Introduction: The Rise of Institutional Economics

Institutional economics, once a marginal area of study, gained prominence in the 1980s with
the rise of New Institutional Economics. By the 1990s, institutions were seen as pivotal in
explaining global economic disparities, becoming a major focus for organizations like the
World Bank and IMF. Chang critiques the oversimplification in mainstream thought, which
posits that poor institutions are the root cause of underdevelopment, and that better
governance structures, usually modeled after Anglo-American institutions, would solve
these problems. He challenges this simplistic view, highlighting that institutions evolve
alongside economic development and that the relationship is far more complex.
Theoretical Problems in Mainstream Institutional Economics
The dominant discourse in institutional economics is flawed due to several theoretical
problems:
1. Linear Causality: The mainstream view suggests that institutions lead to
development but ignores the reverse—how economic development itself shapes
institutions. Chang argues that the evolution of institutions often follows
development, rather than preceding it. This viewpoint challenges the assumption
that liberalized institutions will automatically result in better growth outcomes.
2. The Impossibility of a Free Market: While free-market advocates claim that
economic freedom leads to growth, Chang demonstrates that markets are never
entirely free. Regulatory frameworks and legal systems, which vary by country, shape
economic interactions. The idea of a “free market” is, therefore, subjective and varies
across different institutional contexts.
3. Over-Reliance on Liberalized Institutions: Mainstream economics often promotes
institutions that provide maximum economic freedom, such as strong property rights
protection and minimal government intervention. However, Chang argues that these
liberalized institutions are not universally beneficial. In some cases, they may even
hinder economic development, particularly in countries with different socio-
economic conditions.
Empirical Problems in Institutional Economics
Chang critiques the empirical evidence often cited to support the superiority of liberalized
institutions. This evidence is primarily based on cross-sectional econometric studies, which
compare different countries at a single point in time. Such studies fail to account for the
historical and socio-political complexities of individual nations.
1. Cross-Section vs. Time-Series Evidence: Most of the empirical work supporting
liberalized institutions comes from cross-sectional studies, which lump together
countries with vastly different histories, cultures, and levels of development. Chang
advocates for time-series studies, which would track how institutional changes within
a single country over time affect development. Time-series data offers a more
nuanced view of the relationship between institutions and economic growth.
2. Institutional Quality and Measurement Issues: Defining and measuring institutional
quality is inherently problematic. The composite indicators often used (such as
governance or property rights indices) are highly subjective and fail to capture the
complex reality of institutional structures in different countries. Moreover, cross-
country comparisons often suffer from heterogeneity, making it difficult to draw
meaningful conclusions.
Historical Case Studies: The Evolution of Institutions
One of Chang’s key arguments is that institutions often evolve as a result of economic
development, rather than the other way around. He presents several historical examples to
support this:
1. Western Democracies: Chang points out that today’s rich countries did not always
have the institutions that are now considered prerequisites for development. Many
European countries and the United States acquired modern institutions like
intellectual property rights (IPRs), bankruptcy laws, and central banks after they
became economically developed. The relationship between development and
institutions is, therefore, not linear.
2. Industrial Capitalism: In the 19th century, rising industrial capitalists in Europe and
the United States supported the creation of banking systems that would facilitate
investment. These institutional developments were a response to economic needs,
not the driving force behind industrialization. Similarly, the growth of the welfare
state in the 20th century was a response to the rise of the working class, rather than
an antecedent to it.
3. Latecomer Effect: Developing countries today benefit from being able to import
superior institutions from developed nations without having to bear the full cost of
developing them. This “latecomer” effect complicates the relationship between
institutions and development, as it allows countries to leapfrog certain stages of
institutional evolution.
Institutional Change and Reform
Chang also critiques the mainstream view on institutional reform, particularly in the context
of developing countries. The assumption that institutions can be easily changed to fit a
liberalized model is overly simplistic. Institutional reforms often fail because they do not take
into account the historical and cultural context of the country in question.
1. Costs of Institutional Change: Changing institutions is not cost-free. Establishing and
running high-quality institutions requires significant financial and human resources,
which many developing countries cannot afford. Moreover, the opportunity costs of
institutional reform are often overlooked. The resources spent on reforming
institutions could be better used for more direct development policies, such as
education or infrastructure investment.
2. Human Agency and Institutional Change: Chang emphasizes the role of human
agency in institutional change. Institutions do not evolve in a vacuum; they are
shaped by the people who operate within them. The mainstream discourse often
ignores this, treating institutional change as a purely technical process that can be
managed through external pressure or incentives.
Conclusion
In his conclusion, Chang argues that institutional economists need to take a more nuanced
approach to the relationship between institutions and economic development. The current
dominant discourse is too simplistic, focusing on linear causality and universal solutions that
do not account for the complexities of individual countries’ histories and socio-economic
conditions. Chang calls for a more historically informed approach to institutional economics,
one that recognizes the dynamic and context-specific nature of institutions.
In summary, "Institutions and Economic Development: Theory, Policy, and History" challenges
the prevailing view that liberalized institutions are the key to economic growth. Instead, it
presents a more complex and historically grounded view of the relationship between
institutions and development, arguing that policies must be tailored to the specific needs
and conditions of each country.
This research provides a critical lens through which to understand the ongoing debates on
institutional reform and economic policy, particularly in the context of developing countries.
It calls for a more nuanced, evidence-based approach that takes into account the dynamic
and evolving nature of institutions.