Constitutional Environments and Economic Growthby Gerald W. Scully
In this provocative work, Gerald Scully develops and empirically tests a theory about how a nation's constitutional setting affects its economic growth. Modern growth theory links the rise in the standard of living to capital formation, both physical and human, and to technological progress, and development economists continue to believe that the transformation of the… See more details below
In this provocative work, Gerald Scully develops and empirically tests a theory about how a nation's constitutional setting affects its economic growth. Modern growth theory links the rise in the standard of living to capital formation, both physical and human, and to technological progress, and development economists continue to believe that the transformation of the less developed world cannot occur without massive government control of the economy. Scully, on the other hand, maintains that material advancement is as much affected by the choice of the economic, legal, and political institutions under which people live and work as it is by resource endowment and technological progress. Nothing in the neoclassical theory of growth considers the "rules of the game" under which capital is accumulated and innovation is made. Redressing this neglect, Scully proposes ways of measuring the economic, civil, and political freedom within a society's institutional framework, and he reveals that freedom, or the lack thereof, powerfully and demonstrably influences not only economic progress but also income distribution. Politically open societies grow at nearly three times the rate of those where freedom is more circumscribed, and they also have a more equitable distribution of income. Finally, Scully measures the effect of the size of the state on economic progress, showing that the larger the amount of government expenditures out of gross domestic product, the lower the rate of economic progress.
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Constitutional Environments and Economic Growth
By Gerald W. Scully
PRINCETON UNIVERSITY PRESSCopyright © 1992 Princeton University Press
All rights reserved.
Some thirty years ago, Robert Heilbroner wrote that it was settled that collective ownership and government allocation and distribution of resources would bring a standard of living and a degree of social justice to mankind that was not possible under capitalism. Recently, he said that the evidence from the seventy-five-year struggle between socialism and capitalism was that capitalism had won.
Intellectuals have seen in the de-Stalinization of the Soviet Union, in the agrarian economic reforms of the People's Republic of China, and in the political revolutions of Eastern Europe the promise of a sharp move away from government to individual control of the economy. In the USSR and China, these reforms have been mandated by the Communist Party. In Eastern Europe, reform has been a demand of the population. None of the reforms have led, as yet, to a Western system of private property, freedom of contract, free markets, and the rule of law.
The reforms in the socialist bloc have lessened the grip of government, but it is an illusion to believe that the Soviet or Chinese Communist parties are about to proffer freedom as understood in the West. The brutal suppression of the student democracy movement in June 1989 and the reestablishment of state control of the economy point to the reassertion of power by the Chinese Communist Party. The Soviet Central Committee has been unresponsive to the demands for regional and ethnic autonomy. The Communist Party establishment and the bureaucracy resisted Gorbachev's various timid plans for a planned transition to an economy that has some aspects of market allocation. Monopolists of political power naturally resist the surrender of authority. Life in the socialist bloc is so dismal precisely because of the denial of freedom. The Communist leadership has been forced to concede reforms to avoid utter economic collapse and, perhaps, to avoid rebellion.
The uprisings of the people in Poland, Hungary, East Germany, Czechoslovakia, Bulgaria, and violently in Romania, were spontaneous. The reforms of the system are more promising. At the extreme, the two Germanies are reunified as a democratic, capitalist state. The Soviet Union and Europe could do nothing to stop it. Monetary union occurred in July 1990; political reunification, in October. The reticence of the East Germans has been overcome by the vision of prosperity plain to eyes now open and to the willingness of West Germans to buy off any opposition. Yet problems of reunification remain. Unemployment in the east is high, and investment has been hampered by an inability to secure title to property. For the rest of Eastern Europe, at least the monopoly of the Communist Party is broken. The members have re-formed as socialist parties. The ideology of the opposition groups, other than a deep antipathy to past abuses by the Communist Party, is not clear. There seems to be a general interest in incorporating Western economic institutions to one degree or another. Poland and Czechoslovakia have moved most toward the Western model. But there is a reticence, and perhaps resistance, to fostering Western values and ideology. Even as multi–political party states, these regimes at best will be only partly free. The institutions of private property, free markets, and the rule of law and the values and ideology of capitalism that are crucial to the functioning of a free society need to be built from scratch. Certainly, nearly five decades of communist-socialist ideology will color the reforms in Eastern Europe. The model of man and society that ultimately will be adopted is an open question.
Finally, the political revolutions of Eastern Europe have had little discernible effect on the less developed world. Much of the underdeveloped world remains statist, often with a socialist bent. Civilian government and electoral competition now exists in much of Latin America, but the military continues to pose a threat to civilian rule. Some political competition has emerged in Africa, but coups remain the most common form of political change. On the whole, there is no widespread rush to freedom for most of mankind.
PARADIGMS OF HUMAN PROGRESS
The central argument of this monograph is that the material progress of mankind is as affected by the choice of the economic, legal, and political institutions as it is by resource endowment and technological progress. Each economic, legal, and political system embodies a vision of human progress, a model of man and society. This relationship has preoccupied thinkers since ancient times. Hebrew, Indian, Chinese, and Greek prophets and philosophers all struggled with the rights and responsibilities of the individual versus government and the rules and order of a society that were consistent with a particular vision of human progress.
Before the sixteenth century, the feudal institutions of manors and guilds organized production and distribution. The manors and the towns nearby largely were self-sufficient. Little domestic or foreign trade took place. These institutions broke down, first in England, as internal and external trade developed. They were replaced by centralized government control and mercantilist policy. The renaissance of systematic sociopolitical philosophy began in the later half of the seventeenth century. By the eighteenth century, on the foundations of the economic, political, and legal philosophy of the classical liberal thinkers, many of the Western industrial countries and the United States had chosen an institutional framework that permitted a wide latitude for individual initiative, choice, and responsibility, and a very limited role of government. By the nineteenth century, these countries were solidly capitalist, free market, representative democracies, committed to the rule of law.
There are three great themes in the writings of the European and Anglo-Saxon sociopolitical philosophers. The earliest thinkers (Spinoza, Locke, and Smith) celebrated personal freedom and responsibility, the near-absolute right of private property, the virtues of commercialism, and the concept of limited government. The individualist paradigm of human progress is the intellectual legacy of the classical liberals and the revolution of the middle class. The great themes of the classical liberals were indefinite progress, brought about by the incentives and efficiency of private property, private initiative, and free markets, the sanctity of individual liberty, and the harmony of interests—the serving of the public interest (national wealth) by the unfettered pursuit of private interest.
While freedom brings the opportunity to compete for income streams, it does not guarantee that all will prosper. The transition from feudalism and mercantilism to capitalism and laissez-faire that gave rise to the middle class also created a substantial segment of the working class. The poverty of the working class was thought to be a natural result of the competitive process in market capitalism. This led some thinkers and political activists to a vision of individualism, private property, and freedom of contract constrained by government in the public or general interest. Among this group of thinkers, I include David Hume, Jean-Jacques Rousseau, Jeremy Bentham and the Philosophic Radicals, David Ricardo, and John Stuart Mill. The image of a benevolent, activist government leveling the extreme outcomes of a capitalist economy is their legacy. The tension in modern Western representative government between protecting private property, freedom of contract, and individual freedom (negative rights) and subsidizing failure out of general tax revenue (positive rights) is a result of that legacy.
Dictatorship is the oldest form of government. It remains the most common form. Modern authoritarian government has its origins in nationalism and in the paradigm of authoritarian socialism and central planning. The roots of socialism are in the pessimism of the classical economists, the reformist mentality of mainly English nineteenth-century philosophers, and the Utopians. The classical theory of labor value and the pessimism of an ultimate state of stagnation in capitalism contributed to Marx's prognosis of the inevitable decline of mature capitalist societies and the assumption that the entire structure of rights, law, and representative government was nothing more than tools used by the propertied interests to exploit the working class.
With the end of World War II, rising nationalism in the colonial world brought independence. These new nations were free to structure the institutional framework by which they could progress. Ghandi, Nehru, Nasser, Nkrumah, and other nationalists became spokesmen for decolonization and for a model of man and society that they thought most suitable for human progress. At the time, the Anglo-American model of individualism and capitalism and the Soviet model of statist socialism competed for hegemony. A few of the newly independent nations chose the path of capitalism. A larger number chose a path of private property and economic liberty, but an authoritarian regime of civil and political rights. Enamored of the Soviet model, most of the newly independent countries chose government control of the economy, economic planning, and some form of socialism as the path to economic development. Concomitantly, those in control of these nations are deeply suspicious of private property, individual initiative, and a market allocation of resources. Much of the economic policy of these nations is neomercantilist. Domestic price regulation, import quotas, high tariffs, foreign exchange controls, and so on are common neomercantilist policies. Individual liberty is not an admired attribute of statecraft in these countries.
ORTHODOX DEVELOPMENT ECONOMICS
Development economics is a very broad field of study. It encompasses the grand issues of income growth, income distribution, and policies; development techniques, such as planning models, cost-benefit analysis, and methods of price and fiscal reform; and the role of institutions, culture, geography, health, and so on in micro-level studies. The objective of this book is limited to the basic questions of the effects of the institutional framework, constitutional setting, or "rules of the game" on the prospects for economic progress. The central question in this debate is the role of government versus that of the individual in transforming a society from backward to developed.
The field of development economics began in the 1940s. The founders were European intellectuals. They were influenced heavily by democratic socialism, Keynesian economics, a disdain for commercialism, and a romantic illusion of the possibility of rapid economic transformation through authoritarian planning. The early and influential writers, such as Paul Rosenstein-Rodan, Ragnar Nurkse, Tibor Scitovsky, and Albert Hirschman, emphasized an extensive role of the fiscal state. All of their work is dominated by the idea of "market failure." All favored substantial government intervention in markets and control of resources, particularly in investment. All saw the effect on citizens of government control as benign. Government or public sector failure, the great theme of the public choice tradition, simply never occurred to them.
In the 1950s, there was a great emphasis on import substitution as a policy of spurring industrialization and growth. An inward-looking development program and protection from foreign competition was advocated influentially by Raul Prebisch and Hans Singer. Citing secularly declining and cyclically unstable terms of trade, economists argued that a policy of unrestricted trade would not produce the massive capital imports necessary for rapid industrialization and growth. Attempts at expanding primary exports through devaluation were thought to be doomed, because foreign elasticities of demand were thought to be low. Without a shred of credible evidence on the terms of trade of the less developed countries (LDCs), trade and exchange rate policies were adopted to shield domestic markets from foreign competition.
Government-directed development was the hallmark of the theory and policy of development economics in the 1950s and 1960s. The important neoclassical resurgence of the view that growth of the factors of production and technical change were the engines of growth contributed nothing to the debate of individual versus government control of the process of growth. The "black box" of neoclassical theory is silent about the institutional framework under which inputs are transformed to output and distribution takes place. Yet writers—who were largely ignored—such as Friedrich von Hayek, Ludwig von Mises, Gottfried Haberler, Peter Bauer and Basil Yamey, and others argued that government control of property and markets and central planning were doomed to failure.
A "greening" of development economics occurred in the 1970s. Partly, disenchantment arose because of the failure of central planning and protectionism to bring sustained economic growth. Instead, these policies brought endemic domestic price distortions (resource misallocation) that has in the extreme precluded economic growth. Partly, this disenchantment was due to the success of the export-oriented Asian economies, which were characterized by a high degree of economic freedom, although political freedom is not a hallmark of these countries. Partly, it was due to a perception that where growth had occurred, it had left the poor behind.
Hope of an increased standard of living through a paternalistic, authoritarian control of man and his resources by the government has turned to despair. Naturally, alternative strategies are being sought. A new paternalism in the form of the "new world order" is the democratic socialist alternative. Myrdal, in his 1975 Nobel Memorial Lecture, states the case for redistributing income from those who have chosen institutions and policies that brought economic success to those who chose institutions and policies that utterly have failed:
In this situation there are certainly moral and rational reasons for a new world order and, to begin with, for aid on a strikingly much higher level. In particular, people in rich countries should be challenged to bring down their lavish food consumption. It is estimated that if the average American were to reduce his consumption of beef, pork and poultry by 10 percent, 12 million tons or more of grain would be saved. This would mean making so much more food aid possible, saving perhaps five times as many million people as tons released, or even more, from starvation in the poorest countries. This reduction of meat consumption would be in the rational interest of the American people itself and much less is recommended for health reasons by the American Heart Association: one third. To overeating comes the colossal waste by overserving and spoilage. To a varying and usually lesser extent the same hold true in all developed countries.
As has also been amply demonstrated, the cutting down of consumption, and of production for home consumption, of many other items besides food, and in all the developed countries, is rational and in our own interest. This is what the discussion of the "quality of life" is all about. Our economic growth in a true sense could certainly be continued, but it should be directed differently, and in a planned way, to serve our real interest in a better life. At the same time, it would release resources for aiding the underdeveloped countries on a much larger scale and to begin with for solving the acute food crisis.
The paternalistic welfare program of the "new world order" brings new meaning to the word "dependency." An alternative and more optimistic approach is to encourage institutional and policy reforms that have been synonymous with economic growth in the West. The theme of this book is that the institutional framework, constitutional setting, or "rules of the game" are crucial for economic progress.
NEOCLASSICAL GROWTH THEORY AND THE NEW INSTITUTIONAL ECONOMICS
The neoclassical growth model posits a very simple relationship between the growth rate of per capita national income and the growth rate of the capital-labor ratio, with technology fixed. Two important theoretical extensions of the neoclassical model have been made. Disembodied or embodied technical progress can occur that makes the capital-labor ratio more productive in its production of national output. Exogenous, disembodied technological change is a feature of the Solow model. Arrow showed that technical progress can evolve endogenously through investments in new vintage capital stock. Labor is recognized as reproducible; that is, individuals can accumulate human capital in the form of schooling and job training that augments their productivity. Obviously, such accumulations, like their physical capital counterparts, have positive effects on economic growth. The new neoclassical economics of technical change, pioneered by Paul Romer, Robert King and Sergio Rebelo, and others, endogenizes technological progress through the human capital model and retains exogenous technical change, treating it as an externality or public-type good.
Excerpted from Constitutional Environments and Economic Growth by Gerald W. Scully. Copyright © 1992 Princeton University Press. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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