5 May 2017

The alignment of formal and informal institutions

Abdel writes:*
“The complex ways that societies structure human relationships – the institutions that shape economic, political, religious, and other interactions – appear to be the key to understanding why some societies are capable of sustained economic and political development.” -- Douglass C North, John Joseph Wallis & Barry R. Weingast
It was stated by the editor of this blog [that's me, David] that the productivity of any person could go up by a factor of five [or 10] simply by putting them in a different institutional environment. This may sound unbelievable at first, but think of the following example. A wealthy (yet undeveloped) student studies at a posh university with the goal of acquiring a degree. We express his productivity in units of acquired knowledge. At the posh university he is able to buy good grades and doing so he “earns” his degree without learning too much. Now, however, we transfer this student to another identical university, with one difference: buying good grades is prohibited and anyone who tries gets kicked out of school. Although the resources, the building, the students, and the teachers have not altered, this student’s productivity increases enormously as he now has to study for his degree. Simply by change a single rule, a single institution.

The question arises whether the opposite is true as well? What if we do not transfer the person to a different institutional environment, but bring the institutional environment to the person? A possible example thereof would be to copy the constitution of any high-income country in the West, say France, and apply it to an African state, Mauritania, for instance. Mauritania, as many African states, is a former French colony and until 1959 the French constitution was indeed its constitution. The constitution adopted after independence was heavily inspired by the French constitution. Nonetheless, not many people would claim that Mauritania has a similar level of development as France.
One aspect of the puzzle of institutions and development is the distinction between formal and informal institutions. By replacing a country’s constitution one changes the formal institutions, but what if the informal institutions do not align with the formal institutions? What if they compete with the formal institutions?

The result can be illustrated by returning to the example of our wealthy student. At his new university buying off teachers is formally forbidden. However, as indicated, the teachers are identical to his former teachers and therefore are willing to accept a bribe. Is adding a written rule to the school’s regulations sufficient to prevent the teachers from accepting a bribe? Not if accepting bribes is an informal institutions in the school. Teachers could receive informal sanctioning when they do not accept the bribe. If a teacher knows that all of his colleagues including the headmaster willingly accept bribes would he have an incentive to report to them that a student has attempted to bribe him? Probably not, as the other colleagues would suspect this teacher for reporting their involvement in the bribing business as well. In fact this may be the end of this honest teacher’s career.

Bottom line: Institutions are important and have the potential to significantly increase productivity. However, copying written rules and applying them to a different environment is unlikely to be effective and may have perverse effect when formal institutions do not fit their new (informal institutional) environment.

* Please comment on these posts by students in my growth & development economics course. It really helps if you highlight unclear analysis, alternative perspectives, better data, etc.

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