Private Diversion - Thievery, Squatting, Mafia Protection undertaken by private agents

Public Diversion - Expropriation, corruption by public agents

Close association between output per worker and measures of institutions

Long-standing policies favourable to productive activities rather than diversion

Difference in social infrastructure between Niger and US

Government Anti-Diversion Policies (GADP)

Openness to trade index

Permit or Encourage growth

Hinder Investment and Economic Development

Leads to rent-seeking activity

Eg. Free market compettion among firms is a good institution if properly constrained but can become predatory if firms get too much market power over others and consumers

Eg. Strong government can be effective in providing public goods but can also become predatory against private sectors

Argentina

USA

Institutions emerge as a by product of interactions eg. historical accidents

Different institutions chosen as a result of different beliefs

Institutions that maximise the toal welfare in society will prevail

Cluster of institutions prevailing is an equilibrium outcome of relevant game Agents cooperate, compete and bargain to maximise gains

Getting rid of agriculture as a major social activity --> essential for successful democracy

Concluded that the bourgeoisie were the primary agent of democracy

Key actor of full democracy us not capitalists but organised working class

Franchise expansion is forced on the ruling elites to mitigate revolutionary threat

Suffrage extension suggests that elites might do it voluentarily in their best interest

Institutions are the fundemental cause of long run growth

Level of human capital is more fundemental than institutions

Relative economic and hence coercive power shifts

1. Economic Development

2. Political Development

3. Dynamic Links

Sequence of events

Spontaneous and autonomous transitions from autocracy to democracy

Emerge from anaychy and develop a political-economic structure to produce sufficient order and stability

Territory rulers were winners in the free for all control over the sparse surpluses of the relatively unproductice agricultural economy, Blockmands 1998

Princes benefeited through extra revenues from the cities

Economic development strengthened the business and profession classes

Development of parliamentary democracy in England

Massive education reforms

Employers became more receptive to sharing power with workers organisations

Less fighting of unionisation

Opening the way for Political Transformation

Provide stable and peaceful environment

Political compromises achieved in relatively peaceful and timely manner

Economic development was greatly facilitated

Necessity of a strong army to establish a central monarchy

Repression and economic stagnation

Shaping distinct conservative modernisation path led by authoritarian governents

The later a country develops, a more complex developmental path is followed due to influences by other advanced countries

Savings

Bequests

One individual lives for 2 periods 2 Generations

Land

Capitalists

Workers

Suppose in country A people care a lot more about their offspring than those in country B. How can this be reflected in this model?

Suppose country A is very cold and hence they need to spend more resources on getting warm in order to survive. How may this affect bequests?

How will this affect the consumption decisions of individuals? In other words, which country will tend to leave more bequests?

Proof Of Bequest

Optimal Saving and Bequest

L: Land

Kt: Physical Capital

Ht: Human Capital

Depreciates fully after one period about 20 to 30 Years

At: Knowledge stock

Capitalist borrows at a rate to produce physical capital, rent it to final output producers for a return

Aggregate physical capital

Dominant group becomes first ruler + imposes tax

Highest possible tax rate is determined by ability to hide income

Challenging group becomes new ruler

Maintain current regime Repressed group pays extra fighting cost

Ruler extends political power to challenging group, who will not need to pay eploitative tax anymore

Outcome is stochastic in an open fight

Winning probability is proportianal to group's coercive power

Subgame Perfect Equilibrium (SPE)

Land

Physical Capital

Human Capital

Land is initially dominant Physical Captial Investment starts with enough surplus Human Captial investment of the masses start when physical capital stock is enough

Inequality of land ownership shorterns time for society to start capital investment

Induces change in political system

Capitalists do not emerge from landowners

Doepeke and Zilibotti 2008

Increase stock of physical captial induces faster growth in total output

Elites may find it beneficial to start investing into human capital through public education when investment in physical captial is inefficient

Mutual compromise is reached between elites and workers when too costly to figt

Poliical power extended to workers

Smooth Transition Path Is Benchmark, fighting is too costly

If fighting is less costly --> Open fight occurs

Commitment Problem

Every transaction has an element of trust

Economic backwardness can be explained by the lack of mutual confidence

Set of infomal values or norms shared among members of a group that permits them to cooperate with one another

Average trust level is associated with economic growth

Large Positive effects on performance of organisations

Documentation of substantial amounts of trust

Wallets were placed onto side walks in NYC

More than half were returned w/ Cash intact

Industrial and Organsation psychology

Algan and Cahuc

Pied Piper in 1284

Piper promised to rid the town of rats in return of payment but the villagers reneged on the promise

Cost of litiation + Difficulty of proving information

Reliance on other contract enforcement methods

If there are repeated interactions between diff members --> refrain from trade with a member who has behaved opportunistically

Example: The Maghribi Traders Coalition (1993)

Examples

Korea is less intense Firms would congratulate employeed when their children marry, condolences whose grandparents died

Want ingroups to be monolithic and homogenous

Emphasize homogeneity less and arguments are better

Exhibit high quality legal systems and democracy

Such as kinship and social communiteis

Reason for both Low Legal Quality and Slow Economic Growth

Large proportion of Lawyers in white collar labour force leads to declines in economic performance

US has the largest proportion of lawyers

Changes in US cutlure

Chosen to litigate rather than tolerate discomforts or settle disputes amicably

Communal spirit and stoic temper that kept Americans out of court has withered

US undergone collapse in

Has become part of political debate BUT reformers confrton powerful forces in American culture and politics

Alexis de Tocqueville

Combines distrust of centralised government power + set of structures

Preventing abuse of power, literally preventing agencies from capturing the policiy

Separation of powers

Refer to any mutual agreement between relevant parties

Establishment of legal courts, legal codes and procedures, judges lawyers police force are needed

Promise future gains in established relationship

Need to syay with current partners

Impersonal 3rd Party

Johnson (2002)

Implications: Socially Optinmal Results

Traditional Rich Elite (Rothschild Family)

Elites have higher wealth and education compared to the masses

Benefit from relational contract increses in educational level

Legal quality q of contract enforcement through political process

Agents take legal quality as given and match partnerships

Leading to lower income inequality

Legal development weakens elite but solidifies democracy

Elite rule may cause both low legal quality and inefficient outcome

Giving rise to economic stagnation

Contract Enforcement Model

Assumes that property rights are defined and enforced

Refers to owner's right to use a good or asset for consumption or income generation

Right to transfer to another party

Allows parties to rent or mortgage an asset

Enforce property rights and contracts Provide Public goods

Anarchy

Justification for creation of state

Protection against state predation is more important than private predation

Solution: Create cyclical chain of institutions forming a self sustaining equilibium

Purpose

Effect

Forms

Examples

Used their powers to expropriate producers, imposers arbitrary taxation, allocates the productive resources to allies for economic benefits or political support

Paving the way for property rights and limits on Monarchs Power

Civil War in 1642 and Glorious Revolution in 1688

16th Centruy

17th Century

Example

Gentry and Merchants would have used de facto political power to secure benefits in future + present

Commitment to future allocation not possible as it would be decided by those with future political power

De Facto Political Power is often transient as collective action problems will resurface

Changes in Political Institutions are a way to manipulate political power, economic institutions and outcomes

Stability and Inertia of Political Institutions Overcomes problems such as free-riding problems

Hierarchy of Institutions

When land is main production factor, property security is low

Security becomes higher with physical capital

OLG with fixed popn size and final output production

Relative coercive power of challenging group over the ruler

Why is there an Independent Legal System?

Example

Income

Tax

Rent seeking

Example

Rent Seeking Game is Played

Citizens might have to increase their informal capacities to protect their properties forming a routing and credible counteracting force against the ruler's arbitrary power

Advantages in expropriation is large enough, will keep legal quality at 0 until physical captial investment starts

When advantage in exproporation is large, monarch has small risk of being robbed from others

If advantage is low, monarch has risk of being robbed

Example

Benefit of Legal Quality Increases

Challenge the monarch for political regime transition to democracy leading to impovement in legal quality

Abolishment of Star Chamber in 1641

Legal Quality increases and Rent Seeking Decreases

1. Under Monarchy

2. Under Democracy

Strong rule of law + Strong gov means equal distribution of power

Dominance of physical capital > natural resources

Lower income inequality

Solid Foundation for Better Security

Political Institutions are most fundemental

Economic and Coercive forces can affect legal and political institutions

If legally permitted means are not enough --> de facto political power is used to change political and legal institutions

Questions the purpose of universities

Pressure of vocationalism + cirricular incoherence

Tried to change the mission of the university to "meeting the state's workforce needs"

Germany

Singapore

Motivated to achieve goals

Supportive r/s and love

Economic life to reduce stress and increase security

Feeling safe and having pride

Good health and enough energy

Security vs Creativity

Specific job-related skills to prepare for specific occupations

Broad knowledge + Basic skills in mathematics and communication

Is an extreme example, eliminated vocational education as a seperate track in secondary schools

Most vocational students in school-based programs

Combining school + work based vocational programs

School promoting vocational education focus on school to work transition

Strong support for such trade offs, especially in countries that focus on apprenticeship programs

Vocational education helps school to work transitions but reduces adaptability to changing work environment

Comparing the employment rates across education type and age

General education costly to obtain but enables workers to operate new production technologies

Such as education, training and health

Portion of economic growth that cannot be exaplined by increase in physical production factors

Significant increase of the Solow Residual

Is a business activity driven by profit, employers will invest in specific training not general training when markets are competitive

Capital Market Failure

Education that is perceived to not be contributing to economic growth may not be funded

Similar to firm's decision making

Human beings rented or sold, reduced 2 barriers to optimal human capital investment

Teaching slaves literacy skills became illegal

Prevented slaves from communicating and potentially revolting

Difference in incentive alignment issue

A free person is enslaved neither to the sheer will of another nor to his appetite and passions

Enhanced capital markets and enabled geographical mobility

Important to create wants to encourage people to work for others --> longer hours and relocate for higher income

Forcing labour off the land fundemental limitation on the full rights

Need to work for other coered people into migration to industrial areas and entrance into the industrial labour force

Free Labour: Anyone who laboured for another lacked full property in himself and was "free" in a restricted sense

Emphasised the upward movement into farm ownership and artisanship

Experimenting with liberty depends on civic virtue of country

Written constitutions nor unwritten rights nor militaries can save a nation that won't save itself

Seeks to cultivate and improve humanity

Ideal Citizen is independent and responsible for himeself

Owes no one

Therefore should hold land

Scientific knowledge was accumulated by scholars and started the economic growth

Need to train the masses in relevant skills and technical knowledge

Vocational education for inustrial education

Dual track education continued until after WW2 when a unified general education system was attempted

Increases general ability in learning new knowledge

Increases productivity in problem solving

Task specific skills

Only increases task specific productivity

Evidence

Evidence

Only specific education is allowed

If potential rent is large enough, elites will only focus on general education

D1: Apply frontier knowledge

D2: Generate new knowledge

D4: Increase productivity in any task

D3: More Costly to acquire

Elite impose tax on masses

Mass Specific --> Dual Track --> Mass General Education

Specific education occurs earlier than general education for all

Elite

Masses

Political Elite are educated first in GE, masses do not receive any education

Capital:Labour ratio is high enough for elite to support technical education

Elite rule is replaced by democracy

Mass education may still be Dual track initially

Long run, mass GE is pursued

Ruling Elite invest more into Humanities > Natural Sciences

Esp when politica rent is larger

Public support of mass education

Education and Democracy

Group is fixed and determiend by birth

Only a fixed group is entitled to gains

Bureaucratic system in China

Elites were recruited through standard exams

Open Elite might seem better because it gives everyone equal chance compared to Closed Elite

Took over education from the Church

Aimed to create an intelligent but obedient patriotic citizenship

If you were going to form the directing class of society, a univeity would be created

Established lower and higher primary schools

Primary and Vocational schools

Schools for the Elite

Secondary education opened to all children

Followed by lycees and universities

Reading and writing

Modern type universites to extend the educational ladder

Old class division between privelege and masses was broken

Training a small elite in languages

Increase in vocationla education due to the increase in white collar workers

Transformation of a secondary system into a mass preparatory system

Overlapping Generations

A good that can be used for consumption and investment

Grows at an endogenously determined speed

Reflects that general human capital is more effective in generating new knowledge than specific skills

Physical Captial

General Human Capital

Specific Human Captial

Cannot exceeed total savings + only investing in one type of human capital

Less costly in effor to invest in GE if one has higher ability or parents have higher general human capital

No cost for specific education

Physical Captial --> SHC --> GHC

Only those who are above the treshhold will invest in GE while others in SE

Declines overtime as knowledge stock increases

Knowledge starts to accumulate at fasterspeeds making it beneficial for less able individuals to invest in GE too

Return of investment

Educational Changes in the Benchmark Model: Mass SE --> Dual Track --> Mass GE

Avg level of SHC remains at the endowment level 1 before period t1

It starts to increase as individuals aquire SE from t1

Avg level of SHC decreases as individuals switch from SE to GE

Returns to intial level 1 at T3

Concentration of capital endowment of the few elite

Extra tax revenue they extract

Result

When tax revenue is large enough, elite will only invest in general education

Under elite rule, free mass SE starts

GE for masses will never be supported

Others follow, increase the cost of tax collection so high

Elite rule replaced by democracy

No exploitative tax, education policies are determined by majority voting

Under Democracy, dual track more likely to continue and last longer IF income inequality is high

When initial income inequality is high, large proportion of ppl have high cost to invest in GE

Possible that dual track education is chosen by the majority and not a conspiracy by the elite

Evidence

Mass SE

Evidence

As knowledge stock increases over time

Evidence

Subject to marketplace rules

Invisible hand that coordinate individuals to get efficient results

Visible hand

1. Information flows smoothly

2. People can be trusted

3. Competition is fostered

4. Property rights are protected but not overprotected

5. Side effects on third parties are curtailed

Asymmetric information

Moral Hazard

Market power

Weak property rights protection

1. Must know what to produce

2. Find workers with relevant skills + knowledge and give them incentives to work

3. Who bears the risk and who has the final say

Bulk of economic activity hapens within formal, managed organisations

70% are within firms

Minimise transaction costs

Role

Purpose

Unlimited, Specified, Limited Liability

Non-contingent

Rasiing captial through share issuing

Contingent

Requires investor to be accountable for debts

Restricts libility to the paid-up capital by shareholder

Reallocates risk from shareholders to other creditors and society

Thus corporate legal codes are important

Benefits and Risks

Management objective is to maximise shareholder value

Michael Jensen Shareholder View Public corporation is compilation of complex set of voluntary contracts

Criticises the stakeholder view

Broader view of who's interest should be considered

Many investors take small investments in corporations

Accounting

Heirachies

Incentive

Problems

Important Regulatory Support

External Discipline

Exit R/S

Complain to bring change

Show loyalty

Economics has focused on exits

Pol Science has foucsed on voice

Interdependence

Have a block ownership of about 20%

US investors have a significant force but do not own 20%

Economic Development

Scale of enterprises associated with technological levels

Corporate Law

Conflicts of interests in firms become political through cross firm coalitions of interests

Actions that increase the power of one group will get a Reaction from affected groups

Example

Balance between Trade-offs

Anglo Saxon Countries

German model

Large agrarian sector

US Model

German Model

LME

CME

Long term employment is more feasible where financial systsm are not sensitive to profitability

Presence of financial markets that transfer resources readily

Highly developed stock markets indicate reliance on coordination

High levels of employment protection reflect high levels of non-market coordination in the sphere of industrial relations

CMEs strong labour protection but weak minority shareholder protection than LMEs

Different capacities for innovation

Income distribution

Employment Distribution

Access is not dependent on available financial data or returns

Patient Captial

Germany

A need for private or inside information about the company

Dense business networks from which funders can gain a considerable amount of inside information

Internal strucutre of firm networking monitoring

Germany

Production Strategies

German Industrial R/S

Usage of industry-specific or firm specific skills

Acute problems as workers need to be assured that apprenticeship will result in lucrative employment

Germany

Long term employment contract --> collaborative inter compay relations

Germany

Supports copr strategites that focus on product differentiation and niche production rather than competition

Industry Based Corporation

Group Based Corporation

Germany

Production Strategies

Effective Vocational Training Schemes

Model

Encourage firms to focus on publicly assessable dimensions that affect share price

Firms in LMEs rely on market R/S between individual worker and employer

Top management has control over firm

High fluid labour markets make it easy for firms to fire and hire

More dependent on macroeconomic policy and market comp to control wages and inflation

Encourage individuals to invest in general skills

Perspective of workers

Educational programs stress certification rather than acquisition of specialised skills

High levels of GE lower cost of additional training

Based on standard market relationships and enforceable formal contracts

Anti trust regulations to prevent companies from colluding

Technology transfer is secured through the movement of scientists and engineers from one company to another

Labour market arrangements that allow companies to cut costs in economic downturn are in sync with firm's access to funds

Educational arragements that prioritise GE > SE are in sync with fluid labour markets

Liscensing agreeemtns are more effective than interfirm collaboration

Free trade will not impoverish nations by shifting production abroad

Enriches them by allowing them to specialise

Explains expansion of world trade + patterns of product specialisation

Relative endownment of basic factors

Cross national patterns of specialisation

CMEs better at incremental innovation but LMEs are better at radical innovation

Firms in LMEs more inclined to move activities abroad and better at attracting foreign labour and capital > CMEs

Example

LMEs adjust faster than CMEs

Large German firms have moved operations off shore

Become increasingly sensitive to interruptions in production and inclined to veto lockouts

Disrupted the existing equilibrium

w/o cooperation of large firms, employers associations can no longer resist wage demands

New Equilibrium is found through processess of negotiation and compromise

Process of adjustment will entail period of conflict + suboptimal outcomes

Example: Transition in Sweden