Assume Anarchy

Institutions are all the rage. The absence of institutions—such as efficient and impartial judiciaries, legal systems to protect intellectual property, tax administrations that are efficient and free of corruption, and credible central banks—is offered as an explanation for some of the central puzzles in development economics, including why so many countries don’t grow fast enough to vanquish poverty. But, unfortunately, economic theory offers us little guidance on how strong institutions are created and nurtured. And, unless we develop a better understanding, simply reciting the mantra “institutions” offers little in the way of constructive policy advice to less developed countries, leaving the policy arena open to other, more dubious views. A tremendous amount of research is now being conducted on the provenance of institutions—including whether they are a proxy for deeper forces. But my focus here is on why mainstream economists have neglected this in the past. In particular, I want to ask how much blame for this neglect should be attached to the canonical model in economics: the complete markets model

Raghuram Rajan
Published in: Finance & Development
2004 Pages 65-57