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Despite the current fashion for issues such as institutional transparency or corruption, the modern policy development literature does too little to integrate the core ideas of modern political economy with standard economic theory. Little is done to distinguish the advice given to developing countries-especially on macroeconomic aggregates-from that given to richer nations with stronger institutional environments. The essay uses the Philippines as a case study to suggest what is wrong with leading prescriptions. It suggests a framework that starts from a basic analysis of sectoral distortions to identify the areas where ideal reforms are likely to have the most impact and then pairs such analysis with more institutionally consistent considerations to see which second best reforms are most likely to be implemented. The focus should be on incentive compatible, self-enforcing policy mechanisms which usually imply greater market access and decentralized competition.
JEL classification: O10, O43, O53
I. INTRODUCTION
The rise of the new institutional economics has done much to revitalize thinking on the role of governance, structure, and policy in promoting or hindering economic development. In particular the work of Nobel laureates Douglass North on historical institutions, Ronald Coase on transactions costs, and Elinor Ostrom on local institutional arrangements have often been cited as core ideas inspiring modern ideas about policy in major development agencies. Earlier work on interest groups and social policy deriving from the work of Mancur Olson also helped to reshape modern policy. Institutions are increasingly cited as crucial to growth in mainstream neoclassical studies of development, most notably in the work of Acemoglu, Johnson, and Robinson (2001), and Rodrik, Subramanian, and Trebbi (2004).
But what have we really learned about institutions, and how do we reconcile this with the core lessons of neoclassical theory that should still serve as starting points for any discussion of underperforming economies and the quest to encourage growth?
This paper reviews some of the most salient ideas of the new institutional economics and discusses how these ideas can be interacted with more standard neoclassical concepts to serve as a baseline for framing policy. It argues that sensitivity to institutional and political economy concerns does not invalidate the core ideas of neoclassical theory but should change the way we analyze our options. It will then use...