What institutional economics has to say beyond growth

Institutional economics has been mainly concerned with institutions for economic growth. Will the same insights apply for economic development?

Suppose an island is discovered amidst the pacific and a group of people decided to establish a country there. These people are from a variety of backgrounds, speak different languages and are of differing abilities. They decide that they want to achieve maximum possible development over the long run and consult an institutional economist for advice. They state clearly that growth is not the same as development and that they want to maximise development rather than economic growth. What advice will she be able to give them?

Given the state of theories today, the institutional economist will be able to say precious little by delving into her professional toolkit. First of all the state of knowledge in IE is such that one can only make tentative assertions even about maximising growth. There is at least some consensus among institutional economists that property rights, rule of law and a few other institutions matter for growth. Secondly, there is little in mainstream economics (with which IE is closely associated) to help her conceive what development is beyond growth. Even if she is given an understanding of what development means to these people, there is no theoretical guidance in IE today on how one can go about designing appropriate institutions.

I feel that this state of affairs is mainly due to the restricted conceptual framework that IE is situated in today. I will take up a definition of institutions from the Nobel lecture of Douglass North and will illustrate briefly ways of broadening the horizon. In his Prize Lecture, North said, “Institutions are the humanly devised constraints [emphasis mine] that structure human interaction [emphasis mine]. They are made up of formal constraints (rules, laws, constitutions), informal constraints (norms of behavior, conventions, and self imposed codes of conduct), and their enforcement characteristics. Together they define the incentive structure of societies and specifically economies”. This is perhaps the most widely accepted definition of institutions in economics, and has had a huge conceptual impact. I will start by suggesting two changes to it, followed by further ideas to expand the conceptual framework of institutions & development.

Institutions as enabling & constraining

There has been an argument for some time that we should look at institutions not just as constraints. Institutions also enable us to achieve certain goals collectively. For example, market as an institution enables price discovery. This cannot be understood purely from the perspective of constraints. Secondly, even the constraints that are in place often serve the purpose of enabling certain goals. In the case of the island that we started with, if we know what development means to the people (e.g. peace, all children should have the opportunity for good education, every individual should have income enough to at least meet basic needs, gender equality, etc.) , we can start by thinking of what institutions can enable each of these goals. Though we may not have a perfect solution, we can at least conceive of some institution that will enable these. In contrast, if we start with institutions as constraints, we will be able to go nowhere (e.g. think of the question: what constraints can we develop such that all children have the opportunity to have decent education?).

Action Vs. Interaction

Secondly, institutions do not structure human interaction; they structure human actions. Structuring actions can have the ultimate goal of influencing interaction –this is often so. But to argue that institutions structure human interaction is to miss many important things that institutions do. I will elaborate this argument in a forthcoming article. It suffices to say now that shifting to constraints on action enables us to focus on human freedoms directly. It should come as a surprise to nobody that institutions have an implication for human freedoms both in how it constrains what people can do and in what it enables.

Since most conceptions of development have a conception of freedom, this redefinition takes us closer to thinking of institutions for development. By focusing on interactions, institutional economists have so far focussed on markets, transaction costs, asymmetry of information, etc. By expanding the definition to cover all actions, we will greatly widen the ability of institutional economics to deal with development.

Expanding the conceptual toolkit

Finally, we have to bring in other conceptual toolkits including concepts like distribution of power, social space, etc. from politics and sociology. These will widen our understanding of human dynamics and how they operate through institutions and on institutions. These three sets of steps will significantly widen the ability of institutional economics to deal with development beyond growth.

There are of course many conceptions of development. I suggest that “development as freedoms” framework by Amartya Sen is immensely suitable to think of institutions and development. Sen’s conception of development as “freedoms” directly links to the idea of institutions structuring human actions. There are other significant advantages of his framework to theorise the role of institutions in development. I will take this up in the future.

About Vivek Srinivasan

I work with the Program on Liberation Technology at Stanford University. Before this, I worked with the Right to Food Campaign and other rights based campaigns in India. To learn more, click here.

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