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Law and Regulation

From Bubble to Bubble: Government Policy Blunders

Raj Nallari's picture

Greedy speculators in housing and private bankers, financial innovation and failure of risk models, regulators and credit rating agencies were all deservedly blamed for the recent financial crisis. Behind this all is public policy that worsened the problems.

Have Institutions Failed Us?

Raj Nallari's picture

Institutions matter was the oft chanted mantra for the past fifteen years. We were told that in the presence of social conflict between various groups, between haves and have-nots, political power precedes political institutions, economic institutions and economic policies. But, political power could be de jure (due to constitution, fair elections and smooth transition to political power) or de facto such as dictatorships and authoritarian leaders usurping power by coups and violence. Sixteenth century colonialism established ‘settler’ and ‘exploitative’ institutions depending on the then existing ‘climate’ in the colonized countries. For example, if the climate was unbearable and malaria-stricken, the colonial masters established an exploitative relationship of shipping out natural resources. If the climate was hospitable, they settled in with family in these countries and started administration and other institutions.

More recently good institutions were supposed to emerge when only de jure political power is in place. Also, a political and legal system that places constraints on elites is often conducive for better institutions. Following this logic, institutional economists have reasoned that advanced economies with de jure democratic political institutions have smooth transition, predictability and place constraints on elites and abuse of political power, and have strong institutions that ensure a system of checks on the executive, law and order, property rights, etc. The theory of institutions is that bad policy outcomes are the result of bad institutions and these are common in developing countries, where the distribution of political power needs to be reformed and deeper causes need to be strengthened. Others have argued that market-oriented institutions are important for economic policy management. By this categorization, advanced economies had better institutions that led to sound economic performance and consistently higher economic outcomes.