Greg Clark: Against Institutional Explanations of Economic Divergence

Greg Clark says that Malawi's economic institutions are as good as Sweden's:

FtA: [T]he Heritage Foundation, in an index constructed in conjunction with the Wall Street Journal, ranks Sweden as 21st in the world in its index of economic freedom (72.6% free), and Malawi as 104th (55.5% free) out of 157 countries.... The index weights equally scores on 10 criteria.... [T]he weightings of the components of the index are chosen with the result in mind.  Had Heritage and the Wall Street Journal produced an index which ranked economic freedom higher systematically in poor countries, noone would have liked the index.  This is not a scientific enterprise, it is an ideological one.

Thus the features curtailing economic incentives systematically in high income societies – high marginal tax rates, lump sum provision of many social goods independent of effort, strong restrictions on the labor market, legal systems that threaten enterprises with lawsuits from unhappy investors and consumers – are given very modest weight in the overall index. The features characteristic of low income economies – higher inflation rates, corruption, formal restrictions on business and trade activity – are given relatively high weights.

Yet frequently corruption in low income societies is a way of getting round burdensome bureaucratic requirements.  Why should states like those of northern Europe which impose many arbitrary and vexatious requirements on their citizens and businesses be further rewarded in the index of economic freedom by the fact that their soulless bureaucrats are rigid in the enforcement of these regulations?  Why should states where such arbitrary exactions can be evaded by the deployment of modest bribes be penalized in the index?... [T]he entire oppressive weight of the system of taxes and transfers employed in Sweden, where the government collects 51% of all income, results in a penalty of 48 points compared to Malawi where government taxation is a mere 20% of income.  But more than counterbalancing this is the penalty of 64 points levied against Malawi because “corruption is perceived as widespread.”

Higher inflation rates, characteristic of poorer economies, are also assessed a much higher penalty than any economic losses we would associate with the inflation tax and the reduced value of money as a medium of exchange.  Malawi looses 19 points on this basis. Similarly having assessed Malawi penalties for its legal systems failure to follow the formal rule of law (a whopping 50 points), the Freedom Index then penalizes Malawi a further 41 points under Business Freedom for having a formal set of requirements on business enterprises that are more onerous than in Sweden, even though given the weakness of the legal system we have no idea if any of these rules are applied in practice.  The Chinese market traders so evident across countries like Malawi do not seem to have found the formal business requirements of the Malawian legal code too much of an obstacle.

This was an index enterprise whose result was known before it was ever begun, and whose underpinning is an economic ideology that assumes that economic freedom must produce economice growth, so that the absence of growth must be found in a restriction of economic freedom. Any sensible assessment would say that while their institutions vary, Malawi through its low tax and transfer regime, and its highly unregulated labor market, offers excellent economic incentives for the mass of the population.  Sweden with its high marginal tax rates (see below) and its extensive system of government benefits for all, combined with strong restrictions in the labor market, offers very poor economic incentives to the bulk of the population...

Yet people in Malawi are worse off than people were back in the stone age:

FtA: I first compare England in 1800 relative to hunter-gatherer societies, then England in 1800 against modern Malawi.  The English in 1800 lived at about the same level as the Stone Age.  Incomes in Malawi in 2000-2 seem to have been 33-40% of those of England in 1800, and hence significantly less than those of the Stone Age.

Comments

[Nu]

Oh great !

While I agree that the Heritage Foundation assessment defines economic freedom in a way designed to make the poorer countries not free, I think he entirely misses the point:

Corruption doesn't offset regulation in an equal way. Actually, the fact that some countries still have monopolistic import or export permits is a good example of that.
Corruption is also often ways to bypass burdens that are bigger than the law would suggest. A custom officer at the border or a policeman on the road or a politician trying to get a bribe don't always tell you "you could bypass the existing regulation by paying me", often they say "if you don't pay, i'll find a way to make your life much harder". And in those cases, lawlessness is not an assett for the victim.

Someone should work on concepts like "clarity of extortion" or "negative/positive corruption" or something..

[J. Rothwell]

This is a worthless critique. The Heritage Index matters little to the work of Institutionalists, who collect a wide array of institutional quality measures, but even if it did . . .

Clark has been working hard to forge a career with new ideas, though his ideas always end up sounding like those of James Watson and pseudo-scientific race-based explanations for human difference.

Surely the new institutionalists should have their ideas tested. But is that the best critique Clark can levy? Even if he doesn't care about corruption (though the work of Daniel Kaufman at the World Bank should make him care) Financial Freedom, Trade Freedom, and Property Rights, which are far beterr in Sweden, are ignored, at least in DeLong's quote.

And does he consider why inflation is correlated with poor countries? Bad policies and bad incentives drive by corruption are primary suspects.

If that is the best he can do, I'm not sure what makes him an economist. Where are the regressions that test the institutional hypotheses for robustness.

Clark is no match for the neo-instiutionalists, like Rodrik and Easterly, but more importantly, he is a joke next to those that advance its ideas with the breathtaking rigor of Acemoglu, Johnson, and Robinson.

High marginal tax rates are trivial compared to the rule of law, freedom from arbitrary expropriation, open economies, anti-monopolistic regulation and its concomitant market competition.

[downward insanity]

> Any sensible assessment would say that while their institutions vary, Malawi through its low tax and transfer regime, and its highly unregulated labor market, offers excellent economic incentives for the mass of the population. Sweden with its high marginal tax rates (see below) and its extensive system of government benefits for all, combined with strong restrictions in the labor market, offers very poor economic incentives to the bulk of the population...

Obviously this guy can make his meaningless claims faster than the whole Internet can debunk them. So... maybe there is no reason to listen to him at all?

[a different chris]

>Greg Clark says that Malawi's economic institutions are as good as Sweden's:

Oh c'mon he said no such thing!!

He said that if the Heritage Institute actually scored in the manner you think they would, given all the blather and bombast they exude about the "free market", they would have to have rated Malawi up with or even above Sweden.

Clark's point is that, knowing that doing that would truly expose them for the ideological boneheads they are, they chose different weightings than you would expect given a fair reading of everyfreakingelse they contaminate the public discourse with.

[Nu]

"He said that if the Heritage Institute actually scored in the manner you think they would, given all the blather and bombast they exude about the "free market", they would have to have rated Malawi up with or even above Sweden."

no that's not.
His paper is titled: "Malawi vs. Sweden: Which has better economic incentives?"
and he says: "Any sensible assessment would say that while their institutions vary, Malawi through its low tax and transfer regime, and its highly unregulated labor market, offers excellent economic incentives for the mass of the population. "
I mean the guy isn't saying "we need to redifine the impact of marginal tax rates", he's saying that it's sensible to think that Sweden's high marginal tax rates are a bigger impediment on growth than Malawi's lawlessness and corruption and therefore Sweden's success is best explained by non-institutional theories, like the one he just wrote a book about: malthusian social darwinism.

[Memory]

"Clark is no match for the neo-instiutionalists, like Rodrik and Easterly, but more importantly, he is a joke next to those that advance its ideas with the breathtaking rigor of Acemoglu, Johnson, and Robinson."

I read Acemoglu and Robinson's The Economic Origin of Dictatorship and Democracy a few months ago. I found it fascinating, but I've been wondering ever since whether the mathematical apparatus the used actually contributed to the argument. That's not an attempt to be snarky. I really don't know.

[Bruce Wilder]

I wish a different chris was correct in his interpretation, but I am afraid that Nu's is the better reading of Clark's text.

"Any sensible assessment . . . "
Clark is a Tory -- he really does think that the ideology convenient to the plutocracy's current desiderata is a fair distillation of what economics has to say about institutional incentives for economic activity. The critical role of "insurance" in shaping incentives has been completely missed.

[john]

Then again, he does have a point about corruption and bribery. You can't simultaneously say "regulations are onerous" and "payment of a moderate fee allows you to evade onerous regulations", that's double-counting, since you wouldn't pay the fee if it wasn't smaller than the "onerous" part of the regulation. The net effect of "onerous regulation" plus "bribery" is one or the other, not both. (Quotes are for emphasis, not implying literality.)

Maybe the problem is that the Malawi market is too free, eh? There's a market for everything, even government regulation and the evasion of such.

[Bruce Wilder]

john: "Then again, he does have a point about corruption and bribery. You can't simultaneously say 'regulations are onerous' and 'payment of a moderate fee allows you to evade onerous regulations', that's double-counting,"

You can, if you recognize that the regulation has some worthy object, other than simply being 'onerous'.

Ultimately, high economic output is the result of highly effective, highly efficient economic cooperation. Regulations are usually an attempt to improve the effectiveness or efficiency of cooperation. Paying a bribe to break the cooperative obligation draws resources away from the intended, highly productive cooperative effort to less productive, non-cooperative effort. Hence, the loss associated with corruption.

Let's say the regulation requires dumping waste only at the approved and well-engineered modern land-fill 25 miles away where there's a perpetual queue, but by paying a bribe to the waste management police, you gain the ability to dump your waste nearby, in the crumbling canyon 2 miles away, which is also the source of drinking water for a shanty town.

All of a sudden, the reasons Sweden looks so much better than Malawi seem less mysterious. Why anyone pays the least attention to Greg Clark seems more mysterious, however.

[Bruce Wilder]

Greg Clark tells us that, for England 1800, life expectancy at birth was 38 years, but life expectancy at age 20 was 34 years.

Is there any possible explanation, other than an uncorrected misprint?

[Mr Lazy]

I could believe Malawi and Sweden have equally good institutions for an
economist's definition of institutional goodness.

I think that equality show us something about economics and not very much at all about the role of institutions in development.

[Douglas Knight]

Bruce Wilder,
infant morality of less than 1/3? Surprising, but not enough to conclude a misprint.

[Nu]

john: "Then again, he does have a point about corruption and bribery. You can't simultaneously say "regulations are onerous" and "payment of a moderate fee allows you to evade onerous regulations", that's double-counting, since you wouldn't pay the fee if it wasn't smaller than the "onerous" part of the regulation. The net effect of "onerous regulation" plus "bribery" is one or the other, not both."

The idea that "payment of a moderate fee allows you to evade onerous regulations" is some convinient definition that Clarck decides to use for corruption.
There's no proof it's the case and the Heritage Foundation data isn't based on that narrow definition either.
In the real world, people in Africa pay bribes for services they already pay with their taxes, people pay bribes to avoid being slowed down by a costum officer even if they paid their duties, people also pay bribes and build priviledged relationship to secure import licences, people pay bribes to avoid taxes AND secure the ban of a competitor who pays his taxes..
It's not double accounting. Corruption decreases competition and possible productivity gains, corruption often exists in addition to taxes and tarrifs, corruption is an extra-cost to get a service etc..

[Bruce Wilder]

dk: "infant morality of less than 1/3? Surprising, but not enough to conclude a misprint."

I was thinking that life expectancy at age 20 has to be greater than life expectancy at birth.

[RowanS]

I have on my desk ABN Amro's "Global Investment Returns Yearbook 2006". According to it, Sweden's equity market is the best performing in the (developed) world with a 7.8% pa real geometric return from 1900 to 2005. Australia is second at 7.7% and the US third at 6.5%. Perhaps Sweden's society is not so anti-business after all?

Also, I think that it is very wrong to imagine that corruption just cancels out bureaucracy. In fact, the whole idea that bribery works by paying a standard fee to avoid the law -- that it is the same as paying for any service in a developed economy -- shows he has no understanding of how misusing social or legal power to extort bribes actually works. People I know that have worked in business in countries with culture of bribery have told me that you have to have pay the right people to be on board your project (via consultancy fees, equity in a joint venture at knock-down prices, etc.) or the project doesn't happen at all. The more restrictive the written and unwritten laws are, the more leverage those in power have to extract bribes.

[Michael Sullivan]

I was thinking that life expectancy at age 20 has to be greater than life expectancy at birth.

I assumed in reading the quote that 34 years was the expected time until death for 20 year olds, rather than the expected age at death for 20 year olds. I believe that the former actually the standard meaning of "life expectancy". Of course the two are the same for the most commonly quoted LEs (at birth) which leads to confusion.

[J. Rothwell]

For the institutional perspective, try Agemoglu, Johnson, and Robinson's

"The Colonial Origins of Comparative Development"
http://www.nber.org/papers/W7771.pdf

(To Memory, this is what I was referring to not "Economic Origins of Dictatorship and Democracy," which as you point out, isn't particularly relevant to this debate).

[nu]

Little detail:

In the Heritage Foundation Index, Malawi DOES get a better score than Sweden on fiscal freedom, freedom from government and labour freedom.. And yet performs worse because of: Business Freedom, Trade Freedom, Monetary Freedom, Investment Freedom, Financial Freedom, Propriety Rights, and Freedom from Corruption.

Which economist thinks high marginal taxes have a worse effect than all those domains in which Sweden is more free than Malawi ?

one that has an axe to grind about "institutions not mattering"

[ragnar]

Clark obviously has no idea what he is talking about. His claim that "Malawi through its low tax and transfer regime, and its highly unregulated labor market, offers excellent economic incentives for the mass of the population" is just ridiculous. The country may have low tax rates, but that is of little help if infrastructure is as lousy as it is in Malawi. Water and electricity is reguarly shut off, road and rail connections to world markets are very poor, education levels of the work force low, and the government doesn´t pay its bills. Moreover government budget deficits have crowded out all credit to the private sector.
Too bad I already bought the book!

[Maynard Handley]

"His paper is titled: "Malawi vs. Sweden: Which has better economic incentives?"
and he says: "Any sensible assessment would say that while their institutions vary, Malawi through its low tax and transfer regime, and its highly unregulated labor market, offers excellent economic incentives for the mass of the population. "
I mean the guy isn't saying "we need to redifine the impact of marginal tax rates", he's saying that it's sensible to think that Sweden's high marginal tax rates are a bigger impediment on growth than Malawi's lawlessness and corruption and therefore Sweden's success is best explained by non-institutional theories, like the one he just wrote a book about: malthusian social darwinism."

This is a good explanation of Clark, but, of course, it is not a good explanation of the truth. Clark seems to be living in some economic fairyland where incentives are ALL that matters. In the real world, it doesn't just matter how much you want something, it also matters how realistic a shot you have of achieving it. And your chances of enabling your dreams are a good deal higher if you have a functioning legal system, functioning markets (capital and otherwise), educated workers, political stability, etc etc --- you know, all that institutional stuff that Clark dismisses and that Heritage seems to think comes for free and has no relationship to taxes.