Institutions and Norms in Economic Development.

Institutions and Norms in Economic Development

Mark Gradstein and Kai A. Konrad (eds), CESifo Seminar Series

The MIT Press: Cambridge, MA and London, 2007, xv, pp. 234, $30.00, hardcover. ISBN 978-0-262-07284-7.

The central theme of this book is that social institutions matter and must be brought under review to understand the variety of development experience. The social institutions considered are structure of governance, quality of legal system, and informal norms.

In an empirical chapter on centralisation in government structure, Nicola Gennaioli and Ilia Rainer use data from sub-Saharan Africa to test whether pre-colonial centralisation improved the quality of contemporary social institutions. They show that greater pre-colonial centralisation resulted in higher institutional quality, as represented by two indexes: Control of Corruption and Rule of Law. Centralised authority, they argue, reduces the potential for local elites to capture government. This contention is supported further by qualitative historical evidence from the African colonial period.

Stuti Khemani analyses fiscal federalism in India. Her regression analysis of fiscal deficits at the state level shows them to be connected to a variety of political and economic variables; she concludes that political affiliation between the party in national power and those in local power engenders more profligate spending in the latter. Khemani recommends that an independent fiscal agency be established at a national level to oversee budgeting of constituent states, arguing that political parties lack appropriate incentives for this.

Michael Kremer provides a political economy analysis of the formal institutions governing public education in Kenya, arguing that perverse incentives resulted in resource misallocation and class inequities. The Kenyan system for financing education was a mix of centralised and decentralised institutions. Kremer argues that this finance structure resulted in: too many schools with below optimal size on average; excessive spending on teachers relative to other variable educational inputs; and fees at levels beyond what median voters would prefer. Kremer's methodology is an analytic narrative, including both significant detail on the history of public education in Kenya and two brief mathematical models used to supplement his verbal argument. I did not find all of this fully persuasive.

Daniel Chen has taken advantage of a natural experiment in Indonesia to investigate linkages between religious activity and social violence. In the wake of the financial crisis of 1997-1998, Indonesia experienced a religious resurgence and a surge in social violence. Chen uses cross-section and panel data on violent events and measures of religious activity in a careful econometric analysis that finds a strong causal relationship between religious intensity and social violence. When questions of reverse causality and correlation with other variables are investigated, a robust association remains. Chen finds that religious intensity seems to be necessary but not sufficient to cause social violence. Economic stress is also required, leading him to recommend that governments establish secular social insurance to mitigate the link he finds between religion and social violence.

Other chapters are more theoretical. In a creative examination of the curse of natural resources, Pedro Vicente develops a framework to explain why some resource-rich countries succumb to the curse while others do not. His model involves repeated interactions among four agents who take on one of three roles, depending on outcomes in auctions of two job types: a political post and a bureaucratic post. The politician conducts auctions in the next period, and the bureaucrat can allocate a valuable permit. An agent losing in both auctions becomes a plebeian who may start an insurrection. The bureaucrat's permit allocation can go either to the plebeian or, corruptly, to the initial politician who can influence the probability of receiving the permit. Vicente characterises equilibria under two scenarios distinguished by assumptions on a key parameter representing agent strength. In one, three agents form a social elite while the fourth is continually a plebeian, unless she mounts a successful insurrection. This case of state capture and corruption is conditional on low initial strengths of the agents. If initial strength is sufficiently high, corruption and state capture do not occur and no insurrections are attempted, because the threat of a successful insurrection restricts the politicians' behaviour. He concludes that high-quality social institutions, which can mitigate corrupting influence of natural resource wealth, are related to the political strength of the population.

Michael McBride and Stergios Skaperdas develop a dynamic model of two groups competing for shares of an exogenous surplus value. Two behaviours are possible: War or Armed Peace. Given economic costs of war, they seek to explain why peaceful 'settlements [don't] take place in every case'. Their analysis shows how two particular features can lead to open conflict rather than settlement: (1) long-term contracting on security is not possible and (2) choosing war affects future strategic positions. Choosing war, while dangerous and costly, is a tantalising prospect because it allows a future free of expenditures required for an Armed Peace. A key conclusion is that this 'shadow of the future' is an especially strong inducement to war in lowincome countries because (a) they typically lack robust institutions that are needed to support long-term contracting and (b) Armed Peace is a more likely choice when the contested surplus is larger.

Karl Warneryd uses an abstract model to address the incomplete contracting problem between an entrepreneur and an investor. He constructs a four-stage game: (1) an entrepreneur selects a project, with uncertain payoff, and makes an offer to an investor; (2) the investor accepts or rejects; (3) project payoff is revealed to: (i) the entrepreneur alone or (ii) to both entrepreneur and investor; (4) investor and entrepreneur engage over the project's realised value and receive payoffs. He introduces social institutions by a contest success function that includes a parameter representing effectiveness of a legal system for protecting investors. The presentation is sparse, yet intelligible and insightful. Warneryd concludes that a high degree of investor protection, under asymmetric information, induces the entrepreneur to select less favourable projects while reducing aggregate appropriation costs. Under symmetric information the entrepreneur picks most favourable projects and the socially efficient value of the investor protection parameter is its maximum: 100%. While the immediate application of this model is to legal disputes, it would naturally extend to extra-legal cases, giving it much in common with the previous chapter.

In the final chapter Moses Shayo develops a model of how social identity influences political economy. He clarifies a concept of identity based on individual preferences and defines a social identity equilibrium as a steady state in which: (1) individuals select identities and related behaviour (eg voting), and (2) the social identities chosen are consistent with the social environment resulting from individuals' behaviour. He applies this to a democracy formulating redistribution policy by means of majority vote. There are four predictions: higher income, ceteris paribus, reduces support for redistribution; increased national (versus class) identification among the poor also reduces this support; the poor are more likely to identify with the nation; and cross-section data should show a negative correlation between levels of national identification and the extent of redistribution by the state. Shayo finds support for these propositions in survey data on national attitudes and values.

The role of institutions in economic performance is varied and complex, and this brief volume does not attempt to be comprehensive. Yet each chapter offers valuable insights. Although none of the authors writes from an economic systems perspective, I recommend the book to readers with interest in the institutions--performance connection.

doi:10.1057/ces.2008.8

Richard Lotspeich

Indiana State University, Terre Haute, IN, USA

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