I've added two new links over on the right nav side: World Bank's Poverty and Growth Blog and the NGO Center for Global Development.
November 19, 2008
November 17, 2008
Advise for young economists
Niny Khor, an economist from the Asian Development Bank, sent me some links to excellent blogsites that offer good advice for economist wannabees. The first one is offered by Chris Blattman. The other two is by Greg Mankiw (which Chris also has a link), one for undergrads and another for the graduate students.
They offer very helpful advice. Plus, Greg's post also show links to other advices from different renowned economists. Learn and enjoy!
They offer very helpful advice. Plus, Greg's post also show links to other advices from different renowned economists. Learn and enjoy!
October 13, 2008
2008 Nobel Prize for Economics
Paul R. Krugman won this year's Nobel Price in Economics! He won for his analysis of trade patterns and location of economic activity. I think we used his book (co-authored with Maurice Obstfeld) for our graduate class in international economics back then, and that's just about the extent of his influence to me.
That and the fact that I'm reading his blog regularly.
Congratulations to Dr. Krugman!
September 16, 2008
Top Blog Sites
Want to know the top economics blog sites out there. Check out the Palgrave Econolog lists. It's even updated regularly.
Some of the links I already have on the left nav bar are on the list. I added three new sites that I find interesting from the list.
Some of the links I already have on the left nav bar are on the list. I added three new sites that I find interesting from the list.
September 5, 2008
Chris Blattman's Blog
Added a new link on the nav side, Chris Blattman's blog--highly recommended by Dani Rodrik. Although focusing on Africa and politics, Chris has got some good perspectives on economic development.
Visit his blog site regularly.
Visit his blog site regularly.
August 28, 2008
Right way of comparing poverty across countries
The Asian Development Bank has just recently released this years Key Indicators Publication. It contains a special chapter, which I co-wrote with Rana Hasan and Rhoda Magsombol, focuses on the subject of purchasing power parities (PPPs). Entitled "Comparing poverty across countries: The role of purchasing power parities," this special chapter explores how alternative approaches to compiling PPPs influence internationally comparable estimates of poverty. Well, I wouldn't be surprised if in the next few days, a debate would show up comparing the "Asian" poverty line that we came up and the latest $1.25-a-day poverty line recently published by the World Bank (the media always like conflicts). But what our chapter places more emphasis on, and what I will focus on my piece below, is the importance of the methodology used in generating the PPPs, with the particular goal of using these PPPs for poverty analysis.
By the way, most of my discussion below is drawn heavily from the Highlights paper of the Special Chapter.
Which PPP?
At heart, PPPs are based on comparisons of prices of a selected set of products across countries. There are many types of PPPs, which depend on where the international comparison will be used for: GDP PPP, household consumption PPP, etc. Using household consumption PPP as and example, PPPs are computed in the following way. First, a basket of goods and services relevant for household consumption was identified. Second, the products in the basket were priced through a survey of retail outlets. Third, PPPs were generated at the “basic heading” level – i.e., a grouping of closely related products, for example, different varieties of rice or types of garments. Finally, basic heading PPPs were “aggregated” to generate a final set of PPPs.
Crucially, the process of aggregation involves weighting basic heading PPPs by an appropriate set of expenditure weights, or shares. In my example, the expenditure shares should accurately reflect the relative importance of basic heading groups of products consumed by households.
The general point is that the choice of the basket of goods and services is crucial for purposes of interpretation and use of a given PPP. In practice, PPPs at the GDP level are commonly used for comparing real incomes across countries. If instead the comparison involves standards of living across households, PPPs for household consumption expenditure would be more appropriate than PPPs for GDP.
As noted, PPPs are available for comparisons of GDP and its various subcomponents. Among these, the PPP most naturally suited for poverty comparisons is that pertaining to household final consumption expenditures.
However, as the special chapter clearly emphasizes, consumption PPPs are not ideal for generating comparable estimates of poverty. They may be inappropriate for poverty comparisons if poor households’ consumption patterns are significantly different from those of the general population. Such a difference may be explained by two broad reasons.
First, poor households may consume different types of products from the general population, i.e., the basket of goods and services priced for compiling consumption PPPs may not match up well with the basket of goods and services consumed by the poor. Some of the differences in the products consumed by the poor and by the general population may be quality related. For example, while both the poor and nonpoor may consume rice, the former may consume a lower-quality variety than the latter. Alternatively, some products are consumed by only one group or the other – automobiles, for example.
A further twist can appear if the prices paid by the poor versus the nonpoor differ in some systematic manner. In particular, to the extent that the poor and nonpoor purchase items in different quantities and/or at different types of retail outlets, one can expect the prices paid by the two groups to differ.
For many products, the unit price may well decline as purchase quantities increase. Since the poor are less likely to be able to afford large purchase quantities, they may end up paying more per unit of the product. Conversely, if the poor frequent fresh-produce markets as opposed to modern supermarkets-–where the retail prices may well incorporate the costs of air conditioning, parking space for cars, and other amenities for shoppers – more often than the nonpoor, they may pay less.
Second, even if both groups consume identical products and purchase them in similar quantities and from similar retail outlets, they are likely to spend very different proportions of their total expenditures on these products.
Thus for example, even if the poor and the nonpoor purchase and consume the same variety of rice and buy it in similar quantities and from similar retail outlets, the poor can be expected to spend a larger proportion of their total expenditures on rice than the nonpoor. Since PPPs are ultimately based on aggregating relative prices by expenditure shares, using the expenditure shares of the general population rather than those of the poor may well yield PPPs that are less than ideal for comparisons of poverty across countries.
While the overlap between these individuals and those who are “poor” in terms of a given absolute poverty line is unlikely to be perfect, the bottom 30% should capture the expenditure patterns of the poor better than the expenditure patterns of the entire population for any reasonable poverty line. As expected, the poor – defined here to be the bottom 30% – tend to spend a significantly larger share of their outgoings on food and nonalcoholic beverages. For example, the shares of food and nonalcoholic beverages are 65.6% and 51.1%, respectively, for the poor and for the general population in Bangladesh. More generally, the expenditure weights presented in the figure show systematic and significant differences in the purchase patterns of the general population and of the bottom 30%.
In a nutshell, the practice of using consumption PPPs for international comparisons of poverty implies that the PPPs are derived via a list of products and associated prices that may not be representative of products consumed by the poor and the prices paid by them. Additionally, the consumption PPPs are derived using expenditure weights, or shares from the national accounts, i.e., they reflect the expenditure patterns of the general population and not necessarily the poor.
To what extent do these two factors affect the generation of international poverty lines and associated poverty rates? Well, you'll just have to check the special chapter yourself. I won't go into those details. Suffice it to say, we generated alternative PPPs that make use of a price dataset that is relevant to the poor, as well as expenditure shares that are reflective of the poor. What turns out is that there are differences between the alternative PPPs, and given that our main purpose is to compare international poverty, we recommend the use of PPPs that are calculated using prices paid specifically by the poor, and using expenditure weights that are exactly represented by the poor.
By the way, most of my discussion below is drawn heavily from the Highlights paper of the Special Chapter.
Why the PPPs?
The demand for internationally comparable estimates of poverty is considerable. Policy analysts, researchers, and international donor agencies often want to compare the incidence of poverty across countries. These international comparisons can be carried out globally, regionally, or even across two countries.
Now, three things are needed to make such international comparisons: (1) nationally representative data on household expenditures for each country; (2) an international poverty line is needed that represents some predetermined threshold standard of living that is constant across the countries where poverty is to be compared; and, (3) a conversion factor needed to express the international poverty lines into local currency values in order to finally compute for the estimates of poverty using the aforementioned data on household expenditures.
Getting the first one is easy (depending on the availability). As I mentioned, I won't dwell on the second one. So for the third one, what is the conversion factor to be used?
Crucially, it will not be market exchange rates, but instead it will be the purchasing power parities (PPPs). PPPs are conversion factors that ensure a common purchasing power over a given set of goods and services. The chapter goes into detail on the differences between the market exchange rate and the PPP, but suffice to say the PPPs capture the prices of all products while market exchange only captures prices of tradeable goods. Obviously, the value of the international poverty line will depend on the value taken by PPPs, which means that the precise value taken by PPPs can make a considerable difference to the estimates of poverty for any given international poverty line. Moreover, . For these reasons, it is crucial to get the value of PPPs right.
Which PPP?
At heart, PPPs are based on comparisons of prices of a selected set of products across countries. There are many types of PPPs, which depend on where the international comparison will be used for: GDP PPP, household consumption PPP, etc. Using household consumption PPP as and example, PPPs are computed in the following way. First, a basket of goods and services relevant for household consumption was identified. Second, the products in the basket were priced through a survey of retail outlets. Third, PPPs were generated at the “basic heading” level – i.e., a grouping of closely related products, for example, different varieties of rice or types of garments. Finally, basic heading PPPs were “aggregated” to generate a final set of PPPs.
Crucially, the process of aggregation involves weighting basic heading PPPs by an appropriate set of expenditure weights, or shares. In my example, the expenditure shares should accurately reflect the relative importance of basic heading groups of products consumed by households.
The general point is that the choice of the basket of goods and services is crucial for purposes of interpretation and use of a given PPP. In practice, PPPs at the GDP level are commonly used for comparing real incomes across countries. If instead the comparison involves standards of living across households, PPPs for household consumption expenditure would be more appropriate than PPPs for GDP.
As noted, PPPs are available for comparisons of GDP and its various subcomponents. Among these, the PPP most naturally suited for poverty comparisons is that pertaining to household final consumption expenditures.
However, as the special chapter clearly emphasizes, consumption PPPs are not ideal for generating comparable estimates of poverty. They may be inappropriate for poverty comparisons if poor households’ consumption patterns are significantly different from those of the general population. Such a difference may be explained by two broad reasons.
First, poor households may consume different types of products from the general population, i.e., the basket of goods and services priced for compiling consumption PPPs may not match up well with the basket of goods and services consumed by the poor. Some of the differences in the products consumed by the poor and by the general population may be quality related. For example, while both the poor and nonpoor may consume rice, the former may consume a lower-quality variety than the latter. Alternatively, some products are consumed by only one group or the other – automobiles, for example.
A further twist can appear if the prices paid by the poor versus the nonpoor differ in some systematic manner. In particular, to the extent that the poor and nonpoor purchase items in different quantities and/or at different types of retail outlets, one can expect the prices paid by the two groups to differ.
For many products, the unit price may well decline as purchase quantities increase. Since the poor are less likely to be able to afford large purchase quantities, they may end up paying more per unit of the product. Conversely, if the poor frequent fresh-produce markets as opposed to modern supermarkets-–where the retail prices may well incorporate the costs of air conditioning, parking space for cars, and other amenities for shoppers – more often than the nonpoor, they may pay less.
Second, even if both groups consume identical products and purchase them in similar quantities and from similar retail outlets, they are likely to spend very different proportions of their total expenditures on these products.
Thus for example, even if the poor and the nonpoor purchase and consume the same variety of rice and buy it in similar quantities and from similar retail outlets, the poor can be expected to spend a larger proportion of their total expenditures on rice than the nonpoor. Since PPPs are ultimately based on aggregating relative prices by expenditure shares, using the expenditure shares of the general population rather than those of the poor may well yield PPPs that are less than ideal for comparisons of poverty across countries.
Expenditure weights are provided for two different population groups in each country. The first is based on national accounts weights, i.e., weights are drawn from the national accounts and refer to the whole population in the country. The second is drawn from household expenditure survey data and is based on the expenditure patterns of individuals in the bottom 30% of the distribution of per capita expenditures.
While the overlap between these individuals and those who are “poor” in terms of a given absolute poverty line is unlikely to be perfect, the bottom 30% should capture the expenditure patterns of the poor better than the expenditure patterns of the entire population for any reasonable poverty line. As expected, the poor – defined here to be the bottom 30% – tend to spend a significantly larger share of their outgoings on food and nonalcoholic beverages. For example, the shares of food and nonalcoholic beverages are 65.6% and 51.1%, respectively, for the poor and for the general population in Bangladesh. More generally, the expenditure weights presented in the figure show systematic and significant differences in the purchase patterns of the general population and of the bottom 30%.
In a nutshell, the practice of using consumption PPPs for international comparisons of poverty implies that the PPPs are derived via a list of products and associated prices that may not be representative of products consumed by the poor and the prices paid by them. Additionally, the consumption PPPs are derived using expenditure weights, or shares from the national accounts, i.e., they reflect the expenditure patterns of the general population and not necessarily the poor.
To what extent do these two factors affect the generation of international poverty lines and associated poverty rates? Well, you'll just have to check the special chapter yourself. I won't go into those details. Suffice it to say, we generated alternative PPPs that make use of a price dataset that is relevant to the poor, as well as expenditure shares that are reflective of the poor. What turns out is that there are differences between the alternative PPPs, and given that our main purpose is to compare international poverty, we recommend the use of PPPs that are calculated using prices paid specifically by the poor, and using expenditure weights that are exactly represented by the poor.
August 25, 2008
Why poor countries are... well, poor
by Polar Bear (guest-blogger)
In one of the chapters of his 2006 book, Undercover Economics, Tim Harford presented an engaging analysis that tries to explain why countries such as Cameroon and Nepal are poor.
The author asks the question: Why is it that in spite of (1) potentially higher rate of returns on investment in poorer countries (i.e., aggregate production function exhibits diminishing returns) and (2) the increasing availability and affordability of technology that will allow poorer countries to catch-up with richer ones, some countries like Cameroon fall farther behind?
“Banditry” at the top level which spills over to all aspects of governance is the root of persistent poverty in poor countries. It is in the nature of this problem to resist solution but according to the author, there are some simple reforms which could move poor countries in the right direction. These include (1) cutting red tape, (2) allowing business to be legally established, (3) enlisting the global economy’s help for access to cheaper raw materials, loans and manufacturing equipment, and (4) bringing down trade barriers.
Harford’s analysis is very much in line with theories on New Institutional Economics as popularized by eminent economists such as Ronald Coase, Kenneth Arrow, Friedrich Hayek, Gunnar Myrdal, Herbert Simon, Douglas North and John Commons. In his 1998 article “New Institutional Economics”, Ronald Coase succinctly explained the foundation of NIE as follows:
The welfare of human society depends on the flow of goods and services. The flow of goods and services depends on the productivity of economic system. The productivity of the economic system depends on specialization (or the division of labor). Specialization is only possible if there is exchange. The lower the cost of exchange, the more specialization there will be and so the greater the productivity of the system. The cost of exchange ultimately depends on the institution of a country.
Institution matters. But what does “institution” mean? Oliver Williamson in his 2000 article “The New Institutional Economics, Taking Stock, Looking Ahead” describes the four levels of institutional analysis as follows:
Level 1—the top level is often referred to as the social embeddedness level. This is where the norms, customs, traditions and religion are formed. Institutions at this level change very slowly – on the order of centuries and millennia. The concept of level 1 institutions has been advanced to answer questions such as “What is it about informal constraints that gives them such a pervasive influence upon the long-run character of economies?” Why for instance can the Filipino people ignore character flaws and lack of credential of political personalities the moment they become “anointed” candidates? Religion, no matter how irrational it sometimes is has been imbedded in the Filipino psyche by hundred of years of indoctrination just as the “kanya-kanya” mentality can be rooted to the archipelagic nature of our lands.
Second Level – going beyond informal traditions and codes formal rules such as the constitution, laws and property rights are introduced in this level. While constrained by the informal factors in level 1, the reform instruments in level 2 include the executive, legislative, judicial and bureaucratic functions as well as the distribution of powers across different levels of government. Although these are arguably important, introducing reforms at this level is very hard to orchestrate. Failed attempts to introduce charter change in the Philippines can be categorized in this level. Changing the rules of the game at such level has overwhelming impact that initiatives to institute such wide-ranging reforms are often clouded by distrusts. Nations sometimes need to be pushed on the brink of chaos to introduce change at this level. The massive discontent at the dictatorship of Ferdinand Marcos for instance paved the way for the introduction of the 1987 constitution.
Third level – this is where the institutions of governance are located. Going beyond established rules, the analysis is now centered on enforcing contractual relations. Since it is often costly to settle disputes in court, much of the contract management is dealt with directly through private ordering. For instance, one only has to follow the procedure in getting a business permit from pertinent government agencies in order to obtain one. The rules of the game need not be changed for each person who has to get a business permit. The term “weak governance” is thus explained by deviation from the rules of the game. “Oiling” the process of getting a business permit by giving “lagay” is a governance issue because parties to the transaction deviates from established procedures as defined by established rules and regulations. Similarly, application of the “rules” as defined by the whims and moods of a dictator to suit his personal interest is a categorical breakdown in governance.
Fourth Level – this is the level at which optimality apparatus works. Economic agents now take norms, traditions, rules of the game and enforcement of contracts as given, aligning their actions to the risks and incentives as set by these institutions.
NIE as an analytic tool implies that needed reforms, which will allow poor countries to get out of poverty have to be instituted on a case to case basis. There is no universal remedy.
For instance, while Harford’s article suggests that poor countries can be helped via cheap provision of raw materials such as fuel, loans from international banks and manufacturing equipment, there is no guarantee that this will work. There is one universal principle that guides people’s actions as economic agents – self-interest.
One has to look at levels of a country’s institutional set-up to determine how such actions will flow through its incentive system. It is possible for instance for cheap raw materials to land at the hands of a select and powerful few who could take advantage of the wider margin that they can squeeze out of such a transaction. Positive impact to growth of allowing the economy to benefit from such a concession could eventually cut the flow of cheap goods and can therefore be perceived as a threat by those benefiting from it. Hence, the response would be to ignore the growth objective and pocket as much in order to keep the money flowing in.
Without the right incentive system, economic agents’ response to aid or concessions can be pretty perverse. An example is the outreach program to AIDS infected people in Africa – because families of AIDS infected household heads were given donations, getting well was not perceived as the appropriate response (i.e., without AIDS, there is no aid). According to reports, some even intentionally acquire the disease in order to get donations that will tie their families over at least in the short-run.
There are various reforms that strike at a country’s institutional set-up giving economic agents the right incentives to adopt the appropriate actions. We agree with examples of reforms cited in the case. Among which are:
1. Trade liberalization—In the Philippines, this successfully chipped away at cronyism which was pervasive in the determination of industry winners prior to the liberalized set-up.
2. Free Market—Encouragement of market competition under a transparent environment where the rules are explicit and easy to follow would attract investors, generate jobs, promote growth and alleviate poverty
3. Promotion of Good Governance and Accountabilities—this could include pending reforms such as the botched computerization of the Philippine election system
4. Improvement of the Nation’s soft and hard infrastructure – this should include priority spending on infrastructure projects and education backed up by transparent budgeting and disbursements
Indeed institutions, be it at the first or the fourth level is susceptible to reform. It sometimes takes visionary and reform-oriented leaders to get a country’s institutions right but absent such persons, citizens of a country in their own way can help in the process.
I believe that as ordinary citizens, while it is almost beyond our sphere of influence to reform the government and steer it to adopt and implement the needed reforms as suggested above, there are ways to help facilitate the process.
For instance, as aspiring leaders in our field, we can help advocate and steer our business organizations into practicing good corporate social responsibility which will help our own organizations, and eventually organizations we deal with, to benchmark transaction processes not in the norms and standards set-up by the domestic environment (which we know needs fixing) but by the global community. This in the context of new institutional economics can help countries get out of poverty by:
1. Helping define and implement the rules of the game: While it is expedient to succumb to bribery and ‘lagay’, exerting pressure for the government to define rules more clearly and encourage players to stick to these rules will help businesses in the long-run. Viewed as a repetitive process, transaction with the government under an environment of weak governance can only be damaging to business in the long run. An acknowledgement of the significance of this transaction cost to businesses’ survival, prompting needed reforms to address it, can strike at the heart of level 3 institutions.
2. Helping build the foundation for better norms and traditions through scholarship programs that recognize merit and excellence. This in the long-run can help re-define level 1 institution making our country a nation of achievers.
3. Supporting non-government organizations such as Transparency International and other deserving non-government organizations with credible background who are engaged in social marketing programs (e.g., anti-corruption campaigns, campaign for clean elections).
4. Being vigilant and critical about (a) reform policies being promulgated by the government and (b) actions by the government to help promote good governance and accountability.
5. Practicing responsible advertising (i.e., advertising that promotes good values)
And then again, institutions of whatever level can only be described by the aggregation of the characters of individuals who compose it. Good individuals make good institutions. Practicing good citizenship and observance of the rule of law in our daily lives and in relating to our individual spheres of influences could help in growth promotion and poverty alleviation. If each of us does these, even if we could only hope that the multiplier effect is more than one, one day we will be out of the rot our nation is currently in.
References
Harford, Tim. 2006. “Why Poor Countries Are Poor”. The Undercover Economics.
Coase, Ronald. 1998. "The New Institutional Economics." The American Economic Review. 88(2):72-74.
North, Douglass C. 1993. "The New Institutional Economics and Development." Mimeo. Washington University, St. Louis.
Williamson, Oliver E. 2000. "The New Institutional Economics: Taking Stock, Looking Ahead." Journal of Economic Literature." Vol.38 (September): 595-613.
In one of the chapters of his 2006 book, Undercover Economics, Tim Harford presented an engaging analysis that tries to explain why countries such as Cameroon and Nepal are poor.
The author asks the question: Why is it that in spite of (1) potentially higher rate of returns on investment in poorer countries (i.e., aggregate production function exhibits diminishing returns) and (2) the increasing availability and affordability of technology that will allow poorer countries to catch-up with richer ones, some countries like Cameroon fall farther behind?
“Banditry” at the top level which spills over to all aspects of governance is the root of persistent poverty in poor countries. It is in the nature of this problem to resist solution but according to the author, there are some simple reforms which could move poor countries in the right direction. These include (1) cutting red tape, (2) allowing business to be legally established, (3) enlisting the global economy’s help for access to cheaper raw materials, loans and manufacturing equipment, and (4) bringing down trade barriers.
Harford’s analysis is very much in line with theories on New Institutional Economics as popularized by eminent economists such as Ronald Coase, Kenneth Arrow, Friedrich Hayek, Gunnar Myrdal, Herbert Simon, Douglas North and John Commons. In his 1998 article “New Institutional Economics”, Ronald Coase succinctly explained the foundation of NIE as follows:
The welfare of human society depends on the flow of goods and services. The flow of goods and services depends on the productivity of economic system. The productivity of the economic system depends on specialization (or the division of labor). Specialization is only possible if there is exchange. The lower the cost of exchange, the more specialization there will be and so the greater the productivity of the system. The cost of exchange ultimately depends on the institution of a country.
Institution matters. But what does “institution” mean? Oliver Williamson in his 2000 article “The New Institutional Economics, Taking Stock, Looking Ahead” describes the four levels of institutional analysis as follows:
Level 1—the top level is often referred to as the social embeddedness level. This is where the norms, customs, traditions and religion are formed. Institutions at this level change very slowly – on the order of centuries and millennia. The concept of level 1 institutions has been advanced to answer questions such as “What is it about informal constraints that gives them such a pervasive influence upon the long-run character of economies?” Why for instance can the Filipino people ignore character flaws and lack of credential of political personalities the moment they become “anointed” candidates? Religion, no matter how irrational it sometimes is has been imbedded in the Filipino psyche by hundred of years of indoctrination just as the “kanya-kanya” mentality can be rooted to the archipelagic nature of our lands.
Second Level – going beyond informal traditions and codes formal rules such as the constitution, laws and property rights are introduced in this level. While constrained by the informal factors in level 1, the reform instruments in level 2 include the executive, legislative, judicial and bureaucratic functions as well as the distribution of powers across different levels of government. Although these are arguably important, introducing reforms at this level is very hard to orchestrate. Failed attempts to introduce charter change in the Philippines can be categorized in this level. Changing the rules of the game at such level has overwhelming impact that initiatives to institute such wide-ranging reforms are often clouded by distrusts. Nations sometimes need to be pushed on the brink of chaos to introduce change at this level. The massive discontent at the dictatorship of Ferdinand Marcos for instance paved the way for the introduction of the 1987 constitution.
Third level – this is where the institutions of governance are located. Going beyond established rules, the analysis is now centered on enforcing contractual relations. Since it is often costly to settle disputes in court, much of the contract management is dealt with directly through private ordering. For instance, one only has to follow the procedure in getting a business permit from pertinent government agencies in order to obtain one. The rules of the game need not be changed for each person who has to get a business permit. The term “weak governance” is thus explained by deviation from the rules of the game. “Oiling” the process of getting a business permit by giving “lagay” is a governance issue because parties to the transaction deviates from established procedures as defined by established rules and regulations. Similarly, application of the “rules” as defined by the whims and moods of a dictator to suit his personal interest is a categorical breakdown in governance.
Fourth Level – this is the level at which optimality apparatus works. Economic agents now take norms, traditions, rules of the game and enforcement of contracts as given, aligning their actions to the risks and incentives as set by these institutions.
NIE as an analytic tool implies that needed reforms, which will allow poor countries to get out of poverty have to be instituted on a case to case basis. There is no universal remedy.
For instance, while Harford’s article suggests that poor countries can be helped via cheap provision of raw materials such as fuel, loans from international banks and manufacturing equipment, there is no guarantee that this will work. There is one universal principle that guides people’s actions as economic agents – self-interest.
One has to look at levels of a country’s institutional set-up to determine how such actions will flow through its incentive system. It is possible for instance for cheap raw materials to land at the hands of a select and powerful few who could take advantage of the wider margin that they can squeeze out of such a transaction. Positive impact to growth of allowing the economy to benefit from such a concession could eventually cut the flow of cheap goods and can therefore be perceived as a threat by those benefiting from it. Hence, the response would be to ignore the growth objective and pocket as much in order to keep the money flowing in.
Without the right incentive system, economic agents’ response to aid or concessions can be pretty perverse. An example is the outreach program to AIDS infected people in Africa – because families of AIDS infected household heads were given donations, getting well was not perceived as the appropriate response (i.e., without AIDS, there is no aid). According to reports, some even intentionally acquire the disease in order to get donations that will tie their families over at least in the short-run.
There are various reforms that strike at a country’s institutional set-up giving economic agents the right incentives to adopt the appropriate actions. We agree with examples of reforms cited in the case. Among which are:
1. Trade liberalization—In the Philippines, this successfully chipped away at cronyism which was pervasive in the determination of industry winners prior to the liberalized set-up.
2. Free Market—Encouragement of market competition under a transparent environment where the rules are explicit and easy to follow would attract investors, generate jobs, promote growth and alleviate poverty
3. Promotion of Good Governance and Accountabilities—this could include pending reforms such as the botched computerization of the Philippine election system
4. Improvement of the Nation’s soft and hard infrastructure – this should include priority spending on infrastructure projects and education backed up by transparent budgeting and disbursements
Indeed institutions, be it at the first or the fourth level is susceptible to reform. It sometimes takes visionary and reform-oriented leaders to get a country’s institutions right but absent such persons, citizens of a country in their own way can help in the process.
I believe that as ordinary citizens, while it is almost beyond our sphere of influence to reform the government and steer it to adopt and implement the needed reforms as suggested above, there are ways to help facilitate the process.
For instance, as aspiring leaders in our field, we can help advocate and steer our business organizations into practicing good corporate social responsibility which will help our own organizations, and eventually organizations we deal with, to benchmark transaction processes not in the norms and standards set-up by the domestic environment (which we know needs fixing) but by the global community. This in the context of new institutional economics can help countries get out of poverty by:
1. Helping define and implement the rules of the game: While it is expedient to succumb to bribery and ‘lagay’, exerting pressure for the government to define rules more clearly and encourage players to stick to these rules will help businesses in the long-run. Viewed as a repetitive process, transaction with the government under an environment of weak governance can only be damaging to business in the long run. An acknowledgement of the significance of this transaction cost to businesses’ survival, prompting needed reforms to address it, can strike at the heart of level 3 institutions.
2. Helping build the foundation for better norms and traditions through scholarship programs that recognize merit and excellence. This in the long-run can help re-define level 1 institution making our country a nation of achievers.
3. Supporting non-government organizations such as Transparency International and other deserving non-government organizations with credible background who are engaged in social marketing programs (e.g., anti-corruption campaigns, campaign for clean elections).
4. Being vigilant and critical about (a) reform policies being promulgated by the government and (b) actions by the government to help promote good governance and accountability.
5. Practicing responsible advertising (i.e., advertising that promotes good values)
And then again, institutions of whatever level can only be described by the aggregation of the characters of individuals who compose it. Good individuals make good institutions. Practicing good citizenship and observance of the rule of law in our daily lives and in relating to our individual spheres of influences could help in growth promotion and poverty alleviation. If each of us does these, even if we could only hope that the multiplier effect is more than one, one day we will be out of the rot our nation is currently in.
References
Harford, Tim. 2006. “Why Poor Countries Are Poor”. The Undercover Economics.
Coase, Ronald. 1998. "The New Institutional Economics." The American Economic Review. 88(2):72-74.
North, Douglass C. 1993. "The New Institutional Economics and Development." Mimeo. Washington University, St. Louis.
Williamson, Oliver E. 2000. "The New Institutional Economics: Taking Stock, Looking Ahead." Journal of Economic Literature." Vol.38 (September): 595-613.
July 9, 2008
Inflation and the poor
Getting specific on the effects of the recent rounds of inflation on the poor, Rana Hasan, Rhoda Magsombol and I made a specific analysis on what will happen in the case of India.
Rising food prices can drive households into poverty by reducing the purchasing power of household income, and exacerbate the poverty of already poor households. Especially in rural areas, however, some poor or near poor households may be producers of food and may therefore be shielded from the full force of food price increases. Those with a marketable surplus (after accounting for own consumption) may even find their incomes rise as a result of food price increases. Ultimately, gauging the precise impact of food price increases on poverty, especially in rural areas, is an empirical issue.
The many nuances of the poverty impact of food price increases can be examined by analyzing consumer expenditure survey data from India. To simplify the analysis, consider a price increase on only one group of commodities: cereals (i.e., rice and wheat). Cereals encompass a large share in household expenditures in India, especially among their poor.
To assess the impact, four different scenarios are adopted to analyze the impact on poverty rates (measured using Indian official poverty lines) of the 10% increase in the price of cereals in both urban and rural areas:
First Scenario
All households are affected by the price increases in relation to their reported consumption of cereals. There is no allowance made for consumption from own production (let alone allows for sales of cereals). The simulated impact on poverty is captured by reducing the monthly total consumption expenditures (actual and imputed) of each household by an amount equal to 10% of the household’s total consumption expenditures on cereals.
Second Scenario
More realistic, the this scenario takes into account the fact that some households’ consumption of cereals is on account of home production. The price increases is assumed to have no effect on consumption from home production. To capture the poverty impacts under the scenario, the monthly total consumption expenditures of each household are reduced by 10% of the household’s expenditure on “purchased” cereals. Purchased expenditures are simply equal to total expenditures on cereals less consumption from home-produced cereals.
Third Scenario
The possibility that some households are net producers of cereals is taken into consideration (i.e., their production of cereals is larger than their consumption of cereals) and may, therefore, gain from an increase in the price of cereals. Unfortunately, the Indian survey does not provide information on the quantity of cereals produced or sold. However, the survey does provide information on the industry and occupation corresponding to the main economic activity of each household. Net producers of cereals are defined to be those households that are involved in cultivation of cereals and have cultivated land of 2 hectares or more. It is assumed that any household belonging to this group gains from the increase in price of cereals such that even if they were poor to begin with, they would be nonpoor as a result of the price increase. This assumption is made given that there is no information on the actual quantities of cereals produced and sold. For all other households, the monthly per capita expenditures are reduced by 10% of their consumption of purchased cereals.
Fourth Scenario
Wholesalers and retailers trading in cereals are treated similarly as cultivators of cereals with more than 2 hectares of land in the third scenario. That is, as with the latter group of households, the former are assumed to become nonpoor if they were poor to begin with.
Results
The overall results are quite sensitive in the rural sector to the assumptions on whether and which types of households may gain from the increase in cereals prices.
Based on the first scenario, a 10% increase in cereal prices in India causes an increase in rural and urban poverty. This is to be expected since by assumption any household that consumes cereals will see a decline in welfare. The same case is found for the second scenario, although the extent of the increase in poverty rates is lower as compared to the first scenario, especially in rural areas. Moving to the third and fourth scenarios, where we distinguish between households that are (presumably large) producers of cereals and traders of cereals, we find that poverty incidence in the rural sector decreases as a result of the increase in cereals prices. Poverty incidence in urban areas increases. But the extent of the increase is mitigated as compared to the first two scenarios.
While no doubt stylized, the scenarios considered above are useful in highlighting the fact that even the short run impact of food price increases in rural areas on poverty will be complex.
Rising food prices can drive households into poverty by reducing the purchasing power of household income, and exacerbate the poverty of already poor households. Especially in rural areas, however, some poor or near poor households may be producers of food and may therefore be shielded from the full force of food price increases. Those with a marketable surplus (after accounting for own consumption) may even find their incomes rise as a result of food price increases. Ultimately, gauging the precise impact of food price increases on poverty, especially in rural areas, is an empirical issue.
The many nuances of the poverty impact of food price increases can be examined by analyzing consumer expenditure survey data from India. To simplify the analysis, consider a price increase on only one group of commodities: cereals (i.e., rice and wheat). Cereals encompass a large share in household expenditures in India, especially among their poor.
To assess the impact, four different scenarios are adopted to analyze the impact on poverty rates (measured using Indian official poverty lines) of the 10% increase in the price of cereals in both urban and rural areas:
First Scenario
All households are affected by the price increases in relation to their reported consumption of cereals. There is no allowance made for consumption from own production (let alone allows for sales of cereals). The simulated impact on poverty is captured by reducing the monthly total consumption expenditures (actual and imputed) of each household by an amount equal to 10% of the household’s total consumption expenditures on cereals.
Second Scenario
More realistic, the this scenario takes into account the fact that some households’ consumption of cereals is on account of home production. The price increases is assumed to have no effect on consumption from home production. To capture the poverty impacts under the scenario, the monthly total consumption expenditures of each household are reduced by 10% of the household’s expenditure on “purchased” cereals. Purchased expenditures are simply equal to total expenditures on cereals less consumption from home-produced cereals.
Third Scenario
The possibility that some households are net producers of cereals is taken into consideration (i.e., their production of cereals is larger than their consumption of cereals) and may, therefore, gain from an increase in the price of cereals. Unfortunately, the Indian survey does not provide information on the quantity of cereals produced or sold. However, the survey does provide information on the industry and occupation corresponding to the main economic activity of each household. Net producers of cereals are defined to be those households that are involved in cultivation of cereals and have cultivated land of 2 hectares or more. It is assumed that any household belonging to this group gains from the increase in price of cereals such that even if they were poor to begin with, they would be nonpoor as a result of the price increase. This assumption is made given that there is no information on the actual quantities of cereals produced and sold. For all other households, the monthly per capita expenditures are reduced by 10% of their consumption of purchased cereals.
Fourth Scenario
Wholesalers and retailers trading in cereals are treated similarly as cultivators of cereals with more than 2 hectares of land in the third scenario. That is, as with the latter group of households, the former are assumed to become nonpoor if they were poor to begin with.
Results
The overall results are quite sensitive in the rural sector to the assumptions on whether and which types of households may gain from the increase in cereals prices.
Based on the first scenario, a 10% increase in cereal prices in India causes an increase in rural and urban poverty. This is to be expected since by assumption any household that consumes cereals will see a decline in welfare. The same case is found for the second scenario, although the extent of the increase in poverty rates is lower as compared to the first scenario, especially in rural areas. Moving to the third and fourth scenarios, where we distinguish between households that are (presumably large) producers of cereals and traders of cereals, we find that poverty incidence in the rural sector decreases as a result of the increase in cereals prices. Poverty incidence in urban areas increases. But the extent of the increase is mitigated as compared to the first two scenarios.
While no doubt stylized, the scenarios considered above are useful in highlighting the fact that even the short run impact of food price increases in rural areas on poverty will be complex.
June 29, 2008
Founders of New Institutional Economics: Oliver E. Williamson
Accoding to Oliver E. Williamson, the new institutional economics turned on two propositions: "institutions do matter," and "the determinants of institutions are susceptible to analysis by the tools of economic theory."
One very important contribution brought by Williamson is the use of the four levels of social analysis relevant in the study of institutions:
The top level is the social embededness level. This is where the norms, customs, traditions, etc. are located. Religion plays a large role at this level. Level 1 is taken as given by most institutional economists. Institutions at this level change very slowly--on the order of centuries or millenia. The concept of "embededness," both at the level of society and in the context of ongoing network relations, has been advanced to help explicate one major issue: "What is it about informal constraints that gives them such a pervasive influence upon the long-run character of economies?" Now, different kinds of embeddedness should be distinguished--cognitive, cultural, structural, and political. Still, the concept of embededness remains in need of greater theoretical specification. An identification and explication of the mechanisms through which informal institutions arise and are maintained would especially help to understand the slow change in Level 1 institutions. Informal institutions have mainly spontaneous origins--which is to say that deliberative choice of calculative kind is minimally implicated. Given these evolutionary origins, they are "adopted" and thereafter display a great deal of inertia: some because they are functional (as with conventions); others take on symbolic value with a coteric of true beleivers; and many are pervasively linked with complementary institutions (both formal and informal). Be that as it may, the resulting instituions have a lasting grip on the way a society conducts itself. One thing to remember, though: insular societies often take measures to protect themselves against "alien values."
The second level is referred to as the institutional environment. The structures observed here are partly the product of evolutionary processes but design opportunities are also posed. Going beyond the "informal constraints" (sanctions, taboos, customs, traditions, and codes of conduct) of a Level 1 kind, we now introduce "formal rules" (constitutions, laws, property rights, etc.). This opens up the opportunity for first-order economizing: get the formal rules of the game right. Constrained by the shadow of the past (influenced by Level 1 factors), the design instruments at Level 2 include the executive, legislative, judicial, and bureaucratic functions of government, as well as the distribution of powers across different levels of government (federalism). The definition and enforcement of property rights and of contract laws are important features. Although such first-order choices are unarguably important to the economic productivity of an economy, [cumulative] change of a progressive kind is very difficult to orchestrate. Massive discontent--civil wars, foregin occupations, perceived threats, breakdowns, military coup, or financial crisis--will, occasionally, produce a sharp break from established procedures. Rare windows of opportunity to effect broad reform are thereby opened. Such "defining moments" are nevertheless the exception rather than the rule. At least partly because of our primitive understanding, the response to such opportunities is often one of "failure."
The third level is where the institutions of governance are located. Although property remains important, a perfectly functioning legal system for defining contract laws and enforcing contracts is not contemplated. Since it is costly t o settle disputes in court, much of the contract management and dispute settlement action is dealt with directly by the parties--through private ordering. The need to come to terms with contract laws (plural) rather than an all-purpose law of contracts (singular) is posed. The governance of contractual relations becomes the focus of analysis. So conceived, a governance structure obviously reshapes incentives. Any issue that arises as or can be reformulated as a contracting issue can be examined to advantage in transaction cost economizing terms. A huge number of phenomena turn out to be contractual variations on a common theme. This second-order economizing--get the governance structures right--is realized at Level 3. The possible reorganization of transactions among governance structures is re-examined periodically on the order of a year to a decade, often at contract renewal or equipment renewal intervals.
The fourth and final level is that which neoclassical analysis works. Optimal apparatus, often marginal analysis, is employed, and the firm for these purposes is typically described as a production function. Adjustments to prices and output occur more or less continuously. Agency theory, which emphasizes ex ante incentive alignment and efficient risk bearing rather than ex post governance, nonetheless makes provision for non-neoclassical complications. One area that needs to be developed, though, as compared with technological innovation, the study of organizational innovation has been comparatively neglected. New institutional economics has attempted to rectify this: the idea being that "truly among man's innovations, the use of organization to accomplish his ends is among both his greatest and his earliest."
Source:
Oliver E. Williamson. 2000. "The new institutional economics: Taking stock, looking ahead."
One very important contribution brought by Williamson is the use of the four levels of social analysis relevant in the study of institutions:
The top level is the social embededness level. This is where the norms, customs, traditions, etc. are located. Religion plays a large role at this level. Level 1 is taken as given by most institutional economists. Institutions at this level change very slowly--on the order of centuries or millenia. The concept of "embededness," both at the level of society and in the context of ongoing network relations, has been advanced to help explicate one major issue: "What is it about informal constraints that gives them such a pervasive influence upon the long-run character of economies?" Now, different kinds of embeddedness should be distinguished--cognitive, cultural, structural, and political. Still, the concept of embededness remains in need of greater theoretical specification. An identification and explication of the mechanisms through which informal institutions arise and are maintained would especially help to understand the slow change in Level 1 institutions. Informal institutions have mainly spontaneous origins--which is to say that deliberative choice of calculative kind is minimally implicated. Given these evolutionary origins, they are "adopted" and thereafter display a great deal of inertia: some because they are functional (as with conventions); others take on symbolic value with a coteric of true beleivers; and many are pervasively linked with complementary institutions (both formal and informal). Be that as it may, the resulting instituions have a lasting grip on the way a society conducts itself. One thing to remember, though: insular societies often take measures to protect themselves against "alien values."
The second level is referred to as the institutional environment. The structures observed here are partly the product of evolutionary processes but design opportunities are also posed. Going beyond the "informal constraints" (sanctions, taboos, customs, traditions, and codes of conduct) of a Level 1 kind, we now introduce "formal rules" (constitutions, laws, property rights, etc.). This opens up the opportunity for first-order economizing: get the formal rules of the game right. Constrained by the shadow of the past (influenced by Level 1 factors), the design instruments at Level 2 include the executive, legislative, judicial, and bureaucratic functions of government, as well as the distribution of powers across different levels of government (federalism). The definition and enforcement of property rights and of contract laws are important features. Although such first-order choices are unarguably important to the economic productivity of an economy, [cumulative] change of a progressive kind is very difficult to orchestrate. Massive discontent--civil wars, foregin occupations, perceived threats, breakdowns, military coup, or financial crisis--will, occasionally, produce a sharp break from established procedures. Rare windows of opportunity to effect broad reform are thereby opened. Such "defining moments" are nevertheless the exception rather than the rule. At least partly because of our primitive understanding, the response to such opportunities is often one of "failure."
The third level is where the institutions of governance are located. Although property remains important, a perfectly functioning legal system for defining contract laws and enforcing contracts is not contemplated. Since it is costly t o settle disputes in court, much of the contract management and dispute settlement action is dealt with directly by the parties--through private ordering. The need to come to terms with contract laws (plural) rather than an all-purpose law of contracts (singular) is posed. The governance of contractual relations becomes the focus of analysis. So conceived, a governance structure obviously reshapes incentives. Any issue that arises as or can be reformulated as a contracting issue can be examined to advantage in transaction cost economizing terms. A huge number of phenomena turn out to be contractual variations on a common theme. This second-order economizing--get the governance structures right--is realized at Level 3. The possible reorganization of transactions among governance structures is re-examined periodically on the order of a year to a decade, often at contract renewal or equipment renewal intervals.
The fourth and final level is that which neoclassical analysis works. Optimal apparatus, often marginal analysis, is employed, and the firm for these purposes is typically described as a production function. Adjustments to prices and output occur more or less continuously. Agency theory, which emphasizes ex ante incentive alignment and efficient risk bearing rather than ex post governance, nonetheless makes provision for non-neoclassical complications. One area that needs to be developed, though, as compared with technological innovation, the study of organizational innovation has been comparatively neglected. New institutional economics has attempted to rectify this: the idea being that "truly among man's innovations, the use of organization to accomplish his ends is among both his greatest and his earliest."
Source:
Oliver E. Williamson. 2000. "The new institutional economics: Taking stock, looking ahead."
June 25, 2008
Accelerated Inflation of 2007-2008
Rising food prices contributed to an acceleration of inflation across Asia in 2007, and in 2008, the further rise in food prices has reached alarming proportions. According to the latest paper by the Economics and Research Department of the Asian Development Bank, this accelerated inflation may be more structural then cyclical. This means that the repercussions of this situation may continue for more years.
The Problem
The rise in food prices is worrisome precisely because food price inflation is the most regressive of all taxes--it hurts the poor the most. Concerns over high prices are mounting because inflation eats into real incomes and expenditures, and can undermine the gains from poverty reduction and human development that developing countries have achieved over the last decade or so.
Using unit-level household expenditure survey datasets of four countries (Bangladesh, India, Indonesia, and the Philippines), Rana Hasan, Maria Rhoda Magsombol and myself wrote the section on how the recent events are particularly problematic for the poor. The average share of food in total expenditure is inversely related to income across quintile groups: poorer population subgroups spend a larger share of their total expenditures on food than richer ones. As a result, the poorer population subgroups are more vulnerable to rising food prices.
As it turns out, the fact that the increase in food prices has been driven to a large extent by increases in the price of rice (more on this below) has a special significance for the poverty and distributional impacts of the recent increase in food prices in Asia. This is because of the large share of rice in expenditures--not just food expenditures, but also total expenditures--in Asian economies, especially among the poor.
And so the implication is obvious. The sharp rise in the price of rice, and food more generally, across Asian countries can be expected to wreak havoc among the lower-income groups. In particular, it can be expected to increase the misery of those who are already living below the poverty line. Worst, it can be expected to drive the nonpoor into poverty.
The Causes
Structural factors are fundamental in explaining what has happened to international rice and food grain prices in recent years. Falling global stocks of rice and other cereals are indicative of the fact that production growth has fallen below consumption growth for several years. In addition, the current steep increases in the price at which rice is traded in international markets reflect not only shortfalls in production relative to current consumption, but also reflect the attempt of economies to rebuild stocks themselves, putting even greater upward pressure on demand relative to supply.
Looking at the demand-side factors:
1. Growing world population and strong income growth in emerging economies around the globe. (The second factor is associated with dietary change toward higher-quality food such as mean and dairy products: production of these requires large amounts of grains in the form of livestock feed).
2. Competing use of food grain to produce ethanol as a substitute for oil (i.e., BIOFUELS). Biofuel demand is rising and is leading to diversion of grain, soybeans, sugar, and vegetable oil from use as food or feed.
Among the supply-side factors:
1. Urbanization and competing demand for land for commercial purposes, instead of agricultural.
2. Cropping patterns away from food to biofuels may also reduce the available supply of land devoted to food.
3. Most important, neglect of investment in agricultural technology, infrastructure, and extension programs (e.g., financial) is also to blame for the tepid growth in the supply of rice.
The Solution
In the long run, the notion of food security should move beyond the relatively static focus on food availability and access, to one of higher productivity. As the majority of the poor in developing Asia live in rural areas and depend on agriculture, higher agricultural growth will provide food security by increasing supply, reducing prices, and raising incomes of poorer farm households.
But yields of food crops in most of Asia remain low in comparison with other major producing countries, which is attributed to:
1. Poor crop management skills of farmers.
2. Use of cheaper (and low quality) seeds.
3. Lack of agricultural infrastructure and postharvest technologies to ensure high recovery of harvested grain.
4. Limited research and the gap between available research and practical applications.
5. Inadequate funding for research and development.
Much neglected agricultural sector reforms need to be put into place to promote the use of modern technmology, new seed varieties, and better financial systems.
The Problem
The rise in food prices is worrisome precisely because food price inflation is the most regressive of all taxes--it hurts the poor the most. Concerns over high prices are mounting because inflation eats into real incomes and expenditures, and can undermine the gains from poverty reduction and human development that developing countries have achieved over the last decade or so.
Using unit-level household expenditure survey datasets of four countries (Bangladesh, India, Indonesia, and the Philippines), Rana Hasan, Maria Rhoda Magsombol and myself wrote the section on how the recent events are particularly problematic for the poor. The average share of food in total expenditure is inversely related to income across quintile groups: poorer population subgroups spend a larger share of their total expenditures on food than richer ones. As a result, the poorer population subgroups are more vulnerable to rising food prices.
As it turns out, the fact that the increase in food prices has been driven to a large extent by increases in the price of rice (more on this below) has a special significance for the poverty and distributional impacts of the recent increase in food prices in Asia. This is because of the large share of rice in expenditures--not just food expenditures, but also total expenditures--in Asian economies, especially among the poor.
And so the implication is obvious. The sharp rise in the price of rice, and food more generally, across Asian countries can be expected to wreak havoc among the lower-income groups. In particular, it can be expected to increase the misery of those who are already living below the poverty line. Worst, it can be expected to drive the nonpoor into poverty.
The Causes
Structural factors are fundamental in explaining what has happened to international rice and food grain prices in recent years. Falling global stocks of rice and other cereals are indicative of the fact that production growth has fallen below consumption growth for several years. In addition, the current steep increases in the price at which rice is traded in international markets reflect not only shortfalls in production relative to current consumption, but also reflect the attempt of economies to rebuild stocks themselves, putting even greater upward pressure on demand relative to supply.
Looking at the demand-side factors:
1. Growing world population and strong income growth in emerging economies around the globe. (The second factor is associated with dietary change toward higher-quality food such as mean and dairy products: production of these requires large amounts of grains in the form of livestock feed).
2. Competing use of food grain to produce ethanol as a substitute for oil (i.e., BIOFUELS). Biofuel demand is rising and is leading to diversion of grain, soybeans, sugar, and vegetable oil from use as food or feed.
Among the supply-side factors:
1. Urbanization and competing demand for land for commercial purposes, instead of agricultural.
2. Cropping patterns away from food to biofuels may also reduce the available supply of land devoted to food.
3. Most important, neglect of investment in agricultural technology, infrastructure, and extension programs (e.g., financial) is also to blame for the tepid growth in the supply of rice.
The Solution
In the long run, the notion of food security should move beyond the relatively static focus on food availability and access, to one of higher productivity. As the majority of the poor in developing Asia live in rural areas and depend on agriculture, higher agricultural growth will provide food security by increasing supply, reducing prices, and raising incomes of poorer farm households.
But yields of food crops in most of Asia remain low in comparison with other major producing countries, which is attributed to:
1. Poor crop management skills of farmers.
2. Use of cheaper (and low quality) seeds.
3. Lack of agricultural infrastructure and postharvest technologies to ensure high recovery of harvested grain.
4. Limited research and the gap between available research and practical applications.
5. Inadequate funding for research and development.
Much neglected agricultural sector reforms need to be put into place to promote the use of modern technmology, new seed varieties, and better financial systems.
May 31, 2008
Founders of New Institutional Economics: Douglass North (Part 2 of 2)
Transactions cost economics
"Ronald Coase began his 1960 essay by arguing that when it is costless to transact, the efficient neoclassical competitive solution is obtained. This is so because the competitive structure of efficient markets leads the parties to arrive costlessly at the solution that maximizes aggregate income, regardlesss of the institutional arrangements.
This scenario is mimicked in the real world in situations where competition is strong enough via arbitrage and efficient information feedback to approximate the Coase zero-cost transaction conditions and the parties can realize the gains from trade inherent in the neoclassical argument.
In the real world, however, informational and institutional requirements necessary to achieve and realize the gains are stringent:
1. Players must not only have objectives, they must also know the correct way to achieve them, and it is through the instrumental rationality assumption that players know the correct way to achieve their objectives. The assumption states that even though the actors may have diverse and erroneous models, the informational feedback process and arbitraging actors will correct initially incorrect models, punish deviant behavior, and lead surviving players to the correct models.
2. An even more stringent implicit requirement of the discipline-of-the-competitive-market model is that when there are significant transaction costs, the consequent institutions of the market will be designed to induce the actors to acquire the essential information that will lead them to correct models. The implication of this is that not only are institutions designed to achieve efficient outcomes, but they can be ignored in economic analysis because they play an independent role in economic performance.
Both of these discuss stringent requirements that are realized only very exceptionally. The truth is:
1. Individuals typically act on incomplete information.
2. Individuals act with subjectively derived models that are frequently erroneous.
3. The information feedback is typically insufficient to correct individuals' subjective models.
Perhaps more significant, institutions are not necessarily, or even usually, created to be socially efficient. Rather they, or at least the formal rules, are created to serve the interests of those with bargaining power to create new rules.
In a zero-transaction cost world, bargaining strength does not affect the efficiency of outcomes; but in a world of positive-transaction costs, it does. Bargaining strength thus shapes the direction oflong-run economic change."
Economics of political markets
"I is exceptional to find economic markets that approximate the conditions necessary for efficiency. It is impossible to find political markets that do. This is because it is the polity that defines and enforces property rights. It is therefore not surprising that efficient economic and political markets are exceptional; in other words, inefficient markets are common.
Once an economy is on an "inefficient path" that produces stagnation, it can persist (and historically has persisted) because of the natrue of path dependence. Institutional path dependence exists because of the network externalities, economies of scope, and complementaries that exist with a given institutional matrix. The individuals and organizations with bargaining power, as a result of the institutional framework, have a crucual stake in perpetuating the system.
Institutional path dependence do get reveresed, but this reversal is a difficult process about which we know all too little. The reason is that we still know all to little about the dynamics of institutional change and particularly the interplay between economic and political markets."
Source:
Douglass North. 1993. "The new institutional economics and development"
"Ronald Coase began his 1960 essay by arguing that when it is costless to transact, the efficient neoclassical competitive solution is obtained. This is so because the competitive structure of efficient markets leads the parties to arrive costlessly at the solution that maximizes aggregate income, regardlesss of the institutional arrangements.
This scenario is mimicked in the real world in situations where competition is strong enough via arbitrage and efficient information feedback to approximate the Coase zero-cost transaction conditions and the parties can realize the gains from trade inherent in the neoclassical argument.
In the real world, however, informational and institutional requirements necessary to achieve and realize the gains are stringent:
1. Players must not only have objectives, they must also know the correct way to achieve them, and it is through the instrumental rationality assumption that players know the correct way to achieve their objectives. The assumption states that even though the actors may have diverse and erroneous models, the informational feedback process and arbitraging actors will correct initially incorrect models, punish deviant behavior, and lead surviving players to the correct models.
2. An even more stringent implicit requirement of the discipline-of-the-competitive-market model is that when there are significant transaction costs, the consequent institutions of the market will be designed to induce the actors to acquire the essential information that will lead them to correct models. The implication of this is that not only are institutions designed to achieve efficient outcomes, but they can be ignored in economic analysis because they play an independent role in economic performance.
Both of these discuss stringent requirements that are realized only very exceptionally. The truth is:
1. Individuals typically act on incomplete information.
2. Individuals act with subjectively derived models that are frequently erroneous.
3. The information feedback is typically insufficient to correct individuals' subjective models.
Perhaps more significant, institutions are not necessarily, or even usually, created to be socially efficient. Rather they, or at least the formal rules, are created to serve the interests of those with bargaining power to create new rules.
In a zero-transaction cost world, bargaining strength does not affect the efficiency of outcomes; but in a world of positive-transaction costs, it does. Bargaining strength thus shapes the direction oflong-run economic change."
Economics of political markets
"I is exceptional to find economic markets that approximate the conditions necessary for efficiency. It is impossible to find political markets that do. This is because it is the polity that defines and enforces property rights. It is therefore not surprising that efficient economic and political markets are exceptional; in other words, inefficient markets are common.
Once an economy is on an "inefficient path" that produces stagnation, it can persist (and historically has persisted) because of the natrue of path dependence. Institutional path dependence exists because of the network externalities, economies of scope, and complementaries that exist with a given institutional matrix. The individuals and organizations with bargaining power, as a result of the institutional framework, have a crucual stake in perpetuating the system.
Institutional path dependence do get reveresed, but this reversal is a difficult process about which we know all too little. The reason is that we still know all to little about the dynamics of institutional change and particularly the interplay between economic and political markets."
Source:
Douglass North. 1993. "The new institutional economics and development"
May 18, 2008
Founders of New Institutional Economics: Douglass North (Part 1 of 2)
"The new institutional economics (NIE) builds on and modifies the neoclassical theory of economics. What is builds on is the funamental assumption of scarcity--hence competition. It views economics as a theory of choice subject to constraints. It employs the price theory as an essential part of the analysis of institutions. In particular, it sees changes in relative prices as a major force inducing change in institutions.
What NIE modifies in the neoclassical theory is the instrumental rationality assumption. In a world of instrumental rationality, there is perfect information. Economic and political markets are naturally efficient. Hence, institutions are unnecessary; ideologies don't matter.
The fact is, however, people have incomplete information and limited mental capacity by which to process information. In consequence, human beings impose contraints on human interaction in order to structure exchange. This implies that the consequent institutions inherent in the intrumental rationality assumption is not necessarily efficient. In the real world, ideologies actually play a major role in choices. Markets are not inherently efficient because the act of making an exchange has a cost. Transaction costs result in imperfect markets. And so NIE adds institutions as a critical constraint and analyzes the role of transactions costs as the connection between institutions and costs of production. It extends economic theory by incorporating ideologies into the analysis. More importantly, it models the political process as a critical factor in the performance of economies, as the source of the diverse performance of economies, and as the explanation for "inefficient" markets.
...
First, it must be remembered that individuals enter into economic exchange using mental models they use to interpret the world around them. These mental models are, in part, culturally derived. In another part, they are acquired through experience which is local to the environment where the individual is situated. Naturally, mental models vary widely with different environments and so there is immense variation in mental models. As a result, there are different perceptions about how people look at the world and the way the world "works." Even the formal learning that individuals acquire from educational institutions frequently consists of conflicting models by which the world around is interpreted.
Now as indicated, individuals entering into economic exchange make choices based on their mental models. The incomplete information and limited mental capacity by which to process information determines the cost of tranacting. The costs of transacting arise because information is costly and are assymetrically held by the parties to exchange. Transactions costs are determined by the costs of measuring multiple valuable dimensions of the goods and services exchanged, or of the performance of agents, and the costs of enforcing agreements.
This underlies the formation of institutions. Institutions are formed to reduce the costs of transactions (the uncertainty in human exchange). Together with the technology employed, they determine the costs of transacting and producing.
It should be remembered that at issue is not only the rationality postulate, but the specific characteristics of transacting that prevents the actors from achieving a joint maximization result of the zero-transactions cost model of neoclassical theory. The neoclassical result of efficient markets is only obtained when it is costless to transact. When it is costly to transact, institutions matter.
Because a large part of a country's national income is devoted to transacting (the act of making the exchange), institutions (especially property rights) are crucial determinants of the efficiency of markets."
Source:
Douglass North. 1993. "The new institutional economics and development"
What NIE modifies in the neoclassical theory is the instrumental rationality assumption. In a world of instrumental rationality, there is perfect information. Economic and political markets are naturally efficient. Hence, institutions are unnecessary; ideologies don't matter.
The fact is, however, people have incomplete information and limited mental capacity by which to process information. In consequence, human beings impose contraints on human interaction in order to structure exchange. This implies that the consequent institutions inherent in the intrumental rationality assumption is not necessarily efficient. In the real world, ideologies actually play a major role in choices. Markets are not inherently efficient because the act of making an exchange has a cost. Transaction costs result in imperfect markets. And so NIE adds institutions as a critical constraint and analyzes the role of transactions costs as the connection between institutions and costs of production. It extends economic theory by incorporating ideologies into the analysis. More importantly, it models the political process as a critical factor in the performance of economies, as the source of the diverse performance of economies, and as the explanation for "inefficient" markets.
...
First, it must be remembered that individuals enter into economic exchange using mental models they use to interpret the world around them. These mental models are, in part, culturally derived. In another part, they are acquired through experience which is local to the environment where the individual is situated. Naturally, mental models vary widely with different environments and so there is immense variation in mental models. As a result, there are different perceptions about how people look at the world and the way the world "works." Even the formal learning that individuals acquire from educational institutions frequently consists of conflicting models by which the world around is interpreted.
Now as indicated, individuals entering into economic exchange make choices based on their mental models. The incomplete information and limited mental capacity by which to process information determines the cost of tranacting. The costs of transacting arise because information is costly and are assymetrically held by the parties to exchange. Transactions costs are determined by the costs of measuring multiple valuable dimensions of the goods and services exchanged, or of the performance of agents, and the costs of enforcing agreements.
This underlies the formation of institutions. Institutions are formed to reduce the costs of transactions (the uncertainty in human exchange). Together with the technology employed, they determine the costs of transacting and producing.
It should be remembered that at issue is not only the rationality postulate, but the specific characteristics of transacting that prevents the actors from achieving a joint maximization result of the zero-transactions cost model of neoclassical theory. The neoclassical result of efficient markets is only obtained when it is costless to transact. When it is costly to transact, institutions matter.
Because a large part of a country's national income is devoted to transacting (the act of making the exchange), institutions (especially property rights) are crucial determinants of the efficiency of markets."
Source:
Douglass North. 1993. "The new institutional economics and development"
May 8, 2008
Founders of New Institutional Economics: Ronald Coase
In a first of a three-part series, I will write something about the about who I consider the three major founders of the new institutional economics--the Triumvirs if you will. You see, I think of myself as a new institutional economist, and what better to revitalize this blog than by gracing it first with the main teachings of the Triumvirs and how they introduced this dynamic field. First off--Ronald Coase.
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Coase attributes the term "new institutional economics" to Oliver Williamson (another Triumvir). The term was intended to differentiate the relatively new field with another already existing economic field: the (old) institutional economics.
The economists from the old school were also, of course, men of great intellect. Coase pointed out, however, that the major weakness of the old school is that it does not have theoretical foundations that bind together the facts collected by the old school. The new school does, and the following is what Coase considers to be the basic theoretical framework within which the new school uses economic tools to study all the economic systems.
1. The welfare of the human society depends on the flow of goods and services.
2. The flow of goods and services depends on the productivity of the economic system.
3. Adam Smith also figures importantly in the new school. He explains that the productivity of the economic system depends on the division of labor (specialization).
4. Specialization is only possible if there is exchange.
5. The lower the cost of exchange, the more specialization there will be. This will also lead to greater productivity of the system.6. Finally, the cost of exchange depends on the institutions of a country. The institutions are either the legal system, the political system, the social system, the educational system, culture, etc.
So Coase stated it so clearly and precise:
"In effect, it is the institutions that govern the performance of an economy."
Of course, when we talk about performance of an economy, economic development is not far behind. The next Triumvir that I will discuss is Douglass North, and he has some excellent take on the new institutional economics and economic development.
Source:
Ronald Coase. 1998. "The new institutional economics."
********
Coase attributes the term "new institutional economics" to Oliver Williamson (another Triumvir). The term was intended to differentiate the relatively new field with another already existing economic field: the (old) institutional economics.
The economists from the old school were also, of course, men of great intellect. Coase pointed out, however, that the major weakness of the old school is that it does not have theoretical foundations that bind together the facts collected by the old school. The new school does, and the following is what Coase considers to be the basic theoretical framework within which the new school uses economic tools to study all the economic systems.
1. The welfare of the human society depends on the flow of goods and services.
2. The flow of goods and services depends on the productivity of the economic system.
3. Adam Smith also figures importantly in the new school. He explains that the productivity of the economic system depends on the division of labor (specialization).
4. Specialization is only possible if there is exchange.
5. The lower the cost of exchange, the more specialization there will be. This will also lead to greater productivity of the system.6. Finally, the cost of exchange depends on the institutions of a country. The institutions are either the legal system, the political system, the social system, the educational system, culture, etc.
So Coase stated it so clearly and precise:
"In effect, it is the institutions that govern the performance of an economy."
Of course, when we talk about performance of an economy, economic development is not far behind. The next Triumvir that I will discuss is Douglass North, and he has some excellent take on the new institutional economics and economic development.
Source:
Ronald Coase. 1998. "The new institutional economics."
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