Comparative Economic Systems Eco 518 Final Country Paper .docx

Comparative Economic Systems Eco 518
Final Country Paper
Summary:
You will select one country to analyze in depth and write a
paper discussing their economic system. In
discussing their economic system, you will want to address any
relevant history for the system forming,
its stability, what the system means for economic growth and
development and human flourishing, and
what changes are happening in the system. More information
will be given out separately in class. Each
student should analyze a different country. Your paper is due at
the beginning of class on March 7. A
hard copy needs to be turned into me as well as you must submit
your paper to Blueline.
Proposal format:
Please clearly label the sections of your paper. Do not forget a
title.
1. The introduction. This is your “sell.” Here, you should
motivate your research paper and frame it

within a larger conversation - what is unique about your
country? What general economic
system are they following? What is the outlook for the country?
You won’t go too in depth
here, but the reader should know the main thesis of your paper
and what you are examining.
2. Relevant country history – make sure you frame this in terms
of political economy and economic
systems
a. Subheadings are fine as needed
3. Institutional Analysis - - There is a wide variety of avenues
you could pursue here. Below are
suggestions:
a. Current economic system
i. Baumol may help here
b. Other economic institutions – money, contracts, judicial
system, starting/closing a
business, overall economic freedom, etc.
c. Make sure to look at:
i. Major recent reforms (if present)
ii. Potential for economic growth (or decline or stagnation)
d. Potential subheadings:
i. Stability / revolutions / wars
ii. Major political changes
e. Additional areas you would like to examine
4. Conclusion. Tie it together. You can suggest future (related)
research, reforms for the country,

or a general economic outlook.
5. References – APA or Chicago Style – make sure to cite all
sources!
Paper should be approximately 9 to 12 pages in length, 1 inch
margins, Calibri 11 font or Times New
Roman 12 font and double spaced, excluding your cover page
and references. Graphs and quotes from
outside sources can be used as long as properly cited – make
sure they are advancing your paper and
not used as filler. Please use proper grammar, citation style,
spelling, etc. While not formally counted in
the rubric, these will impact your grade.
Potential sources (non exhaustive list, please come see me if
you are having difficulties finding
information for your country):
atters
– Fraser Institute
Year Book

ion Index
Your paper is due at the beginning of class on March 7. A hard
copy needs to be turned into me as
well as you must submit your paper to Blueline.
Grading Rubric
Intro Captures the reader’s attention
(sell); motivates the proposal
(20)
Country History Identifies and explores relevant
recent country history / dynamics
(15)
Institutional
Analysis
Economic and political institutions
analysis

Current economic system
Important specific economic
institutions
Stability
Potential areas of reform
Economic growth / outlook
(50 total)
Conclusion Pulls together paper; may reiterate
why the research is important; may
suggest areas of future research;
future reforms
(10)
References Uses an accepted reference style
and shows all relevant sources
(5)
Total points:
Citation:
Benjamin Powell, Economic Freedom and Growth: The Case
of the Celtic Tiger, 22 Cato J. 431 (2003)

Provided by:
Klutznick Law Library / McGrath North Mullin & Kratz Legal
Research Center
Content downloaded/printed from HeinOnline
Wed Mar 21 17:14:55 2018
-- Your use of this HeinOnline PDF indicates your acceptance
of HeinOnline's Terms and Conditions of the license
agreement available at http://heinonline.org/HOL/License
-- The search text of this PDF is generated from
uncorrected OCR text.
-- To obtain permission to use this article beyond the scope
of your HeinOnline license, please use:
Copyright Information
Use QR Code reader to send PDF to
your smartphone or tablet device
http://heinonline.org/HOL/Page?handle=hein.journals/catoj22&
collection=journals&id=437&startid=&endid=454
https://www.copyright.com/ccc/basicSearch.do?operation=go&s
earchType=0&lastSearch=simple&all=on&titleOrStdNo=0273-
3072
ECONoMIC FREEDOM AND GROWTH: THE
CASE OF THE CELTIC TIGER
Benjamin Powell

Ireland was one of Europe's poorest countries for more than two
centuries. Yet, during the 1990s, Ireland achieved a remarkable
rate
of economic growth. By the end of the decade, its GDP per
capita
stood at $25,500 (in terms of purchasing power parity), higher
than
both the United Kingdom at $22,300, and Germany at $23,500
(Economist Intelligence Unit [EIU] 2000: 25). In 1987, Ireland's
GDP per capita was only 63 percent of the United Kingdom's
(The
Economist 1997). As Figure 1 shows, almost all of the catching
up
occurred in a little over a decade. From 1990 through 1995,
Ireland's
GDP increased at an average rate of 5.14 percent per year, and
from
1996 through 2000, GDP increased at an average rate of 9.66
percent
(International Monetary Fund 2001).
Most theories of economic growth can be dismissed as an expla-
nation for the rapid growth of the Irish economy. The thesis of
this
paper is that no one particular policy is responsible for Ireland's
dramatic economic growth. Rather, a general tendency of many
poli-
cies to increase economic freedom has caused Ireland's economy
to
grow rapidly.
The first section of this paper looks at general policies and eco-
nomic growth in Ireland from 1950 to 1973. The second section
examines Ireland's experience with Keynesian policies and a
fiscal
crisis in the 1973-87 period. The third section considers the

policies
used to correct the fiscal crisis and achieve the dynamic growth
that
occurred from 1987 through 2000. The policies in the above
periods
Cato Journal, Vol. 22, No. 3 (Winter 2003). Copyright @ Cato
Institute. All rights
reserved.
Benjamin Powell is a Ph.D. candidate in Economics at George
Mason University and a Social
Change Fellow at the Mercatus Center. He thanks Peter Boettke,
Christopher Coyne, Todd
Zywicki, the participants at the Association of Private
Enterprise Education conference in
Cancun 2002, the participants at the Mercatus Center "brown
bag" series, and an anonymous
referee, for helpful suggestions on earlier drafts. He also thanks
the Mercatus Center and the
American Institute for Economic Research for financial support.
431
CATO JOURNAL
FIGURE 1
IRELAND'S PER CAPITA GDP CONVERGENCE
30,000 -
25,000
0

S20,000
0
0 15,000
a
C.1000
Qloxt
-+- Germany
+l-reland
-&-United Kingdom
-*--United States
-,K-E~lJ5
SOURCE: OECD (2002).
are explained more broadly in the context of economic freedom
and
its relationship to economic growth in the fourth section. Other
pos-
sible explanations of Irish economic growth are briefly
explored. The
paper ends with conclusions that can be drawn from Ireland's
expe-
rience.
Early Prospects for Growth, 1950-73
The Irish Republic had a dismal record of economic growth
before
1960. At the dawn of the 20th century Ireland had a relatively

high
GDP per capita, but it declined markedly vis-A-vis the rest of
north-
western Europe up until 1960. During the 1950s, the policy
stance of
successive governments was that of protectionism. Exports as a
pro-
portion of GDP were only 32 percent, with more than 75 percent
of
those exports going to the United Kingdom (Considine and
O'Leary
1999: 117). The high level of government interference in trade
and
the other parts of the economy caused dismal economic
performance.
In the 1950s, average growth rates were only 2 percent, far
below the
postwar European average (EIU 2000: 5). That dismal
performance
432
CELTIC TIGER
was reflected in massive emigration that reduced Ireland's
population
by one-seventh in the 1950s (Jacobsen 1994: 68).
The Irish government slowly shifted away from highly
protectionist
policies in the 1960s and began to pursue a strategy of export-
led
growth (Considine and O'Leary 1999: 117). Unilateral tariff
cuts in

1964 and again in 1965, as well as the Anglo-Irish Trade
Agreement
in 1965 that swapped duty-free access of Irish manufactures to
Britain
for progressive annual 10 percent reductions in Irish tariffs,
were
particularly beneficial policies that helped make Ireland more
attrac-
tive to foreign investors (Jacobsen 1994: 81).
Trade liberalization during the 1960s fueled Ireland's economic
growth. Output expanded at an average annual rate of 4.2
percent,
nearly double that achieved in the 1950s (EIU 2000: 5). Still,
there
was a great deal of state intervention in the economy during this
time,
and while the growth was much higher than the 1950s, it is not
nearly
as remarkable as the growth Ireland has experienced since 1990.
During the decade of the 1960s, the rest of Europe was also
experi-
encing about 4 percent GDP growth. Ireland's freer trade
policies
merely allowed it to cash in on the generally good growth rates
the
rest of Europe was experiencing. Ireland made no progress
converg-
ing to the rest of Europe's standard of living; in fact, it actually
fell
slightly, from 66 percent of the EU 12 average in 1960 to 64
percent
in 1973 (Considine and O'Leary 1999: 117).
Keynesian Policies and Fiscal
Mismanagement, 1973-86

In the early 1970s, Ireland made further advances in trade liber-
alization and joined the European Economic Community in
1973.
For the most part, however, the period from 1973 until 1986
was
characterized by Keynesian policies that led to a fiscal crisis.
Follow-
ing the first oil shock in 1973 and continuing through the
second oil
shock in 1979, Ireland tried to boost aggregate demand through
in-
creased government expenditures-a policy that failed to revive
the
Irish economy.
The expansionary fiscal policies had the effect of putting the
gov-
ernment in poor fiscal condition. The government had run
substantial
deficits, associated with the first oil shock, mostly for the
purpose of
financing capital accumulation up until 1977, which caused a
balloon-
ing current-account deficit (Honohan 1999:76). After 1977, the
gov-
ernment engaged in an even more unsustainable fiscal expansion
causing public-sector borrowing to rise from 10 percent of GNP
to 17
433
CATO JOURNAL

percent, despite increased taxation. All categories of
government
spending increased between 1977 and 1981: wages and salaries
in-
creased due to national pay agreements; public bodies took on
more
staff to try to reduce unemployment; transfer payments
increased;
and an ambitious program of public infrastructure expansion
caused
capital spending to increase (Honohan 1999: 76). Interest
payments
also increased during this time. International interest rates were
at an
all-time high, and lenders required Ireland to pay a high risk
pre-
mium. Interest rates in Ireland were 15 percent higher than in
Ger-
many (Considine and O'Leary 1999: 118).
The government reacted, in the early 1980s, by increasing taxes
on
labor and consumption to try to reduce the budget deficit.
Although
the primary deficit was cut in half, the debt-to-GDP ratio
continued
to climb, and by 1984 further tax increases were not seen as a
viable
solution to Ireland's fiscal situation (Lane 2000). The level of
accu-
mulated debt was 116 percent of GDP by 1986 (Considine and
O'Leary 1999: 119). High levels of government debt, interest
pay-
ments, and expenditures put the Irish government in a
precarious
fiscal position.

Ireland's economic growth during this time period was as dismal
as
its fiscal condition. Ireland averaged 1.9 percent expansion of
GDP
per year between 1973 and 1986 (Considine and O'Leary 1999:
111).
Although that low growth rate was the same as during the
1950s, the
difference was that the rest of Europe also grew slowly. Conse-
quently, Ireland remained at about two-thirds the level of GDP
per
capita of the European Union. There was one sector of the Irish
economy that did do relatively well during the 1973-86 period.
Be-
cause of Ireland's increasing openness to trade, foreign-owned
firms
continued to expand, increasing their employment by 25 percent
(Considine and O'Leary 1999: 119).
Unleashing the Tiger, 1987-2000
A radical policy shift was needed because of Ireland's fiscal
crisis.
The newly elected prime minister, Charles Haughey, had not
fol-
lowed a policy of limited government while previously in office
(1979-82). In fact, his big spending policies played a part in
creating
the crisis (The Economist 1988). Prior to the 1987 reforms,
Haughey
and the incoming Fianna Fail government had campaigned on a
populist platform against cutting public spending. It was the
urgency
of the fiscal crisis, not an ideological shift, that caused policy
to

change in Ireland. As Lane (2000: 317) notes, "The fiscal
adjustment
434
CELTIC TIGER
program was broadly based and non-ideological. Rather, there
was a
wide consensus that drastic action was the only option, with the
al-
ternative being a full-scale debt crisis requiring external
intervention
from the IMF or EU." Haughey himself said, "The policies
which we
have adopted are dictated entirely by the fiscal and economic
reali-
ties, I wish to state categorically that they are not being
undertaken
for any ideological reason or political motives" but because
they are
"dictated by the sheer necessity of economic survival"
(Jacobsen 1994:
177). Even the main opposition party supported Haughey's
reforms
(Lane 2000).
Since Ireland was a member of the European Monetary System
(EMS), and had just successfully cut back its rate of inflation
from
19.6 percent in 1981 to 4.6 percent in 1986, monetizing the debt
through inflation was not a viable option (Lane 2000). Tax
increases
had already failed to resolve the crisis in the early 1980s. With

both
inflation and tax increases ruled out, reducing government
expendi-
tures was Ireland's only option to resolve its fiscal crisis.
In order to bring Ireland's budget under control, health expendi-
tures were cut 6 percent, education 7 percent, agricultural
spending
fell 18 percent, roads and housing were down 11 percent, and
the
military budget was cut 7 percent. Foras Forbatha, an
environmental
watchdog, was abolished as were the National Social Services
Board,
the Health Education Bureau, and the Regional Development
Orga-
nizations. Through early retirement and other incentives, public
sec-
tor employment was voluntarily cut by nearly 10,000 jobs
(Jacobsen
1994: 177-78).
After cutting government spending in 1987, a budget was set for
1988, which had the biggest spending cuts Ireland had seen in
30
years. Current spending was reduced by 3 percent and capital
spend-
ing was cut by 16 percent (The Economist 1988: 9). The
reductions in
government spending got Ireland out of its fiscal crisis. The
primary
deficit was eliminated in 1987, and the debt-to-GDP ratio
started
falling sharply from its 1986 peak. By the end of 1990,
government
debt was less than 100 percent of GDP (Honohan 1999: 81).

Although the reductions in government spending were made to
solve the fiscal crisis and not as an attempt to achieve a more
eco-
nomically liberal state, over the course of a few years, they did
have
the effect of reducing the size of the government's role in the
economy. Government noninterest spending declined, from a
high
of about 55 percent of GNP in 1985, to about 41 percent of GNP
by
1990 (Honohan 1999: 80).
With the size of government in the economy reduced, the
macro-
economic environment stabilized, and the free trade policies
that had
435
CATO JOURNAL
existed for decades, Ireland's economy began growing at a rate
of 4
percent by 1989 (Jacobsen 1994: 181). That level of growth was
im-
pressive compared with the 1.9 percent growth between 1973
and
1986, when the government had been pursuing activist fiscal
policies.
However, the 4 percent growth is not nearly as remarkable as
the
"tiger" growth experienced in the late 1990s. The government
made

further policy changes in the 1990-95 period, which helped to
bring
about the higher rate of growth.
Once Ireland resolved its fiscal problems, there was the
possibility
that it could begin engaging in reckless expansionary fiscal
policies
again. The signing of the Maastricht Treaty in 1992 helped to
make
Ireland's commitment to sound fiscal policies more credible and
per-
manent. The treaty required members to maintain fiscal deficits
be-
low 3 percent of GDP and set a target of a 60 percent debt-to-
GDP
ratio by the start of the Economic and Monetary Union in 1999.
Those provisions constrained Ireland's ability to issue debt in
order to
expand government spending.
Inflation is another option to finance an expansion of
government
spending. Ireland has been a member of the EMS from the
outset in
March 1979. There is a fixed exchange rate between the Irish
cur-
rency and the other EMS members, limiting Ireland's ability to
pur-
sue an expansionary monetary policy and inflation. With the
exception
of an early bout of high inflation through 1984, Ireland's annual
rate
of change in the CPI was less than 5 percent in all but two years
up
to 1995, and inflation averaged only 1.9 percent from 1995

through
1999.
With commitments limiting the government's ability to fund in-
creased spending through inflation or debt issue, increased
taxation is
the only other available method. Traditionally, it has been
harder to
increase government spending through taxation, because it is a
more
obvious burden to voters. This reality has helped to assure
investors
that the government is not likely to engage in another dramatic
in-
crease in spending.
High levels of taxation were already in place in Ireland before
either monetary or debt policy was constrained. Ireland had top
mar-
ginal tax rates as high as 80 percent in 1975 and 65 percent in
1985.
During the 1990s both personal and corporate tax rates
decreased
dramatically, and tariff rates continued to decline. In 1989 the
stan-
dard income tax rate was lowered from 35 percent to 32 percent,
and
the top marginal rate was lowered from 58 percent to 56 percent
(Jacobsen 1994: 182). The standard rate was down to 24 percent
and
the top down to 46 percent by 2000. Those rates were further re-
duced for 2001 to 22 percent and 44 percent, respectively (EIU
2000:
436

CELTIC TIGER
28).' Although Ireland has had relatively free trade for a long
time,
the mean tariff rate continued to decline from 7.5 percent in
1985 to
6.9 percent in 1999.
The standard corporate tax rate fell from 40 percent in 1996 to
24
percent by 2000 (EIU 2000: 29). There is also a special 10
percent
corporate taxation rate for manufacturing companies and
companies
involved in internationally traded services, or located in
Dublin's In-
ternational Financial Services Centre or in the Shannon duty-
free
zone (EIU 2000: 29). Ireland came under pressure from the
Euro-
pean Commission to eliminate the special 10 percent corporate
tax.
In an agreement with the EC, Ireland promised to raise the
special 10
percent rate, however, it will also lower the standard rate. In
2003 the
standard rate will be lowered to 12.5 percent, and the 10 percent
rate
will not be offered to new firms. Some firms, who are currently
eligible, will keep the 10 percent rate until 2005 or 2010.
Overall, this
change should be beneficial to Ireland's economy because it will
almost cut in half the standard corporate tax rate and eliminate
the

bias to particular industries and areas that the special 10 percent
rate
created.
Because of the many decreases in tax rates and the growth of
the
Irish economy, Ireland now enjoys a lower tax burden than any
other
EU country except Luxembourg. Ireland's total tax revenue in
1999,
(including social security receipts) was 31 percent of GDP,
much
lower than the EU average of 46 percent (EIU 2000: 28).
During the period from 1987 through 2000 Ireland closed and
surpassed the living standard differential with the rest of
Europe.
There was strong growth in the early part of the 1990s and
remark-
able "tiger" growth in the late 1990s when GDP growth
averaged
more than 9 percent from 1996 through 2000. The policies
under-
taken during that time were not the sole cause of the growth that
has
taken place. Rather, they are better viewed as the final missing
piece,
'The social partnership agreement between government,
employer federations, and labor
unions has played a role in the continued tax reductions and low
inflation. The agreements
began in 1987 and have been continually renewed with minor
revisions since. Those
agreements have effectively turned unions into a force lobbying
for reductions in taxes and

inflation. Lane (2000) notes that the unions promised wage
moderation, partly compen-
sated by a reduction in labor taxes and with the implicit promise
that the government would
maintain price stability. McMahon (2000) argues the holding
down of wage rates by these
agreements was important for making Ireland more competitive
in attracting companies
which resulted in growth. It is important to remember though,
that the wage constraint on
the part of the unions was not so much a sacrifice by workers to
attract business, as it was
the unions forcing a reduction in taxes to compensate the
workers, so their real after-tax
wage could still increase, while attracting more businesses and
creating more jobs.
437
CATO JOURNAL
which when finally put in place, allowed the broader cause of
eco-
nomic growth to take hold.
Economic Freedom and Growth in Ireland
Government actions that hinder people's ability to engage in
mu-
tually beneficial exchanges limit the standard of living that the
people
are able to achieve. Restrictions on international trade and
domestic
regulations interfere with some mutually beneficial trades.

Taxes and
inflation take wealth away from citizens that could have been
used to
make trades to increase their well being. Legal security and the
rule
of law give people the confidence that when they undertake
long-
term projects for mutual benefit, the government or other
citizens
will not be able to arbitrarily seize their increased wealth.
While an
imperfect measure, per capita GDP roughly reflects the standard
of
living. As Ireland increased economic freedom, per capita GDP
rose.
Holcombe (1998) provides a theory of the relation between
entre-
preneurship and economic growth, in which the entrepreneur is
the
endogenous engine of economic growth. 2 According to
Holcombe,
when entrepreneurs take advantage of profit opportunities, they
cre-
ate new entrepreneurial opportunities that others can act upon.
In
this way, entrepreneurship creates an environment that makes
more
entrepreneurship possible. Since the Kirznerian entrepreneur
(see
Kirzner 1973) is alert to profit opportunities that satisfy
consumer
desires, the more entrepreneurship there is, the more consumer
de-
sires are satisfied, and the more growth will result. The
Kirznerian

entrepreneur is also omnipresent; hence, the institutional
environ-
ment in which he operates must be considered to explain
differences
in economic growth. According to Holcombe (1998: 58-59),
When entrepreneurship is seen as the engine of growth, the em-
phasis shifts toward the creation of an environment within
which
opportunities for entrepreneurial activity are created, and
success-
ful entrepreneurship is rewarded. Human and physical capital
re-
main inputs into the production process, to be sure, but by
them-
selves they do not create economic growth. Rather, an
institutional
environment that encourages entrepreneurship attracts human
and
physical capital, which is why investment and growth are
correlated.
When the key role of entrepreneurship is taken into account, it
is
* For a survey of the endogenous growth literature that
Holcombe is incorporating his
theory into and contrasting his theory with, see Romer (1994).
438
CELTIC TIGER
apparent that emphasis should be placed on market institutions
rather than production function inputs.

Harper (1998) examines the institutional conditions for
entrepre-
neurship. His central thesis is that the more freedom people
have, the
more likely they are to hold internal locus-of-control beliefs,
and the
more acute will be their alertness to profit opportunities. That
in-
creased alertness leads to more entrepreneurial activity.
Combining Holcombe (1998) and Harper (1998), we have a
theo-
retical argument for why increases in economic freedom provide
an
institutional environment that promotes more entrepreneurship,
and
how more entrepreneurship functions as an endogenous source
of
growth. Their argument is consistent with empirical
investigations
into the relationship between economic freedom and growth.
There is vast amount of literature linking economic freedom to
growth and measures of well being. Studies by Scully (1988 and
1992), Barro (1991), Barro and Sala-I-Martin (1995), Knack and
Keefer (1995), Knack (1996), Keefer and Knack (1997) all show
that
measures of well-defined property rights, public policies that do
not
attenuate property rights, and the rule of law tend to generate
eco-
nomic growth. Gwartney, Holcombe, and Lawson (1998) found
a
strong and persistent negative relationship between government
ex-

penditures and growth of GDP for both OECD countries and a
larger
set of 60 nations around the world. They estimate that a 10
percent
increase in government expenditures as a share of GDP results
in
approximately a 1 percentage point reduction in GDP growth.
Using
the Fraser and Heritage indexes of economic freedom, Norton
(1998)
found that strong property rights tend to reduce deprivation of
the
world's poorest people while weak property rights tend to
amplify
deprivation of the world's poorest people. Grubel (1998) also
used the
Fraser Institute's index of economic freedom to find that
economic
freedom is associated with superior performance in income
levels,
income growth, unemployment rates, and human development.
All of
those findings are consistent with Holcombe's entrepreneurial
theory
of endogenous growth and Harper's theory of institutional
conditions
conducive to entrepreneurship. That theoretical structure and
those
empirical regularities are also consistent with Ireland's
economic
freedom and growth.
Some aspects of economic freedom have been present in Ireland
for a long time. During times when gains in economic freedom
oc-
curred, growth improved. The rapid growth of the "Celtic tiger"

only
occurred once all aspects of economic freedom were largely re-
spected at the same time.
After the protectionist decade of the 1950s, when economic
growth
439
CATO JOURNAL
averaged only 2 percent a year, the 1960s saw the liberalization
of
trade policy, which increased economic freedom and growth im-
proved, averaging 4.2 percent over the course of the decade.
The
1970s saw further advances in the liberalization of international
trade,
but, at the same time, the government was engaging in
Keynesian
interventionist fiscal policies that interfered with citizen's
economic
freedom. Growth stagnated in Ireland as well as in the rest of
Europe.
During the early 1980s, high inflation, fiscal instability, a high
level of
government spending, and high taxation all limited economic
free-
dom-resulting in an average growth rate of only 1.9 percent
from
1973 to 1986. The contraction in the level of government
spending, in
response to the fiscal crisis, increased economic freedom and
growth

resumed. During the 1990s further tax reductions and credible
com-
mitments not to engage in a reckless expansion of government
spend-
ing continued to increase economic freedom. Never before have
all of
the components of economic freedom been present
simultaneously in
Ireland. When all aspects of economic freedom were respected
in
Ireland, the synergy between the components allowed the
dynamic
growth that occurred in the late 1990s.
The above description of economic policies that increased and
decreased economic freedom is broadly reflected in the Fraser
In-
stitute's 2002 index of economic freedom. Ireland was the 13th
freest
country in the world, in 1970, and had an overall summary
rating of
6.7. The rating had fallen to 5.8 in 1975 and by 1985 it had
increased
to 6.2. By 1990, when Ireland's economic growth began to pick
up,
Ireland's score had increased to 6.7. When Ireland was
experiencing
its rapid "tiger" growth, in 1995, it was the world's 5th freest
economy, and in 2000 it was the 7th freest economy, achieving
scores
of 8.2 and 8.1, respectively. From 1985 to 2000, Ireland
improved its
score on all five of the freedom index's broad categories
(Gwartney
and Lawson 2002).

Figure 2 plots Ireland's five-year average growth rates and its
over-
all freedom scores from 1970 through 2000. The figure shows
Ire-
land's growth was strongest when its freedom scores had the
most
dramatic improvements.
Other Possible Explanations of Ireland's
Growth Considered
There are a number of other possible explanations for Ireland's
dramatic economic growth. One explanation is that the
neoclassical
growth model predicts convergence, so Ireland's economic
growth
440
CELTIC TIGER
FIGURE 2
IRELAND's ECONOMIC FREEDOM SCORE AND GROWTH
RATE
10%
Left scale: enoic freedon saxe (bar dart).
FIght scae: growth of real per capita GDP, 5year average (line
chart).
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990
1992 1994 1996 1998 2000

NOTE: The growth rate plotted in 1973 is the average growth
rate for the
years 1971-75; the point at 1978 is for 1976-80, and so forth.
SOURCES: Gwartney and Lawson (2002), OECD (2002).
should be expected. Another explanation is transfer payments
from
the EU have caused economic growth in Ireland. Other
explanations
focus on foreign direct investment (FDI) or economies of
agglom-
eration as the source of Ireland's growth. Finally, some have
even
suggested that the dramatic growth is only an illusion in the
GDP
account. All of those explanations are either incorrect or
incomplete.
Each will be considered in turn.
One alternative explanation is that there has not been a "Celtic
tiger." As The Economist (1997: 21) reported, "Is it too good to
be
true? Yes a few critics say: it was all done with smoke mirrors
and
money from Brussels." One argument is that Ireland's GDP is
much
higher than GNP because of the amount of profits that foreign-
owned
companies send back to their owners overseas. The high GDP
num-
bers, therefore, do not necessarily translate into wealth for the
Irish
citizens. Yet, The Economist also notes that "Ireland's GNP has
been
growing nearly as quickly as its GDP." The dramatic economic

growth
441
8.5-
8-
7.5
7
6.5
6
5.5
CATO JOURNAL
in the 1990s is not only evident from the increases in both GDP
and
GNP but also in other statistics. For example, by 1995 life
expectancy
at birth was 78.6 years for women and 73 years for men, up
from 75.6
and 70.1, respectively in 1980-82 (EIU 2000: 17). The economic
growth is also translating into more material goods for the Irish
popu-
lation. For example, between 1992 and 1999, the number of cars
registered in Ireland increased by 40 percent (EIU 2000: 19).
Perhaps
the strongest indications that economic growth actually
occurred in

Ireland are the immigration statistics. Ireland has typically
experi-
enced emigration, however the trend reversed itself in the
1990s.
Between 1996 and 1999, there was an average annual increase
in the
population of 1.1 percent-higher than the population growth rate
of
any other EU country during that time. In the 12 months leading
up
to April of 1998, Ireland had 47,500 immigrants arrive, the most
immigrants Ireland had recorded up to that time (EIU 2000: 15).
Regardless of any difficulties with measurement of GDP or
GNP, all
statistics point to a dramatic improvement in the Irish economy
dur-
ing the 1990s.
Both theoretical and empirical evidence show that EU subsidies
have not been a major cause of Ireland's economic growth. The
difficulties of economic calculation and public choice problems
pre-
sent theoretical reasons why transfers to the Irish government
cannot
be a major cause of growth.
The government needs some method to calculate which projects
have the most potential, if a transfer to the Irish government
from the
EU is going to be used to create the greatest possible growth.
When
a businessman faces this problem he looks at expected profits
and
then uses profit-and-loss accounting to evaluate his decisions ex
post
to make corrections. The government does not have that method

of
calculation available to it (Mises 1944, 1949). It is true that
when
Ireland receives subsidies from the EU and spends the money on
new
projects there will be an increase in measured GDP. However,
the
government has no way to evaluate whether the project was the
citizens' highest valued use of the EU transfer or if the project
was
valued at all. The GDP that is created is not necessarily wealth
en-
hancing. It may actually retard growth by directing scarce
resources
to government projects that could have been better used by
private
entrepreneurs if the government had not bid the resources away.
Agricultural subsidies are one component of EU transfers and
are
an example of how well-meaning transfers can get in the way of
economic development. McMahon (2000: 89-90) notes that,
"These
[subsidies] boost rural incomes but have little impact on
investment
and may retard economic adjustment by keeping rural
populations
442
CELTIC TIGER
artificiaHy high." The subsidies change the marginal incentives
for

farmers, making them more likely to stay on their farms, instead
of
migrating to the cities. In this way, the subsidies hinder the
process of
moving resources to their most highly valued use. As long as
people
are subsidized to stay in particular professions, Ireland will not
fully
exploit its comparative advantage in the international division
of la-
bor. This depresses incomes and slows growth.
Public choice theory points to another problem with the
argument
that EU transfers have caused massive growth. Why would
govern-
ment officials ever allocate the resources to the most growth-
enhancing project even if they were able to calculate?
Entrepreneurs
direct resources to the highest valued projects because they
have a
property right in the profits from the investment. Government
offi-
cials have no such residual claim. They can benefit more by
giving the
transfers to projects that benefit their political supporters,
instead of
directing them to the most growth-enhancing projects. That
strategy
would impose a dispersed opportunity cost on the rest of
society,
while creating a concentrated benefit for special interest groups
(Ol-
son 1965). Unless the political process perfectly disciplines
elected
officials and bureaucrats for not allocating EU transfers to the

most
growth-enhancing projects, they will not have incentives to do
so.
Since voters have incentives to remain rationally ignorant, there
is
little reason to believe they do perfectly discipline public
officials.
The presence of EU funds retards growth in another way as
well.
Baumol (1990) argues that while the total supply of
entrepreneurs
varies among societies, the productive contribution of the
society's
entrepreneurial activities varies much more because of their
alloca-
tion between productive activities, such as innovation, and
unproduc-
tive activities, such as rent seeking. The presence of EU funds
creates
a rent for Irish entrepreneurs to seek. This will cause some
entrepre-
neurs, who were previously engaging in productive and
innovative
activity, to engage in rent seeking instead. This rent seeking
wastes
both physical and human resources that could have been used to
satisfy consumer demands and increase economic growth.
There is no sound theoretical case for viewing EU structural
funds
as the cause of Ireland's economic growth. Government officials
have
no way to know what investment projects will generate the most
growth and, even if they did, they have little incentive to
undertake

them.
Empirically, if EU transfers were a major cause for Ireland's
growth, we would expect Ireland's growth to be highest when it
was
receiving the greatest transfers. Figure 3 demonstrates that this
is not
the case, and that growth rates and net transfers as a percent of
GDP
443
CATO JOURNAL
FIGURE 3
NET EU RECEIPTS AND GROWTH RATES
12%
10
-*- Real per capita GDP growth
-u-Net receipts from EU as % of GDP
8
6
4
2
0
SOURCE: Department of Finance, Ireland (2002).

have actually moved in opposite directions during Ireland's
rapid
growth. Ireland began receiving subsidies after joining the
European
community in 1973. Net receipts from the EU averaged 3.03
percent
of GDP during the period of rapid growth from 1995 through
2000,
but during the low growth period, from 1973 through 1986, they
averaged 3.99 percent of GDP (Department of Finance 2002). In
absolute terms, net receipts were at about the same level in
2001 as
they were in 1985. In 1985 Ireland's net receipts were 1,162.3
million
euros and in 2001 they were 1,268.8 million euros. Throughout
the
1990s, Ireland's payments to the EU budget steadily increased
from
359.2 million euros in 1990 to 1,527.1 million euros in 2000.
Yet, in
2000, the receipts in from the EU are 2,488.8 million euros, less
than
the 1991 level of 2,798 million euros. Ireland's growth rates
have
increased, while net funds from the EU remained relatively
constant
and have shrunk in proportion to Ireland's economy.
If the subsides were really the cause of Ireland's growth, we
would
also expect other poor countries in the EU, who receive
subsidies, to
have a high rates of economic growth. EU Structural and
Cohesion
Funds represented 4 percent of Greek, 2.3 percent of Spanish,

and
3.8 percent of Portuguese GDP (Paliginis 2000). None of those
coun-
444
CELTIC TIGER
tries achieved anywhere near the rate of growth the Irish
economy
experienced. Greece averaged 2.2 percent GDP growth, Spain
aver-
aged 2.5 percent GDP growth, and Portugal averaged 2.6
percent
GDP growth, from 1990 through 2000 (Clarke and Capponi
2001:
14-15).
Ireland's growth also cannot be explained by the neoclassical
con-
vergence that a Solow growth model would predict. That model
pre-
dicted Irish convergence incorrectly for more than 100 years.
Even
during the 1960s, when Ireland's economy had a high rate of
growth,
it still was not converging on the standard of living of other
European
nations. It was actually losing ground. All of Ireland's
convergence
occurred in a 13-year time span, from 1987 through 2000. The
Econ-
omist (1997: 22) was wrong when it reported, "There is more to
it

than the surge since 1987. Ireland has been catching up for
decades.
... In many ways the dreadful years between 1980 and 1987
were
more unusual than the supposedly miraculous ones since 1990."
Ire-
land had not done any catching up before 1987. In 1960 the
Irish
Republic had a GDP per capita that was 66 percent of the EU
average, and in 1986 it had actually decreased to 65 percent of
the
average (Considine and O'Leary 1999). There had been some
growth
during that time but it was less than the EU experienced. The
model
needs to explain why Ireland converged only after 1987 and
why it
converged so rapidly.
Knack (1996) found empirical evidence of strong convergence
in
per capita incomes among nations with institutions-namely,
secure
private property rights-conducive to saving, investing, and
produc-
ing. That form of conditional convergence, with the
introduction of
free-market institutions, is much more plausible in Ireland's
case than
neoclassical convergence. Ireland did experience increases in
eco-
nomic freedom just prior to and during its remarkable growth.
The
extent that it was conditional convergence that drove growth, as
op-
posed to just adopting the appropriate institutions, is not clear.

The
fact that the Irish economy has not slowed since achieving
conver-
gence casts doubt on the importance of even conditional
convergence
and instead points to the adoption of market-friendly
institutions as
the source of growth. Once Ireland had converged with the EU
and
United Kingdom's standard of living, it achieved record growth
of
11.5 percent during 2000 (EIU 2001: 11). While convergence
condi-
tional on an institutional environment of secure private property
rights is more consistent with Ireland's experience than
neoclassical
convergence, both fail to explain Ireland's rapid growth in the
last few
years of the 1990s and in 2000.
FDI and economies of agglomeration are two explanations of
Ire-
445
CATO JOURNAL
land's growth that do have some merit but that are incomplete
by
themselves. FDI has certainly played a role in Ireland's growth.
America alone had $10 billion ($3,000 per capita) invested in
Ireland
by 1994, and by 1997 foreign-owned firms were said to account
for 30

percent of the economy and nearly 40 percent of exports (The
Econ-
omist 1997: 22). Economies of agglomeration, where like firms
try to
locate near each other to take advantage of positive
externalities, have
also helped. Ireland has had particular success in attracting
industrial
developments with large numbers of high tech and
manufacturing
companies that benefit from being near each other. The relevant
question is, Why did massive FDI, which has spurred economies
of
agglomeration, not occur sooner? What changed in Ireland were
the
institutional conditions that attracted FDI. The FDI and
economies
of agglomeration are an indication of institutional factors
favorable to
economic growth, not the cause of the growth.
The interesting question to ask is, What gives rise to favorable
conditions that allow growth to occur? This article has
maintained
that it is the institutional framework that hinders or helps the
market
achieve economic growth. The key institutional factor is the
degree of
economic freedom enjoyed by the people.
Conclusion
In May 1997, The Economist stated, "How much longer the Irish
formula will deliver such striking success is difficult to say. . . .
Ireland
grew quickly for more than 30 years because it had a lot of

catching
up to do, and because policy and circumstances conspired to let
it
happen. Success of that kind, impressive and unusual though it
may
be, contains the seeds of its own demise." The article concluded
by
saying, "If Ireland has another decade as successful as the last
one, it
will be a miracle economy indeed" (The Economist 1997: 24).
The fact is Ireland had not been catching up for 30 years; it ac-
complished its catching up in 13 years. Rapid rates of growth
have
continued to be recorded since converging with Europe's
standard of
living. The neoclassical growth model does not account for
Ireland's
success. Rather, rapid growth has been driven by increases in
eco-
nomic freedom. As long as Ireland continues to pursue policies
that
increase economic freedom, the Irish "miracle" is likely to
continue.
References
Barro, R. (1991) "Economic Growth in a Cross Section of
Countries." Quar-
terly Journal of Economics 106: 407-43.
446
CELTIC TIGER

Barro, R., and Sala-I-Martin, X. (1995) Economic Growth. New
York: Mc-
Graw-Hill.
Baumol, W. (1990) "Entrepreneurship: Productive,
Unproductive, and De-
structive." Journal of Political Economy 98 (5): 893-921.
Clarke, R., and Capponi, E. (2001) OECD in Figures. Paris:
OECD Publi-
cations.
Considine, J., and O'Leary, E. (1999) "The Growth Performance
of Northern
Ireland and the Republic of Ireland, 1960 to 1995." In N.
Collins (ed.)
Political Issues in Ireland Today. New York: Manchester
University Press.
Department of Finance, Ireland (2002) Budgetary and Economic
Statistics
March 2002
(www.irlgov.ie/finance/publications/otherpubs/bes02a.pdf).
The Economist (1988) "Survey Republic of Ireland," 16
January: 3-26.
(1997) "Europe's Tiger Economy," 17 May: 21-24.
(2000) "Hot and Sticky in Ireland," 29 June: 47-48.
Economist Intelligence Unit [EIU] (2000) Country Profile 2000
Ireland.
London: Economist Intelligence Unit.
(2001) Country Report Ireland. London: Economist Intelligence
Unit (August).

Grubel, H. (1998) "Economic Freedom and Human Welfare:
Some Empiri-
cal Findings." Cato Journal 18 (2): 287-304.
Gwartney, J.; Holcombe, R; and Lawson, R. (1998) "The Scope
of Govern-
ment and the Wealth of Nations." Cato Journal 18 (2): 163-90.
Gwartney, J., and Lawson, R. (2002) Economic Freedom of the
World: 2002
Annual Report. Vancouver, B.C.: Fraser Institute.
Harper, D. (1998) "Institutional Conditions for
Entrepreneurship." Ad-
vances in Austrian Economics 5: 241-75.
Holcombe, R. (1998) "Entrepreneurship and Economic Growth."
Quarterly
Journal of Austrian Economics 1 (2): 45-62.
Honohan, P. (1999) "Fiscal Adjustment and Disinflation in
Ireland: Setting
the Macro Basis of Economic Recovery and Expansion." In F.
Barry (ed.)
Understanding Ireland's Economic Growth. New York: St.
Martin's Press.
International Monetary Fund (2001) International Financial
Statistics Year
Book. Washington: International Monetary Fund.
Jacobsen, J. (1994) Chasing Progress in the Irish Republic. New
York: Cam-
bridge University Press.

Keefer, P., and Knack S. (1997) "Why Don't Poor Countries
Catch-Up? A
Cross National Test of Institutional Explanations." Economic
Inquiry 35:
590-602.
Kirzner, I. (1973) Competition and Entrepreneurship. Chicago:
University of
Chicago Press.
Knack, S. (1996) "Institutions and the Convergence Hypothesis:
The Cross-
National Evidence." Public Choice 87: 207-28.
Knack, S., and Keffer, P. (1995) "Institutions and Economic
Performance:
Cross-Country Tests Using Alternative Institutional Measures."
Economics
and Politics 7: 207-27.
Lane, P. (2000) "Disinflation, Switching Nominal Anchors and
Twin Crises:
The Irish Experience." Journal of Policy Reform 3: 301-26.
McMahon, F. (2000) Road to Growth, How Lagging Economies
Become
Prosperous. Halifax, N.S.: Atlantic Institute for Market Studies.
447
CATO JOURNAL
Mises, L. (1996 [1944]) Bureaucracy. Reprint. Grove City, Pa.:
Libertarian

Press.
(1998 [1949]) Human Action. Reprint. Auburn, Ala.: Ludwig
Von
Mises Institute.
Norton, S. (1998) "Poverty, Property Rights, and Human Well-
Being: A
Cross National Study." Cato Journal 18 (2): 233-45.
Olson, M. (1965) The Logic of Collective Action. Cambridge,
Mass.: Harvard
University Press.
Organization for Economic Cooperation and Development
[OECD] (2002)
Annual National Accounts-Comparative Tables
(http://cs4hq.oecd.org/
oecd/eng/wdsview/dispview url.asp).
Paliginis, E. (2000) "Institutions and Development in the EU
Periphery."
Zagreb International Review of Economics and Business 3 (2):
81-92.
Romer, P. (1994) "The Origins of Endogenous Growth." Journal
of Eco-
nomic Perspectives 8 (1): 3-22.
Scully, G. (1988) "The Institutional Framework and Economic
Develop-
ment." Journal of Political Economy 96: 652-62.
(1992) Constitutional Environments and Economic Growth.
Prince-
ton, N.J.: Princeton University Press.

448
Institutional Stickiness and the New
Development Economics
By PETER J. BOETTKE, CHRISTOPHER J. COYNE,
and PETER T. LEESON*
ABSTRACT. Research examining the importance of path
dependence
and culture for institutions and development tells us that
“history
matters,” but not how history matters. To provide this missing
“how,”
we provide a framework for understanding institutional
“stickiness”
based on the regression theorem. The regression theorem
maintains
that the stickiness, and therefore likely success, of any proposed
institutional change is a function of that institution’s status in
relation-
ship to indigenous agents in the previous time period. This
framework
for analyzing institutional stickiness creates the core of what we
call
the New Development Economics. Historical cases of postwar
recon-
struction and transition efforts provide evidence for our claim.
Teeth-gritting humility, patience, curiosity and independent
thinking are
called for in learning how superior foreign technology works

and how it
can be improved. Without these conditions the technical
assistance “does
not take.” The cut flowers wither and die because they have no
roots.
Paul Streeten (1995: 11–12)
I
Introduction
FIRST INTRODUCED BY NORTH (1990), the notion of
institutional “path
dependence” has received increasing attention among those
interested
in the connection between institutions and economic growth
(see, for
*Peter J. Boettke is at the Department of Economics, George
Mason University.
Christopher J. Coyne is at the Department of Economics, West
Virginia University. Peter
T. Leeson is at the Department of Economics, George Mason
University. We thank the
Editor and an anonymous referee for helpful comments and
suggestions. The financial
support of the Earhart Foundation, the Oloffson Weaver
Fellowship, the Mercatus
Center, and the Kendrick Fund is also gratefully acknowledged.

American Journal of Economics and Sociology, Vol. 67, No. 2
(April, 2008).
© 2008 American Journal of Economics and Sociology, Inc.
instance, Pierson 2000a, 2000b; Buchanan and Yoon 1994).
Path
dependence emphasizes the increasing returns to institutions,
which
tend to “lock in” particular institutional arrangements that have
emerged in various places for unique historical reasons.
Locked-in institutional arrangements may be suboptimal in the
sense that, given today’s information, agents would be better off
if
they moved to some other arrangement. In such cases, it is
typically
argued that in order to put agents on a new and improved
institutional
path, some outside entity, like the development community, is
required to provide the exogenous “shock” necessary to break
society
out of the suboptimal scenario. This belief has presently led
devel-
opment economists to emphasize the role of exogenous
institutions in
determining economic growth. Current analyses of economic
devel-
opment thus concern themselves with finding the “right”
institutional
mix to promote progress in various countries.
However, the success of these efforts has been spotty at best.
For
instance, most underdeveloped countries in sub-Saharan Africa

and
many postsocialist transitioning nations continue to struggle
despite
development-community attempts to exogenously introduce
institu-
tional change. We argue that this failure stems at least partly
from the
fact that the concept of path dependence as it has been applied
to
institutions to date tells us only that “history matters” in the
develop-
ment of institutions. It does not, however, tell us how history
matters.
Research that considers culture suffers from a similar problem.
While
this work performs an important function in pointing out that
“culture
matters,” it does virtually nothing in terms of telling us
analytically or
empirically how culture matters (see, for instance, Buchanan
1992;
Pejovich 2003; Boettke 2001b).
We aim to provide the missing “how” in these closely related
streams of research. We contend that institutional
“stickiness”—the
ability or inability of new institutional arrangements to take
hold
where they are transplanted—is central to understanding how
history
matters for institutions. Furthermore, it is central to
understanding
how the relationship between history and institutions matters
for
development economics.

We provide a framework for understanding stickiness based on
the regression theorem.1 The regression theorem maintains that
the
332 The American Journal of Economics and Sociology
stickiness, and therefore likely success, of any proposed
institutional
change is a function of that institution’s status in relationship to
indigenous agents in the previous time period. This framework
for
analyzing institutional stickiness is at the core of what call the
New
Development Economics.
The New Development Economics builds directly on the
volumi-
nous body of research that examines the emergence, operation,
and
effectiveness of spontaneously ordered institutional
arrangements.
The idea that these institutions tend to be efficient and most
effective
in promoting the ends of indigenous agents is not original to us.
On
the contrary, Hayek (1960, 1973, 1991) was among the first to
empha-
size these aspects of spontaneously emergent institutions, in
particular
law. Following him, a number of others including Glaeser and
Shleifer
(2002), La Porta et al. (1998), Djankov et al. (2003), Posner
(1973), and
Benson (1989) have examined the comparative properties of

endog-
enously emergent common law systems versus exogenously
created
civil law systems, and in several cases their relationship to
economic
development, and have empirically confirmed Hayek’s insights.
Others, such as Nenova and Harford (2004), Hay and Shleifer
(1998),
and Leeson (2006, 2007a, 2007b), have pointed to the
effectiveness of
spontaneously emergent institutions for the provision of “public
goods,” including property rights protection, normally thought
of as
being capably provided only by the state. Still others have noted
the
effectiveness of monetary institutions when they emerge as
sponta-
neous orders, and contrasted this with the relative
ineffectiveness of
such institutions when they are created in a “top-down” fashion
by
government (see, for instance, Menger [1871] 1994; Selgin
1994; Selgin
and White 1994). Important work by Elinor Ostrom (1990,
2000) and
James Scott (1998) also has highlighted the importance and
success of
endogenously emergent institutional solutions to a range of
coordi-
nation problems, as well as the potential for unintended,
undesirable
outcomes when political authorities artificially construct
institutional
solutions to these problems.
These important strands of research have tended to contrast two

kinds of opposing institutional emergence: those that emerge
entirely
spontaneously (what in our framework we call “indigenously
intro-
duced endogenous institutions”), and those that are constructed
and
Institutional Stickiness and the New Development Economics
333
imposed by “outsiders” (what in our framework we call
“foreign-
introduced exogenous institutions”). In addition to these
opposing ends
of the institutional spectrum, this article introduces a third class
of
institutions—those that are indigenously introduced but
exogenous in
nature. In introducing this third class of institutions and
considering its
“stickiness” properties alongside those institutions that fall on
either
side of it, we hope to illuminate what characteristics give
institutions
their stickiness and, in doing so, to provide a framework for
investi-
gating proposed institutional reforms in the context of economic
development.
Finally, this article should also be seen as building on existing
work
in comparative institutional analysis. In addition to North
(1990, 2005),
Aoki (2001) emphasizes the importance of informal

complementary
institutions that allow formal institutions to function in the
desired
manner. Similarly, Platteau (2000) notes the importance of
norms and
complementary institutions for the operation of formal
institutions
such as the legal system.
The remainder of this article is organized as follows. Section II
provides an institutional taxonomy for the purposes of
analyzing the
stickiness properties of various types of institutional
arrangements.
Section III presents the regression theorem and uses it to
analyze the
stickiness properties of institutional types. Based on this
insight, this
section also explores what our analytical findings suggest for
the
development community. In Section IV, we examine our
framework in
light of cases of postwar reconstruction and transition efforts in
former
Communist countries. To illuminate the regression theorem and
its implications for economic development, we consider
successful
reconstruction in Germany and Japan and unsuccessful reform
in
Bosnia. We then consider cases of successful (Poland) and
failed
(Russia) transition efforts. In Section V, we conclude.
II
A Taxonomy of Institutions

WE CAN BROADLY CONCEIVE of institutions as belonging
to one of three
separate categories: foreign-introduced exogenous (FEX)
institu-
tions, indigenously introduced exogenous (IEX) institutions,
and
indigenously introduced endogenous (IEN) institutions. The
foreign
or indigenous component in each of these categories is fairly
self-
explanatory: institutions designed chiefly by outsiders are
foreign-
introduced, while those designed chiefly by insiders are
indigenously
introduced. Of course, this breakdown significantly
oversimplifies
institutional origin. Nearly any institutional arrangement can be
found
to exhibit influence from outsiders at some point in time. Thus,
institutions are never purely foreign or indigenously introduced.
Nev-
ertheless, we can broadly view institutions as being primarily
the
creation of foreign or indigenous forces in most instances, and
it is in
this spirit that we propose the distinction.
The exogenous/endogenous component of institutional origin
requires additional explanation. Exogenous institutions are con-
structed and imposed from above. These are the creations of

govern-
ments or other formal authorities like the IMF, USAID, or the
World
Bank. Note that these can be created indigenously by national
gov-
ernments or by outsiders when they are foreign-introduced. In
con-
trast, endogenous institutions emerge spontaneously as the
result of
individuals’ actions, but are not formally designed. Thus, by
their
nature, endogenous institutions are indigenously introduced.
Concretely, FEX institutions are those we typically associate
with
development-community policy. For instance, a legal system
change
introduced by the development community in a reforming nation
would constitute a FEX institution. Although the decision
regarding
such a change ultimately lies in the hands of the indigenous
govern-
ment, the policy change is chiefly the creation of outsiders, and
the
institutional change is constructed.
IEX institutions are those we associate with the internal policies
created by national governments. For example, federalism in the
United States is an IEX institution. Federalism represents a
state-
constructed institution designed by Americans. Similarly, the
British
Parliament constitutes an IEX institution. It is a designed
institution of
British construction.

Finally, IEN institutions are those we associate primarily with
spon-
taneous orders. These embody the local norms, customs, and
practices
that have evolved informally over time in specific places.
Language,
for instance, is an IEN institution.
335
Of course, these institutional categories are purely conceptual.
Furthermore, they are not rigid, as presented above. The same
insti-
tutions may fall into different categories in different places;
perhaps
even more importantly, the same institution may fall into
different
categories at different times in the same place. Consider, for
instance,
the institution of money. Before the advent of central banking,
money
constituted an IEN institution in much of 19th-century Europe
(Rothbard 1990; White 1995). However, in the 20th century,
money
creation was monopolized by national governments in most
places in
the world. Thus, in the 20th century, money in Europe would be
classified as an IEX institution.
III
The Regression Theorem: A Framework for
Analyzing Institutional Stickiness

IT IS WIDELY AGREED that the underlying institutional
framework of an
economy influences its ability to progress (see, for instance,
Scully 1992;
Kasper and Streit 1999; North 1990; Platteau 2000). More
specifically,
there is a broad consensus within the development community
that the
market institutions of private property, rule of law, and liberal
trade—
so-called growth-inducing institutions—are required for
successful
development.2 However, while generally identifying growth-
enhancing
institutions is an important step in creating prosperity,
questions remain
about how to operationalize these answers to economic growth.
In this regard, perhaps the most important question we must
consider is: Are these institutions transportable? Mixed
empirical evi-
dence heightens the significance of this question. On the one
hand,
recent attempts at imposing these institutions in developing
nations
abroad have met mostly with failure (Easterly 2001, 2006). On
the
other hand, not all institutional impositions have failed (Coyne
2007).
For instance, for reasons explored in Section IV, postwar
economic
reconstruction in Japan and Germany proved relatively
successful.
When we are talking about transporting institutions, we are

neces-
sarily talking about FEX institutions. Whether we are dealing
with the introduction of development-community–devised
policy
in postsocialist transition nations or the imposition of new
politico-economic orders in war-torn Europe, we are dealing
with FEX
institutions. The question thus emerges: What are the stickiness
prop-
erties of FEX institutions, and how are they related to the
stickiness
properties of IEX and IEN institutions?
A. Indigenously Introduced Endogenous (IEN) Institutions
To answer this question, we begin by analyzing the properties
of IEN
institutions. This serves as an appropriate starting point for our
analysis
because, as we discuss below, IEN institutions necessarily
precede
effective FEX and IEX institutions historically. As spontaneous
orders,
IEN institutions have their roots in the behavior of individual
agents
pursuing their own ends (see, for instance, Menger [1871] 1994;
Hayek
1996). To the extent that agents’ ends are at least partially
dependent
upon social interaction, various obstacles to this pursuit emerge
along

the way. For instance, agents desiring exchange who lack a
coincidence
of wants find this problematic for executing desired
transactions.
IEN institutions can be thought of as endogenously emergent
solu-
tions to such obstacles confronting socially interacting agents
(Hayek
1996). For instance, in the example above, agents find recourse
to
resort to indirect exchange to overcome the lack of coincidence
of
wants in a barter economy. At first the medium of exchange
employed
between two traders for this purpose is a peculiarity. Only over
time
do agents find certain media of exchange more useful for
facilitating
exchange than other media, and only over time do more and
more
traders find it useful to resort to indirect exchange. At some
point,
particular media of exchange desired for their properties in
enabling
trade become so widespread that they take on the status of an
institution. This is the spontaneous evolution of money (see, for
instance, Menger [1871] 1994; Mises 1949; Selgin and White
1994).
Several things are worth noting about the process by which IEN
institutions, like money, surface. First, they emerge
endogenously. The
institution is not constructed by some entity like government,
exog-
enous to the market process. Second, the institution’s

endogenous
emergence is necessarily indigenously introduced. As we have
noted,
precisely for these two reasons, we call these institutions IEN
institutions.
337
The features that make an institution an IEN institution are of
particular importance in analyzing its stickiness properties.
First, the
endogenous emergence of the institution points to its
desirability as
seen from indigenous inhabitants’ point of view. IEN
institutions are
informal in the sense that they are not compelled and are
flexible to
the changing preferences of the individuals they assist. As such,
their
persistence tends to indicate their preferredness to other
informal
arrangements that might supplant them (Hayek 1991).
Second, both features of IEN institutions suggest that these
institu-
tions are firmly grounded in the practices, customs, values, and
beliefs
of indigenous people. In other words, both the indigenous
introduc-
tion of an IEN institution as well as its endogenous emergence
strongly suggest an IEN institution’s foundation in mētis.
A concept passed down from the ancient Greeks, mētis is

charac-
terized by local knowledge resulting from practical experience.3
It
includes skills, culture, norms, and conventions, which are
shaped by
the experiences of the individual. This concept applies to both
inter-
actions between people (e.g., interpreting the gestures and
actions of
others) and the physical environment (e.g., learning to ride a
bike).
The components of mētis cannot be written down neatly as a
system-
atic set of instructions. Instead, knowledge regarding mētis is
gained
only through experience and practice.
In terms of a concrete example, think of mētis as the set of
informal
practices and expectations that allow ethnic groups to construct
successful trade networks. For instance, the diamond trade in
New
York City is dominated by orthodox Jews who use a set of
signals,
cues, and bonding mechanisms to lower the transaction costs of
trading. The diamond trade would not function as smoothly if
random
traders were placed in the same setting. This difference can be
ascribed to mētis. Because it is based in the accepted,
understood, and
habituated mentalities and practices of indigenous peoples, the
pres-
ence or absence of mētis explains the stickiness of various types
of
institutions. In fact, mētis can be thought of as the glue that
gives

institutions their stickiness.
IEN institutions ensure their foundation in mētis for two
reasons.
First, the fact that they emerge endogenously in an informal,
uncon-
structed fashion means that they emerge directly from mētis.
Similarly,
their indigenous introduction means that they are in harmony
with
local conditions, attitudes, and practices. This fact is closely
related to
Frey’s (1997) important work on the “intrinsic motivations” of
indi-
viduals, which suggests that spontaneously emergent
institutions
effectively reflect—and in fact grow out of—the preferences of
local
actors. In this sense, IEN institutions are institutionalized mētis.
As
such, IEN institutions tend to be the stickiest institutions of all.
Stephen Innes’s (1995) study of the economic culture of Puritan
New England provides an excellent example of the stickiness of
IEN
institutions based on their strong foundation in mētis.
According to
Innes, the social ecology of Puritanism led to the success of the
Massachusetts Bay Colony in the 17th century. A mutated
cultural mix
of British culture with Puritan ideology among the settlers

combined
to free the economy of restraints and place moral sanction on
private
property and the work ethic.
The settlers’ fierce devotion to God in this case led to a social
commitment to engage the world and to prosper. This
underlying
customary belief system that composed part of Puritanical mētis
was
reinforced by market-based IEN institutions within the Puritan
com-
monwealth, which promoted economic growth and development.
Much of America’s modern private property order is based upon
Puritanical mētis. Indeed, precisely because of this foundation
in
mētis, the institution of private property in the United States is
extremely sticky, as evidenced by its persistence over centuries.
Private international commercial law provides another example
of a
highly sticky IEN institution rooted in mētis. This law
constitutes an
outgrowth of the lex mercatoria, an informal system of
customary law
rooted in international commercial norms that evolved
spontaneously
from the desires of individuals to engage in cross-culture
exchange in
11th- and 12th-century Europe (Benson 1989; Leeson 2006).
The con-
tractual arrangements and procedures for dispute settlement that
emerged endogenously as flexible solutions to obstacles
confronting
international traders under the lex mercatoria strongly reflected
the

evolved practices, norms, and customs of the traders, rooting
these
IEN institutions of international exchange in mētis. These
institutions
have exhibited tremendous stickiness and, while continually
evolving,
remain the institutions that govern most international commerce
in the
339
modern world (see, for instance, Benson 1989; Berman 1983;
Volckart
and Mangles 1999).
B. Indigenously Introduced Exogenous (IEX) Institutions
We have seen how mētis acts as the glue that gives institutions
their
stickiness. Furthermore, we have seen why IEN institutions,
with their
close relationship to mētis, tend to be the stickiest institutions.
But
what about FEX and IEX institutions? Where do they fall in
terms of
stickiness?
As our analysis suggests, the further an institution falls from
mētis,
the less sticky it will be. IEX institutions are indigenous, but
are
exogenously introduced. This means that while some formal
authority

is responsible for creating the institution, this formal authority
is not
foreign. Because IEX institutions are exogenously imposed, the
ten-
dency for them to be as closely connected to mētis as IEN
institutions
is missing. The fact that formal authorities lack intimate
knowledge of
mētis creates a greater likelihood for incongruities between the
imposed institution and the underlying mētis.
Consider, for example, J. Stephen Lansing’s (1991) study of the
Balinese water temples. The water temples scattered across Bali
were
places of worship of various gods, but they also managed the
irriga-
tion schedule for farmers throughout Bali. In the 1960s and
1970s, the
International Rice Research Institute sought to eradicate the
backward
native practices of rice production throughout Asia. This was
known
as the “Green Revolution.”
Indigenous methods of rice production would be replaced with a
variety of rice that required the use of fertilizers and pesticides.
In
Bali, the government introduced an agricultural policy in
conformity
with the Green Revolution, which promoted continuous
cropping of
the new rice. Rice farmers were encouraged to plant rice
without
taking account of the traditional irrigation schedule dictated by
the
water temples. The immediate effect was a boost in rice

production,
but the policy soon resulted in a water shortage and a severe
out-
break of rice pests and diseases. In short, the IEX institution
created
by the Balinese not only failed to have its desired effect but
actually
made matters worse. In this way, because IEX institutions are
exogenously imposed, they often fail to conform to underlying
mētis.
However, given that the authority creating an IEX institution is
familiar to some degree with local practices, attitudes, and so
forth—
that is, it may itself be part of a larger local mētis—it stands to
reason
that the authority is able to craft institutions in such a way as to
be
relatively consistent with these factors. In this way, some
relationship
between IEX institutions and mētis remains intact. The dual
compo-
nents of IEX institutions thus pull them in two opposing
directions
relative to mētis. On the one hand, the fact that they are
indigenously
introduced pulls them closer to mētis. On the other hand, the
fact that
they are created by formal authorities who tend to be somewhat
remote from actors pulls them away from mētis. So, while less
sticky

than IEN institutions, IEX institutions retain some stickiness.
As we note above, many formerly IEN institutions, such as law
and
money, have become IEX institutions as governments have
grown and
taken control over them. Precisely because these IEX
institutions have
their roots in IEN institutions closely connected to mētis, they
have
proved quite sticky despite their changed institutional status.
Much of
the American legal code, for instance, essentially codifies
preexisting
informal common law arrangements. Similarly, with money, the
U.S.
dollar is historically connected to the thaler (pronounced
“tholler”)—a
unit of silver currency from the days of privately minted
commodity
money in 15th-century Europe (Rothbard 1990). These examples
illus-
trate successful IEX institutional impositions.
As the Balinese example points out, however, these successes
do
not mean that all IEX institutions are always sufficiently sticky.
Their
relative lack of stickiness compared to IEN institutions does
place
some parameters on what successful IEX institutions can look
like. For
instance, if the U.S. government decided that ashtrays would
circulate
tomorrow as the new legally mandated medium of exchange,
this

institutional change would not stick. People would simply
refuse to
use ashtrays for this purpose or would resort to a black market
in
currency, where dollars or gold would circulate as the de facto
medium of exchange. The notion of ashtrays as money strongly
conflicts with American mētis. As such, the glue needed to
make this
new institution stick would be absent. In this way, the necessity
of
341
having some IEN institution to act as a mētis-based core for
IEX
institutions constrains what IEX institutions are possible.
When it comes to IEX institutions, there are again two
countervail-
ing forces at work. Local authorities have better knowledge than
foreign authorities about existing focal points that serve to
coordinate
the local population’s activities. Pulling in the other direction,
however, is the fact that institutional change in this case occurs
exogenously, and so may not fully respect existing nodes of
orientation.
C. Foreign-Introduced Exogenous (FEX) Institutions
Following our logic, FEX institutions tend to be the least sticky
of all.
On the one hand, unlike IEN and IEX institutions, FEX
institutions are

foreign-introduced. This means that the distance between the
process
of institutional design and the location of hoped institutional
“take-
hold” is considerable. Foreign institutional designers are less
equipped
to tailor institutions in such a way that they do not conflict with
indigenous mētis because of this increased physical and social
dis-
tance, which tends to make designers less aware of the local
condi-
tions where they desire to transplant institutions. Compounding
this
increased distance, FEX institutions are exogenous. So, like
IEX insti-
tutions, they are less connected to mētis because formal
authorities
that tend to be more remote from parochial environments create
them.
Both of these features tend to make FEX institutions lack the
stickiness for them to be effective. Consider, for instance,
Robert
Blewett’s (1995) study of the pastoral policy of the Maasai in
Kenya.
Precolonization, the Maasai followed a practice of communal
owner-
ship governed by tacit norms of restricted access. This practice
evolved as a method to reduce the transaction costs associated
with
the collective action necessary for cooperation, including
pastoral
coordination and environmental risk management.
British colonial rule, however, substituted explicit contracts for
the

tacit norms governing land usage in practice. Explicit contracts
did not
codify an existing IEX or IEN institution, but instead were
created in
direct conflict with existing underlying mētis about land usage.
As a
result, the complex IEN institutional land structure of the
Maasai was
disrupted, and the long-term viability of the common land was
destroyed. According to Blewett, this destruction undermined
the
existing Maasai social structure that enabled cooperative
agriculture
and created a situation of rampant conflict among formerly
coopera-
tive agents that manifested itself in the form of rent-seeking
activities.4
Since, concretely, FEX institutions are those created by the
devel-
opment community for transplant in reforming countries, their
ten-
dency to lack stickiness is a severe problem indeed. This
suggests
that even if the development community can correctly identify
what
institutions are required for growth in general terms, it cannot
trans-
plant these institutions where they do not exist as a means of
promoting development. Attempts to do so are unlikely to work
because host countries reject FEX institutions, which lack the

glue
required to stick.
This is certainly not to say that host countries always reject
FEX
institutions. FEX institutions can, and have in some cases,
successfully
taken hold where they are transplanted. As we discuss below,
Japan
and Germany’s post–World War II reconstruction provide a case
in
point. However, the relative lack of FEX institution stickiness
places
significant constraints on what successful FEX institutions can
look like.
In the same way that successful IEX institutions are connected
to IEN institutions, successful FEX institutions are connected to
IEX
institutions. In other words, because FEX institutions that
embody
formerly IEX institutions are closer to mētis, they are more
likely to
stick than FEX institutions that do not embody formerly IEX
institu-
tions. For instance, while attempts at imposing private property
orders
among stateless tribes in sub-Saharan Africa are unlikely to
work,
creating constitutional provisions in post–World War II
Germany that
embody some elements of pre-Nazi Germany’s constitution have
a
greater chance of working. Likewise, the use of preexisting
institutions
by occupiers in the post–World War II reconstruction of Japan

was a
major reason for the stickiness of FEX institutions.
In short, the connection to mētis weakens as we move from IEN
to
FEX institutions. Thus, stickiness falls as we move in this
direction as
well. Figure 1 illustrates this relationship graphically.
Because successful IEX institutions form the basis for effective
FEX institutions and successful IEX institutions must embody
IEN
343
institutions, indirectly, IEN institutions constrain the form of
FEX
institutions as well. In circumscribing what shape FEX and IEX
insti-
tutions may take, IEN institutions point to an important result
for
development economics. Successful institutional changes in
develop-
ing parts of the world must have IEN institutions at their core.5
We
place this claim at the center of the New Development
Economics. To
determine if any particular development-community proposal
for insti-
tutional change meets this criterion, we suggest the following
test: If
the proposed change cannot be traced back to an IEN
institution, it

should not be attempted.
We call the claim that successful institutional changes must be
ultimately traceable to IEN institutions the regression theorem.
The
regression theorem states that the stickiness, S, of any given
institu-
tion, I, in time t is a function of that institution’s stickiness in
time t - 1.
The stickiness of this institution in t - 1 is in turn a function of
its
stickiness in t - 2, and so on. In other words, S S St
I
t
I
t
I= ( )−1 , where
S S St
I
t
I
t
I
− − −= ( )1 1 2 , and, generally, S S St nI t nI t nI− − − +( )= (
)1 .
This chain, however, does not infinitely regress. This is because
the
stickiness of an institution at the time of its emergence an
arbitrarily

Figure 1
Institutional Stickiness
FEX
IEX
IEN
Metis
large number of periods ago, N, is determined by its status vis-
à-vis
agents when it first emerges as an institution in t - N. That is, in
t - N,
the stickiness of institution I depends upon whether it is an
IEN, IEX, or FEX institution. So, S S I I It N
I
t N
I
− −= ( )IEN IEX FEX, , where
S S SI I I
IEN IEX FEX
> > per our analysis from above. In this way, the
regression theorem grounds the stickiness of institutions today
in their

past stickiness, which is ultimately a function of how closely
they are
connected to mētis.
It is important to note that in our framework, institutional
sticki-
ness is not equivalent to institutional “goodness.” Although
Hayek
(1960, 1991) and others have highlighted a tendency for
efficient
institutions to evolve when they do so endogenously, it is not
the
case that every endogenously created institution in all
circumstances
is efficient or conducive to economic development. Thus, that a
particular institution is traceable back to an IEN institution does
not
itself establish that it is conducive to economic growth. In fact,
many IEN institutions are themselves growth inhibitors. For
instance,
if the embedded local custom in Tanzania has a taboo on private
ownership, Tanzania will have difficulty progressing. The
regression
theorem only points out that if the institution of private
property is
imposed on Tanzania, it will have trouble sticking and will
probably
not produce the desired effect. In this sense, we should
understand
the traceability of a proposed institutional change to an IEN
institution under the regression theorem as providing insight
regard-
ing the limitations of development-community activity, rather
than
as establishing evidence of having met the institutional
requirements

that progress demands.
It is equally important to point out that not all FEX institutions
that
exhibit sufficient stickiness to take hold where they are imposed
promote growth. For instance, in many parts of Stalinist Eastern
Europe, FEX institutions imposed by force stuck, but harmed
eco-
nomic progress. The fact that a particular FEX institution sticks
speaks
only to the fact that an IEX institution (and indirectly IEN
institution
rooted in mētis) is at its core. The core IEX or IEN institution it
is built
around may be “bad” in the sense that it is an obstacle to
develop-
ment. Stickiness is therefore a necessary though not sufficient
institu-
tional attribute for creating economic growth.
345
IV
Historical Examples
HISTORICALLY, WE FIND empirical support for the
framework outlined
above. We first focus on cases of postwar reconstruction in
which new
political and economic orders are imposed upon a populace. We
look
at what are considered relatively successful reconstructions—

post–
World War II Japan and West Germany. Next, we look briefly at
Bosnia
as a case in which reconstruction efforts have been unsuccessful
due
to the failure of FEX institutions to dovetail with mētis. We
then turn
to cases of transition economies, where we consider successful
(Poland) and failed (Russia) transition efforts within the
framework
developed above.
A. Successful Reconstruction in Japan and West Germany:
Dovetailing Mētis with FEX Institutions
Japan and West Germany are usually considered instances of
success-
ful reconstruction, meaning the development of a self-sustaining
democracy. In both cases, there was an occupation by external
military forces and a democratic political order was imposed in
a short
period of time.
Americans—notably General Douglas MacArthur, the Supreme
Commander of the Allied Powers for the Occupation and
Control of
Japan (SCAP)—played a key role in rebuilding Japan.
MacArthur
produced an English-language draft of the new Japanese
constitution
in 10 days. After eight months of negotiations in which minor
changes
were made, Japanese politicians presented the constitution, in
Japa-
nese, to the populace as their own innovation. Following the
recon-

struction period (1945 through the early 1950s), Japan
experienced a
period of high growth, lasting through about 1990.
We can attribute the success of Japan’s reconstruction to the
fact that
a significant portion of the Japanese mētis remained intact in
the
postwar period. For centuries, Japanese culture has been geared
toward large-scale organizations and a positive view of trade
and
market exchange (Fukuyama 1996: 161–170). Such a culture
aligns
well with the incentives of a liberal political and economic
structure.
In the reconstruction process, while mētis indeed changed, the
key
aspects of the commercial heritage remained intact. The
practical
knowledge that allowed people to coordinate in the prewar
period
allowed for similar results in the postwar period.
Moreover, the translation of the imposed constitution from
English
to Japanese shows the potential value of ambiguity. While the
native
Japanese did not play a large role in drafting the new
constitution,
they did play a role in translating it into Japanese. The English
and the

Japanese versions differ because in many cases the two
languages do
not have equivalent terminology (Inoue 1991). While the
Japanese
adopted a constitution affirming their commitment to Western
demo-
cratic institutions, much of the language expresses pre–World
War II
traditional Japanese social and political values. In other words,
the
FEX institutions created under the constitution retained key
elements
of traditional Japanese mētis and in this sense embodied
preexisting
IEX and IEN institutional arrangements. Finally, U.S. occupiers
relied
on existing IEX and IEN institutions, such as the emperor and
the Diet,
to implement policy changes. The use of these established and
accepted solutions facilitated the acceptance of FEX
institutions.
The fact that mētis remained intact played an important role in
postwar Germany as well. Given that German governments at
the
local level had a strong tradition of self-government, a 1944
U.S. Civil
Affairs Guide indicated that local politics was to be the
springboard for
political reform throughout Germany (Boehling 1996: 156).
Writing on
British plans to democratize Germany, Marshall notes: “It was
recog-
nized, however, that beneath the nationalist and aggressive
policies
perpetuated by German central governments, there had existed a

healthy democratic tradition at the local level” (1989: 191).
Allied advisors, many of whom who were experts in German
history, recommended retaining particular indigenous traditions.
The
reconstruction process, for instance, included some native
Germans.
The military governments in the U.S. zone appointed Germans
in
villages, towns, and cities to assist in the implementation of
Allied
policies. In choosing native Germans for these positions,
emphasis
was placed on past administrative experience and the perceived
ability to cooperate with military authority rather than on pro-
democracy/anti-Nazi leanings (Boehling 1996: 271). As a result,
at
347
least part of the German mētis was incorporated into the
political
rebuilding process, which in turn supported the stickiness of
FEX
institutions in the reconstructed political order.
In sum, while there was widespread physical destruction in both
Japan and Germany, the preexisting endowment of mētis
remained
largely intact. As Eva Bellin notes, despite the physical damage,
“Japan
and Germany retained the human, organizational, and social
capital

(that is, skilled workers, skilled managers, and social
networks)”
(2004–2005: 596). The endowment of mētis included the
complemen-
tary institutions required to allow externally reconstructed
formal
institutions to sustain and operate in the desired manner.
B. Unsuccessful Reconstruction in Bosnia: Conflict
Between Mētis and FEX Institutions
Bosnia is a case in which postwar reconstruction has failed to
develop
self-sustaining institutions that facilitate economic
development. The
three and a half years of internal ethnic conflict in Bosnia ended
with
the signing of the Dayton Peace Agreement (DPA) in 1995 and
then
the arrival of international peacekeepers. It is critical to note
that while
there was no occupying force present to “impose” order in
Bosnia, the
DPA was reached “only after the United States and other key
partici-
pants exerted substantial pressure on the . . . parties” (Kreimer
et al.
2000: 23). In other words, the DPA did not arise through
indigenous
desires to achieve peace, but from outside pressures coupled
with the
presence of peacekeepers.
Despite obtaining some semblance of peace, the DPA has failed
to put Bosnia on a path of sustainable development. Indeed, it is
far

from clear that a sustainable order would exist if troops and
peace-
keepers were to withdraw. The fact that the FEX institutional-
based
peace treaty was not aligned with the underlying mētis of the
parties
involved, coupled with the stipulations of the DPA regarding
the
political order, is to blame for the reconstruction’s failure.
The DPA implemented a single state, but it also created a
multilay-
ered political structure consisting of multiple entities with often
con-
flicting interests. For instance, the two entities created by the
DPA, the
Federation of Bosnia and Herzegovina and Republika Srpska,
share some common institutions in the form of a General
Council of
Ministers. Further, the tripartite presidency consists of one
Bosnian,
one Bosnian Croat, and one Bosnian Serb, who rotate power
every
eight months. These common FEX political institutions oversee
a
range of policy issues including foreign relations, monetary and
fiscal
policy, and other social policies and regulations.
However, it is important to note that the existence of additional
sovereign institutions below these common FEX institutions has

created an ongoing conflict of interests. For instance, each
entity
has a separate constitution, president, vice-president, and
political
system. Further, the Office of High Representative (OHR) has
over-
riding authority implementing the peace process. The
composition of
the OHR, a FEX institution, is nominated by the Peace
Implementation
Council, which consists of 55 countries and organizations
involved in
the peace process, approved by the U.N. Security Council. The
complicated structure of the Bosnian government along with the
outside influence of the OHR creates a clash between the newly
created FEX institutions and underlying mētis. The very
structure of
the government allows for a continued conflict of interests at
virtually
all levels. The existence of multiple constitutions has allowed
different
entities to pursue different and often conflicting ends.
The reconstruction of Bosnia illustrates another problem: the
FEX
democratic process was rushed before the political order aligned
with
underlying mētis. The timing of elections was set at the signing
of the
DPA and stated that elections should take place no later than
nine
months after the signing. The rushed elections prevented the
devel-
opment of grassroots support for democracy, and existing
nationalist
parties thus had a distinct advantage.

It may be argued that the reason efforts in Bosnia and elsewhere
(such as Haiti, Afghanistan, and Kosovo) have failed is because
of a
lack of international aid and manpower. However, a
consideration of
international funding and military presence across
reconstruction
efforts demonstrates that this is not the case. If one looks at the
per
capita assistance during the first two years after the end of
conflict, it
is clear that relatively high levels of external assistance do not
guar-
antee success. Bosnia received approximately $1,400 per
person,
while Kosovo received slightly over $800 per resident, Germany
349
approximately $300, Haiti approximately $200, and Japan and
Afghanistan approximately $100 per resident (Dobbins et al.
2003:
158).6 Bosnia, Kosovo, Haiti, and Afghanistan must all be
considered
unsuccessful if our benchmark is a self-sustaining democracy.
Likewise, the number of soldiers per thousand inhabitants of
each
country at the conclusion of conflict does not guarantee
success.7
Initial deployment was relatively high in Germany

(approximately 100
soldiers per 1,000 inhabitants), Bosnia (18.6 soldiers per 1,000
inhab-
itants), and Kosovo (20 soldiers per 1,000 inhabitants).
However,
initial force levels were relatively low in Japan (5 soldiers per
1,000
inhabitants), Haiti (3.5 soldiers per 1,000 inhabitants), and
Afghanistan
(2 soldiers per 1,000 inhabitants) (Dobbins et al. 2003: 149–
151).
Again, we observe successes and failures in both the case of
relatively
high and low military presence. Clearly, aid and military
presence
cannot, by themselves, explain successful reconstruction. It is
our
contention that mētis is one of the key factors that allows for
the
achievement of such successes. If underlying mētis does not
dovetail
with the institutions being imposed, these institutions will fail
to stick
regardless of the level of aid or military presence provided.
C. The Transitions of Poland and Russia: Contrasting Cases
of Mētis’s Relationship to Institutional Reform
As with reconstruction efforts, transition involves the shifting
of insti-
tutions. Whether these institutions stick and have the desired
effects
depends upon the degree to which they dovetail with the mētis
of
politicians and the populace. This fact is evident in the
privatization

efforts in both Poland and Russia. We must note upfront that
both
Poland’s and Russia’s transitions are vast topics and we do not
pretend
to cover all of their nuances or angles. Nonetheless, we seek to
provide
some basic insights in the context of the framework developed
above.
Poland’s transition must be considered a relative success
compared
to other countries in similar situations. From 1992 to 2000, its
GDP
grew at an average of 5 percent to 6 percent a year. Russia’s
economic
performance in the transition period stands in clear and
dramatic
contrast to Poland’s. In the aftermath of transition efforts,
Russia’s GDP
fell by 40 percent from 1991 to 1998, with a 5 percent decline
in 1998.
Moreover, Poland has not been plagued by the extensive
corruption,
crony capitalism, or theft of state property that characterize
Russia
(Goldman 2003: 200). Both countries were communist and
began
undertaking reforms at the same time. Why do we observe this
dramatic difference?
By looking closely at the pre- and postwar mētis in both

countries,
it is clear that Poland had the underlying mētis to support
privatization
efforts while Russia did not. Considering Poland first, its
transition to
the market was facilitated by the fact that a small but legitimate
number of private firms had been tolerated throughout the
communist
reign. Although it is clear that these private firms were not a
dominant
part of Poland’s economy during the communist period, they did
serve
to develop a mētis of “how to get things done” in the context of
private business interactions. Following the collapse of
communism
and the subsequent privatization efforts, it was easier for both
the
populace and politicians to build on that underlying mētis and
accept
private business on a much grander scale.
Even before the collapse of communism, Poland passed the
1988
Law on Economic Activity, which granted every Polish citizen
the right
to engage in private business. During 1990–1995, about 2
million new
businesses were registered, with an additional 1 million
registered
over the next five years (Goldman 2003: 200–201). A survey of
the
richest 100 businessmen in Poland concluded that most Polish
citizens
built their fortunes via startups. As we will see below, this
stands in
stark contrast to Russia, where most of the oligarchs became

wealthy
by taking over control of state assets. It must also be noted that
close
to 80 percent of the farms in Poland were not collectivized.
While this
does not mean that they operated efficiently, it does mean that
they
developed a unique mētis based on private ownership that
served to
facilitate privatization efforts.
We have already noted Russia’s poor economic performance in
the
postcommunist period. As with Poland, a brief consideration of
the pre-
and postcommunist mētis in Russia adds insight into Russia’s
failure. In
1992, those in charge of reform—Yegor Gaider and Anatoly
Chubais—
along with economic and legal advisors from both the United
States and
Russia formulated a bold plan for privatization, and reformers
moved
immediately to privatize up to 70 percent of state enterprises.
These
351
privatization efforts failed, largely because after 70 years of
communism
the social, political, and economic climate was not ready for
privatiza-
tion (Goldman 2003: 76). In other words, the underlying mētis

neces-
sary to support the privatization efforts was lacking and had no
roots in
the pretransition period. The reformers recognized this but
proceeded
nonetheless. As Shleifer and Vishny (who were part of the
reform team)
wrote, “[t]he architects of Russian privatization were aware of
the
dangers of poor enforcement of property rights” but assumed
they
would come into existence after privatization (1998: 11). As a
result,
privatization efforts failed to stick as expected.
In Poland, even under communist rule, some private business
was
allowed. There was nothing, however, comparable in the Soviet
Union.
The pretransition mētis that allowed for the smooth
postcommunist shift
to privatization that existed in Poland was missing in Russia.
The result
was widespread corruption, crony capitalism, and the
prevalence of
organized crime. Reform efforts failed to be effectively
supported by
both politicians and the populace—the mētis that acts as the
glue to give
institutional changes their stickiness was absent.
It is also important to note that, like in the case of Bosnia, the
inability
of designed institutional changes to stick in Russia was not the
result of
insufficient aid. Between 1991 and 1999, Russia received over

Comparative Economic Systems Eco 518 Final Country Paper .docx

Comparative Economic Systems Eco 518 Final Country Paper .docx

Recommended

Recommended

More Related Content

Similar to Comparative Economic Systems Eco 518 Final Country Paper .docx

Similar to Comparative Economic Systems Eco 518 Final Country Paper .docx (14)

More from templestewart19

More from templestewart19 (20)

Recently uploaded

Recently uploaded (20)

Comparative Economic Systems Eco 518 Final Country Paper .docx