Section
3: Achieving a Natural Advantage of Nations
Those
who believe that the market on its own is the
most efficient way to allocate scarce resources
would disagree with many of the previous suggested
government measures. Giving free reign to the
invisible hand of the market, they argue, is the
best way to ensure the most desirable outcomes
for society as a whole. In Section 1, and again
in the introduction to Section 3, it was stated
that over the last 30 years a far more sophisticated
understanding of the market has developed that
allows us clarity to see when markets may fail
and when it may be beneficial for governments
to act.
As communities we have a range of goals, one of
which is protecting the health of the natural
ecosystems on which we depend. As neither our
resources nor our lives are infinite, not all
goals can be fully realized and somehow we have
to make choices about what to do. In this context,
efficiency matters precisely because we are interested
in realizing as many of our goals as possible.
Hence, the strong call for markets to be efficient.
Governments and their detractors have often suggested
that the state should not intervene in markets
for this very reason. They claim that free markets
allocate resources in the most efficient way possible
and interference would only make matters worse.
Is this really the case? Before we can answer
this important question, we need to understand
two main concepts: first what is a market?, and
second how do economists define efficiency?
Dr
Stephen Dovers, Senior Fellow at
theCentre
for Resources and Environmental Studies,
Australian National University.
Institutions
can be either significant allies or obstacles
to achieving sustainability and understanding
the issues and challenges for institutions in
addressing sustainability is critical to assist
nations achieve genuine progress. We invited Dr
Dovers, a world renowned expert in institutions
and sustainability, to provide an overview of
how nstitutions are tackling sustainability issues.
Markets
and efficiency
Many
years ago the economist Keynes wrote:
"The
ideas of economists and political philosophers,
both when they are right and when they are wrong,
are more powerful than is commonly understood. Indeed,
the world is ruled by little else. Practical men,
who believe themselves quite exempt from any intellectual
influences, are usually the slaves of some defunct
economist. Madmen in authority, who hear voices
in the air, are distilling their frenzy from some
academic scribbler of a few years back". Keynes
[1936].
This
chapter provides an introduction to the important
work of the 2001 Nobel Laureates in Economics: George
A. Ackerlof, A. Michael Spence, and Joseph E. Stiglitz,
for their analyses of markets with asymmetric information.
View
Website
In
his Nobel Prize Lecture, Joseph Stiglitz states:
"The
research for which George Akerlof, Mike Spence,
and I are being recognized is part of a larger research
program which, today, embraces hundred, perhaps
thousands, of researchers around the world. In this
lecture, I want to set the particular work which
was sited within this broader agenda, and that agenda
within the broader perspective of the history of
economic thought. I hope to show that Information
Economics represents a fundamental change in the
prevailing paradigm within economics. Problems of
information are central to understanding not only
market economics but also political economy, and
in the last section of this lecture, I explore some
of the implications of information imperfections
for political processes."
"Many
of the major political debates over the past two
decades have centered around one key issue: the
efficiency of the market economy, and the appropriate
relationship between the market and the government.
The argument of Adam Smith [1776], the founder of
modern economics, that free markets led to efficient
outcomes, 'as if by an invisible hand' has played
a central role in these debates: it suggested that
we could, by and large, rely on markets without
government intervention. There was, at best, a limited
role for government. The set of ideas that I will
present here undermined Smith's theory and the view
of government that rested on it. They have suggested
that the reason that the hand may be invisible is
that it is simply not there - or at least that if
is there, it is palsied."
From
Joseph Stiglitz's Nobel Prize Lecture
View
Lecture Transcript
Michael
Spence's Nobel Prize Lecture
View
Lecture Transcript
George
Akerlof's Nobel Prize Lecture
View
Lecture Transcript
Key
references of their work include:
For
a seminal model of the market for insurance under
conditions of imperfect information see;
Rothschild,
M. and Stiglitz, J. (1976) 'Equilibrium in competitive
insurance markets: an essay on the economics of
imperfect information', Quarterly Journal of Economics,
90(4).
Shapiro,
C. and Stiglitz, J. (1984) 'Equilibrium Unemployment
as a Worker Discipline Device', American Economic
Review, 74(3).
Greenwald,
B. and Stiglitz, J. (1986) 'Externalities in Economies
with Imperfect Information and Incomplete Markets',
Quarterly Journal of Economics, 101(2).
Historical
Perspective on the debate over the role of Market
and State
To
understand the significance of their work one needs
to understand the history of the debate over the role
of market and state. For an introduction to this debate
seethe PBS website Commanding Heights : the Battle
for the Global Economy.
View
website
Significant
Developments in Economics
For
further information on the individuals and the key
breakthroughs in economics fromthe last 40 years,
see the following web sites on Nobel Prizes in Economics
from 1969-2004
View
web site #1
View
web site #2
Institutions
and the Market
Building
Institutions for Markets: World Bank Development Report
2002
"Effective
institutions can make the difference in the success
of market reforms. Without land-titling institutions
that ensure property rights, poor people are unable
to use valuable assets for investment and income growth.
Without strong judicial institutions that enforce
contracts, entrepreneurs find many business activities
too risky. Without effective corporate governance
institutions that check managers' behaviour, firms
waste the resources of stakeholders. And weak institutions
hurt the poor especially. For example, estimates show
that corruption can cost the poor three times as much
as it does the wealthy."
World
Bank (2002), 'Building Institutions for Markets',
World
Development Report, 2002.
View
PDF | View
Website
Institutions
for Sustainability
Dovers,
S. 2001. Institutions for Sustainability. Tela paper
7. Melbourne : Australian Conservation Foundation.
This paper discusses the institutional arrangements
that help or hinder the pursuit of an ecologically
sustainable and humanly desirable society.
Download
PDF | View
Website
National
Councils for Sustainable Development (NSCDs)
Agenda
21, together with numerous other statements, also
argues that furthering the sustainable development
agenda will require ongoing collaboration between
governments, the private sector and community organisations
(civil society), in the development and implementation
of national policy that integrates ecological, social
and economic dimensions over the long term. NCSDs
are promoted as a core element of such an approach,
for particular purposes and at a particular scale.
View
website
References
from the Book
1
Named after the economist Vilfredo Pareto (1848-1923),
who made several important contributions to economics,
especially in the study of income distribution and
in the analysis of individuals' choices.
2
Smith, A. (1999) An Inquiry into the Nature and Causes
of the Wealth of Nations, Penguin, London
,
Book I, Ch vii.
3
Ibid (Book V, Ch i).
4
Arrow, K. and Debreu, G. (1954) 'Existence of an Equilibrium
for a Competitive Economy', Econometrica, vol 22,
no 3, pp265-290.
5
Indeed, the conditions are arguably inconsistent:
the more we narrow the definition of a particular
good, the less likely is competition.
6
For a seminal model of the market for insurance under
conditions of imperfect information see Rothschild,
M. and Stiglitz, J. (1976) 'Equilibrium in Competitive
Insurance Markets: An Essay on the Economics of Imperfect
Information', Quarterly Journal of Economics, vol
90, no 4.
7
Shapiro, C. and Stiglitz, J. (1984) 'Equilibrium Unemployment
as a Worker Discipline Device', American Economic
Review, vol 74, no 3.
8
In fact, informational imperfections form one of the
principal reasons that the completeness and competitiveness
requirements of the First Fundamental Theorem do not
hold in real-world economies. We noted above that
completeness requires a complete set of 'risk markets',
yet the informational asymmetries outlined above mean
that many insurance markets are fragile and prone
to collapse. Similarly, perfect competition requires
that there is no 'price dispersal': a can of tomatoes
in South
Sydney
on a Tuesday night should cost the same in every shop.
But searching the city to find the lowest price for
a tin of tomatoes is time-consuming. Some firms capitalize
on this by raising prices and marketing to those customers
who are 'money-rich and time-poor', whilst others
sell themselves as 'no frills' shops. The cost of
obtaining information about prices means that these
prices are dispersed and competition is imperfect.
9
Greenwald, B. and Stiglitz, J. (1986) 'Externalities
in Economies with Imperfect Information and Incomplete
Markets', Quarterly Journal of Economics, vol 101,
no 2.
10
In a democracy, the electoral process confers (some
degree of) legitimacy upon the government. This in
turn enables governments to exercise their power of
compulsion: the state, unlike private institutions
or individuals, can compel all of its citizens to
adhere to its laws, pay it money, and so on. Such
compulsion, legitimately exercised, is one of the
principal strengths of the government; unlike trades
in the private sector, which are conducted only if
they are mutually beneficial, the power of coercion
relieves the state of the need to make everybody better
off all of the time.
11
For a more detailed discussion of the roles and regulation
of capital markets, see Stiglitz, J. (1994) Whither
Socialism?, MIT Press, Cambridge
MA
,
Ch 12.
12
An early seminal paper on credit and asymmetric information:
Stiglitz, J. and Weiss, A. (1981) 'Credit Rationing
in Markets with Imperfect Information', American Economic
Review, vol 71. The model in this paper predicts that
interest rates may not necessarily adjust to equalize
the supply and demand for bank loans, explaining the
'credit rationing' observed in real world economies,
but which classical theories of the interest rate
cannot explain.
13
For example, suppose I expect that the Thai baht is
going to depreciate in the near future, then, as a
speculator, I can sell my baht today and buy it back
more cheaply after the depreciation. If I buy and
sell in very large quantities I can make a very large
amount of money.
14
For a very readable account of the pressures applied
to developing countries, see Stiglitz, J. (2002) Globalization
and its Discontents, Allen
Lane ,
London
,
Ch 3.
15
For a statistical study of the relationship between
capital market liberalization and economic performance,
see Rodrik, D. (1998) 'Who Needs Capital Account Convertibility?',
paper prepared for the 1998 Princeton International
Finance Section Symposium. Rodrik investigates the
relationship between a country's capital account regime
and economic performance using data from nearly 100
countries over the period 1975-1989, finding no evidence
that countries without capital controls grow faster,
invest more or experience lower inflation.
16
For a more detailed account of the Asian crisis and
how Malaysia and China were able to weather the crisis
whilst other economies in the region floundered, see
Wade, R. (2000) Governing the Market a Decade Later,
London School of Economics Development Studies Institute
Working Paper No 00-03, London School of Economics,
London.
17
Suggestions for further reading: one of the best technical
papers on the causes of the Asian crisis is Corbett,
J. and Vines, D. (1999) 'The Asian Crisis: Lessons
from the Collapse of Financial Systems, Exchange Rates
and Macroeconomic Policy', in Agenor, P., Miller,
M., Vines, D. and Weber, A. (eds) The Asian Financial
Crisis: Causes, Contagion and Consequences, Cambridge
University Press, Cambridge. For a more detailed examination
of the issues introduced in this chapter, see Stiglitz,
J. (1999) Must Currency Crises be this Frequent and
this Painful? In Agenor, P., Miller, D., Vines and
Weber, A. (eds) The Asian Financial Crisis: Causes,
Contagion and Consequences, Cambridge University Press,
Cambridge
.
18
Gittens, R. (2003) 'The Humbled Fund has had to Rethink
its Operations', Sydney Morning Herald 29 March and
'The International Monetary Fund does a www - we were
wrong', The Age 29 March.
19
IMF response to criticism on the issue of its handling
of the Asian economic crisis is as follows: 'When
the IMF was created in 1944, its founders envisioned
a world in which trade was free but in which the restrictions
on movement of capital across countries then in place
were to be retained. In the jargon, current accounts
were to be open, but capital accounts highly regulated.
Capital account restrictions were considered necessary
to support the "Bretton Woods system", the system
of fixed exchange rates then in place. There is no
denying the vision of the world being promoted by
the IMF in the mid-1990s was different. At the 1997
IMF-World Bank meetings the proposal on the table
was to amend the IMF's articles of agreement to give
it jurisdiction over the liberalization of capital
movements. But while the popular characterization
of a greater push toward capital account liberalization
is broadly correct, it is inaccurate in many important
details. The IMF did not encourage countries to liberalize
short-term flows through the banking sector, which
is what turned out to be the Achilles Heel during
the Asian crisis'.
20
Prasad, E., Rogoff, K. , Wei, S.-J. and Kose, M.A.
(2003) Effects of Financial Globalization on Developing
Countries: Some Empirical Evidence, 17 March, International
Monetary Fund, Washington
,
DC
.
21
Dawson, T. (2002) The IMF's Role in Asia
:
Part of the Problem or Part of the Solution?, prepared
remarks for the Institute
of Policy
Studies
and Singapore Management University Forum, Singapore
,
10 July.
22
Braithwaite, J. and Drahos, P. (2000) Global Business
Regulation, Cambridge University Press, Cambridge
,
p704. Professor John Braithwaite and Professor Peter
Drahos have been awarded the Grawemeyer Award For
Ideas Improving World Order. This award is presented
annually to the winner of a competition designed to
stimulate the recognition, dissemination and critical
analysis of outstanding proposals for improving world
order.
23
Ibid.
24
Ibid.
25
World Bank (2003) World Bank Development Report 2003:
Sustainable Development in a Dynamic World, Oxford
University Press, Oxford, Ch 1, p3.
26
Dovers, S. (1997) 'Sustainability: Demands on Policy',
Journal of Public Policy vol 16, pp303-318.
27
Commonwealth of Australia
(1992) National Strategy for Ecologically Sustainable
Development, Australian Government Publishing Service,
Canberra
.
28
Stein, J. P. (2000) 'Are Decision Makers too Cautious
with the Precautionary Principle?', Environmental
and Planning Law Journal, vol 17, pp3-24; Dovers,
S. (2002) 'Sustainability: Reviewing Australia's Progress',
International Journal of Environmental Studies, vol
59, pp559-571.
29
Connor, R. and Dovers, S. (2004) Institutional Change
for Sustainable Development, Edward Elgar, Cheltenham
.
30
Goodin, R. (1996) 'Institutions and Their Design',
in Goodin, R. (ed) The Theory of Institutional Design,
Cambridge University Press, Cambridge
.
31
Dovers, S. (2001) Institutions and Sustainability,
ACF Tela Paper 7, Australian Conservation Foundation,
Melbourne
.
32
This is a central and contested proposal in the sustainability
literature, i.e. that environmental protection depends
on economic growth. Here, the issue is not belief
or disbelief in this proposal, but rather policy and
institutional settings aimed at either establishing
such a link in practice, or further testing the proposition.
33
Connor, R. and Dovers, S. (2004) Institutional Change
for Sustainable Development, Edward Elgar, Cheltenham
.
34
For example, local and state government coordinated
action on a widely dispersed but nodal economic activity
with particular environmental or social implications.
35
This is illustrative and far from a comprehensive
listing of either sustainability principles or options.
36
Note that it is argued by some that such reorganization
is unnecessary in local government, given the small
size and thus non-fragmentary nature of local councils.
37
Dovers, S. and Wild
River
,
S. (eds) (2003) Managing Australia's Environment,
Federation Press, Sydney. This study, and the one
reported in Connor and Dovers (see below), were funded
by Land
&
Water
Australia
,
and R&D agency of the Australian Government.
38
Connor, R. and Dovers, S. (2004) Institutional Change
for Sustainable Development, Edward Elgar, Cheltenham
.
39
Drawing on this idea from North, D. (1993) 'Institutions
and Credible Commitment', The American Economic Review,
vol 84, pp359-368.
40
Filmer, D. (2000) The Structure of Social Disparities
in Education: Gender and Wealth, World Bank Research
Policy Working Paper 2268, World Bank, Washington
,
DC
.
41
The following piece summarizes an analysis of NCSDs
more fully reported in Connor, R. and Dovers, S. (2004)
Institutional Change for Sustainable Development,
Edward Elgar, Cheltenham, Ch 5.
42
United Nations (1992) Agenda 21: The UN Programme
of Action from Rio
,
United Nations, New
York ,
Chs 8, 27, 30.
43
This draws on d'Evie, F. and Beeler, B. (eds) (2002)
Integrating Global Environmental Conventions at National
and Local Levels: NCSD Report 2001, Earth Council,
San Jose, Costa Rica; d'Evie, F., MacDonald, M., Mata,
R. and Rodriguez, R. (eds) (2000) National Experiences
of Integrative, Multi-Stakeholder Processes for Sustainable
Development: NCSD Report 2000, Earth Council, San
Jose, Costa Rica.
44
Boyer, B. (2000) 'Institutional Mechanisms for Sustainable
Development: A Look at National Councils for Sustainable
Development in Asia
',
Global Environmental Change, vol 10, pp157-160.
45
For basic descriptive material, see d'Evie, F., MacDonald,
M., Mata, R. and Rodriguez, R. (eds) (2000) National
Experiences of Integrative, Multi-Stakeholder Processes
for Sustainable Development: NCSD Report 2000, Earth
Council, San Jose, Costa Rica; d'Evie, F. and Beeler,
B. (eds) (2002) Integrating Global Environmental Conventions
at National and Local Levels: NCSD Report 2001, Earth
Council, San Jose, Costa Rica.
46
d'Evie, F., MacDonald, M., Mata, R. and Rodriguez,
R. (eds) (2000) National Experiences of Integrative,
Multi-Stakeholder Processes for Sustainable Development:
NCSD Report 2000, Earth Council, San Jose, Costa Rica.
47
Basic information and a range of the Council's submissions
to governments are available in English on the website
for the Belgian Federal Council for Sustainable Development.
48
Doering, R. (1993) Canadian Round Tables on the Environment
and the Economy: Their History, Form and Function,
Working Paper 14, National Round Table on the Environment
and the Economy (NRTEE), Ottawa
.
49
NRTEE (2001) National Round Table on the Environment
and the Economy Annual Report 2000-2001, NRTEE, Ottawa
.
50
Information can be found on the website for the UK
Sustainable Development Commission.
51
d'Evie, F. and Beeler, B. (eds) (2002) Integrating
Global Environmental Conventions at National and Local
Levels: NCSD Report 2001, Earth Council, San
Jose ,
Costa
Rica
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