Policies but Can be used to Capture Policies
Model of Legal Development: Intuitions
Definitions
Contract
Refer to any mutual agreement between relevant parties
Relational Contract
Not backed up by law
Relies on beneficial future dealings to prevent cheating
Legal Contracts
Explicity rely on 3rd Party for enforcements
Intuition 1: Historical Sequence
Informal contract enforcement at individual and communal level
Legal enforcement happens much later in history
Requires intentional public investment
Establishment of legal courts, legal codes and procedures, judges lawyers police force are needed
Implications on Modelling, Huang (2012)
Political Economy Model
Legal developmen is a costly public good
Usage is determined by cost-benefit analysis
Intuition 2: Comparative Advantages
Relational Contracts
Promise future gains in established relationship
Need to syay with current partners
BUT makes individuals reuctant to do business with new productive partners
Legal Contracts
Impersonal 3rd Party
Deters cheating and thus freeagents from the burden of maintaining less productive relationships.
The more productive new business opportunities with strangers are relative to old ones, the higher the returns of using legal enforcement, the larger incentive to invest in legal system
Evidence
Johnson (2002)
The development of legal institutions brings indirect efficiency gains, by lowering entry barriers
Direct efficiency gains through strengthening confidence in contracts
Implications: Socially Optinmal Results
Societies more suitable for usage of relational contracts start legal investment late and have lower legal quality
Socially optimal pace of legal development vary across societies
Higher quality legal system per se is not always better for development , collective culture is not always bad
Intuition 3: Political Economy Issues
Individuals have heterogenous returns thus conflicting interests in improving legal quality
Traditional Rich Elite (Rothschild Family)
Richer than others when legal contract enforcement is not available or weak
They enjoy higher gains in using relational contracts
They benefit less from legal enforcement whereas the less privileged masses stand to gain more from having a competent system
Evidence
Traditional elite given land and other natural resources, stable soruces of income
Business transactons are conducted mostly through relational contracts with elite families
Elites are composed of a rich minority
North et al. (2009)
Landed elite group in England was only about 0.5% - 1%
Pipes (1995)
Those in power have no need of courts and laws to have their way; it is the poor and the weak who do.
Conflicts of Interest
Masses in general have more to gain from competent legal system compared with a dysfuntional one, than the elite
Both can be true
Implications: Political Economy Results
Rich elite are politcally dominant and choose legal investment to maximise own welfare
Legal investment tends to be too large under majority rule Too small under elite rule
Legal quality is often higher in democratic society
Implications: Inequality
Income Inequality falls when legal quality improves
A better legal sysmte provides all agents with equal access to new trade opportunities
Quality of their initial matches and endowment less important
Dampens income gaps between traditional elite and the rest
Links between elite rule, low legal quality and high income inequality can be mutually reinforcing
Self Reinforcing
Under Majority Rule
And higher legal quality consolidates the majority rule
Under Slite Rule
But higher legal quality undermines the elite rule
Mutual reinforcement among economic, political, and legal conditions.
Model Analysis and New Insights
Two Types of Agents
Elites and Masses
Elites have higher wealth and education compared to the masses
Benefit from relational contract increses in educational level
Model has 2 Phases
First Phase: Legal Investment
Legal quality q of contract enforcement through political process
Second Phase: Business Partnerships
Agents take legal quality as given and match partnerships
Business projects using relational or legal contracts
Summary of Results
Gains from outside opportunities are larger, socially optimal legal development more likely to start
Leading to lower income inequality
Poltical system determined by balance of economic power
Legal development weakens elite but solidifies democracy
There is a legal quality threshold as the elites will never change the power balance to one where they can't sustain
Empirical Evidence
Collective culture may slow down legal development but not reduce the overall welfare
Elite rule may cause both low legal quality and inefficient outcome
New Insights
Rich elite take advantage of lawlessness by engaging in rent seeking activities or corruption
Giving rise to economic stagnation
Contract Enforcement Model
Inefficiency is not caused by rent-seeking activities but genuine differences in benefits
Traditional elite have comparative advantages in using relational contracts
Inefficient legal development not only occurs under elite rule but also majority rule as well
Elite-ruled societies under invest in legal contract enforcement Democratic society tends to overinvest in it
Property Rights
Introduction to Property Rights
Property Rights in Economics
Classical economists central position to the role of property rights
1st and 2nd Welfare Theorem
Assumes that property rights are defined and enforced
Most literature focus on savings and capital accumulation an institution free world with perfect property rights
New Institutional Approach Puts effective property rights as the centre of development
Types of Property Rights
Use Rights
Refers to owner's right to use a good or asset for consumption or income generation
Transfer Rights
Right to transfer to another party
Sale, Gift or Bequest
Right to Contract
Allows parties to rent or mortgage an asset
Employment R/S
Property Rights and State
State
Enforce property rights and contracts Provide Public goods
Anarchy
Absence of state, individuals must invest in private production of securtiy by acquiring capacity for violence
Justification for creation of state
Presence of higher authority to oversee
Overseer enables people to replace the costly and inefficient anarchy with set of rules to improve welfare
Predation: State Vs Private
Protection against state predation is more important than private predation
Informal contract enforcement can arise spontaneosly and such private order is usually desirable to state and citizens
Self-Sustaining Equilibrium
Issue of commitment, credibility and trust
Solution: Create cyclical chain of institutions forming a self sustaining equilibium
Checks and Balances
Purpose
Limits the power of government to expropriate subjects
Keep each other in their proper places
Counter ambition with ambition
Federal conflict is protection of freedom
Effect
Glorious Revolution (1688)
Credibility of government to commit themselves to honour financial agreement
Securing of private rights
Lower borrowing costs
Forms
Separation of powers
Legislative
Executive
Judicial
Multi-Cameralism
Upper and Lower House
Federalism
Institutional Mechanisms
Limits on Majority Rule
Veto rights for individual / Supermajority Requirement
Protection of Property Rights
Must be enforced in equilibrium by economic agents with rational foresight and incentives
Property Rights in English History
Low Security under Monarchy
Co-evolution model of political institutions is also the developmental path of property rights institutions
Examples
Renege on Debts
The Stuarts secured most of their loans under threat known as forced loans
Repayment was highly unpredictable + never on the terms of original agreement
The Crown borrowed 111k but did not repay the ful amount
Behaved similarly on 1611 and 1625
Loans looked more like taxes
Property rights largely decided by monarchs
Used their powers to expropriate producers, imposers arbitrary taxation, allocates the productive resources to allies for economic benefits or political support
Development of Property Rights
17th Century showed changes in the economic and political institutions
Paving the way for property rights and limits on Monarchs Power
Civil War in 1642 and Glorious Revolution in 1688
Gentry and Merchants
16th Centruy
King possessed de facto political power
No social group could amass sufficient de facto power to challenge king
Changes in land market and expansion of trade
Increased economic forturnes, increasing de facto power of land owners and merchants
Had conflicting interests with the King, King wanted to increase tax income
17th Century
Growing prospetiy of merchanges and gentry allowed them to field military forces over the King
De Facto Power overthrew Stuart Monarchs in Civil War and Glorious Revolution
Change in distribution of property rights, political power + changes in economic institutions
Dynamic Commitment Problems
Dynamic Commitment Problems
Major commitment problems as groups with political power cannot commit to not use their power to change resource distribution
Example
Economic instrituions increased security of property rights would not have been credible if monarch monopolised political power
Could promise to respect property rights but renege on this promise
Credible property rights required a reduction in political power of the monarch
Inter-Temporal Issues
Individuals care about the future
Gentry and Merchants would have used de facto political power to secure benefits in future + present
Commitment to future allocation not possible as it would be decided by those with future political power
Transient de Facto Political Power
De Facto Political Power is often transient as collective action problems will resurface
Many revolutions are followed by conflict, groups with de jure power become stronger in the future
Change in policies and economic institutions that rely on de facto political power will be reversed in the future
Transforming De Facto to De Jure Politial Power Via Institutional Change
Gentry and Merchants wanted to alter political institutions and future allocation of de jure power
Used De Jure Political power to make changes more durable
Changes in Political Institutions are a way to manipulate political power, economic institutions and outcomes
De Jure Power backed up by De Facto Power
Stability and Inertia of Political Institutions Overcomes problems such as free-riding problems
Dynamic consistency with each other
Incremental changes in economic development may lead to qualitative shifts of de facto political power
Significant enough to change the allocation of de jure political power via Institutional Adjustment
A Model on Property Rights Security
Is there a mix and match of various methods? OR is there a hierarchy of impact?
Dynamic Evolutionof Instituions
Hierarchy of Institutions
Informal Rent Seeking
High when legal quality is low
Legal Quality
Can't be high when masses have little political rights
Political Rights
Can't be high when factor owners can't defend their own interests by economic and coercive means
Key Insights: Changing Factor Compostition
Legal quality adapts to evolving factor composition
When land is main production factor, property security is low
Land can be expropriated, small groups can be accumulated and manage big lands
Security becomes higher with physical capital
Owners more diverse
Easier to defend against confiscation
Stock increases faster than land
Model Setup
The Economy
OLG with fixed popn size and final output production
The Political Regime
Relative coercive power of challenging group over the ruler
Current Regime Continue
Replace
Independent Legal System
Dynamic Inconsistency
Why is there an Independent Legal System?
Ruler promisis to change change tax rate may not be credible due to dynamic inconsistency
To make the epromise credible, use an independent legal system to enforce tax rate
Promised tax rate is lower than expropriation rates --> ruler has incentives to renege on promise
Example
Ruler may announce the lower tax rate before production starts but change the tax rate to a much higher level
Repeated interactions and reputation may mitiage such dynamic inconsistency to some degree
Independent legal system provides a more reliable institutional warrant that guarantees the promised tax rate
Legal Quality
Is chosen to maximise the ruler's expected total revenue through
Income
Tax
Rent seeking
Individuals may invest in rent-seeking capacities to twist legal system to favour
Example
Purchasing guns or bribery
Enforced or Not
Rent Seeking Game is Played
2 Types of Coercion
Coercion in Determining Political Regime
Informal Rent-Seeking
Resources invested into informal rent-seekin capacities are permanenty transformed into coercive forces
Coercive force in crucial periods of political transition (De Facto Power) is not constant but are Infrequent and Temporary
Need establishment of fundemental political and legal institutions (De Jure Power)
Made possible by protection capacities of citizens
Citizens might have to increase their informal capacities to protect their properties forming a routing and credible counteracting force against the ruler's arbitrary power
Main Results and Evidence
1. Legal Quality under Monarchy
Monarch Optimal Legal Quality is 0
Advantages in expropriation is large enough, will keep legal quality at 0 until physical captial investment starts
When advantage in exproporation is large, monarch has small risk of being robbed from others
Thus optimal to have no rule of law
If advantage is low, monarch has risk of being robbed
Positive legal quality is optimal and will slowly increase as income increases
Example
Crown was responsible for day to day gov operations --> paid the judges
Influenced judges and openly fired those who were against them
Had people jailed without charge or lengthy periods + excessive bail to make it costly for opposition
2. Improvement of Property Protection
Physical Capital Stock increases
Benefit of Legal Quality Increases
Rent seeking intensity decreases
Wealth and Coercive power of citizens become large enough
Challenge the monarch for political regime transition to democracy leading to impovement in legal quality
Example
Abolishment of Star Chamber in 1641
Made sure all cases had to be tried at common law --> supremacy of common law, favourable to property rights
Crown could not use "divine right of kings" to put themselves above law
Parliament supremacy
Management of the government and direct check on crown
Summary
Politial rights become more democratized
Legal Quality increases and Rent Seeking Decreases
Changing R/S
1. Under Monarchy
Strong gov --> Weak Law
2. Under Democracy
Strong Gov --> Strong Law
Strong rule of law + Strong gov means equal distribution of power
Concluding Remarks
Property Rights Security
Determined by evolving factor composition and income distribution of citizens
Dominance of physical capital > natural resources
Lower income inequality
Solid Foundation for Better Security
Instituional Hierachy
Political Rights > Legal Rights > Informal Rent Seeking Effectiveness
Political Institutions are most fundemental
Determine Legal Instituions
Shape Economic Institutions via enforcement of property rights and contracts
Economic and Coercive forces can affect legal and political institutions
via Lobbying + Informal Rent Seeking Activities
If legally permitted means are not enough --> de facto political power is used to change political and legal institutions
Education and Human Capital
Purpose of Education
Debates on the Purpose of Education
University of Chicago
Questions the purpose of universities
Pressure of vocationalism + cirricular incoherence
Jeopardises the possibilities for liberal learning
University of Wisconsin
Tried to change the mission of the university to "meeting the state's workforce needs"
Wisconsin Gov Walker backed off when the issue became public and sparked outrage
Univeristy continues to affirm importance of general education as the foundational principle for liberal learning
Examples
Germany
Public Institutions
Corporate agents of public service and of the Imperial State
University tradiion had less responsibilities toward civil society compared to the US
Not considered to be institutions dedicated to advancing democratic political or social values
Singapore
KPI Syndrome
School consistently rank high in international exams
TIMSS, PISA
No.1 in healthy life expectancy and absence of corruption categories
Fared less well in social support, freedom and generosity
Singaporeans ranked 9/145 in financial but low 100s in others
Measures of Well Being
Purpose
Motivated to achieve goals
Social
Supportive r/s and love
Financial
Economic life to reduce stress and increase security
Community
Feeling safe and having pride
Physical
Good health and enough energy
Trade-off of Well Being
Security vs Creativity
Secutiy alone might produce a smug and stationary society
Needs creativity as its counterpart to keep the adventure of life there
Movement towards new and better things
It is not a Utopia to desire but where imagination and hope are alive and active
Hellen Keller
Security is a superstition
Avoiding danger is just as risky as facing it
Life is a daring advenure or nothing
Benjamin Franklin
Giving up a little liberty to gain a little security will deserve neither and lose both
Illusion of freeom / security
Vocational vs General Education
Different Scooling Structures
Vocational
Specific job-related skills to prepare for specific occupations
General
Broad knowledge + Basic skills in mathematics and communication
Foundation for future OJT and learning
Across Countries
US
Is an extreme example, eliminated vocational education as a seperate track in secondary schools
Specific skills become obselete too quickly and need to give them ability to adapt
EU and Others
Most vocational students in school-based programs
Combining school + work based vocational programs
Emphasise apprenticesips --> involvement of industry
3 Outcomes
Labour Market Outcome
School promoting vocational education focus on school to work transition
Gains in youth employment could be offset by less adaptability and diminshing employment later in life
Strong support for such trade offs, especially in countries that focus on apprenticeship programs
Used International Adult Literacy Survey to determine
Employment Outcome
Vocational education helps school to work transitions but reduces adaptability to changing work environment
Comparing the employment rates across education type and age
Initial employment advantage of vocational turns into a disadvantage
Macro Effect Outcome
General education costly to obtain but enables workers to operate new production technologies
Usage of vocational (skill based) compared to general (concept based) causes slower adoption of new technologies
Economic policies that favour vocational education will grow slower in equilibrium
Gap increases with growth rate of available technology
Human Capital Theory
Definition of Human Capital
Skills the labour force possess and regarded as a resource or asset
Investments in people increase individuals productivity
Such as education, training and health
1. Who provides for it 2. Where would it take part 3. What role does the state play?
Formal Concept
Returns to Education
Increased Productivity of Labour
Importance of Human Capital
Solow Residual
Portion of economic growth that cannot be exaplined by increase in physical production factors
Significant increase of the Solow Residual
Can be reduced when accounting for the growth in human capital
Critics of Human Capital
The human is not as important as physical capital
Education is no conceived as an integrated strategy to promote freedome, self enrichment, human development
Is a business activity driven by profit, employers will invest in specific training not general training when markets are competitive
Issue of Human Capital Investment: Capital Market Failure
Capital Market Failure
Financial constraints of borrowing for current training
Specific vs General
Firm specific skills and general-usage skills
Education that is perceived to not be contributing to economic growth may not be funded
Similar to firm's decision making
Institutions and Human Capital
Slavery
Extreme form of human capital
Human beings rented or sold, reduced 2 barriers to optimal human capital investment
1. Capital Market Constraints
Masters would have been wealthier --> no issue in borrowing against their future earnings
2. Having and employer to invest in general skills of employee
BUT Endowning Slaves with skills was Banned
Teaching slaves literacy skills became illegal
Prevented slaves from communicating and potentially revolting
Difference in incentive alignment issue
Moral hazard situtation: masters want to keep them dumb, don't get the full returns
The Relevance of Slavery
Can you control what you want?
A free person is enslaved neither to the sheer will of another nor to his appetite and passions
Serfdom
Not free to move, owed labour to owners and continued for generations
Indentured Servitude
Given period to pay back a loan (usually passage to US)
Declined as transport costs decreased as incomes increase
Enhanced capital markets and enabled geographical mobility
Wage Slavery
In a legally free labour force, legal and economic arrangements coerce the behaviour of the labour market
Important to create wants to encourage people to work for others --> longer hours and relocate for higher income
Property Rights in Persons
Forcing labour off the land fundemental limitation on the full rights
Another method is the creation of debt to increase labour input
Need to work for other coered people into migration to industrial areas and entrance into the industrial labour force
Labor Contracts: Apprenticeships
Free Labour with its Associated Educational Institutions
18th Century
Free Labour: Anyone who laboured for another lacked full property in himself and was "free" in a restricted sense
19th Century
Emphasised the upward movement into farm ownership and artisanship
Factory Labour was avoided
Governmen is instituted no less for the protection of property than of the individual
Liberties and Virtue
Security vs Freedom
Freedom is Easily Degenerated
License or licentiousness threatened the existence of a nation
Experimenting with liberty depends on civic virtue of country
Responsibility
Independence
Community Spirit
Civic Virtue
Hopes for America are on the character of its people
Written constitutions nor unwritten rights nor militaries can save a nation that won't save itself
Highest reflection of humankind's political or communitarian nature
Seeks to cultivate and improve humanity
Independence by Land Ownership
Self interest is different from selfish interest
Ideal Citizen is independent and responsible for himeself
Owes no one
Therefore should hold land
Land ownership allowed citizens to cultivate virtue and independence
Model for Educational Change
Motivation and Evidence
Change in School Structure
Universities were invented before primary schools
Mass Specific Education vs Elite General Education
Only elite were given general education
Mass education started as vocational education
Evidence
Before 19th Century no formal education for the masses, only elites were educated in classical studies to create free thinkers
Scientific knowledge was accumulated by scholars and started the economic growth
Industrial revolution started the rise of science based industries
Need to train the masses in relevant skills and technical knowledge
Vocational education for inustrial education
Nothing changed for the Elites
Dual track education continued until after WW2 when a unified general education system was attempted
Elite Education
Universities offered ARTS, LAW, MEDICINE and THEOLOGY
Trained the future leaders for State and Church
In the Renaissanace, studu of language and literature was known as humanities
Model Intuitions
Distinction between General and Specific Education
General
Increases general ability in learning new knowledge
Costly to acquire becauses needs to be built on a knowledge base
Increases productivity in problem solving
Increases skills to extract gains and defend interests
Specific
Task specific skills
Less costly to acquire
Narrow in knowledge coverage
Not deep enough to facilitate further learning and adaptation
Only increases task specific productivity
No always rent seeking skills or organising efficiency
Implications
When technological changes are slow, more beneficial to gain specific skills as there is less need to adapt to new tech
Evidence
Primary schools teach reading and number skills in prep for future vocational training
Inculcating blind obedience
Primary schools teach thinking and indepdent studies in prep for future academic endeavors
Political Side
Evidence
“ A man who has never gone to school may steal from a freight car, but if he has a university education he may steal the whole railroad"
Better educated people are beter organised and more active politically
Mass Education
Only specific education is allowed
Elite will benefit more from an efficient workforce through larger tax revenues
Elites political privileges will also be threatened when the masses acquire more general education
Evidence
Elite in england opposed mass schooling as it would render the labourous classes insolent to their superiors
Elites will focus on mass specific education when potential loss of political rent is > productivity gain
Specific education can be supported by the elites because it is not necessarily conducive to democratisation
Elite Education
If potential rent is large enough, elites will only focus on general education
Will not follow the choice of specific education that comes from pure economic concerns
Basic Results
Driving Forces of the Model
Differences
D1: Apply frontier knowledge
D2: Generate new knowledge
D4: Increase productivity in any task
D3: More Costly to acquire
Political Conflicts
Elite impose tax on masses
Tax increases in the Elties' GE
Decreases in the masses's GE
Mass Specific --> Dual Track --> Mass General Education
Implications
Benchmark Results (w/o Political Conflict)
Specific education occurs earlier than general education for all
Main Results (w/ Political Conflict)
Elite
NOT invest in specific education but general education to extract more tax
Masses
Under elite rule, specific education may arrive earlier and general later when compared to benchmark
Three Pases of Educational Change
1. Elite Education
Political Elite are educated first in GE, masses do not receive any education
2. Stratified Education
Capital:Labour ratio is high enough for elite to support technical education
Education system is stratified ie. layers
3. Mass Education
Elite rule is replaced by democracy
Determined by GE of masses
Mass education may still be Dual track initially
SE and GE are pursued
Long run, mass GE is pursued
Extensions
1. Humanities vs Sciences
Humanities more likely to increase political rent seeking skills
Ruling Elite invest more into Humanities > Natural Sciences
Esp when politica rent is larger
Elite more willing to teach masses natural sciences than humanities
2. Obedient Masses
Teach massess values that solidify their rule
Public support of mass education
State building rationale of mass schooling
How it relaes to educational change over time
New Insights
Education and Democracy
Compatibility between mass specific education with the elite rule
Average schooling level may not be a sufficient statsitic for education
What children are taught is more important
Explains why Prussia started mass education first but democracy was later than others
Mass education was predominantly vocational with heavy does of obedient and patriotic conditioning
Work well for authoritarian / elite rule
3. Closed Vs Open Elites
Closed Elite: West
Group is fixed and determiend by birth
Only a fixed group is entitled to gains
Open Elite: China
Bureaucratic system in China
Elites were recruited through standard exams
Which is better for social welfare?
Open Elite might seem better because it gives everyone equal chance compared to Closed Elite
But this is not true
1. Open Elite System is more stable in stabilising elite rule
Richest and smartest individuals will invest in GE and join the elite
Masses have no education or only SE thus little political power to challenge the elite
2.Open Elite System over invest in humanities
Over investing in humanities and Under investing in matural sciences
Differences between Fedual China and Western Europe
Historical Evidence
Germany
Prussia started mass education
Took over education from the Church
Stratified 2 class school system
Aimed to create an intelligent but obedient patriotic citizenship
If you were going to form the directing class of society, a univeity would be created
Basic pattern of 2 class education has not changed
France
Law of 1833 and French national education in 1870
Established lower and higher primary schools
Mass education
2 Class School System
Primary and Vocational schools
Schools for the Elite
Reforms in 1960
Secondary education opened to all children
Followed by lycees and universities
England
Compulsory elementary education for the masses
Reading and writing
Educational provisions and made the general provision of secondary education possible
Modern type universites to extend the educational ladder
Was not that effective as only a small % of children moved into secondary school and even lesser went into university
1944 Education Act
Old class division between privelege and masses was broken
Most state maintained secondary schools are comprehensive
US
Similar to that in Europe
Training a small elite in languages
Elementary schools established as basic education to the masses
Secondary school increased
Increase in vocationla education due to the increase in white collar workers
Rapid growth of higher education occured after WW2
Transformation of a secondary system into a mass preparatory system
Educational Change: Analysis
Model Setup
The Economy
Preferences
Overlapping Generations
Optimal Bequests
Technology
A good that can be used for consumption and investment
Human Capital
Workers with general human capital can utilise frontier knowledge stock A
Specific human capital can only access knowledge stock they had before
D1 - 1st difference
Knowledge
Grows at an endogenously determined speed
Speed of knowledge accumulation is strictly increasing in general human capital
But with regard to the stock of specific skills
D2 - 2nd difference
Reflects that general human capital is more effective in generating new knowledge than specific skills
Capital Investment
Physical Captial
General Human Capital
Specific Human Captial
Cannot exceeed total savings + only investing in one type of human capital
Cost of General Education
Individuals have heterogenous innate abilities
Less costly in effor to invest in GE if one has higher ability or parents have higher general human capital
No cost for specific education
D3 - 3rd difference
D1 D2 D3 D4 Tax generating sills of the elite and tax evading skill of the masses
The Benchmark Model
Results
Knowledge accumualtes overtime
Economy invests in
Physical Captial --> SHC --> GHC
Lemma 1
Wage rate of GHC is > SHC
Gap increases in knowledge stock and capital:labour ratio
Lemma 2
Unique threshold ability a* in each generation
Only those who are above the treshhold will invest in GE while others in SE
Declines overtime as knowledge stock increases
Timeline of Capital Investment
There is only physical captail investment
From t, specfic education starts
t2, GE starts
Knowledge starts to accumulate at fasterspeeds making it beneficial for less able individuals to invest in GE too
GE will be available for all
Models
Return of investment
Educational Changes in the Benchmark Model: Mass SE --> Dual Track --> Mass GE
Average Human Capital
T1
Avg level of SHC remains at the endowment level 1 before period t1
It starts to increase as individuals aquire SE from t1
T2
Avg level of SHC decreases as individuals switch from SE to GE
Returns to intial level 1 at T3
Inverted U shape pf SE is observed during economic development phase
Accumulation of GHC starts later than SE but stock increases over time
Proposition 1
SE starts earlier than GE when knowledge sock increases exogenously at a slow rate
All Agents invest in GE when growth of At is sufficiently fast
Indiviudal Ability
The Political Economy Model
General human capital enhances an individual poltiical bargaining ability
Tax generating sills of the elite and tax evading skill of the masses
D4
Results
Channels to have a higher bequest theremore larger aggregate stock of physical captial in each period
Concentration of capital endowment of the few elite
Extra tax revenue they extract
Result
Elite will invest earlier and much more into SHC and GHC when compared to the benchmark model
Eite might skip stage of specific eduacation to start direcly with general education
Reverse Order
Possible because of GE increases ability to in political rent seeking
Brings higher return to individuals and above its role in production
Example
Propertied elite could have specific education
Enhancing management and values of their properties
1.Elite General Education
Proposition 2
When tax revenue is large enough, elite will only invest in general education
Elite education starts earlier and invests more
Educational Change in the Political Economy Model: Elite to Mass General Education
2. Stratified Education (Elite GE and Mass SE)
Proposition 3
Under elite rule, free mass SE starts
Only happens once capital : labour ratio is reached
GE for masses will never be supported
Masses are able to evade taxes
If ever supported, will not go beyond a certain level
3. Political Regime Change
SE increases income of masses --> allows them to leave bequests and investments
Exploitative tax and free SE under elite rule discourages masses to invest in GE
BUT the ablest non-elite individuals find it beneficial to acquire GE
Others follow, increase the cost of tax collection so high
Elite rule replaced by democracy
Under democracy
No exploitative tax, education policies are determined by majority voting
People decide the choice of public education investment that is best for the future
4.Mass Education Under Democracy (Dual Track to Mass GE)
Proposition 4
Under Democracy, dual track more likely to continue and last longer IF income inequality is high
Dual Track means free SE and private GE
eventually replaced by free GE
When initial income inequality is high, large proportion of ppl have high cost to invest in GE
Prefer with free SE
Possible that dual track education is chosen by the majority and not a conspiracy by the elite
Conclusion
Political Economy Model Accounts For Educational Change FROM
1. Elite Education
Evidence
15th to 19th Century
Liberal Education formulated by the Greeks dominated the elite education
Germany
English public schools
American Colonies
2. Stratified Education or Dual Track Education
Mass SE
Evidence
1870 - 1960
Secondary school and Universities for the privileged
Elementary and Vocational schools for the masses
3. Mass General Education
As knowledge stock increases over time
Evidence
France
1960
Access to Secondary education open to all children
1980
Access to higher education
England
1960
Increased in number of comprehensive skills
Association between mass GE and Democracy Association between mass SE and Elite Rule
Varieties of Capitalism
Economic Institutions: Firms Vs Markets
Markets: Exchange Platform
Exchange that is voluntary
Subject to marketplace rules
Markets Vs Organisations
Markets
Invisible hand that coordinate individuals to get efficient results
Organisations
Visible hand
Market Failure and Transaction Costs
Workable Platforms
1. Information flows smoothly
2. People can be trusted
3. Competition is fostered
4. Property rights are protected but not overprotected
5. Side effects on third parties are curtailed
Market Failure
Asymmetric information
Moral Hazard
Market power
Weak property rights protection
Firms
Production functions
1. Must know what to produce
2. Find workers with relevant skills + knowledge and give them incentives to work
3. Who bears the risk and who has the final say
Importance of Firms
Bulk of economic activity hapens within formal, managed organisations
70% are within firms
Why do Firms Exist
Minimise transaction costs
Identify and describe what uo want
Find what you want
Checking the quality
Find people who want output
Measure the cost of producing a unit of good / service
What to do if contracts are violated
Role and Purpose
Role
Coordinate contracts
Governing using authority
Purpose
Gain profit
Exerting influence
Organisational Forms
Sole Operations
Partnerships
Collectives
Unlimited Liability
Incorporated bodies]
Unlimited, Specified, Limited Liability
Limited Liability Corporation is the most predominant
Corporations
Best suited for large scale business enterprise
Allows for the separation of financing + managerial
Allows holders of capital to invest w/o needing skills to manage
Allows individuals with talent to manage w/o having capital
Financing Methods: Debt vs Equity
Debt Finance
Non-contingent
Return to lender is pre-determined
Lenders face default risk
RA is impt
Equity
Rasiing captial through share issuing
Contingent
Return to investory is dependent on the performance of the enterprise
Liability
Unlimited Liability
Requires investor to be accountable for debts
Limited Liability
Restricts libility to the paid-up capital by shareholder
Reallocates risk from shareholders to other creditors and society
Shareholder sovereignty model of corporate governance
Potentially go bankrupt and demand that shareholders be liable for debt
Thus corporate legal codes are important
Benefits and Risks
Limited liability has risks but creditors have benefited in the long run from the productivity of limited liability firms
W/o limited liability firms are more risk adverse
Leading to lower investment, Lower Consumption
Less innovation and Less economic growth
Society takes inceased responsibility through worker's comps, govt assistance
Corp Governance Issues
In whose interest is the firm governed
Shareholder Sovereignty
Management objective is to maximise shareholder value
Michael Jensen Shareholder View Public corporation is compilation of complex set of voluntary contracts
Vest control rights in the constituency bearing the risk
Criticises the stakeholder view
No guidance for managers when there is a COI
Managers serve the shareholders and act in the best interest of them
Stakeholder View
Broader view of who's interest should be considered
Separation of ownership and management have principal-agent problems
Governance Issues
Diversification
Many investors take small investments in corporations
Result in fragmented shareholdings
Who invests resources to monitor the management?
Internal Governance
Accounting
Tracking financial resources
Heirachies
Decision rights, defined roles and responsibilities
Incentive
For management decision making
Problems
Information Asymmtery
Complexity of Businesses
High Monitoring Costs
Incentive Problems
Managers and employees often have personal incentives to use resources
But might not be in the firms interests
Agency Slack
External Regulation
Important Regulatory Support
Setting common accounting standards
Independent audits of incorporated bodies
Public financial reports
Borader disclosure provisions
Timely public statements that might have sig impact on a firm's share price
External Discipline
Laws, codes, regulations that specify the fiduciary duties of those in control
Rules on stock exchange and trading
Credit rating agencies, auditing firms
Efficient
Low cost, well goverened and trusted
Exit, Voice, Loyalty Framework
Exit
Exit R/S
Sell stock
Quit club
Change firm
Break up
Voice
Complain to bring change
Loyalty
Show loyalty
Examples
Economics has focused on exits
Market signals from investors selling shares
Provoking reform
Pol Science has foucsed on voice
Protest or electoral change leading to improved governance
Interdependence
Hirshman crucial importance of recuperation mechanisms
Interdependence of the exit and voice options in the case of firms
If everyone chooses to EXIT there would be instability and misallocation of resources
If no one chooses to EXIT then VOICE has no impace
Must have an optimal mix of EXIT and VOICE to stimulate recuperation mechanisms
Corp Ownership Patterns
Different Patterns of Corporate Ownership
Germany, France, Italy, Sweeden
Have a block ownership of about 20%
US
US investors have a significant force but do not own 20%
Why are there differences?
Economic Development
Scale of enterprises associated with technological levels
Corporate Law
Political Economy View
Laws arise from politics --> need to understand what the interests that society demands
Conflicts of interests in firms become political through cross firm coalitions of interests
Equilibrium: Action + Reaction
Actions that increase the power of one group will get a Reaction from affected groups
Aiming to diminish the negative impact on their interest
Example
Anti-market actions by gov or private actors
Gov laws empowered unionised labour agaisnt managers --> affected shareholders
Strong block shareholders so managers dont give in
Balance between Trade-offs
Democractic nations conciously want a balance
Collective action and individual liberty
Co-operation in the pursuit of public goods and competition
Respect for social value and individual self interest
Optimal trade off between social fairness and economic efficiency
Institutional Complementarity and Clusters
Institutional Clusters
Liberated Market Economies (LME)
Anglo Saxon Countries
Strong VC
GE
Flexible labour laws
High Tech industries with radical innovation
Coordinated Market Economies (CME)
German model
Vocational training
Long Term Corportaion
Engineering industries reliant on incremental innovation
Long Term Investment
Customer specific products
Mediterranean Market Economies
Large agrarian sector
State intervention leaving them with non-market coordination in corp finance but liberal arrangements in labor relations
Coordination via Markets or Relations
US Model
Market co-ordination of economic agents
Address market failiures
Tradable pollution permits
Patents
Coase Theorem
German Model
Non-market coordination
Long term strategic relationships
Welfare protection
Pigouvian Intervention
Instituional Complementarity
Firms
LME
Invest in switchable or general assets
Can be realised if diverted to other purposes
CME
Invest in specific assets
Assets that cannot be liquidated easily
Assets that depend on the active coorperation of others
Complementarity between Financial and Labour Institutions
Long term employment is more feasible where financial systsm are not sensitive to profitability
Presence of financial markets that transfer resources readily
Fluid labour makets effective at sustaining employment
Highly developed stock markets indicate reliance on coordination
High levels of employment protection reflect high levels of non-market coordination in the sphere of industrial relations
CMEs strong labour protection but weak minority shareholder protection than LMEs
Performance Differences
Despite having some variations, CMEs and LMEs are able to provide satisfactory levels of long run economic performance
Systematic variation
Different capacities for innovation
Income distribution
Employment Distribution
Full time equivalent employment total number of hours worked per year
GINI is post-tax, post-transfer income inequality
In LMEs, adult popn engaged more extensively in paid employment and levels of income inequality are high. In CMEs, working hours are shorter and incomes are more equal.
CME and LME
CME
Financial System
Access is not dependent on available financial data or returns
Patient Captial
Firms are able to retain skiled workforce even through economic downturns
Invest in proejcts to generate returns in the long run
If finance is not dependent, how can investors monitor performance to ensure investment value?
Germany
Close R/S between suppliers and clients
Knowledge from cross-shareholding
Joint membership in avtive industry associations
A need for private or inside information about the company
Presence of dense networks between managers and technical personnel
Reliability
Firms sharing information with 3rd parties to monitor the firm
Sanction it for misleading others
Reputation
Membership is the value
Deter members from providing false information
Systems for network reputaitonal monitoring
Dense business networks from which funders can gain a considerable amount of inside information
Internal Structure
Internal strucutre of firm networking monitoring
Germany
Major decisions require agreements from employee reps, major shareholders
Consensus decision making
Encourages sharing of information and development of reputations
Long term employment contracts
Inclines managers to focus less on profitability
Industrial Relations
Production Strategies
Rely on highly skilled labour force + sharing of information
Continuous improvements in product lines and production process
Vulnerabilieis
Hold up by their employees
Poaching of skilled workers by other firms
German Industrial R/S
Set wages through industry level bargains between trade unions and employer associations
Equalising wages at equivalent skill levels across an industry
Hard to poach workers and assures them that they are fairly being paid
Limit inflationary effects of wage settlements
Establishment of work councils
Made up of employee reps
Provide employees with secuity agaisnt layoffs or negative changes to working conditions
Underpinned by capcity of either side to appeal to a dispited decision
Specific Training
Usage of industry-specific or firm specific skills
Dependent on education and training systems
Acute problems as workers need to be assured that apprenticeship will result in lucrative employment
Firms investing in training need to know that workers will acquire relavant skill and not be poached by companies
Germany
Publicly subsidized training sysmte
Employer associations provide benefits to their members
Encourage members to take apprentices + monitor their participation
Limits free riding on training effors by others
Ensures that training fits the firms needs + No external demand for graduates not employed by firms
Inter-Firm R/S
Long term employment contract --> collaborative inter compay relations
Diffusion of new technologies
Work with public officials to create publicly subsidized progs to improve firm competencies
Research is financed by companies in collab with quasi-public research institutes
Germany
Encourages relational contracting among companies
Tightly written formal contracts are not enough to sustain long term r/s
Diff from collusion
German Courts permit open-ended clauses in inter firm contracts
Presence of strong industry associations making standards well known and resolving disputes are impt
Supports copr strategites that focus on product differentiation and niche production rather than competition
Variations of CME
Industry Based Corporation
North EU
Group Based Corporation
Japan and S.K
Built on Keiretsu
Families of companies with dense interconnections
Encourages cooperation on sensitive matters
Firms operating in different sectors but under same family
Encourages firms to develop disinctive corporate strategies take advantage of capacities for cross sector tech transfer
Germany
Dependent on business associations and trade unions
Organised along sectoral lines
Vocational training schemes that cultivate skills
Corporate condition that is industry specific
Summary
Production Strategies
Dependent on specific skills
High level of corp commitment which are secured by
Long term employment contracts
Industry based wage
Protective work council
Only feasible with systems for network monitoring that provides firms with access to capital
Independent from fluctuations
Effective Vocational Training Schemes
Supported by industrial relation system that discourages poaching and encourages high level of industry specific skills
Encourages collective standard setting
Inter firm collab
Promotes technology transfer
Enhances how the industry operates
Economic returns is greater than its components parts alone
Model
LME
The Financial System
Encourage firms to focus on publicly assessable dimensions that affect share price
Dependent on valuation in equity market
Dispersed investors rely on public information to value company
Compensation systems that reward top management for increases in net earnings or share price
Industrial R/S
Firms in LMEs rely on market R/S between individual worker and employer
Top management has control over firm
High fluid labour markets make it easy for firms to fire and hire
More dependent on macroeconomic policy and market comp to control wages and inflation
Encourage individuals to invest in general skills
Transferable across industries and firms
General Skills
Perspective of workers
General skills are impt as can be used in many diff firms
Educational programs stress certification rather than acquisition of specialised skills
High levels of GE lower cost of additional training
Companies in LMEs focus on in house training
Interfirm R/S
Based on standard market relationships and enforceable formal contracts
Anti trust regulations to prevent companies from colluding
Technology transfer is secured through the movement of scientists and engineers from one company to another
Complementarities in LME
Labour market arrangements that allow companies to cut costs in economic downturn are in sync with firm's access to funds
Educational arragements that prioritise GE > SE are in sync with fluid labour markets
Makes technology transfer more feasible
Liscensing agreeemtns are more effective than interfirm collaboration
Context of legal system that militates relational contracting
Dynamic Instituitional Change
Comparative Instituional Advantage
Comparative economic advantage
Free trade will not impoverish nations by shifting production abroad
Enriches them by allowing them to specialise
Explains expansion of world trade + patterns of product specialisation
Relative endownment of basic factors
Land, Labour and Capital
Comparative Instituional Advantages
Cross national patterns of specialisation
CMEs better at incremental innovation but LMEs are better at radical innovation
Firms in LMEs more inclined to move activities abroad and better at attracting foreign labour and capital > CMEs
Change in National Systems
Institutional reform can snowball into other spheres
Example
Financial markets in CMEs are deregulated, difficult to find long term employment
Hard to recruit and sustain worker loyalty, changes in production regime
Adjustment
LMEs adjust faster than CMEs
Instituional complementarities generate incentives to radical change
Actors want to preserve arrangements in one sphere to protect complementary institutions
Producer groups have incentives to reach new agreement
Example: Germany
Revising vocational training schemes rather than abolish
Production regimes demand particular type of skills
Example: Wage Setting Equilibirum
German wage depended on employers' association to mount resistance to exorbitant wage demands
Major firms resisted high industry settlements on wages to maintain solidarity with smaller firms
Only increasing their own workers wage only after an angreement had been reached
Equilibrium-Disrupting Shocks
Under recent higher levels of international integration
Large German firms have moved operations off shore
Become increasingly sensitive to interruptions in production and inclined to veto lockouts
Disrupted the existing equilibrium
Deterioration in Wage Coordination
w/o cooperation of large firms, employers associations can no longer resist wage demands
Smaller firms drop out and trade union leaders are unable to accept small increases to preserve employment
Transition to New Equilibria
New Equilibrium is found through processess of negotiation and compromise
Process of adjustment will entail period of conflict + suboptimal outcomes
Presence of institutions give strong incentives to cooperate with each other
Example: Transition in Sweden
Sweden peak level bargaining broke down in 1980s
No longer meeting the needs of firms facing new technologies and greater international comp
Trade unions and employers developed new forms of wage-bargaining
Rather than revert to purely liberal arrangements