From Economics of Transition to Economics of Institutions. Gérard Roland UC Berkeley

Introduction. Economics of institutions, for a long time outside the mainstream despite the influential work of North, Williamson and others, is now in the mainstream. Acemoglu, Johnson and Robinson (2001) article “The Colonial Origins of Comparative Development: An Empirical Investigation” is one of the most cited economics articles of the last 20 years. I want to argue that the transition from socialism to capitalism and the lessons from that experience have played an important role in bringing institutions to the mainstream.

The transition experience. The transition form socialism to capitalism was (and is), beyond its policy importance, a unique opportunity to test our understanding of the capitalist system since the transition involved the sui generis establishment of the capitalist system. Interest in transition in the early stages was mostly policy-oriented because of the expectation that the existing body of knowledge in economics was sufficiently advanced so that transition would mainly be implementation of existing theories.

The transition experience. The “Washington consensus” –Liberalization (markets) – Privatization (incentives) – Stabilization (stable macro environment). Seemed very reasonable for anybody who has studied economics. However,…there were many unexpected surprises.

First surprise: output falls after liberalization!

Strong difference in performance between three groups of countries! Output fall after price liberalization was puzzle for economic theory. All the more surprising given the high inefficiencies under socialism.

The output fall puzzle Standard theory (general equilibrium) could not explain the output fall or differences in output path. Explanations based on imperfections in institutional environment (Blanchard and Kremer, 1997) or on absence of markets and contractual considerations (Roland and Verdier, 2000) solved the puzzle (see e.g. Konings and Walsh, 1999, and others).

Further transition surprises. Privatization led in many cases to asset- stripping. Stabilization was often unsuccessful because of soft budget constraints (Russia). Huge difference in outcomes between countries was very unexpected.

The transition surprises. Transition policies were different in Asia compared to Central and Eastern Europe. However, there were no significant differences in policies between Eastern Europe and Central Europe. Policies alone could not explain the “Great Divide” between Central and Eastern Europe. Institutional differences appeared to play a big role.

The evolution of the unofficial economy as a share of GDP in selected transition countries. Country Hungary 2729 Poland Czech republic Slovakia 65.8 Estonia Russia Ukraine Georgia Source: Johnson, Kaufmann and Shleifer (1998).

Questions Once established the importance of the difference in institutions in the “Great Divide”, many questions are still raised: How to explain different institutional evolutions ? Why do some countries adopt better institutions than others? Which are the institutions that really matter (legal, political, cultural) and how? How to replace inefficient institutions by more efficient ones?

The influence of transition economics. 1.Transition has contributed to a general shift in economic thinking taking contracts and transactions as object of analysis (output fall puzzle). 2.Abuse rather than exchange is the core problem in contracting (mafia, corruption, predation) => first order importance of protection against private and public abuse 3.Transition has shifted emphasis in age-old controversy on size of government. Emphasis on effects of organization of government on effectiveness of public good provision (democracy, federalism, presidentialism, checks and balances).

The influence of transition economics. 4.Political sustainability of institutions and need to build support for continuous reforms and new institutions, taking into account political constraints (key in transition, standard idea now) 5.Transition has helped overcome a naïve view of institutions as easily imported and exported. More serious thinking is now devoted to thinking about historical and geographical adequacy of institutions. The Chinese experience is a very serious spur! 6.Transition has generated interest in idea of benefits of flexibility of institutions relative to commitment.

The influence of transition economics 7.Transition has put to the forefront enforcement issues, not just formal versus informal institutions. 8.Transition has renewed interest in the difficult topic of complementarities between institutions and the consistency of an institutional system. Problems of institutional transplantation linked to this. 9.Transition has forced to think about institutions in a dynamic way: the conditions for change or their absence, how momentum for change is created, how existing institutions can help or block change.

Conclusion. Research agenda for the “new” comparative economics: –Comparative analysis of legal institutions (civil law and common law) –Comparative analysis of political institutions (presidential, parliamentary, electoral systems, degree of federalism) –Comparative analysis of culture –Interaction between these different institutions and effects on institutional evolution and change.

Conclusion. The transition experience has contributed to bring the economics of institutions into the mainstream due to the first order effect of institutions. At the same time, it has raised new questions about how institutions emerge, evolve and change and how they interact. Much future thinking will go not into how important institutions are but how to better understand them and better think about them.