GOV 324F Midterm 2

Douglas C North

“thinking about different rules by thinking of institutions”

Institutions are:

-rules of the game

-humanly devised constraints/framework that shape human interactions

-must be enforced to be effective

Institutional functions:

-reduce uncertainty (what to do/ expectations)

-define and limit set of human choices/constraints

Formal int:

-rules human beings devise, such as laws and regualtions

Informal int:

-Those that evolved over time, such as conventions, traditions, and codes of conduct

Organizations (players of the game)

political bodies: parties, parliament, council, regulatory agency

economic bodies: firms, trade unions, farms, cooperatives

social bodies: churches, clubs, athletic associations

educational bodies: schools, universities

Int affect development (negatively or positively) by:

-altering exchange/transaction costs

-changing production costs

ex:

-transitions from centrally planned economy market econ

-constitutions

-tax regimes

-private property rights

Political regime

-set of rules determining the main rules for a country’s politics

Categorization based on:

Freedom House’s aggregate scores

electoral rights, civil rights, and rule of law

How does a political regime affect development?

Daren Acemoglu

James Robison

=Both economic prize winners (applied statistical methods)

Democratic govs tend to:

-tax and invest more than authoritarian regimes do

-They tend to invest more in medical care and education: human capital

Not all political regime transitions may be equal:

the first election of regime transition is critical

Steven Fish seminal work:

Outcome of the initial election from soviet-style socialism determined the extent of economic reform by mid-1990s

Having a high score in intial elections index scores by country

-more liberal/pro-reform the outcome of the “founding election was”

-got rid of communist ideas→ led to their extensive economic reform

Regional governor’s turnover (more uncertainty)

→ less firms entering the market especially in 1-2 years tim

More deomcartic the region

→ Higher small form entry, but lower medium to large firm entry

The BLAT

-The system of informal contacts and personal networks which was used to obtain goods and services under the rationing during the SU

-In russia it means “petty crimes”

Blatnot

-notepad for blat contacts

-social security net, a social norm, specific contacts

There is Blat refrences to:

-Getting jobs for friends and relatives

-Exemption from different campaigns

-rights to maintain religious rituals

-meeting consumption needs

-important to this day: for getting into hospital, getting to good schools, enjoying leisure activities

Should PCS develop strong int first and development will follow or do they grow together?

-If institutions don’t come first you run the risk of state capture (need a strong administration 1st)

Corruption in PCS

-PCS have relatively high level of corruption compared to other regions of the world

Corruption

Misuse of public office for private gain

-bribes, kickbakcs, embezzlement of state funds, stripping of state assets, nepotistic hiring, violations of electoral and party finance rules

Prototypical case: politicla corrpution

-an individual or group deriving a benefit through public/state channels

Measurement of corruption

NGO

World Bank

Means of measurment:

-Ratings of country experts

-risk analysts evaluations

-polls of business executives and citizens

-experience based indicators

Problems with measurement

-stereotypes/perceptions vs actual incidences: on country level the correclation is quite weak

-some key data for comparison is only available from late 1990s

-Data on prosecution and registered crimes are available in some contexts, but may be biased

Perceived corruption in PCS

-Only some PCS were included in the early years—> first decade of transition is unknown

-CPI Score: higher score=less corruption

Business corruption in PCS

Percentage of firm executives who said it was always true that firms like theirs had to make additional irregular payments or gifts to get things done (BEEPS)

Determinants of corruption

Treisman: 60-80% of differnece in corruption in PCS can be explained by:

(THINGS ARE NOT EASY TO CHANGE)

-intial GDP per capita

-the number of years the country had been communist

-a measure of the country’s natural resource endowment

-the percentage of the population that adhered to Protestantism

HOLMES:

-The more authoritatrain a country is= the more perceived corruption there is

-Culture (measured by religion) also affect perceived corruption

-Higher GDP=Less perceived corruption

More reform in the 1990s=less perceived corruption

-more liberalism=less corruption

Graft as a state institution: Ukraine

-There are circumstances under which corrupt practices, such as graft can be beneficial (It can strengthen the state!)

-Ukraine: Some types of graft maintains administrative hierarchy of the state, because it permits systematic obedience=hierarchy-reinforcing graft

Conceptualization of the state: principal agent problem

principal (the state)→agent (state officials)

Agents are contracted to perform important functions for salary

-implement/enforce laws and decrees

-appropriately employ the power and financial resources of state office

ways to solve the problem:

-reward

-monitor

-sanction for noncompliance (no beaucratic drift)

States with higher corruption

-have higher tax revenues

-more gov expenditure

Graft

-Subordinates were allowed to steal from the state

-state orgs (security service, tax police) even helped lower-level officials to cover their tracks

-tracking of graft

-gave state evidence to enforce obedience (selective prosecution)

-allowed the state to track its share from the theft

-enabled the state to blackmail subordinates to gerner votes or achieve other political ends

Georgia: Maintaining fight against corruption

-As of 2019, Georgia was the highest performer on the CPI index

-Actions under its anti-corruption reforms include:

-Strengthening tax collection

-improving and cleaning up customs collection

-deregulating businesses

-Rooting out corruption in university entrance exams

-decentralizing municipal services

Why is it starting to falter in the recent years? (Georgia)

-Lack of checks and balances

-Kept clinging to power concentration

-Dominance of informality

-lack of independent judiciary

-state capture

Russia: Putin’s palace

-Alexey Navalny’s Anti-Corruption Foundation released a two hour video in 2021

-Supposed to be worth a billion dollars and ultimate manifestation of massive corruption

Accountability

• Citizens and society can hold politicians and bureaucrats accountable for corruption or misconduct.

• Accountability helps reduce corruption.

• Key methods include:

  • Elections

  • Performance evaluations of government officials

  • Audits of public institutions

  • Protests

Accountability:

Elections and blame attribution in Russian cities

Ø United Russia (Putin’s party) receives less

votes in regional elections in cities where

the city mayors/managers is appointed (vs.

elected) when economic conditions worsen.

Ø They attribute the blame for bad economic

conditions to the United Russia party if they

know the party appointed its leader.

Transparency

The quality of public processes and information being open and accessible

Ø Makes it harder to for elites and bureaucrats to engage in corrupt activities

Ø International financial institutions, multinational companies, transnational advocacy

groups play important roles in incentivizing postcommunist countries to pursue

transparency.

Transparency

Ø Example: Kazakhstan

-It resisted adopting international community’s

transparency standards in its extractive industry

until 2014.

-During economic difficulty, it adopted them

(information on government tax revenues and

expenditure, contract with international oil

companies)

Importance of independent media

Ø Blame attribution and ability to sanction leaders is critical for accountability and

transparency.

Ø It is only possible when there is independent media.

Ø Some argue this is why political regimes are correlated with corruption.

Ø Bad economic news is not

censored, but it is systematically

blamed on external factors.

Ø Good news is systematically

attributed to domestic politicians.

Ø Why do you think corruption levels are considered generally higher in PCS than

other regions of the world?

Weak institutiuons, communist legacies, and limited accountability made it easier for officials to misuse power

Why is corruption so hard to get rid of?

It becomes a part of the political system and benefits powerful elites who do not want change

Can corruption serve the society and economy? Can it be good?

It can help systems function short term, but in the long run it harms the economy and society

State Capacity

The state’s ability to do what it has and intends to in general or in relations to particular policies

Measuring state capacity

-Most efforts measure state failure; moderate state capacity is not accurately assessed (measuring presence vs absence)

-Others are based on expert opinions

-Most efforts do not provide a parsimonious (minimalist, simple explanaton/factor) concept of state capacity,as they bring wide raning concepts

measuring state capacity hard to measure concepts:

-Legitimacy

-Social stability

-Administrative capacity

-Coordination capacity

Public goods approach to state capacity

-Focuses on the logistical ability and infrastructural capacity of the state

-Public Goods: Any good, potentionally provided by the gov, that is both non excludable and non rivalrous

-EX: national defense, clean air, street lighting, public parks, the radio, fire defenses.

Non-excludabe

-Impossible to exclude certain/some groups of people from consumption/access due to failure to pay

-EX:

non-rivalrous

-use by one person/group does not reduce its availability to others

Taxing capacity:

Measures extractive capacity and ability to oblige its citizens

Progress in infrastructure reform:

Measures the government’s ability to formulate coherent goal and implement across its territory

Levels of corruption:

-Quality of property rights protection: Key for capacity to support development

-Ratio of noncurrency money (banks) to total money supply, or ‘contract intensive

-money’: Measures quality of contract enforcement

Ø Hungary, Estonia, Slovenia, and Czech

Republic are

The leaders

Kyrgyzstan, Tajikistan, and Turkmenistan are

the laggards

Russia is around the…..

Median

Level of state capacity stayed stable over the first and half of the second decade of transition →

State capacity is hard to change

Does state capacity promote economic development?

Yes! Through two primary channels:

• factors that enable markets to allocate resources more efficiently (law and order,

business environment)

• better performance in sectors where markets are more likely to fail (education,

infrastructure, and technology)

Reverse Causation

A situation where it is unclear whether A causes B or B causes A. In this context, economic development may increase state capacity instead of state capacity causing development.

Spurious Correlation

A relationship between two variables that appears causal but is actually caused by a third, unobserved factor (such as culture or institutions) influencing both.

EX: Shark & Ice Cream

Huge spike of ice cream sales around the same time of shark attacks; same correlation

Was the Soviet Union a capable state?

Its scope of activities was wide:

Ø Strong surveillance/coercion apparatus

Ø Reached every aspect of citizens’ lives

However, it lacked capacity:

Ø It was administratively dysfunctional

Ø Did not have funds/almost bankrupt

Administrative capacity of the state

-Bureaucracy is the interface between the state and citizens and main vehicle of policy

implementation.

-Generally, bureaucracy in transitional economics differ from the ideals of bureaucracy in market economies.

Market economy bureaucracy

(Weberian ideals):

• Professional service separate from the

political structure

• Selected competitively based on merit

• Bureaucracy makes decisions based on

rules

• Clear career path independent from

political changes

Transitional economy:

Bureaucracy is part and parcel with politics

• Bureaucracy constitutes a patronage network

for the government (e.g., state-dependent

middle class; privileged status)

• Bureaucratic discretion is rather large

• Career paths depend on political

directions/networks

Invisible hand

Bureaucracy: well-

organized, generally

uncorrupt, relatively

benevolent

• It provides public

goods and basic

regulations, but

private sector

prevails

Helping hand

Bureaucracy:

promotes private

economic activity

for some firms;

pursue industrial

policy, and often

have close economic

and family ties to

entrepreneurs.

Corruption is limited

and organized.

• The legal framework

plays a limited role--

-bureaucrats

adjudicate most

disputes

Grabbing hand

Bureaucracy:

intervenes in

economy, but not

organized---they are

independent

pursuing their own

goals and profits.

• It creates an

environment of

predatory regulation-

--harms

development.

How does bureaucracy affect development?

Through its structure

• Bureaucracies based on meritocracy and reward-based career paths tend to support

development

• Corruption networks/structures of bureaucracy determine if it helps or hurts development

• Large bureaucracies may have greater capacity to interfere with market mechanisms

More depends on the nature of bureaucracy:

-bureaucrats are substitutes for one

another: they compete to provide the

same service for the private sector

(More bureaucrats → low burden on

companies → better development)

-Bureaucrats are complements to one another: they

provide separate services for the private sector

(More bureaucrats → more burdern on

companies → worse development)

Ø How did size of bureaucracy affect privatization effectiveness?

• Data: 1985 to 2004 data on the performance of 25,000 state-owned and privatized

firms

• Method: Lab-like environment in Russian regions—77 regions

• Results: Privatization has a large and positive effect on firm performance

(productivity) in regions with relatively large state bureaucracies.

• Mechanism: The size of regional and local bureaucracies affects the post-

privatization business environment (shorter waiting times and fewer bribes when

dealing with bureaucrats).

Principal agent problem

Principal: (the state) → Agent (state officials)

Agents are contracted to perform important functions for salary

• Implement/enforce laws and decrees

• Appropriately employ the power and financial resources of state office

Moral hazard problem

Agents/political or economic actors become more risk-prone/reckless, if they believe that they are “insured” (someone else will carry the risk of loss).

Bureaucrats can experience a moral hazard problem if the government carries the risk/they feel immune to the consequences of their action (such as in the case of politicization of the bureaucracy)

“bureaucratic drift”

Why might state capacity in PCSs not change much over time?

• Institutional persistence: Bureaucratic structures, norms, and patronage networks become entrenched.

• Elite incentives: Political elites may benefit from weak capacity (less accountability).

• Low resources: Limited tax base restricts administrative expansion.

• Path dependence: Early institutional choices shape long-term outcomes.

• Conflict or instability: Repeated crises prevent long-term institutional reform.

Are shifts between different models of bureaucracy possible? Under what conditions?

Yes, but they are rare and usually require:

• Major political shocks (revolution, regime change, war, economic collapse)

• Strong reform coalitions with political will

• External pressure or incentives (EU accession, IMF conditions)

• Professionalization reforms (merit-based hiring, anti-corruption measures)

• Stable economic growth to fund institutional reform

Without strong incentives or crisis, bureaucratic models tend to remain stable.

From a public goods perspective, is Russia a capable state? What about broader capacity concepts? Is the US?

🇷🇺 Russia

• Public goods capacity: Mixed. Strong in defense and security, weaker in consistent service provision.

• Coercive capacity: High (security apparatus, repression).

• Coordination capacity: Strong centralized executive control.

➡ Capable in coercion and coordination, but uneven in broad public goods provision.

🇺🇸 United States

• Public goods capacity: High in taxation, infrastructure, welfare, and administration (though uneven).

• Coercive capacity: High but constrained by rule of law.

• Coordination capacity: Strong but limited by federalism and polarization.

➡ Generally high capacity, but fragmentation and political polarization can reduce coordination efficiency.

resource curse

-It refers to the hypothesis that countries rich in certain natural

resources tend to perform worse economically compared to

similar countries that lack these resources (Alexeev and Conrad:

we disagree!)

-Among the PCS, we observe that resource-rich states (Russia,

Kazakhstan, Azerbaijan, Turkmenistan etc) are laggards in

economic reform and development and resource-poor states

(Estonia, Latvia, Lithuania etc) are leaders.

Economic channels:

Dutch disease: when massive foreign cash comes into the

economy from resource export, it makes non-resource sectors less competitive

Political channels:

Politicians tax less in resource-rich countries, so they become

more repressive and authoritarian. Corruption increases.

Bureaucratic channels:

Bureaucracies become lucrative during times of windfall

income. Less qualified bureaucrats become attracted to bureaucracy lowering administrative capacity of the state.

Historical development of oil industry

Soviet/Russian oil industry

started in Azerbaijan.

By the early 1800s, a primitive

oil industry developed—82

hand-dug wells by 1829.

The industry was slow due to:

Ø Poor economy

Ø Corruption

Ø State monopoly

Ø Location away from

industrial centers

after WWI,

Russia and communist countries started to truly depend on oil

revenues.

Dependent variable:

fiscal system/tax system=how well can you tax your population

Russia is rich in natural resources:

Ø Oil reserve of 106.2 thousand million barrels (~6% of world reserve)

Ø Natural gas reserve of 49 trillion cubic meet (~24% of world reserve)

Ø Coal reserve of 173 billion tonne (~19% of world reserve)

Ø Other minerals: copper, diamonds, lead, zinc, bauxite, nickel, tin, mercury, gold, and

silver

Oil and gas are wasting assets

Cheap oil is running out: The industry is not modernized enough to exploit

reserves in ”greener” fields

- Russia is notorious for failing to invest in further exploration and technology

Russia’s natural resource reserve funds

• Stabilization Fund (2003): Created to save excess revenues from Russia’s oil and gas profits for future economic stability.

• Split in 2008: The fund was divided into the Reserve Fund (to protect the budget during economic downturns) and the National Wealth Fund (to invest in development and support future generations).

• Outcome after 2014: The Reserve Fund helped stabilize Russia’s budget when oil and gas prices dropped after 2014, and it was eventually fully used and discontinued.

Oil-war hypothesis:

countries tend to become more aggressive towards other

states when natural resource revenue, particularly oil price, is high

The Permanent Shock (2002):

Regional leaders adopted pro-business policies

The Temporary Shock (2014):

Regional leaders did not support businesses

Geography can play a critical role in development

This is a (second) hypothesis from Adam Smith:

Physical geography can affect a country’s economic development

Ø Coastal regions has easier access to sea trade vs. inland areas,

so they are wealthier

Countries of tropical and desert climate zones have:

higher transportation cost

• higher rates of infectious diseaseà higher fertility; younger

population

• lower agricultural fertility, esp for staple foods (wheat, maze,

rice)

than nations in temperate zonesà over time larger economies

Most developed nations/regions are in

the temperate-snow zone

Almost all the temperate-zone countries have either high-income economies

(North America, western Europe, Korea and Japan) or middle- income economies

with restrictive policies (eastern Europe, the former Soviet Union and China).

Access to sea also play a role per Adam Smith

Landlocked countries of South

America, Africa and Asia, tend to be

considerably poorer than their coastal

counterparts

Ø Economic production is mostly

concentrated near coasts in temperate

zones.

Postcommunist countries

Ø They are all in the temperate/temperate-snow zone.

Ø We know that not all countries within the PC space experienced the same development.

Ø There is considerable variation within the temperate zone as well as the PC space.

Proximity to the West/border of the non-communist world

Kopstein and Reilly: This is an important factor that determined why some PCS succeeded in

adopting liberal market economy, while others have failed.

Mechanisms: spatial diffusion across borders of:

Ø Influence

Ø Institutions

Ø Norms

Ø expectations

Proximity to the West/border of the non-communist world

Distance from the West increases the economic freedom scores of a given country

significantly.

Ø Distance from the West critically affects a country’s political openness.

We need to expand our thinking about “geography” → space and diffusion may matter not

only through geographic locations but through other channels.

We need more disaggregated measure of space and diffusion? Yes!

Ø Openness (number of TVs, tourists etc): Countries that are more open have been more

advanced in their economic reforms.

Ø Neighborhood score (neighbor’s marketization level): The more open your neighbor’s

economy is, the more open your economy is.

Diffusion: spatial and temporal concept

Geographic diffusion: The more open your neighbor’s politics is, the more open your

politics is. The more developed your neighbors are, the wealthier you are.

Ø Temporal diffusion: Diffusion is the process whereby past events make future events more

likely

Diffusion explains clustering of political or economic outcomes: All CA countries are

autocracies.