Political Organization, Efficient Markets, and Economic Development
Directors: Barry Weingast, Stephen Haber, and Douglass North

The past two decades have witnessed two large scale economic experiments to transform centrally planned economies (such as that of the former Soviet Union) or market economies with high levels of central planning (such as those found in Latin America in the 1950s-1980s) into economies with efficient markets. Much to everyone's surprise, the end results of these experiments have not been sustained economic growth. The economy of the former Soviet Union sputtered and stalled, and then collapsed after 1998. The economies of Latin America, with the sole exception of Chile, performed only somewhat better. Most countries have undergone periods of strong growth that are then followed by equally strong collapses, of which the recent Argentine meltdown is only one example. The per capita GDP figures for virtually all countries tell the same story: real per capita incomes in 2002 are at the same level they were in 1980.

This research program evaluates the set of market-based policies—the so-called Washington Consensus—that have underpinned the Russian and Latin American experiments and pursues an alternative view based on the centrality of politics to institutions and economic development. Overall, the Washington Consensus has suffered from two fatal flaws. First, the prescribed reforms often have not been based on an comprehensive understanding of what makes for efficient markets. Policy makers did not consider the ways that institutions interact across different markets. Instead, each piece in a series of institutional reforms was ad hoc. Second, the Washington Consensus concentrates on only one part of institutional design—the creation of economic institutions designed to promote markets. It neglects an equally important part of institutional design—the creation of political institutions that constrain political agents from subverting the economic institutions that underpin markets. In reform after reform, the short- term political goals of politicians took front seat to the long-term goals of economic growth and efficiency.

Our alternative view is that political institutions—and not the personal attributes of leaders—determine whether the government fosters markets or undermines them. This implies that the diagnosis of the problem of economic development in the development literature and in the Washington Consensus is wrong, namely, that development requires taking politics out of economic policymaking. Not only is this impossible to do, but attempting it implies that advice for developing countries is doomed to fail. Political institutions are needed to enforce contract and property rights; world history offers us no case of a well-developed market system that was not embedded into a well-developed political system. Yet any government strong enough to enforce the rules of commerce and provide economic stability is also strong enough to confiscate the wealth of its citizens and bestow favors on some firms and industries at the expense of others.

Thus, successful economic development requires two crucial inputs. First, there must be economic institutions that support markets. Second, there must be political institutions that protect markets from politics. That is, the organization of government must give government officials incentives to foster markets. This research program examines both of these inputs. Initially, we are focussing on the economic and political institutions that make for efficient financial systems. Financial systems are the nerve centers of modern economies, and governments policies have a direct and strong effect on their operation. Thus, they are a good starting point for our research agenda.

Back to Research Groups