The Cambridge Realist Workshop: Ha-Joon Chang on Institutions and Economic Development: Theory, History and Policy

Redactor: Jae Ho Chung, Queens' College

Monday, November, 28th

   Ha-Joon Chang recently gave a talk for the Cambridge Realist Workshop, organised by The Cambridge Social Ontology Group (for more information on the Realist workshop, please look at http://www.econ.cam.ac.uk/seminars/realist/index.htm). Dr. Chang provided a critical examination of the currently dominant view on the relationship between institutions and economic development. First, Dr. Chang pointed out that the dominant discourse suffers from a number of theoretical problems - its neglect of the causality running from economic development to institutions, its inability to see the impossibility of a free market, and its belief that the freest market and the strongest protection of private property rights are best for development. Second, he pointed out that the evidence showing the superiority of liberalized institutions relies too much on cross-section econometric studies, suffering from defective concepts, flawed measurements and heterogeneous samples. Lastly, he argued that the dominant discourse has a poor understanding of changes in institutions themselves, which often makes it take unduly optimistic or pessimistic positions about the feasibility of institutional reform.

   Dr. Chang argued that the dominant discourse suffers from two categories of problems. First, it almost exclusively assumes that the causality runs from institutions to economic development, ignoring the important possibility of reverse causality, i.e. economic development changes institutions. Second, in considering the ‘institutions to development’ part of the causality, the dominant discourse theorizes the relationship in a too simplistic, linear, and static way. Discussions regarding theoretical problems involved many provocative questions such as:

1)      Do better institutions lead to more effective economic development?

2)      Are liberalized institutions better for economic development?

A.      Do institutions that provide greater economic freedom lead to faster growth?

B.       Is a stronger protection of private property rights better for growth?

C.       Is the relationship between institutions and economic development always the same?

    Dr. Chang also noted that there is now a huge amount of cross-section econometric studies indicating a positive correlation between the degree of liberality of institutions and economic growth across countries. He presented several areas where potential problems arise regarding the evidence presented by the supporters of the dominant discourse:

1)      Cross-section versus time-series

2)      Measuring the quality of institutions

3)      Problem of sample heterogeneity

    Dr. Chang also noted that the dominant discourse has a poor understanding of how institutions themselves change. The issue of the costs of establishing and running institutions is ignored, making their proposals for institutional reforms appear more attractive than what they really are. In methodological terms, they are either hopeless optimistic about the prospects of institutional change (the Global Standard Institutions discourse) or unduly fatalistic (the climate-culture school). Dr. Chang argued that only theories taking into account both structural constraints and real human agencies seriously can guide us between these two extremes.

    Dr. Chang concluded that: “institutions have become politically too important to be left to those who believe in these simplistic and extremist arguments.” I strongly recommend his article to students who are interested in the role of institutions in economic development.

 His paper can be downloaded from: http://hajoonchang.net/downloads/pdf/JOIEInstitutionsAndDevelopment.pdf

Quincentenary Lecture by Professor Sir Mervyn King



Redactor: Inna Grinis

Fri, 25/11/2011 - 17:00 - 17:45
St John’s College, Cambridge Quincentenary Lecture
by PROFESSOR SIR MERVYN KING, GBE FBA
Governor of the Bank of England

“The Global Financial Crisis"

   In 30 minutes the Governor presented the emergence and the development of the global financial crisis. His main message was that it is important not to confuse symptoms with causes.

    The latter go as far as the collapse of the Soviet Empire and the disappearance of an alternative to capitalism. From the late 1980s emerging economies started adopting market reforms and focusing on trade surplus growth. Capital flew not from the developed world to the developing one, as common sense would suggest, but the other way round. For instance China accumulated $3 trillion of Treasury bills by 2011.  Unfortunately the recipient countries did not have enough profitable investment projects, and this inflow of cheap money pumped consumption to unsustainable levels, and translated into bubbles in housing and stock markets.

     Mervyn King stressed that imbalances are the major cause of this crisis. In the context of Europe competitiveness disparities have accrued since 1999 with Nordic countries, such as Germany or the Netherlands, running 5% trade surpluses, while the periphery countries accumulated 10% deficits. Someone had to finance these, and until last summer this role had been undertaken by the private sector. The Bank sector debt rose from 100-200% of GDP to 500%. However this could not last forever, and the liquidity crisis began on the 9^thof August with BNP Paribas Investment Partners freezing their three investment funds, and the BCE injecting 94.8 billion euros into the financial system.

    The actual amount of subprime mortgages was not big enough to provoke such a crisis. It was the huge amount of bets on the mortgages - whether they would be repaid or not - that plunged western economies into this crisis. After BNP Paribas’ filial had suspended its three investment funds, it turned out that all the big banks had been involved. The sum of gains and losses should have been zero, but simple economic arithmetic could not work in this case since no one knew who the real gainers and losers were.  Mistrust took place and banks stopped lending to each other. Indeed banks’ leverage dropped from £50 to £20. Governments had to save these banks by recapitalising them, but at the time no one asked whether they could afford doing so. Hence debt was transferred from the finance sector to the public one. 

      The Great Panic has already destroyed 3 million jobs, and, as the Governor said at the beginning of his speech, no one has the ability to forecast the future.



Questioning the Basic Premises of Free Market Economics: Market, State, and Institutions

Talk by Ha-Joon Chang , Reader in the Political Economy of Development at the University of Cambridge.

Redactor: Inna GRINIS

Ha-Joon Chang decided to base his today’s talk on one of his articles published in 2002* that laid the foundations for a new heterodox approach to economics: the Institutionalist Political Economy (IPE).   Instead of simply criticising the free market doctrine for its anti-interventionist rhetoric, Chang reveals the four real weaknesses of “neo-liberalism” or as he calls it: the “unholy alliance” of neoclassical economics and the Austrian-libertarian tradition.

·  What is a “free market”?

The definition of a free market has evolved over time and there is probably no such thing as a “free market”. Whether a state intervention is considered as undermining the free market or not, will actually depend on the legitimacy and hierarchy of the “rights-obligations” present in a society. Consider for example child labour: today even the most neoliberal person won’t be happy to bring it back, however during the Industrial Revolution, regulating child labour was effectively disrupting a free contract between children who wanted to work, and employers who were keen on employing these children at the ongoing wages.

Therefore we might well see a market as “free” simply because we cannot distinguish between the regulation behind it and the values we have embodied over time.

 ·  “If the market fails, the economy fails”

We can only speak about “market failure” in contrast to some benchmark: the “ideal market”. But who sets the latter? Consider the example of a monopoly: by neoclassical standards this is a “market failure” since the benchmark is the “perfect competition”. On the other hand, according to J. Schumpeter this is a “market success”: monopolies drive capitalism through innovations and their presence makes the economy alive and efficient.

·  The “market primacy assumption”

Already K. Polanyi in The Great Transformation (1944) suggested that it is the state that institutes the market. Examples include the markets for electricity, telephoning, the defence of property rights... The experience of developing and ex-communist countries suggests than once you have destroyed the state, the market does not come in naturally, you need to create it.

·  Market, state and politics

Chang criticises the neoclassical solution of deregulating and depoliticising the market in order to eliminate the problems related to corruption and the interference of selfish bureaucrats with the free market. First of all “self-interest” is not the only motivation of human behaviour, but more importantly the “market is itself political”. The state determines the participants in different markets as well as their rights. Was the interest rate set at 0.25% because of the Supply and Demand interactions in the loanable funds market, or is it a political decision?   

Here comes the paradox: the “free market” that neoliberals want to save from the corrupted politics has been created inside an institutional structure and therefore is itself based on a set of political beliefs.  
   Capitalism is in fact much more than just “the market”: it is a complex set of formal and informal institutions such as the state, firms, markets, social norms...

   The IPE tries to overcome the above weaknesses by introducing the role of institutions. The latter motivate individuals’ behaviour, but individuals themselves can affect and change institutions. We cannot draw a clear boundary between the market, the state and institutions. A framework analysing their interrelation must be created.

*’Breaking the Mould – An Institutionalist Political Economy Alternative to the Neo-Liberal Theory of the Market and the State’, Cambridge Journal of Economics, 2002, vol. 26, no. 5

If you want to read the full article: http://www.unrisd.org/unrisd/website/document.nsf/0/44552a491d461d0180256b5e003cafcc/$file/chang.pdf

This is Ha-Joon Chang’s personal website: http://www.hajoonchang.net/

A great resource if you are interested in this topic.