Sources
These five sources represents an example of the methodological approach used in this report. One aim is to uncover consensus or divergence among a range of reports, books of selected economists (Ostrom, Piketty, Kahneman, etc..) and institutions (IMF, World Bank). As a litmus test to check for consistency, these conclusions are supplemented with primary statistical analysis reviews broad social, political and economic data from the Legatum Institute (Legatum Institute, 2019). Sources are also selected from human behavior and sociology fields to gain a deeper theoretical understanding of the microfoundations of the economic models and assertions.
Washington consensus : Review of results from Latin America by the World Bank
A critical review of the Washington Consensus for Latin America was presented in a 2010 report by the Office of the Chief Economist of the World Bank (Birdsall, 2010). The report is a collection of contributions from economists from Latin America and Nancy Birdsall from the US who were familiar with the context and the outcomes. The report presents the Consensus as a policy shift for Latin America towards market based liberalization reforms. The report reviews the development starting with a background introduction and description of the implementation and the performance in the years after the reforms. The report concludes that the results were lackluster and had not met the expected outcomes. The criticisms are organized into three categories - poor implementation, flawed design and the authors’ main position - an incomplete agenda. The authors conclude that the reforms were “patently incomplete, that it did not include all of the relevant reforms needed to achieve sustainable and equitable growth” (Birdsall, 2010). The report lists five shortcomings which share the common denominator of known market failures
Incomplete agenda, shortfalls of the Washington Consensus (Birdsall, 2010)
Volatility
Institutional reform
Knowledge systems
Equity
Environmental sustainability, especially climate change.
The report concludes by offering the summary of an alternative improvement “ Washington Contentious” model for sustainable and equitable development (Birdsall, 2010).
Fiscal policy : Best practices from the International Monetary Fund (IMF)
The Fiscal Monitor is a series of reports by the IMF for policy makers. Each report examines a particular topic in detail and summarizes the knowledge from academics, empirical evidence and common best practices by member states. The 2014 report “Public Expenditures Reform : Making Difficult Choices” (IMF, 2014) provides policy makers with a guide for fiscal consolidation. The report presents an overview of recent trends in debt and deficits by country and region and the best practices for managing public spending. The authors limit the scope to providing guidance for how to control spending and leave the decisions of the size of government and level of decentralization as a political choice based on the local “social preference” in each country. The authors provide caution to policymakers to set realistic expectations that the political demands on the state for public goods and services are likely to be higher for more advanced economies based on the evidence of “Wagner’s law” and furthermore these costs are likely to increase with rising human development due to “Baumol’s cost disease”. They acknowledge the combined political barriers to fiscal consolidation of both resistance to raising taxes and to cutting spending and organize their recommendations to 5 main points :
Best practices for managing public expenditures for fiscal consolidation (IMF, 2014).
Avoid broad non-surgical hiring freezes or wage cuts
Focus on the top ticket items - public wage bill, pensions
Make the investment to dive deeper for long term reforms aimed at efficiency/rationalization of how the institutions operate
Do not neglect public investments and deplete the public capital stock over time
Mobilize consensus to ensure that the reforms are implemented flawlessly
Institutions : Lessons learned governing Common Pool Resources
Institution design for “common pool resources” (CPR) was the motivation of Elinor Ostrom’s work “Governing the Commons” to critically evaluate the evidence of Hardin’s tragedy of the commons dilemma (Ostrom, 1990). She investigated to determine whether or not commons were destined to a tragic end in the absence of either privatization or central authority. Ostrom defines institutions as the set of rules that govern collective behavior. She further identifies institutions as three-level nested hierarchy of operational, policy and constitution where lower level frequent execution decisions are performed at the operational level and less frequent, structural decisions at the constitution level. Her institutional analysis framework is organized into the roles, boundaries, set of actions, information and payoffs in the system. The CPR cases were shortlisted based on specific features of renewable, scarce resources shared by a small community size of < 15,000 and a few other conditions (Ostrom, 1990). Ostrom found that stable institutional forms which have persisted over long periods of time include features that incorporate cooperative and competitive dynamics and utilize both formal and informal controls. Ostrom used the economic game theory framework to analyze the theoretical design of the institutions for managing CPR. She complimented the economic analysis with secondary case studies of field research to look for patterns to understand and predict when they were stable and when they risked tragic ends.
While Ostrom did find tragic cases, she also found success cases from Switzerland, Spain, Philippines and Japan (Ostrom, 1990). She recognized the potential for the free rider problem, but also found solutions that did not take the traditional institutional forms of the “firm” or the “state”. The forms she encounters can be thought of as hybrids which share features of the two traditional forms but do not fit into either the employee-consumer-entrepreneur roles in a for-profit firm or the citizen-governor roles in the state which commands a monopoly on coercive force. Features she identified with the successful cases overlap with liberalization reforms -
Features of successful, sustainably managed common pool resources (Ostrom, 1990)
Clearly defined boundaries
Incorporation of site specific information
Decentralized authority
Careful attention to design of incentives for maintenance and monitoring
Enforcement of rules
Means of conflict resolution
Opportunity for the participants to be able to adjust and fine tune these rules through democratic participation
While components of the institutions for governing appear similar, profit and rent seeking are not the only motives driving participation and commitment and there are clear differences in the ownership structure of the traditional for-profit firm model. There are multiple forms of collective ownership participation - both direct and representative and there is less segregation of roles between labor, shareholders and customers. Participants fulfil combinations of these roles (Ostrom, 1990). The rules and the structures accounted for both reciprocal, cooperative, conforming and selfish “opportunistic” tendencies. The implication of Ostrom’s insights for the problem of setting rules and governing restraint on individuals selfish interests is that it does not need to be left to chance. Instead the rule determination process can be formally represented with democratic like institutions, explicit forms of rights of representation and channels for direct participation in rule setting and enforcement.
Empirical evidence : Analysis of national metrics 2009-2019 Legatum Prosperity database
The Legatum Institute was founded by and run by Baroness Philippa Stroud, a Conservative Party Minister of Parliament of the UK. The institute compiles and publishes the Legatum Prosperity Index for the purpose of improving policy effectiveness on broad social goals. The dataset covers 294 measures from 167 countries over a 10 year period from 2009 to 2019. The Prosperity Index measures are organized into 3 domains - empowering people, open economies, and inclusive societies. Each domain is further divided into 12 pillars and 65 elements. Finally the elements are composed of the 294 measures (Legatum Institute, 2019). The composite index like many broad based measures of general national progress shows a high correlation with the Economic Freedom Index and this relationship is the inspiration for the analysis in Appendix B. Correlation is not causation and there could be many explanations for a correlation of two broad indexes composed of national performance metrics. Appendix B explores the statistical relationships contained within the dataset as an empirical test of the claims of liberalization and its criticisms. In particular the analysis investigates the statistical evidence for three focus areas - trade-offs, development stage dependency and policy subsets.
Inquiry claims of liberalization policy from the Legatum Prosperity database (Appendix B)
Presence of trade-off among different measures of prosperity
Dependency of relationships on national stage of development
Subset of liberalization policies which have stronger evidence than others.
The result of the analysis found evidence of one dominant “general national success” signal separating developing from advanced economies, and this general success signal was correlated to many other measures of success. Causation however cannot be concluded from this study alone and a hidden Z factor [1] cannot be ruled out. The analysis also found evidence supporting all three inquiry claims. Details of the statistical analysis of the Legatum dataset is presented in Appendix B.
Human behavior : Review of theory and first principles with science of human behavior
Appendix C presents an overview of the science of human behavior and motivation compared to what is assumed for the liberalization model. The section summarizes work from sociologists - (Shalom Schwartz, 2012 ; Solomon Asch, 1952), anthropologist Robin Dunbar (Zhou, Dunbar 2005) neuroendocrinologist Robert Sapolsky (Sapolsky, 2017) and economists (Richard Thaler, Cass Sunstein 2009 Daniel Kahneman, Amos Tversky 1979, 2011 ; Elinor Ostrom, 1990 ; George Akerlof, 1970 ; Robert Axelrod, 1984 ; David Easley 2010 ; Xavier Gabaix, 2017 ; Adam Smith 1776, 1790). The classical economic model promotes competitive markets as universal solutions for a wide range of collective action problems and like all theories it is based on a set of ideal simplified assumptions. In particular the theory assumes that market participants are self-interested, motivated by maximizing profit, rational and actionable information is perfectly transmitted and incorporated into the price. While this holds in some limited circumstances the model of real human behavior as social beings presents serious challenges to these basic model assumptions. Eight features of motivation and behavior are identified that challenge the classical economic model assumption.
Features of motivation and behavior that challenge the classical economic model (Appendix C)
Humans as social beings are dual capable for cooperative and competitive behavior
Behavior operates as genetically selfish overall with cooperative adaptations
Collective action for common pool resources is challenging but not an inevitable tragedy
Complex social networks can amplify, reinforce inequality through winner-takes-all
Information barriers at source and destination create asymmetries and distort markets
The biological reality of cognition biases decisions from rational expectations
Choice architecture manages cognitive limitations while still preserving limited autonomy
A meaningful definition of prosperity extends well-being beyond the self in the present
Footnotes
[1]. “Hidden Z factor” is the acknowledgement that a correlation between X and Y does not imply causation X → Y as either the reverse could be true Y → X or there could be a “hidden Z factor” causing X and Y simultaneously. Z → Y, Z → X
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