Modern Economic Theory and Development; Perspectives on Policy

Two Extreme Views: “Rational Development” and Public Choice Theory


Implicit in much of the policy discussion in the past have been two

extreme views of policy interventions. One is based on the premise of

“rational development”: all that is required is to provide individuals in

the economy with information about the consequences of different policies,

and Coasian rationality will ensure that the parties will make use

of that information to arrive at an efficient solution. To be sure, there

may be market failures, but social institutions arise spontaneously to

address them. Thus, only lack of information could lead to “inefficient

outcomes.” (In some variants of this view, government appears as a

benevolent dictator outside the economy, with the ability to act freely

on it. Thus, all that a policy analyst needs to do is to find out which

policies maximize social welfare and transmit that information to the

government, and it will be acted on.)


Few today hold to that view. If the adviser shows that there is an

optimal set of tariffs and encourages the government to put in place a

highly differentiated tariff structure, the advice might be followed. The

tariff structure, however, will depend not on the subtle deadweight-loss

arguments of the policy adviser but, rather, on the corrupting influence

of special-interest groups trying to seize the opportunities afforded by a

differentiated tariff structure to increase protection for their industries.

To be sure, they may even follow the “rules of the game,” hiring economic

analysts to show that an industry satisfies the conditions stipulated

for higher tariff protection. But of course, both they and the

government know that these are simply arguments needed to satisfy

public demands for probity.


The second polar view is the extreme public choice view: as social

scientists, we can just watch and interpret the playing out of the development

drama—we cannot change policies. In this view, political forces

produce an equilibrium set of policies. There are no degrees of freedom

for normative intervention—a situation that has been called the

determinacy paradox (Bhagwati, Brecher, and Srinivasan 1984).

We—and we dare say most development economists—reject both of

these extreme views of the role of outsiders’ advice. Conditional on the

information available, equilibria are often not Pareto efficient. Institutions

that arise in response to a market failure may not only fail to cure

it but may actually make matters worse, as we saw in the previous

sections. Outsiders can, however, have an effect on outcomes—and in

ways other than simply changing the information sets of participants.

But our understanding of the processes by which interventions do affect

outcomes is seriously incomplete, and many of the failures of the

past can be traced to naïveté in intervention strategies.

For instance, there is mounting evidence that the practice of conditioning

foreign aid to a country on its adoption of policy reforms does

not work, at least in the sense of leading to sustained changes in policies

that increase growth and reduce inequality and poverty. One cannot

“buy” good policies (World Bank 1999a). There are good reasons

for this: it is widely recognized today that successful policies need to

have the country’s “ownership”—not only the support of the government,

but also a broad consensus within the population—to be effectively

implemented. Policies imposed from the outside will be

circumvented, may induce resentment, and will not withstand the vicissitudes

of the political process (see Bruno 1996; Stiglitz 1998c).


Theories of the Ineffectiveness of Government Intervention


The issue raised by the public choice school is whether an adviser can

influence policy. A second, distinct issue is whether, in a market economy,

government intervention can promote good outcomes. There is a long

tradition in economics that the only proper role for the government is

to define and enforce property rights and to provide public goods. Beyond

that, government interventions are likely to be—in the extreme

versions, inevitably will be—ineffective, unnecessary, or counterproductive.


The fact that most of the “success” cases of economic growth have

involved heavy doses of government intervention provides a strong

counterweight to these general allegations. For instance, in the United

States the government has, since 1863, played a role in financial market

regulation. Evidence that since World War II downturns have been

shallower and shorter and expansions longer is consistent with the

hypothesis that better macroeconomic management does work. Even

in industrial policies, the United States has a credible history—from

the founding of the telecommunications industry, with the first telegraph

line between Baltimore and Washington in 1842, to its most

recent contribution to that industry, the creation of the Internet; from

the support of research and dissemination in the dominant sector of

the 19th century, agriculture, to support of research in the dominant

high-technology industries of today. Still, it is worth disposing quickly

of the major theoretical arguments underlying the ineffectiveness of



Government is unnecessary: anything the government can do, the

private sector can do better. The fact is that government is endowed

with powers which the private sector does not have, and these powers

are essential in addressing the public good and externality problems

that are rife throughout the economy. Coasians are simply wrong in

arguing that private parties by themselves, with given, well-defined property

rights, always resolve these issues.


Anything government does will be undone by the private sector. Although

there are specific models for which this assertion is true (see, for

instance, Lucas 1973; Lucas and Prescott 1974), it is generally not true—

for example, when government changes relative prices through taxation.

Still, there is an important moral to these models: the actual

consequences of government policies can be markedly different from

the intended ones.


Government is always captured by special-interest groups (Stigler

1971). To be sure, there are incentives for producer special-interest

groups to try to capture, for instance, the regulatory process. But there

are countervailing incentives for other groups. Stigler does not explain

why in some states it is consumer groups that capture, say, electricity

regulation, while in others it appears to be producer groups. In this,

too, there is an important moral: political processes are critical, but the

outcome of political processes is more complicated than simple theories

of capture would suggest.


A variety of interventions can affect outcomes i.e.

– Interventions to solve coordination problems,

–  Information as an intervention,

–  Interventions to change the dynamics of the political process, and

–  Interventions to change the distribution of wealth.




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