The New Comparative Economics Simeon Djankov, Edward L. Glaeser, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer NBER Working Paper No. 9608 April 2003 JEL No. H1, K1, P1, P14, P16, P37, P5, P51 Abstract: In recent years, comparative economics has experienced a revival, with a new focus on comparing capitalist economies. The theme of the new research is that institutions exert a profound influence on economic development. We argue that, to understand capitalist institutions, one needs to understand the basic tradeoff between the costs of disorder and those of dictatorship. We then apply this logic to study the structure of efficient institutions, the consequences of colonial transplantation, and the politics of institutional choice. The traditional field of comparative economics deals mostly with the comparison of socialism and capitalism. Under socialism, the principal mechanism of resource allocation is central planning. Under capitalism, this mechanism is the market. Comparative economics, which dates back at least to the discussions of market socialism in the 1930s, asks under what circumstances either the plan or the market delivers greater economic efficiency and equality. By the time socialism collapsed in Eastern Europe and the Soviet Union, this question lost much of its appeal. It was clear that socialism produced misery and inefficiency – not to mention mass murder by the communist dictators who practiced it. Capitalism, in contrast, produced growth and wealth. With capitalism triumphant, is comparative economics dead? The answer, we argue in this paper, is NO. Traditional comparative economics has evolved into a new field. This field shares with its predecessor the notion that by comparing alternative economic systems, we can understand better what makes each of them work. But it sees the key comparisons as being those of alternative capitalist models that prevail in different countries. Each capitalist economy has many public and private institutions. These institutions function to choose political leaders, to secure property rights, to redistribute wealth, to resolve disputes, to govern firms, to allocate credit, and so on. Political economy over the last two centuries, as well as recent empirical research, demonstrate that these institutions differ tremendously and systematically among countries, with significant consequences for economic performance. The analysis of these differences is the subject of the new comparative economics. In thinking about these issues, it is best to start from first principles. Since the days of the Enlightenment, economists agreed that good economic institutions must secure property rights, enabling people to keep the returns on their investment, make contracts, and resolve disputes. Such security encourages people to invest in themselves and in physical capital, and thereby fosters economic growth. As Smith wrote, “in all countries where there is tolerable security [of property], every man of common understanding will endeavor to employ whatever [capital] stock he can command... In those unfortunate countriesThe New Comparative Economics Simeon Djankov, Edward L. Glaeser, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer NBER Working Paper No. 9608 April 2003 JEL No. H1, K1, P1, P14, P16, P37, P5, P51 Abstract: In recent years, comparative economics has experienced a revival, with a new focus on comparing capitalist economies. The theme of the new research is that institutions exert a profound influence on economic development. We argue that, to understand capitalist institutions, one needs to understand the basic tradeoff between the costs of disorder and those of dictatorship. We then apply this logic to study the structure of efficient institutions, the consequences of colonial transplantation, and the politics of institutional choice. The traditional field of comparative economics deals mostly with the comparison of socialism and capitalism. Under socialism, the principal mechanism of resource allocation is central planning. Under capitalism, this mechanism is the market. Comparative economics, which dates back at least to the discussions of market socialism in the 1930s, asks under what circumstances either the plan or the market delivers greater economic efficiency and equality. By the time socialism collapsed in Eastern Europe and the Soviet Union, this question lost much of its appeal. It was clear that socialism produced misery and inefficiency – not to mention mass murder by the communist dictators who practiced it. Capitalism, in contrast, produced growth and wealth. With capitalism triumphant, is comparative economics dead? The answer, we argue in this paper, is NO. Traditional comparative economics has evolved into a new field. This field shares with its predecessor the notion that by comparing alternative economic systems, we can understand better what makes each of them work. But it sees the key comparisons as being those of alternative capitalist models that prevail in different countries. Each capitalist economy has many public and private institutions. These institutions function to choose political leaders, to secure property rights, to redistribute wealth, to resolve disputes, to govern firms, to allocate credit, and so on. Political economy over the last two centuries, as well as recent empirical research, demonstrate that these institutions differ tremendously and systematically among countries, with significant consequences for economic performance. The analysis of these differences is the subject of the new comparative economics. In thinking about these issues, it is best to start from first principles. Since the days of the Enlightenment, economists agreed that good economic institutions must secure property rights, enabling people to keep the returns on their investment, make contracts, and resolve disputes. Such security encourages people to invest in themselves and in physical capital, and thereby fosters economic growth. As Smith wrote, “in all countries where there is tolerable security [of property], every man of common understanding will endeavor to employ whatever [capital] stock he can command... In those unfortunate countries