Institutions, Technology, and Circular and Cumulative Causation in Economics

Henning Schwardt

• Publisher: Palgrave Macmillan
• Year: 2013
• Print ISBN: 9781137333872
• eBook ISBN: 9781137333889
• Topic: Business
• Subtopic: Business generale
• Index: Business

The book investigates the relation between technology and institutions and their mutual influence during processes of development and change and illustrates this on the development process in Argentina after 1946. General and case-study specific policy recommendations are offered.

1

Introduction

In this work, we present an evolutionary-institutional model of the economic development process, and an analysis of the Argentine economy and its development dynamic since 1946. The focus of the formulation is on integrating institutions and technology, and allowing for complex feedback processes among influencing factors, in patterns of circular and cumulative causation. Argentina has shown a very interesting development dynamic – from an analytical perspective; for the affected, painful has often been more appropriate. The country was seen to be on the verge of joining the most developed economies a few times during the twentieth century, but its development process was regularly interrupted, leading to periods during which it lost ground relative to more developed as well as some developing economies, and at times even in absolute terms. This was particularly puzzling as Argentine society and economy have abundant access to the factors that had long been seen as the crucial ingredients for a successful economic development. Focusing on institutional framework and technological capacity for understanding a development trajectory, we can stress some aspects that are often neglected and thus offer some additional insights here.

1.1 Development as a distinctive phenomenon

After treating economic phenomena from a more integrative perspective during the first century after the establishment of modern economics, in the political economy of the classical approach, the focus and methods of many economists became increasingly narrow (as may be exemplified by Marshall’s Principles of Economics, 1920 (1890), in comparison to the writings of Adam Smith, for instance). Adapting a broader perspective again leads to results that suggest different problem sets countries may be facing in the course of processes of development and change, which require distinct policies and solutions, as opposed to a one-size-fits-all-inspired attempt at offering recommendations. The limited success shown by the latter suggests this may present a worthwhile extension of development concepts.

A treatment of growth and development questions as posing distinct problems only consistently began in the wake of the Keynesian revolution (Harrod, 1939; Rosenstein-Rodan, 1943; Domar, 1946; albeit with some noticeable earlier exceptions, such as Schumpeter, 1997). This is also connected to the fact that ‘modern economic growth’ (Kuznets, 1971) only became widely recognized as a distinctive phenomenon during the period of de-colonialization. A principal reason, however, is the emerging understanding that what we now call (neoclassical) microeconomics, and the assumption that an economy can be understood as the simple aggregate of representative individuals’ decisions, is problematic to draw on for answering economically relevant questions.

In fact, one aspect of the Keynesian revolution is the recognition that such a direct aggregation can be seriously misleading about the desirability of results (‘fallacy of aggregation/composition’). Development economists have generally based their analysis on this recognition, with a specific focus on improving access to and allocation of investment means. But when development economics could not be translated into policies that significantly strengthened development processes, and dominant growth models had been analyzed as far as they could be, the resulting loss of interest in the field meant that by the 1970s questions concerning development problems were only rarely explicitly discussed.

The integration of such questions into mainstream economic research re-emerged a couple of decades ago, again firmly in the neoclassical tradition (following the publications of the endogenous growth models by Romer, 1986, 1990; Lucas, 1988, and others, as well as quantitative studies by Barro, 1991 and Mankiw et al., 1992). Since then, the inclusion of institutional factors into the research agenda (drawing on the work of North as part of the new institutional economics) has added new perspectives and further increased the interest in the field. As a result, the number of factors investigated (or, at least, proxies integrated) in quantitative analyses has increased substantially. The possibility of influences from factors that are not, strictly speaking, economic is not a new discovery, however (compare the chapters in Lewis, 1955, for instance, that cover all fields from which current regressions draw their variables). In fact, suggestive first quantitative studies specifically addressing differences in the development process and economic performance of different countries had already been undertaken by Adelman and Taft Morris (1967, 1973), who estimated that around 70 percent of the differences in the levels of economic activity could be traced to non-economic causes.

1.2 Limiting factors and shifting policy focuses

Paralleling changes in theoretical and quantitative approaches to questions of growth and development, the focus in policy suggestions has shifted. Originally centered on physical capital, it later concentrated on human capital, then moved to a focus on policies and institutional reform, and finally the development of social capital or similar constructs (Adelman, 2001; Kenny and Williams, 2001). The last aspects, also related to what have come to be termed governance issues, derived from the focus on property rights to reduce risk for agents in substantial parts of the new institutional economics as part of its transaction cost core. In this understanding, the function of well-formulated institutions is to get agents to act as if a perfect market existed. Where cognitive limitations and information asymmetries threaten to lead to suboptimal behavior, rules are to alter incentive structures so as to lead agents to achieving improved results. Presumably, all relevant information is available in the system, just not to all relevant agents. If addressed properly through adequate rules, Pareto improvements then follow. Still, so far, a broad range of results has been observable in econometric exercises (more than 100 variables have been tested, of which only investment has been found to show a consistently positive correlation with growth, e.g., Kenny and Williams, 2001; Glaeser et al., 2004; Trebilcock and Mota Prado, 2011).¹ This suggests that the view of economic matters and, more specifically in this case, on development that lies behind the theoretical formulations and derived studies may be unsuitable for the purposes of understanding a country’s position and for being able to formulate policies to rectify problematic situations. Development is a complex process (e.g., Myrdal, 1968; Adelman and Taft Morris, 1997; Kenny and Williams, 2001; Paus, 2004). Numerous factors shape the eventual development trajectory of an economy, and the influence of specific factors is not universally given and stable, but may well turn out to be context-dependent and changing (e.g., Gerschenkron, 1962; Greif, 2006; Chang, 2008; Cimoli et al., 2006). Of course, at any given moment, an ex post reconstruction of certain events based on the premise of rational agents and purely economic motivations in an environment uninhibited by uncertainty, non-linear and non-singular influences, through structurally stable patterns of influence between clearly distinguished dependent and independent variables, non-diminishing returns to well-defined production factors, and so on, may well be possible. But the general assertion that models can only describe what was, not predict what will be, holds (Harcourt, 2006; also, for instance, Heilbroner, 1970). The transferability of a parameter constellation permitting such a reconstruction to other places or times, or samples and periods, is likely to prove problematic. Derived policy recommendations can then be expected to be problematic as well. Still, as these concepts, or variations of them, continue to dominate in the economics literature, it appears necessary to dedicate some space to their more detailed discussion.

The first objective of this work, therefore, is to take up the principal perspectives under which the process of economic development has been approached and develop a formulation of a concept proper of that process that rectifies weaknesses identified in earlier formulations. This will have to involve a shift of the line where the trade-off between ‘simplified but tractable’ is usually made towards ‘somewhat more complex but in turn better suited to base policy recommendations on’. The second objective is to then apply this formulation to an analysis of the development trajectory of the Argentine economy since 1946 in order to improve our understanding of this trajectory and offer an analysis of its current strengths and possible continuing weaknesses.

1.3 Institutions and technology

Non-economic motivations are important aspects for agents’ decisions (see the discussion in Chapter 2). And aspirations in different areas of human life cannot be translated into a single currency to make them commensurable and open the possibility for calculable trade-offs between them (e.g., Simon, 1955). Therefore, an attempt to understand agents’ behavior cannot succeed without a proper recognition of the role of non-economic factors. This means that, even though we are dealing with an economic topic, social and political structures (as reflected in an institutional environment) have to be assessed as well in order to be able to formulate a framework that can serve as the basis for later empirical analyses. The understanding of the original (American) institutional economics, that institutions include values and habitual behavioral patterns, provides an important ingredient to this analytical structure. The effective dynamics resulting from factors in the institutional sphere and their changes can only be understood from the interplay of its various components (also, e.g., Harriss, 2002; Casson et al., 2010). For the focus of this work, such a broader approach appears to provide a more reliable foundation.

The second conceptual aspect, besides the more inclusive understanding of institutions, that sets this work apart from most of the research undertaken in the area of economic development is the explicit recognition of the importance of technology and technological change, resulting in structural changes in economic relations during the development process, in fact, constituting development (which is neglected with surprising frequency; Lee and Kim, 2009). A framework for the understanding of development questions, then, requires a clear concept of what technology is. We will follow C.E. Ayres (1996) to understand technology as the combination of skill and equipment, never one of these categories alone. Changes in technology develop in a mutually dependent relation to the institutional environment that agents face, through influences on skills, patterns of thought, requirements in processes applying technology, and so on. The process-nature of economic development, as an ongoing change of structures and capabilities, is a reflection of changes in these tightly linked subsystems of political economies.

1.4 Economic development

The term economic development is usually employed in one of two senses. Either it is used to ‘presumably (mean) the process of change of one type of economy into some other more advanced type’ (Hirschman, 1958, pp. 51–52), or it is understood to directly mean long-term per capita growth (compare the approaches discussed in Chapter 2). The perspective we adopt combines the two, in that the observations on which the second approach is based are taken to be the manifestation of the changes that are the focus of the first (so that growth without changes does not constitute economic development, and nor do changes that are not followed by an increased ability to meet the provisioning requirements of a country).

The focus on economic expansion can be more broadly justified, as ‘[t]he advantage of economic growth is not that wealth increases human happiness, but that it increases the range of human choice ... The case for economic growth is that it gives man a greater control over his environment, and thereby increases his freedom’ (Adam Smith, as quoted by Arndt, 1987, p. 151). The second part of the quote should be modified to state that an increase in structured knowledge increases the capacity for manipulation and domination of nature – the very notion of humans as the masters of nature that is often traced to be a crucial component of the mindset that has allowed the sustained economic expansion of European societies (Mokyr, 1990) – and at the same time bears the seed that enables economic expansion, meaning that the causation is actually reversed with respect to the quote. It nevertheless helps to stress the value of improvements in the economic sphere because of their instrumentality for changes in other areas of human existence.

The basic judgment that lies at the heart of that statement is to some degree a short version of Amartya Sen’s capabilities approach for the evaluation of development processes (as presented in depth in Development as Freedom, Sen, 1999), which can be reduced to one fundamental idea, namely that human beings will agree on the notion that more freedom is preferable to less freedom in all areas of life, including economic, social, and political (as is, based on Sen’s work, partly reflected in the construction of the United Nations Human Development Index). Then, the availability of more choices is to be judged an improvement of an individual’s personal circumstances. The capacity to understand such possibilities and make such choices, an expansion of agency capacities, is a crucial part of this. Economic development signifies that means are generated that may allow freedom in the economic sphere to be expanded. The extremely interesting point that an ‘affluent society’ (Galbraith, 1998) may continue to see technological and economic changes that are aimed at satisfying ceremonially inspired and newly created necessities can unfortunately not be taken up here.

The ability to make choices can be constrained by many factors, not only economical, but social and political as well, and ‘(a) good starting point for the analysis of development is the basic recognition that freedom is both the primary objective of development and its principal means’ (Sen, 2001, p. 506). Therefore, progress is needed in every area, and true development can only signify improvements in the overall situation a human being faces. So, even though economic progress may facilitate progress in other areas, a focus on one exclusive field to judge the overall results obtained may fall short of offering satisfying assessments of people’s real situation, and consequently of producing solutions that take the whole set of necessities present into account. The development of a society in general should facilitate its economic development; which direction is taken is influenced by the overall values that the group has come to accept, and eventually habitually assumes. At the same time, the economic development of a society should be translated into broader development, in the sense of expanding freedom in all areas of life, for it to have a long-term value. As development means change, people have to be capable and free to introduce novelties into their society. The central role of institutions and the interplay of institutions and technology will permit a perspective that can accommodate these requirements and also help shed light on possible sources of effects leading to stagnation or regress in a society.

We will, nevertheless, focus primarily on economic variables in the first approximation to the development question, and especially on changes in per capita income. A sustained increase in per capita income is most likely the result of a sustained increase in productivity and due to innovations and concurrent structural changes in an economy. Innovations as changes in technology are reflections of changes in skill level and equipment in an economy. The skill level develops as a function of economic and non-economic factors. Changes in the equipment base are the result of investment decisions. We can draw links to the institutional framework here, so that an overview of changes that have manifested in economic variables can provide the structure for approaching an analysis of the institutional background that has provided the foundation for these developments. In other words, the focus on economic measures and some social indicators can serve to identify especially interesting periods for an analysis, namely, those preceding particularly noteworthy events and periods of noticeable change.

1.5 Changing structures and context-dependent influences

To fully appreciate this point, we have to be aware that economic development is part of the wider process of the modernization of a society, and that, therefore, economic growth may well end up being a ‘destabilizing force’ (Olson, 1963). Newly emerging, or strengthened, interest groups can move into positions of demanding societal participation, leading to at least a perceived threat to already existing interests. As Huntington (1996) stresses, the modernization process presents the political system organizing the aggregation of interests and the moderation between different interests with continuous challenges, as the more complex interest formulation and the continuous creation of new and more differentiated interest groups that result from the increased complexity of economic activity have to be mirrored by an increased complexity in a society’s political structures. A failure to formulate adequate political institutions can be expected to result in political instability, as new interests press for influence in the political process which cannot, however, be properly exercised within existing structures. But adequate institutional depth of a political system is not an automatic result of economic processes. Newly emerging requirements thus have to be dealt with in the course of the processes of change societies undergo. These are likewise felt in social structures and value systems. The degree to which they are integrated and accommodated shapes future opportunities.

As economic development is concurrent with change, the importance of different factors for sustaining a position or for fostering change may well change over time, either as the consequence of the process that a country has undergone, or as the outcome of changes in the conditions in the wider (social, political, technological) environment. We also expect continued dynamics along different dimensions of the institutional framework, with a tendency towards reducing the openness towards actual change (a ceremonialization of structures; see Section 2.4). The ability to start and sustain a process of economic growth and development will then depend on the ability to change continuously. We can, furthermore, assume that some adverse influence does not have to mean the end of the process, but that every adverse factor can to some degree be overcome by a suitable combination of other influencing factors, possibly redirecting the path of changes that has been pursued before. As a result, we should expect different paths to emerge along which economies have moved, depending on which problem structures they managed to overcome, and how. Then, no first best solution is likely to be easily specifiable or even transferabl...

Table of contents

• Cover
• Title
• 1  Introduction
• 2  Concepts of and Models for Growth and Development Dynamics
• 3  The Analytical Framework: Institutions, Technology, and Circular and Cumulative Causation
• 4  Economic Development in Argentina after 1946
• 5  Consequences for Development Policy
• Notes
• References
• Index