Chapter 1 and 2 Institution and Development.pptx

Debre Tabor University
College of Business and Economics
Department of Economics
Course: Institution and Development
(EconDev5051)
Yismaw Ayelign (PhD)
August 04, 2022
1
e-mail: andnethilnew@gmail.com

course outline
 Chapter One: Introduction
 What are institutions?
 Do institutions matter in development?
 Chapter Two: Empirical evidence on the role of institutions
 Colonization
 Corruption
 Patronage politics
 Chapter Three: Informal institutions vs. Development
 Traditional institutions
 Chapter Four: Property rights institutions vs. Development
 Property titles
 Empowerment and efficiency
2

Assessment Method Weight
Assignment -1 (Individual)
(Critical review of an
article)
10 %
Assignment-2 (Individual) (Critical
review of an article)
20 %
Assignment-3 (Group) (Article
review with presentation)
20 %
Final Exam
50 %
3

1.1. The concept of development
Trends Development
 Growth in income
 Life expectancy
 HDI
 Welfare
 As freedom (Amartya
Sen: Nobel laureate in
economics)
 The process of improving
the quality of all human
lives and capabilities by
raising people’s levels of
living, self-esteem, and
freedom.
5

 Every nation strives after
development. Economic
progress is an essential
component, but it is not
the only component.
 Development is not
purely an economic
phenomenon.
 In an ultimate sense, it
must encompass more
than the material and
financial side of people’s
lives, to expand human
freedoms. Development
should therefore be
perceived as a
multidimensional process
involving the
reorganization and
reorientation of entire
economic and social
systems. 6

 In addition to improvements in incomes and output,
it typically involves radical changes in
institutional, social, and administrative
structures as well as in popular attitudes and even
customs and beliefs.
 Although development is usually defined in a
national context, its more widespread realization
may necessitate modification of the international
economic and social system as well.
7

 Four Classic economic growth and development
Theories ----- all initiated after World War II
1) the linear-stages-of-growth model (e.g. Rostow and
H-D models)
2) theories and patterns of structural change (e.g. Lewis
and Chenery),
3) the international-dependence revolution,
4) the neoclassical, free-market counterrevolution (e.g.
Solow).
8

1. Linear stages of growth models
 Theorists of the 1950s and 1960s viewed the process of
development as a series of successive stages of
economic growth through which all countries must
pass. It was primarily an economic theory of
development in which the right quantity and mixture
of saving, investment, and foreign aid were all that was
necessary to enable developing nations to proceed
along an economic growth path that had historically
been followed by the more developed countries. 9

 Development, thus, became synonymous with rapid,
aggregate economic growth.
2. structural change models
 which focused on theories and patterns of structural
change, used modern economic theory and statistical
analysis in an attempt to portray the internal process of
structural change that a “typical” developing country must
undergo if it is to succeed in generating and sustaining
rapid economic growth.
10

3. the international-dependence revolution
 It was more radical and more political. It viewed
underdevelopment in terms of international and
domestic power relationships, institutional and
structural economic rigidities, and the resulting
proliferation of dual economies and dual societies
both within and among the nations of the world.
11

 Dependence theories tended to emphasize external
and internal institutional and political constraints on
economic development. Emphasis was placed on the
need for major new policies to eradicate poverty, to
provide more diversified employment opportunities,
and to reduce income inequalities.
12

 These and other egalitarian objectives were to be
achieved within the context of a growing economy,
but economic growth per se was not given the exalted
status accorded to it by the linear stages and
structural-change models
13

4. This neoclassical (neoliberal) counterrevolution
 It emphasized the beneficial role of free markets, open
economies, and the privatization of inefficient public
enterprises. Failure to develop, according to this theory, is
not due to exploitive external and internal forces as
expounded by dependence theorists. Rather, it is primarily
the result of too much government intervention and
regulation of the economy.
14

 Endogenous growth models (Romer 1986,
Lucas 1988), take into consideration elements
(such as increasing return to scale, human
capital, externalities) whose origins it is not
difficult to make to go back to the economic
relations that are settled down between the
agents, and therefore to the institutions.
15

Introduction:
1. Stylised Facts about Global Income Inequality
Country
Per capita GDP in
Population
(millions)
Manufacturing
share of GDP
1981 2021 1981 2021 1981 2021
Ethiopia 303.45 852.00 36 118 4.4 4.6
Kenya 1242.33 1643.57 17.06 54.99 10.58 7.24
Rwanda 439.19 902.62 5.33 13.28 15.74 9.18
India 401.48
1961.42
715.38 1.39
(Billion) 16.77
13.1

Country Per capita GDP in Population
(millions)
Manufacturing
share of GDP (%)
1981 2021 1981 2020 1981 2020
South Korea
4282.34 32644 38.72 51.74 21.83 25.39
Malaysia 3159.54 10827 14.13 32.78 21.30 23.49
Indonesia 1130.19 3855.8
150.94 276.36
13.43
(1983) 19.25
China 447.12 11188.3 993.885 1.41 billion
31.98
(2004) 27.44
Japan
20011 35278 117.66 125.68
23.47
(1994)
19.75
(2020)

Country Per capita GDP Population
(millions)
Manufacturing %
of GDP
1981 2021 1981 2021 1981 2021
Israel
25179.97
(1995) 39913.1
3.88 9.36 15.5
(1995)
11.32
(2020)
DRC
1019.47 517.93
27.04 92.4 8.84
(1996)
17.43
Botswana
1946.31 6887.75
0.93 2.4
6.06
5.67
(2020)

Country Per capita GDP Population
(millions)
Manufacturing
% of GDP
1981 2021 1981 2021 1981 2021
New Zealand 24,397 4,0778
3.12 5.12
26.04
9.83
(2019)
Netherlands
25,980 48,424 14.25 17.53 15.85 10.85
Ghana
904 2084
11.35 31.7
5.97 10.7
Singapore 14,737 66,176 2.53 5.45 25.76 20.54
Yismaw Ayelign (PhD) 19

 The basic question to be addressed is that why
poor countries are poor
 Potential Causes of per capita income variation
across nations
 Variation in Natural resource endowment???????? Natural
resource abundant economies tend to grow slower than
economies without substantial resources.
 For e.g., growth losers, such as Nigeria, Zambia, Sierra
Leone, Angola, Saudi Arabia and Venezuela,
20

are all resource-rich, while the Asian tigers:
Korea, Taiwan, Hong Kong and Singapore, are
all resource-poor.
 BUT many growth winners such as Botswana,
Canada, Australia, and Norway are rich in
resources.
21

 Sachs and Warner (1995) rent-seeking
hypothesis: resource abundance leads to a fall
in institutional quality in turn lowering
growth. Found that this mechanism was
empirically unimportant.
22

 Botswana, with 40% of GDP stemming from
diamonds, has had the worlds highest growth rate
since 1965. Acemoglu et al. (2002) attribute this
remarkable performance to the good institutions
of Botswana. Another example is Norway.
23

 On the other hand, in countries with weak
states, resource abundance stimulate
violence, theft and looting, by financing
rebel groups, warlord competition
(Skaperdas, 2002), or civil wars. Collier and
Hoeffler (2000) find that `the extent of primary
commodity exports is the largest single
influence on the risk of conflict'.
24

 Variation in Capital accumulation
??????????????? Discuss with examples of
theoretical explanation. Compare H-D and
Solow with endogenous growth models

25

 Cultural and geographical differences.????????
26

 Differences in institutional set up????????????
Review using empirical
27

1.2. Definitions of Institutions
 the rules of society that provide a framework of
incentives that shape economic, political, and
social organization and behaviour.
 Traditional economics considers institutions as
mere details rather than critical drivers of
economic growth and development. Do you agree?
Why and why not?
28

 Three important features of institutions are apparent
in this definition:
a. a. They are “ humanly devised, which contrasts with
other potential fundamental causes, like geographic
factors, which are outside human control;
b. They are “the rules of the game” setting
“constraints” on human behaviour;
c. Their major effect will be through incentives (see
also North, 1981).
29

So, institutions are:
 Arrangements that coordinate the behaviour of
individuals in society.
 Institutions are sets of regulatory norms.
 An institution is a stable, valued, recurring
pattern of behaviour.
30

Example of category of economic institutions
 Trust
 Information
 Property rights and Privatizations
 Rent-seeking, Groups of pressure and lobbies
 Bribe/corruption
 Reputation and Values
31

 Mechanisms of selection,
 Competition and cooperation
Intermediary
Bureaucracy
Organizations
Laws and constitutions
Industrial relations
Yismaw Ayelign (PhD) 32

Markets require non-market institutions to work well
33
a. Markets are not self-creating
i. Property rights
ii. Contract enforcement
b. Markets are not self-regulating
i. Regulatory authorities
ii. Correction of market and coordination
failures

34
c. Markets are not self-stabilizing
i. Monetary, fiscal and currency
arrangements
d. Markets are not self-legitimating
i. Political democracy
ii. Social insurance
iii. Redistribution

 The school of thought that discourse the
relevance of institution is called institutional
economics
 Do you think that institutional economics
different from neoclassical theory?
35

 Why do you think the structural adjustment program and
other programs enhanced by WB and IMF failed in Africa?
 It is because they were designed as institution-free
technocratic reforms
 Institutional differences across countries were ignored,
thereby recommending identikit policies, in what has
come to be known as the ‘one size-fits-all’ approach
to economic policy
36

 Today, it is widely accepted even by many orthodox
economists that policies directly derived from the
experiences of the developed countries – or, even
worse, from economic textbooks – are likely to fail in
developing countries, where certain institutions
whose existence these policies take for granted (e.g.,
well-defined private property rights, a developed
government bond market) simply do not exist.
37

 countries escape poverty only when they have
appropriate economic institutions, especially private
property and competition.
 How countries can establish the right
institutions?
 when they have an open pluralistic political system
with competition for political office, a widespread
electorate, and openness to new political leaders.
38

Conclusion
 Institutions matter in enhancing development of poor
countries.
 Countries with better "institutions" (more secure
property rights and less distortionary policies):
 will invest more in physical and human capital
 will use the factors (physical and human capital)
more efficiently to achieve a greater level of
income.
39

Chapter Two: Empirical evidence on the role
of institutions
2.1. The effect of Colonization on Institutional
development
 Do institutions matter in development?
 Illustration based on the article titled:
 The Colonial Origins of Comparative
Development: An Empirical Investigation
40

Colonization continued
 Author(s): Daron Acemoglu, Simon Johnson,
James A. Robinson
 Source: The American Economic Review, Vol. 91,
No. 5 (Dec., 2001), pp. 1369-1401
 Published by: American Economic Association
41

 Theories about the role of institutions in economic
development:
 Douglass C. North and Robert P. Thomas, 1973; Eric L. Jones,
1981; North, 1981:
 Countries with better "institutions" (more secure
property rights and less distortionary policies):
 will invest more in physical and human capital
 will use the factors (physical and human capital)
more efficiently to achieve a greater level of
income. 42

 Macro level studies support cross-country
correlations between measures of property rights and
economic development (Stephen Knack and Philip
Keefer, 1995; Paulo Mauro, 1995; Robert E. Hall and
Charles I. Jones, 1999; Dani Rodrik, 1999).
 Micro studies also indicated +ve relationship between
property rights and investment or output (e.g.,
Timothy Besley, 1995; Christopher Mazingo, 1999;
Johnson et al., 1999).
43

 More evidence:
 the divergent paths of North and South Korea.
 East and West Germany, where one part of the country
stagnated under central planning and collective
ownership, while the other prospered with private
property and a market economy.
44

 Why this article?
 To estimate the impact of institutions on economic
performance and propose the exogenous
determinant of institutional difference among
countries colonized by European countries.
45

Three premises:
i. European powers set up "extractives states” and
Neo-Europes.
 the main purpose of the extractive state was to
transfer as much of the resources of the colony to the
colonizer (example: Belgian colonization of Congo)
 No protection for private property
 No check and balance against government
expropriation.
46

 Neo-Europes are European settlers in colonies.
 The Neo-Europes tried to replicate European
institutions with strong emphasis on private property
and checks against government power.
 Example: Neo-Europes in Australia, New Zealand,
Canada, and the United States.
ii. In places where the disease environment was not
favourable to European settlement, the formation
of the extractive state was more likely.
47

iii. The colonial state and institutions persisted even
after independence.
 Given these premises, what is the instrument for
current institutions in the colonies?
 the instrument is mortality rates expected by the
first European settlers.
 Data used:
 mortality rates of soldiers, bishops, and sailors
stationed in the colonies (b/n 17th and 19th
century) 48

FIGURE : RELATIONSHIP BETWEEN INCOME AND SETTLER MORTALITY
OF 70 SAMPLE NATIONS
49

 The figure shows a strong negative relationship.
 This relationship reflects the effect of settler
mortality working through the institutions brought
by Europeans.
 To substantiate this, the authors regress current
performance (logGDP per capita income in 1995)
on current institutions (current institutions
instrumented by settler mortality rates).
50

 Colonies where Europeans faced higher mortality rates
are today substantially poorer than colonies that were
healthy for Europeans.
51

Mortality rate comparison:
 Annual mortality rate of local troops serving with
British army in India (Madras) was 13/1000.
 Annual mortality rate of British troops serving in
India (Madras) was 170/1000 due to lack of
immunity.
 Annual mortality rate of British troops serving in
British 15/1000.
52

 Based on the previous premises the hypothesis to be
tested in the model is:
 Settler mortality affected settlements; settlements
affected early institutions; and early institutions
persisted and formed the basis of current institutions.
53

OLS RELATIONSHIP BETWEEN EXPROPRIATION RISK AND
INCOME:
54

OLS RELATIONSHIP BETWEEN SETTLER MORTALITY
AND EXPROPRIATION RISK :
55

 Summery:
 Differences in colonial experience could be a
source of exogenous differences in institutions.
 Neo-Europes strategy adopted by Europeans set up
institutions that enforced the rule of law and
encouraged investment.
 Example: U.S.A, Australia and New Zealand
56

 Extractive state strategy adopted by Europeans was
detrimental (harmful) to investment and economic
progress. Example: Congo
 The colonization strategy was in part determined by
the feasibility of European settlement.
 Early institutions persisted to the present.
 NB: The article does not imply that institutions today
are predetermined only by colonial policies and
cannot be changed.
57

2.2. The effect of Corruption on dev’t
 Title: OBTAINING A DRIVER’S LICENSE IN INDIA: AN
EXPERIMENTAL APPROACH TO STUDYING
CORRUPTION
 Authors: MARIANNE BERTRAND, SIMEON DJANKOV,
REMA HANNA, SENDHIL MULLAINATHAN
 Journal: The Quarterly Journal of Economics,
November 2007
58

Why this study?
 To clear thought about debatable ideas (arguments)
on corruption:
 Argument 1: Corruption merely “greases the
wheels” of the bureaucracy (efficiency
implications of corruption).
 Argument 2: Corruption harms the society
(distortions in how bureaucrats allocate services)
59

 GETTING A DRIVER’S LICENSE IN DELHI, INDIA
Two paths to get a driving license in India:
 Agent path (costs applicants 2.5 times of the official
fee) extra legal payments.
 Official path
60

Methodology
 International Finance Corporation (IFC) followed 822
driver’s license candidates, collecting data on whether
they obtained licenses as well as detailed micro data
on:
 the specific procedures
 time and
 expenditures involved
61

 At the end of the process, the IFC administered an
independent surprise driving test (simulating the
test that is supposed to be given by the
bureaucrats) to determine whether individuals
who were granted a license could drive.
 How an accredited driving school administer surprise
practical driving test?
62

 oral examination to judge whether a subject could
operate a car (unable to answer this exam let the subject
to be cancelled from taking practical driving exam)
 Ex: Basic knowledge questions like; “which pedal would
you use to speed up? “how would you start the car?”
 if the subject pass the oral exam, the test-giver administer
a road test.
63

To understand whether and how corruption affects
allocation of license, candidates were randomly
assigned to one of the following three groups:
 Bonus group
 Lesson group
 Comparison group
64

 The “bonus group” offered a large financial reward if
they were able to obtain a license in 32 days.
 The “lesson group” offered free driving lessons, to be
taken immediately after recruitment into the survey.
 The comparison group were simply tracked through
the process.
 Incentives provided by IFC for each group that could
motivate the subjects to share their experience to the
project team:
65

 As an inducement to return, each subject was offered
Rs 800 upon completion of the final survey.
 However, to generate a stronger incentive for obtaining
a license, the IFC also offered a bonus of Rs 2,000 (on
top of Rs 800 for completing the surveys) for the bonus
group, if the individuals could obtain their permanent
licenses within 32 days.
 NB: Normally total official fee to obtain a license is Rs
450.
66

Why additional reward?
 to ensure a large enough treatment effect.
 Why the three groups?
 The bonus treatment allows us to assess whether and
how the allocation of licenses responds to
willingness to pay. That is:
 Are a group that are willing to pay more for licenses more
likely to get licenses?
 But also, are there more unqualified drivers receiving
licenses in such a group? 67

 The lesson treatment allows us to assess whether
allocation decisions by the bureaucracy are
responsive to the socially desirable component of
the regulatory process– one’s ability to drive.
 The comparison (control group) allows us to show how
the variables (performance indicators) in the
treatment group (bonus and lesson) statistically differ
from the untreated group (control group).
68

Licensing status of participants
69

Findings of the Experiment (OLS Result) 70

The way to proceed:
 We will see the OLS result of the bonus group first and
that of the lesson group next.
 Impact of each independent variable (being in the
bonus and lesson group) on the dependent variables
(outcomes) is indicated relative to that of the
comparison group (control group).
71

 Findings of being in the bonus group:
 Significance at the 10% level is represented by ∗, at the
5% level by ∗∗, and at the 1% level by ∗∗∗.
 All the dependent variables in the column headings
are dummy variables. (Ex: 1 if a given individual
obtained a permanent driver’s license and 0
otherwise).
72

 The dependent variable in column 2 is different from
column 1 as the dependent variable “Obtained license”
(or the outcome) in column 2 exclude 65 subjects who
indicated their final licensing status to the project
team over the phone but refused to attend the final
session to take the survey and driving exam.
 However similar results are indicated in these two
samples. That is:
73

 individuals in the bonus group are about 25 percentage
points more likely to obtain final licenses at 1% significant
level.
 Individuals in the bonus group are 42 percentage points
more likely to get their permanent licenses within 32 days
or less (see column 3).
 Hence, these first findings suggest that individuals who
have a greater need to get a license quickly are able to
achieve their objective.
74

 Increased propensity to get a license comes at a social
cost: more bad drivers (see column 4).
 Individuals in the bonus group are 13 percentage
points more likely to get their permanent licenses
without taking the legally required RTO exam
(column 4).
 Columns (5)–(8) shows that the lack of testing is
accompanied by an increase in the number of licensed
drivers with poor driving skills.
75

 Individuals in the bonus group are 29 percentage
points more likely to obtain licenses without
having anyone teach them how to drive (column
5) and are not more likely to have attended
driving schools (column 6).
 They are also much worse drivers than the
comparison group: they are 18 percentage points
more likely to be licensed drivers who
automatically fail the independent driving test
(column 7). 76

 They are 22 percentage points more likely to be
licensed drivers who score below average (50%) on
the independent test (column 8).
 In this regard, it is useful to benchmark how bad the
marginal drivers actually are.
77

 The failure rate on the independent exam is 0.60
(0.29/0.48) among the licensed drivers in the
comparison group (see column 2 and 7).
 However, the failure rate on the independent exam
is 0.75 (0.18/0.25) among the marginally new
licensed drivers in the bonus group (see column 2
and 7).
 Summery of findings of the bonus group:
78

 The evidence reported suggests that a bureaucratic
system responsive to a higher willingness to pay
(captured by the bonus group) for a license translates
into:
 an increase in the number of license getters (a socially
efficient component of the bureaucratic response)
 an increase in the number of license getters who do
not know how to drive (a socially inefficient
component of the bureaucratic response).
79

 Findings of being in the lesson group:
 Under an extreme view of a corrupt bureaucracy, one
might expect the allocation of licenses to be driven only
by willingness to pay.
 Thus, considering findings of the lesson group could help
us whether the bureaucracy is totally responsive to
willingness to pay or not.
80

 Columns (1) and (2) show that individuals in the
lesson group are between 12 and 15 percentage
points more likely than the comparison group to
obtain permanent licenses.
 Individuals in the lesson group are not more likely
than individuals in the comparison group to
obtain licenses within 32 days and without taking
the RTO`s exam (column 3&4).
81

 The lesson group are also more likely to obtain their
licenses while having had someone teach them
how to drive (column 5) and especially having
attended a driving school (column 6).
 The lesson group are 12 percentage point less likely
to obtain their licenses had someone didn`t teach
them (column 5).
82

 The lesson group are 35 percentage point more
likely to obtain their licenses had attended
driving school (column 6).
to fail the independent exam(column 7).
to score less than average (50%) of the
independent exam(column 7).
83

 Summary of findings of the lesson group:
 Individuals access to driving lessons did raise their
driving skills and also increased the likelihood that
they obtained driver’s licenses.
 This finding is consistent with the view that
bureaucrats do not completely ignore driving
ability in the allocation of licenses.
84

2.3. Article on Patronage Politics
 Patronage Politics = political corruption = with
politically connected firms = Wilfully defaulting
 Title: DO LENDERS FAVOR POLITICALLY
CONNECTED FIRMS?
 Authors: Asim Ijaz Khwaja and Atif Mian (April 2005)
 Published: The Quarterly Journal of Economics, Vol. 120,
No. 4, pp. 1371-1411
85

 The paper deals with how firms political
connections (networks) favour firms access to
loan and the overall economic cost of
preferential treatment.
 Why this study? Justification of the study
 Despite a rich theoretical literature that explain
economic costs of corruption and rent-seeking, there
is limited empirical work.
86

 Cross country studies so far related corruption to poor
do not identify channels through which corruption
and rent provision occurs.
 Politics and Lending: The Institutional Environment in
Pakistan
i. Politicians and Corruption: Politics in Pakistan has
been closely linked to clientelism, rent-seeking and
corruption.
 Clientlism (patronage politics) is the exchange of g & s
for political support(often involving an implicit or explicit
quid-pro-quo).
87

 Simply, reward for political supporters.
 it is an exchange system where voters trade
political support for various outputs of public
decision making process.
 Rent-seeking is an attempt to obtain economic
rent by manipulating (controlling) regulatory
agencies to gain monopolistic advantages while
imposing disadvantages on competitors.
88


 Rent-seeking is an attempt to obtain economic rent
by manipulating the social and political
environment rather than by creating new wealth.
 Corruption is illegitimate use of public power to
benefit a private interest.
89

ii. A Mechanism for Political Rents:
 How does political corruption carried out?
 Based on National Accountability Bureau, lion`s
share of large scale corruption (in terms of the
amount of corrupt money changing hands)
happened by:
90

 taxation departments
 state-owned banks and development finance
institutions
 power sector utilities and
 civil works departments
 Government Bank`s Act of Pakistan in 1974:
 The act explicitly states that:
91

 the top hierarchy of government banks (i.e.,
chairman, president and board members) are to be
appointed by the government.
 the board determines the credit , personnel
policies of the bank (including appointment and
removal of officers and employees) and
guidelines for entering into any compromise
with borrowers and other customers of the bank.
92

 Methodology
i. Data:
 two primary data sets:
 detailed loan level information for every corporate
loan made in Pakistan from 1996 to 2002 (from Credit
Information Bureau (CIB) in Pakistan)
 electoral outcomes for the two elections that overlap
the loan data period
93

 CIB data base includes:
 loan outstanding by loan type (fixed, working
capital, etc.)
 default amounts and litigation (on judiciary
process)
 write-offs or recoveries against the loans
 information on the name, location and directorship of
the borrowing firms and lending banks
94

ii. Matching Politicians to Firms
 The CIB data includes names and addresses of all
directors of a borrowing firm.
 Since almost all firms are private firms directors are
typically one of the main owners of the firm.
 Who is politician?
 A politician is defined as any individual who stood in
the national or provincial elections.
95

 A politician is matched to a firm director, if their full
(first, middle and last) names match exactly.
iii. Mechanism to check politically connected firms
obtain loan in the form of preferential lending
(preferential treatment) :
 Credit access (loan size)
 Default rate
96

iv. Model: OLS regression based on the cross section data
base.
 specification of the model:
 Model 1: Model to test measures of preferential treatment
 Where Yij= measures of preferential treatment
 Politicali = Measure of the firm is politically connected
or not ( is coefficient of interest).

97

 captures the preferential treatment a politically
connected firm receives, and henceforth shall be
referred to as the political preference effect.
 Example: When default rate is the dependent
variable we can interpret as the additional
default by politicians per dollar of borrowed
amount.
98

 Model 2: to test whether the same firm receives
(greater) preferential treatment if it is politically
connected when it borrows from a government
compared to a private bank.

 Where Govj = is an indicator variable for whether the
lender is a government bank or private bank.
99

 Results/Findings:
 Result based on model 1( preferential treatment for
politically connected firms)
 (coefficient of interest) captures the extent to
which a politically connected firm receives
preferential lending from a government bank as
compared to the unconnected.
100

 Column(1) presents evidence for political
preference in terms of credit usage.
 – Loans to politically connected firms are 37% as
large as those to unconnected firms .
 Politically connected firms default 6.2
percentage points more than unconnected ones.
 To sum up, politically connected firms receive
preferential treatment on two accounts: They are
able to borrow larger amounts and their default
rates are higher. 102

Result based on model 2(Political Rents and Government
Banks)

103

 Since government banks are more susceptible to
political force (in Pakistan) due to their organizational
design we expect them to provide greater rents
(benefits) to politically connected firms.
 •Thus, we are going to examine whether this is the case
for the two measures of preferential treatment,
default rate and access to credit.
104

Preferential Treatment: Default Rate
 •Restricting the data to loans from government
banks only shows that loans to the politically
connected firms have 11 percentage points higher
default rates.
 • Restricting the data to loans from private banks
only there is hardly any difference in default rates
between the politically connected and
unconnected firms in private bank loans.
105

 The coefficient of interest is the double interaction
term ( (Political*Government)) that shows
politically connected firms default 9.9
percentage points more than the unconnected in
loans from government banks relative to loans
from private banks (column 5).
106

 Under column (5), what does the small negative
coefficient (-0.78) on the dummy for political firms
show?
 It might show that greater monitoring or better
selection for politically connected firms by
private banks.
107

 Preferential Treatment: Accesses to Credit
 Here, we restrict to firms that borrow at least 1% of
their lending from each type of bank.
 That is firms that borrow from a single bank type are
not included as they do not directly affect our
coefficient of interest
 Moreover, comparing preferential treatment for loan
requires controlling the demand effect.
109

 In other words, access to credit for the politically
connected firms might be larger simply because their
demand is higher which prevent us from generalizing
preferential treatment is given to the political firms.
 To avoid this demand effect, comparison was made
among firms with the same credit demand.
110

 The OLS Result (credit access):
 Government banks provide 29 percent more loan
to politically connected firms than the
unconnected from government banks relative to
loans from private banks.
111

 The Costs of Rents (Preferential Treatment)
 Cost of corrupt lending to the economy analyzed:
 Loss of taxation
 Cost of investment distortion
 Loss of taxation:
 This refers to costs due to the increased taxation
necessary to bail out bad government loans.
 Loans that default due to political corruption can be
considered as a transfer payment to politicians.
112

 The transfer is ultimately from tax payers as the
government uses its revenues to bail out government
banks.
 To obtain the cost of taxation from such transfers we
need to estimate the size of this transfer (i.e. the extra
default or incremental loss due to corrupt
lending).
 To get the extra default we need to subtract the
natural default rate from the corrupt lending default
rate 113

 Based on data of Pakistan:
 Natural default rate = 6%
 Corrupt lending to PCF= 30.8%
 Then, extra default = 30.8%-6%=24.8%
 Given total government banks lending of Rs 190
billion ($ 3.2 billion) in 2002, 38 % of which was given
to politically connected firms, the total
additional revenue lost from political corruption
is Rs 17.9 billion annually (190*0.38*0.248).
114

 •However, even non-political loans have
substantial elements of rents because such loans
also face a high default rate (19.9 percent).
 • Subtracting the natural default rate from it, we could
have incremental loss of 13.9%.
 • Thus, if we count non-political loan default on
government banks the taxation revenue lost from
corruption is Rs 34.3 billion annually (17.9 +
190*0.62*0.139).
115

 Conservative DWL estimates indicated that the
marginal costs of taxation is at around 40 cents for
every dollar raised [Ballard et al., 1985].
 • Accordingly, the DWL of revenue lost for Pakistan
was found to be Rs 13.7 billion each year or 0.3% of
GDP annually.
 Cost of investment distortion:
 refers to the foregone value when corrupt loans are
poorly invested.
116

 • If influential like politicians get cheap money from
government banks, they are unlikely to invest
their loans efficiently. Why?
 rates of return to investment might be lower
 may not invest at all and simply consume it
 deposit it in offshore accounts
117

 To estimate the cost of such investment distortion, one
needs to know the rate of return to corrupt lending.
 To calculate the rate of return what one need to know
is market and book value of the firm.
 Rate of return=MV/BV.
 Using this approach, a Market to Book ratio for
Pakistan estimated at 2.96.
118

 Given MV/BV ratio of 2.96, annual costs of investment
distortion is found to be Rs 35 billion to Rs 67 billion
or 0.8% to 1.6% of GDP each year. That is:
 Inv`t distortion cost = (2.96-1) *(Inefficient Government
Lending)
 where the inefficient government lending is either corrupt
lending to PCF or corrupt lending to all firms (i.e., Rs17.9
billion or Rs 34.3 billion)
 2.96-1 gives the return rate had the corrupt loan invested.
119

Chapter Three:
Traditional Institution and Development
Traditional institutions
 Institutions are the rules of behaviour in a society,
or more formally speaking, the restrictions on which
man has figured out how to shape human interaction
 informal institutions— unwritten rules of
behaviour, social norms, networks.
 e.g. In the Ethiopia context.
120

 Besides formal institutions, i.e. constitutions, laws,
property rights,
 informal institutions encompass customs,
traditions and codes of conduct.
121

 Economic institutions significantly affect economic
incentives in society and the achievement of certain
economic outcomes, that may be formed through
formal or informal institutions.
122

 By increasing human and social capital certain
communities reach a more efficient use of the
institutional framework
 However, the observation of the institutional
framework is most frequently focused exclusively on
formal institutions.
123

 In addition, to formal institutions, a significant
impact is achievable through informal institutions as
well.
 Thus, legal or formal institutions that do not
have strong “informal” supports are unsupported
legislative declarations rather than real
institutions.
124

Within the framework of the definition, informal
institutions refer to:
 extension, argumentation and
 codification of formal rules that go beyond the official
limits,
 socially punishable norms of behaviour,
 including behaviour, customs, adopted rules of
behaviour and tradition.
125

 A stronger influence of informal institutions in
relation to the rule of law commonly occurs in certain
periods of crisis, such as war.
 the institutions are formed according to the official
rules, informal constraints and their enforcement
characteristics.
126

 Informal rules of behaviour are much more complex
and they include the way in which certain things are
done, whereby the norms as part of an informal
institutional framework become almost more
important than formal rules of behaviour
127

 To reduce risk and transaction costs humans create
institutions, writing and enforcing constitutions,
laws, contracts and regulations—so-called formal
institutions—and
 structuring and inculcating norms of conduct,
beliefs and habits of thought and behaviour—or
informal institutions.
128

 the performance of a market economy depends upon
the formal and informal institutions and modes of
organization that facilitate private transactions and
cooperative behaviour.
 Norms, beliefs and similar informal institutions seem
to be deeply engrained and the product of intractable
factors, such as a society’s history or its ethnic,
religious, or linguistic heterogeneity. What can a
society do if its culture is inhospitable?
129

 If the relationship between formal and informal
institutions is critical to economic performance, if
that relationship is poorly understood, and, worst of
all,
 If our basic ability to alter slow-moving institutions is
limited, we may not be capable of providing the policy
advice that statesmen and bureaucrats regularly seek”
130

Empirical Evidence:
Role of traditional institutions
 Title: Traditional Institutions Meet the Modern
World: Caste, Gender and Schooling Choice in a
Globalizing Economy
 Authors: Kaivan Munshi and Mark Rosenzweig (2006)
Publication: American Economic Review, Vol. 96, N. 4.
131

 The paper addresses the question of:
 how traditional institutions interact with the
forces of globalization? Or
 how old institutions clash with the forces of
globalization in shaping responses of
individuals in the new economy.
132

 It is crucial to deal with this issue as the interaction or
the clash shape the economic activity and welfare
of particular groups of individuals in the new
economy.
 Thus, the authors explored the role of traditional
institution (or the caste system) in shaping career
choices by gender in Bombay Dadar area in India.
133

 What is caste system?
 Caste system (in India) is a system of social
stratification which historically separated
communities into thousands of endogamous
hereditary groups called jatis.
 Jatis are translated into English as castes.
 Endogamy is the practice of marrying within a specific
ethnic group, class or social group rejecting others for
marriage or any kind of close relationship.
134

 Castes could be divided as:
 The upper caste (this grant administrative job and
senior appointments)
 The Lower caste
 Our concern here is that the interaction of lower
castes with the forces of globalization.
135

 Classification of job in India:
 working class job (traditional hourly works or manual
industrial works that labourers do on wage basis)
 White collar job (non-traditional works that are
usually salaried)
Medium of instruction:
 Marathi
 English
136

The Institutional Setting:
 i. Bombay’s Labor Market
 ii. The schools in Dadar
 Bombay’s Labor Market
 This frequent job turnover gave rise to labor market
networks.
137

 The labor market networks are crucial in case:
 the quality of a freshly hired worker is difficult to
assess and
 performance-contingent wage contracts cannot be
implemented.
 This information asymmetry give rise to:
 jobbers to lean on social connections outside his
workplace such as his kinship and neighbour
hood connections.
138

 The endogamous sub-caste or jati served as a natural
social unit from which to recruit labor.
 Why this?
 because marriage ties strengthen information flows
and improve enforcement.
 This widespread use of caste-based networks thus
led to a fragmentation of the Bombay labor
market along social lines.
139

 Caste-based networks in Bombay were restricted to
working class jobs.
 –because the information and enforcement problems
that give rise to such networks tend to be more acute
(sensitive) in working class jobs.
 Women were conspicuously absent from Bombay’s labor
force, particularly in the working class jobs.
 This patterns of labor force participation by gender will
help us explain the schooling choice dynamics (for
boys and girls). 140

 The Schools in Dadar
 Here, we will highlight the medium of instruction as
the salient feature of schooling choice in Dadar.
 The choice of the language of instruction proxies for
school quality.
 Justification?
Based on school based survey conducted:
 school quality indicators (such as student-teacher
ratio, class size, number of students per desk,
141

 computers per student, and the proportion of teachers
with B.Ed. degrees and postgraduate degrees) are each
very similar.
 English schools are relatively expensive. In contrast,
school fees in the Marathi schools are subsidized
by the state government.
 Performance of English school students on
standardized secondary school certificate is
better.
142

Students in the English schools perform much better in
terms of: percentage that pass
 percentage that receive a first class and
 Percentage that receive a distinction.
 The better performance of English schools students
could be explained as differential in selection
ability into English and Marathi schools
(differential in pre-school ability or human
capital).
143

 The survey also indicated that parents who worry
for their children`s role in the society dominate
those parents worry for school quality in their
schooling choice.
144

 Conclusions
 •Male working class networks significantly affect
schooling choice of male students which could
contribute to persistence of the traditional
occupation.
 However, the cohort effect indicates gradual
decline of the role the working class network due
to the relatively higher return in the non-
traditional occupation (white-collar).
145

 Girls appear to be taking full advantage of the
opportunities that have become available in the new
economy.
 Individuals schooled in English no longer needs the
traditional caste network; indeed, the English
educated form a caste by themselves.
 • Remark:
 –Bad institutions retard nations & vice versa.
146

Chapter Four:
Property Right and Development
 Property :
Tangible: Housing, land
Land as property requires tenure
Intangible : intellectual ======== copy right vs
patent right
Right: control over assets and the “return to the
assets that are produced and improved”
147

 Copyright, which includes literary and artistic works
such as novels, poems and plays, films, musical works,
artistic works such as drawings, paintings,
photographs and sculptures, and architectural
designs.
 Industry property right is a term referring to
creation of the intellect for which a monopoly is
assigned to designated owners by law, i.e., inventions
(patents), trademarks, industrial designs, and
geographic indications of source 148

 Property right is secure when the right holder
perceives it to be stable and predictable over a
reasonable period of time and
 protected from expropriation or arbitrary
change, with claims that are backed up by some type
of authority.
 Security typically implies the ability to appropriate
benefits arising from a particular property right.
149

 The economic case for secure property rights is that
growth depends on investment;
 however, investors do not invest if there is a risk of
government or private expropriation
 property owners can legally exclude others from using
a good or asset.
150

 Four main channels through which secure property
rights influence economic activity and resource
allocation
1. Security channel whereby investment is expected to
lead to a flow of income, which needs to be
protected against expropriation through secure, well-
defined property rights.
151

 Such protection provides incentive to invest; by
implication, insecure property rights could mean
that firms or individuals may fail to realise the fruits
of their investment and efforts.
2. Efficiency channel, enhancing the mobility of
assets through transactions such that assets are
transferred to those who can use them most
productively.
152

3. Reduced protection costs – secure property rights
mean that individuals can devote fewer resources to
protecting their property and these resources can go
to productive uses.
4. Transactions facilitation – property rights allow for
the use of property in supporting other transactions
by using it as collateral to raise resources on the
financial market. This may increase productivity.
153

 Thus, property right is one of the non- market
institution
 The standard model of traditional economics
assumes a well-defined set of property rights.
 It also assumes that contracts are signed with no fear
that they will be revoked when it suits one of the
parties.
155

 So, in the background there exists institutions that
establish and protect property rights and enforce
contracts.
 a system of laws and courts to make even
"perfect" markets function are required.
 the market economy is necessarily "embedded" in a
set of non-market institutions
156

 The establishment of secure and stable property
rights have been a key element in the rise of the West
and the onset of modern economic growth.
 It stands to reason that an entrepreneur would not
have the incentive
 to accumulate and innovate unless s/he has adequate
control over the return to the assets that are thereby
produced or improved.
157

 Note that the key word is "control" rather than
"ownership."
 Formal property rights do not count for much if they
do not confer control rights.
 By the same token, sufficiently strong control rights
may do the trick even in the absence of formal
property rights.
158

 Russia today represents a case where shareholders
have property rights but often lack effective control
over enterprises.
 Town and village enterprises (TVEs) in China are an
example where control rights have spurred
entrepreneurial activity despite the absence of clearly
defined property rights.
159

 Establishing "property rights" is not a matter of just
passing a piece of legislation.
 Legislation in itself is neither necessary nor sufficient
for the provision of the secure control rights.
 In practice, control rights are upheld by a combination
of legislation, private enforcement, and custom and
tradition.
160

 They may be distributed more narrowly or more
diffusely than property rights.
 Stakeholders can matter as much as shareholders.
161

Empirical Evidence
 Title: Effects of property rights on agricultural
production: The Nigerian experience
 Authors: A. A. Akinola* and R. Adeyemo (2013)
 Published on: Journal of Development and Agricultural
Economics. Vol. 5 No. 10, pp. 382-389
162

 The study was conducted to examine the effects of
property rights and other factors on the outputs of
maize, yam and cassava in three zones of Osun State
in Nigeria.
163

 This study employed a multi-stage sampling
technique to select 105 farmers involving growers of
maize, yam and cassava in the study area.
 Data were analyzed with the aid of descriptive
statistics, budgetary techniques and a multiple linear
regression model.
164

Findings
 Land rights type (having either use right/use and
transfer right) and security of land defined by
duration of land use affected maize output while
duration and ownership type affected yam output,
whereas, duration only affect cassava output.
165

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