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).

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. 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 intervention.

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.



2 responses

  1. Think outside the box. Look at the world from space, as if you never stepped on this world. Now what you see is real, the systems today called civilizing factors are serving the few invented by the few.

    Democracy is a placebo to pacify the masses into believing they have a say.

    Democracy is really only a method where private financial institutions can loan their printed moneys on the value of your property “tax paying public” (without your direct consent) to your representatives and

    maintain an inflow of moneys owed and interest on capital of that “financial institution’s printed money’s stated value” using

    laws backed up with raw force (police and courts) if necessary to enforce the tax paying public to pay back with interest for what private institutions spend only pennies to print.

    The concept government, bureaucracy and every form of financial system that makes money from money was invented by the few to serve the few.

    Government is a quick fix so a few can harvest from the many.

    Governance is looking at the whole and finding out what wants from the whole are feasible.

    The idea of many pooling their money to form a mill to produce products was fantastic, today its a warped and weird idea to make money from money and is called the stock market.

    Thinking outside the box is easy once you step away from the rhetoric spouted by financial learning institutions intrenched into supporting the present day systems.

    The pyglassypiss condition is the give-me-gold & razzle-dazzle coloured glasses.

    Best Wishes


  2. Well thought out and food for thought. thanks

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