Saturday, March 1, 2008

Lin on Institutions and Development

We can count Justin Lin, the new chief economist of the World Bank, among those who believe that institutions are crucial for economic growth. He told the Wall Street Journal:
At the beginning, people put a lot of emphasis on resources, and that’s why we had family-planning policy, not only in China but in other parts of the world. [The thinking was that] The more resources per capita, the wealthier the nation. Later on people thought that natural resources may not be so important, they think that capital and technology are important. Now economists start to understand that for all those things — capital needs to be accumulated, technology needs to be adopted, human capital also needs to be accumulated — you need to understand the incentive, the motivation behind those kind of human choices.

These kind of traditional factors of wealth are just some kind of proximate causes. It’s like you say rich people have a lot of money, but you need to understand why they have a lot of money. Now you need to look into what is the deep cause, the real fundamental cause of development. I think increasingly people now understand that institutions are the most fundamental cause.

Because institutions will shape the incentive structure in an economy, about people’s motivation and willingness to engage in work, lending, accumulation of capital. Now people understand that to understand why a country is performing well or performing poorly, institutions are the key. Fundamentally all economic progress needs to be achieved by people’s effort. We need to understand people’s incentives, and people’s incentives are shaped by the institutions in a country.

Although we recognize institutions’ importance, that institutions matter, from what I see, institutions are an area that requires more research. They are often second-best, they are a choice under a certain kind of constraint. If we do not remove those kinds of constraints, if we want to change the institution, you may jump from the second-best to the third-best. Many interventions did not achieve the intended goal, it’s because they did not really address the cause of those kind of distortions.

It sounds like he is reading his Dani Rodrik, and indeed, Professor Rodrik is pleased.

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