Journal Issue


International Monetary Fund. External Relations Dept.
Published Date:
June 1986
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Oliver E. Williamson

The Economic Institutions of Capitalism

The Free Press, New York, 1985, xiv + 450 pp., $27.95.

We record and admire the artistic and engineering achievement of Chartres Cathedral or the pyramids. But the organizational efforts that have gone into them—coordinating the actions of many people, motivating them, and so on—go largely unrecorded and are forgotten. The Economic Institutions of Capitalism contributes to restoring a balance between our understanding of the role of technology and that of organization in the institutions of capitalism.

Williamson’s analysis, which draws on law, economics, and organization theory, is a sequel to his own justly famous Markets and Hierarchies. His approach emphasizes the need to economize in transaction costs; this need, Williamson believes, explains the institutions of capitalism. While the assumption of movement in a vacuum has proved useful in physics for some purposes, it would not do for the design of parachutes. Similarly, to assume the absence of transaction costs, quite common in neoclassical economics, is not useful for the analysis of a number of important capitalist institutions.

Markets, in which transactions are conducted at arm’s length, and firms, in which they are run by hierarchies according to bureaucratic rules, are alternative forms of organization. Williamson’s analysis helps to answer such questions as, why can’t a large firm do everything that a collection of small firms can do, and more? The answer is that there are bureaucratic constraints, and incentives are blunted (an employee of a large firm has not the same incentive to appraise the value of a traded-in car as a small, self-employed dealer), just as there are advantages in taking some transactions out of the market and subjecting them to bureaucratic control within a firm.

Transaction cost economics makes two crucial assumptions: first, that of bounded rationality and, second, that of opportunism. The first can be summed up in the noncontradictory proposition “it is perfectly rational not to be perfectly rational” (equating marginal utilities is itself subject to diminishing marginal utility); the second under the proposition that people are sometimes deviously self-seeking. People will not keep promises if it serves their purpose not to. The concept covers moral hazard and adverse selection, broadly interpreted. “Economize on bounded rationality and safeguard against opportunism!” provides a richer and more realistic invitation to explore transactions and institutions than “maximize profits!”

The other two building stones are asset specificity and fundamental transformation. If assets were not specific, the potential damage from bounded rationality and opportunism would be much smaller. The fundamental transformation is the changed competitive situation after the initial bargain has been struck; it can become a monopoly, even though initial bidding was competitive, because specific assets come to be owned or controlled by the winner in the competition. The problem presented by specificity of assets can be illustrated in this way: We have two options for an investment. We can build a machine that would produce at low cost if the anticipated output and sales materialize, but if they diverge from this, costs would rise steeply. Or we could build a machine that would produce the anticipated output at higher costs, but divergencies from it would show lower costs. There is a trade-off which is determined by uncertainty, bounded rationality, and opportunism.

There can be not only market failure and government bureaucratic failure but also private bureaucratic failure. The important dividing line is therefore not between the public and the private sector but between relatively small private firms, suited to internalize transactions, and what might be called (not by Williamson) the “institutions,” both the large private firms and the large public sector organizations.

The applications of transaction cost economics are manifold. This book discusses mainly the fields of industrial organization, labor economics, and the modern corporation, including multinationals. Other promising areas are comparative economic systems, business history, the study of the family and the household, and nongovernmental organizations.

Paul Streeten

W.W. Rostow

Eisenhower, Kennedy and Foreign Aid

University of Texas Press, Austin, TX, 1985, 342 pages, $30.

W.W. Rostow’s latest book is a somewhat confusing albeit generally stimulating effort. It wanders far afield from its purported subject: the attitudes and events leading to an initiative sponsored by Democratic Senator John F. Kennedy and Republican Senator John Sherman Cooper in 1958-59 calling for substantial US participation in a worldwide effort to promote economic development in India. Its thesis—that the last years of the Eisenhower Administration marked a turning point in US development assistance policy—remains unconvincingly substantiated.

The book is stimulating, however, in its broad-brush analysis of the US foreign aid debate in the 1950s and early 1960s. Rostow is at his best in documenting the important role he and his colleagues at MIT’s Center for International Studies played in fashioning an intellectual rationale for aid that emphasized its role in “the evolution of societies that are stable in the sense that they are capable of rapid change without violence.” Rostow also correctly identifies the underlying question asked of aid in the 1950s: What interest did the United States and the West have in the fate of the developing regions worth the allocation of scarce resources? The lack of a definitive answer to that question still has adverse consequences for the aid effort.

Certainly the answer was not apparent to many in Eisenhower’s first administration. Rostow presents an excellent glimpse of their views by quoting liberally from memoranda and letters. C.D. Jackson, an advisor to Eisenhower on foreign aid, summed up the state of affairs: “Neither the President nor the Secretary of State has evidenced, in public, anything but the most routine pressure on this subject—no new ideas, no new words, no drive.”

It is Rostow’s thesis that this log-jam broke in 1957. He attributes this to some key personnel changes and some dramatic developments in the external environment, notably the launching of Sputnik and Mao’s “Great Leap Forward.” Perhaps Rostow is correct: the Development Loan Fund, forerunner of the Agency for International Development was created in 1957; the International Development Association and the Inter-American Development Bank were born before the advent of the Kennedy Administration. I am not certain which is more telling, however: these institutional creations or Rostow’s judgment that “virtually none of this new enterprise was reflected in current US budgetary outlays or in the aid dispositions of the Congress.”

Rostow analyzes the Kennedy years from the vantage point of an insider at the State Department. Not surprisingly, Kennedy’s foreign aid policies get high marks, since they implemented to a great extent the ideas previously formulated by the author and his MIT team. New initiatives included the Alliance for Progress and the Peace Corps, and in the early 1960s US aid increased by about one third. Rostow does not sufficiently contrast this with the latter Eisenhower Administration, however, nor does he explore the possible linkages between foreign aid and military interventionism, in Vietnam and elsewhere.

Overall a worthwhile book that asks some extremely important questions. The biggest is whether development aid has contributed significantly to economic and social progress in developing countries. Those of us who would answer in the affirmative must nevertheless substantially agree with Rostow’s conclusion, that “any attempt to answer the question is inherently arbitrary, impressionistic, and personal.”

Robert L. Ayres

Jagdish N. Bhagwati

Essays in Development Economics

Edited by Gene Grossman

Volume 1: Wealth and Poverty

xii + 319 pp.

Volume 2: Dependence and Interdependence

xii + 396 pp.

The MIT Press, Cambridge, MA, USA, 1985, $37.50 each.

Development economics is on trial. Many of the axioms and premises of this subdiscipline, first expounded by its founding fathers in the 1950s and since accepted by most economists and followed by policy makers in many countries, have been undergoing a profound reappraisal. Economic planning, the role of the public sector, use of controls and subsidies, and a strategy of import substitution are progressively giving way to privatization, the recognition of the important role of incentives, market pricing, and export promotion. The experience and disenchantment with policies based on orthodox development economics, the striking success of a handful of countries that followed a different course, and the general revisionism in economic thinking that has taken place in the past decade help to explain this swing.

These volumes by Professor Bhagwati are most welcome for two reasons: he has been a major figure in development economics—and in international economics—since the time when the basic articles of faith of orthodox development economics were promulgated; yet he has always been eclectic and moderate in his approach, belonging to no particular ideological camp and, depending on the issue, at home with various intellectual factions. A third and equally important reason is that Bhagwati belongs to that rare species of economist who writes clearly, often with verve and humor.

These essays provide a rich menu: articles old and new, long and short, theoretical and policy-oriented (in particular with regard to the experience of the author’s native India). The reviewer, especially if limited by space (as in this case), faces a difficult task—how to do justice to some 42 essays, written over 25 years, and covering a wide spectrum of topics?

Volume 1 is divided into five parts. The first is on development theory and strategy, and the opening chapter, “What Have We Learnt?” is a masterly retrospective of the whole field. According to Bhagwati the lessons are many, to wit: the internal problems of LDCs were more complex than appreciated and “export pessimism” was unwarranted; economic success comes from taking risk and seizing opportunities (echoes of Schumpeter, not to mention modern neo-conservative writers); high investment rates are necessary but not sufficient for economic growth; sustained growth is a difficult process (a truth keenly appreciated by countries attempting to “grow out” of their debt problem); aid may often have served as a disincentive to domestic savings (although this in itself is not an argument against aid); the impact of growth on poverty is a slow and tenuous process; fears regarding the trade-off between consumption (including expenditures such as health and education) and investment were exaggerated; and the mistakes (of those who proffered policy advice based on the premises mentioned earlier) were rooted in idealism. The latter I found particularly intriguing: I don’t know whether it brings comfort to those countries that followed the advice of the mainstream development economists, sometimes with unfortunate consequences, but does it imply that the relatively few economists who recommended alternative (then unfashionable) strategies such as export promotion, market prices, and so on were less idealistic? I think not.

The second part, on economic structure, includes a very interesting paper on the splintering and disembodiment of services. The third part discusses, inter alia, the relationship between education, class structure, and income inequality, and includes an important article on the theory of transfers and welfare. Technology and employment is the subject of the fourth, and the volume is rounded off with sketches and commentary on three eminent development economists, Sir Arthur Lewis, Raul Prebisch, and Gunnar Myrdal.

Volume 2 is in four parts. Professor Bhagwati has perhaps written more than any other major economist on North-South issues—including his contribution to the September 1983 issue of this journal—and these form the subject matter of the first part. For whatever reason, one no longer hears very much about the “New International Economic Order.” However, in the wake of the first oil price shock of 1973–74 this topic excited considerable international interest and debate, although in the end few (if any) of the specific proposals that were to constitute the new order were implemented. This section contains a good historical review.

Trade policy and development, specifically import substitution versus export promotion as a development strategy, is covered in the second section. The inward-looking strategies, born out of the export pessimism of the 1950s, had harmful effects in a number of countries and these strategies, though they still attract a small band of faithful adherents, have been generally discarded. Bhagwati, who is clearly of the export promotion school, examines many aspects of this subject and offers an excellent review of the issues. Some of the work was done under the aegis of the National Bureau of Economic Research and in conjunction with Anne Krueger, to whom this volume is dedicated.

The effectiveness of foreign economic assistance has been and continues to be a controversial issue. Bhagwati, sensibly, takes a position between those who would dismiss foreign aid out of hand and those who would maintain that aid can only help. As the special section in the March issue of this journal showed, the question is a complex one and while improvements are possible, the overall effect of aid has been positive.

The fourth part, on international migration and investment, is, for this reader, less convincing than the remainder of the two volumes, though Bhagwati brings incisive reasoning and analysis to the subject. People have always moved, except where physically prevented, in search of better opportunities for life, liberty, and the pursuit of income and happiness. The phenomenon is neither new nor limited to the developed country-developing country axis, even if immigration laws are now more discretionary. So why all the attention, all the exotic proposals (e.g., a “brain drain” tax)? Parenthetically, the economics profession must be grateful that Jagdish Bhagwati himself succumbed to the brain drain! More pertinent is Bhagwati’s discussion of the freedom of private investment flows, which is germane to the prospective new round of GATT negotiations as well as to efforts to help prevent future external debt crises.

All in all an impressive collection of essays, by a major creative economist, and of interest to both the professional economist and—perhaps especially—the intelligent policy maker.

Bahram Nowzad

Gary Clyde Hufbauer and Jeffrey J. Schott

Economic Sanctions Reconsidered

History and Current Policy

Institute for International Economics, Washington, DC, 1985, xvi + 753 pp, $35 (cloth).

M.S. Daoudi and M.S. Dajani

Economic Diplomacy

Embargo Leverage and World Politics

Westview Press, Boulder, CO, USA, 1985, xiii + 258 pp., $30 (cloth).

These books are useful contributions to a study of the techniques and implications of economic diplomacy and economic warfare, which lend an added dimension to the Clausewitzian dictum of war as a continuation of politics by other means.

The authors of Economic Sanctions Reconsidered have analyzed 103 cases of sanctions, from those imposed in 1914 (against Germany) to recent major episodes, such as the grain embargo and the Soviet gas pipeline. It is possibly the first systematic attempt to estimate the cost of sanctions to both the target and the “sending country”—a rather quaint description for the country imposing the sanctions. The analytical framework includes both qualitative and quantitative techniques, the latter based on multiple regression analysis, relating the case success scores to all the variables simultaneously. The political variables include companion policies to economic sanctions, the extent of international cooperation in imposing sanctions, international assistance from other sources to the target country, the length of sanctions, and the political stability of the target country. The economic variables include the respective economic size of the countries measured by the ratio of the GNP levels of the sender and target country, commercial relations between sender and target countries, and costs imposed on the sender and target. The multiple regressions are apt to convey a misleading sense of accuracy in a complex field where unique qualitative influences tend to override the quantifiable factors. The authors might have also resorted to some form of discriminant analysis in tandem with regression analysis.

The authors conclude that in most cases sanctions do not contribute very much to the achievement of foreign policy goals, and that success has proven more elusive in recent years (1973–84) than in the previous period. Finally, they offer nine commandments to concerned statesmen, which begin and end with some very homely aphorisms ranging from “Don’t bite off more than you can chew” to “Look before you leap.” Neither the conclusions nor the exhortations are of a counter-intuitive character. The scholarly apparatus, however, is indeed impressive to the extent that the main text of 92 pages is weighed down by massive statistical, historical, and methodological appendices running over 600 pages—a rare species of an unusually fattailed intellectual sheep. Possibly the very nature of the subject matter warranted such an unusual layout. Altogether, the book’s value will be chiefly as a source of reference on a perennially controversial theme.

Daoudi and Dajani’s book is by contrast a trenchant essay in the international political economy of commodity power. It examines the uses of economic resources and raw materials as political leverage in international affairs by investigating the power of one specific resource—oil—which also happens to be the single most important commodity in world trade. The authors analyze the Arab oil producing nations’ use of oil to influence the foreign policy of a number of major Western nations. It is a multivariate analysis of the “oil weapon” in historical, political, and cultural contexts focusing on three major episodes: the 1956 Suez Crisis, the 1967 Arab oil embargo; and the 1973–74 oil embargo. The book examines the scope and limits of economic diplomacy as a substitute for force in achieving political goals. One main conclusion is that “although an oil exporter’s economy may depend on the commodity it uses as political leverage, in cases where the conflict is perceived as having assumed crisis proportions and where emotional traumas affect masses of people, the sender’s need to score political points will outweigh economic considerations.” The book is a realistic appraisal which pulls no punches. It explicitly presents points of view that are only inferred in the Hufbauer-Schott book. As such the two neatly complement each other.

Anand G. Chandavarkar

Iftikhar Ahmed (editor)

Technology and Rural Women Conceptual and Empirical Issues

George Allen and Unwin, London, 1985, xvi + 383 pp., £18.50.

This useful survey synthesizes the fragmented empirical evidence on, and the wide range of theoretical approaches to, the effects of modernization on women in developing countries. The authors find that the imperfections of rural factor markets have contributed to a concentration of women in labor-intensive sectors marked by low productivity and low returns. It begins with a conceptual overview and analyzes the applicability of traditional theories of technological change and its impact on gender-based distributional questions. African and Asian experiences are compared and the African situation is examined regionally and in a set of country case studies.

These overviews and studies produce some interesting findings and conclusions, although others tend to be belabored. The more interesting ones relate to the complexity of the labor process and to the mechanisms and causes of female labor displacement. The impact of technological change on the welfare of rural women, for instance, is hard to predict, for reasons such as the involvement of both men and women in different aspects of some production processes. Palm fruit, for instance, is grown and provided by men, but processed by women; it is not clear what the women’s value-added in the process is, and therefore on what basis their share of rewards might increase or decrease with technological innovations. Similarly, because of the interrelationship between tasks undertaken by different members of the household (e.g., in the provision of water), a rural woman’s disposition of time may or may not improve as a result of a technological innovation (she would not gain any time, for example, if other household members withdraw help normally extended for water collection). As to female labor displacement the principal causes of a male “take-over” seem to be the mechanization or commercialization of any activity or sector previously using female labor (whether wage or non-wage, in the case of mechanization).

Less interesting are some of the book’s seemingly self-evident findings: for instance, that gender hierarchy has both a production and a distribution component (like the traditional macroeconomic theories of technological change) and that technological change is not therefore indifferent to gender, any more than it is indifferent to class. Similarly, does it need emphasizing that some forms of innovation will not be adopted if they conflict with social mores (e.g., an innovation that requires the woman to leave the compound will not be adopted where female seclusion is the norm)? Perhaps it does!

The important gap in this collection is a discussion of the criteria needed to evaluate the impact of technological change on rural women’s welfare. In places it is considered “bad” that women have to work more, in others, equally “bad” that they have to work less. It is not just a question of income, either. Women, it is argued, could become worse off by earning more, because the male provider might react by earning less. This is certainly not an easy set of issues to grapple with, as it goes to the heart of the mechanization debate, but it does need to be tackled in a work of this sort. All in all, a useful collection of overviews and insights, but not terribly interesting to someone not already concerned with the role of women in the development process.

Ann Duncan

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