Capitalism, Institutions, and Economic Development

Published by EH.NET (October 2010)

Michael G. Heller, Capitalism, Institutions, and Economic Development. New York: Routledge, 2009. xx + 312 pp. $130 (hardcover), ISBN: 978-0-415-48259-2.

Reviewed for EH.NET by Brandon Dupont, Department of Economics, Western Washington University.

In Capitalism, Institutions, and Economic Development, Michael Heller draws on a variety of classic works in economics and sociology — Max Weber’s work most frequently — to explain institutional change during contemporary capitalist transitions. Heller spends much of the book outlining the theoretical aspects of capitalist transition but also focuses on the policy relevance of these ideas.

Throughout the book, Heller attempts to dispel the notion that developing countries must follow a long and tortuous path to economic and institutional maturity. He reaches this position primarily because he views capitalism as being of only a single form; as a result, there is no need for separate evolutionary paths to be followed in different countries to solve each country’s particular needs. Heller argues throughout that the prevailing incrementalist approaches to institution-building in developing economies are flawed; instead, he proposes what may be considered shortcuts to institution-building on the route to capitalism.

In the first chapter, Heller draws on Weber?s Economy and Society (1978) to discuss the foundations for a theory of “subsystem interactions” in capitalist economies. The complexity of institutional arrangements is clear in this description of the simultaneous effects that lead to institutional integration. The goal is easy enough to describe — it is to reduce uncertainty (or, achieve relative certainty) about organizational or regulatory procedures. Every subsystem has the responsibility of promoting and monitoring the procedural norms of each of the other subsystems.? When innovations occur in one area, the way in which other areas react and adapt determines the success of that innovation.

Precapitalist societies lack the impersonal regulation of the state, an important feature of capitalist economies, even though many have the facade of the impersonal state, particularly through corporate-government alliances as described in Heller’s second chapter. In precapitalist societies, actual decisions are more often made below the surface using ad hoc informal channels according to various personal loyalties which encourage rent seeking and, importantly, all this occurs in the absence of the countervailing powers of true capitalist institutions. Generalized trust is more effective than personal trust as economies mature and transition. The notion of generalized rather than personal trust is not fully incorporated into precapitalist societies and this can impede the transition to capitalism. These kinds of impersonal governing principles are critical in every society because they create a regularity of action and reduce uncertainty.

Heller draws on Max Weber’s scholarship to argue in favor of a limited (what he calls “parametric”) state that is unimpeded by direct pressure from various interest groups and is thus more responsive to citizens. This parametric state leaves “most market decisions to enterprises … resource allocation is mainly by means of the price mechanism … [and the ideal state?s function is to] design and enforce universal rules for the safe and proper structure and conduct of competitive economic action” (p. 43). While the theoretical descriptions are clear, Heller seems to fall short in his explanation of relevant policy for contemporary transitions. Which market decisions should be left to enterprise? What, if any, resource allocation should not be left to the price mechanism? Those questions are, unfortunately, left unexplored.

In the chapter on “The Modern State,” Heller provides the reader with a thorough description of Weber’s views on the legitimate functions of the state, primarily that of legal regulation. This is a nice overview of Weberian theory, including an interesting review of the implications of the theory for the capture of the policy process by “negative interests,” which is linked to the size of the state or to the number of functions it attempts to perform. Heller emphasizes the importance of sequence in the transition and explains the risks associated with democratizing before market freedom, rule of law, and impersonal public administration have fully developed.

The most interesting chapter in the book is on “Law and Economy,” in which Heller argues that since communitarian ethics are abandoned as the transition from closed to open markets occurs, a switch to the law as the ultimate source of trust is important. Weber, as Heller describes, envisioned an ethical transformation that includes both the destruction of ethics that subordinate economic exchange to social approbation by status, kinship, ritual, etc. and the ethic that legitimizes cheating in exchange with people outside the community. Heller includes a clear description of how, at least in Weber’s theory, the ethical principles of fair dealing in exchange are preserved and extended and eventually become broader general social norms of behavior.

The process Weber described, and Heller adopts, is the transition from custom to convention and finally to formal law as society moves from the interpersonal market ethics of precapitalism to formal state enforcement of impersonal rights. With respect to contemporary capitalist transitions, Heller argues that global technological, economic, or political developments may prompt the selection of capitalist norms. While this is consistent with Weber’s hypothesis that normative changes may happen by innovation, it is not clear how or why particularly useful norms of behavior would be “selected” or under what conditions innovation might reasonably be expected to do this.

Heller advocates establishing effective legal frameworks for regulating private business before (or during) market liberalization but notes that historically the reverse has often occurred. He writes that, “Like the ethical norms that precede them, legal mechanisms for the adequate regulation of economic action almost always follow from the expansion of markets” (p. 100).? In a significant departure from the approach generally taken by the World Bank and other international agencies, Heller argues that modern policymakers have erred in attempting to create regulatory order prior to sufficient market liberalization. This contrast is clear when one considers Joseph Stiglitz’s (2000) argument that, It has become increasingly clear that financial and capital market liberalization — done hurriedly, without first putting into place an effect regulatory framework — was at the core of the problem.

In the fourth chapter, Heller describes his framework, which is based more on Schumpeter than Weber, for understanding the often discontinuous process of institutional change during the transition to capitalism. While Schumpeter’s work dealt with entrepreneurial innovation, Heller applies his framework to institutional change during transition as an alternative to incrementalism. In this chapter, Heller provides a typology of four forces of institutional change which he hopes might be harnessed for better economic development strategies. The four forces are: (1) routine equilibrium change, which is the very gradual aggregation of many smaller unorganized changes that slowly and incrementally modify the institutional system; (2) external disequilibrium change, which is the result of discontinuous pressures that originate outside the economy but that reshape the environment in which transition occurs; (3) internal disequilibrium change, which is due to policy innovations in the domestic economy and is the main mechanism for transition; and (4) routine disequilibrium change, which refers to the “continual discontinuity” of institutional change in most capitalist societies. Heller argues in favor of bringing Schumpeterian ideas about disequilibrium endogenous and exogenous institutional changes into the discussion rather than focusing on the “do institutions grow or are they made” question that dominates that discussion. While Heller agrees with Hayek that market order is spontaneous, he tempers this view by drawing on Buchanan?’ (2001) argument that “deliberate design or reform of a legal or constitutional framework is required.” Spontaneous evolution of institutions is not necessarily efficient in the same way that unimpeded markets are in Heller’s view. The rest of this chapter applies the Schumpeterian “institutional progress by entrepreneurial leadership” model to policy in transition. The motives for institutional policy innovations are more complex than the economic motive of profit but are fundamentally still driven by self-interest; specifically, the pursuit of power, status, prestige and public approval.

In the fifth chapter, “Carriers of Change,” Heller asks how knowledge and sequences of institutional change are created and how citizens and leaders can be persuaded to take the capitalist path. As Heller aptly notes, “Capitalism produces almost everything, but not the human feeling that could guarantee its survival” (p. 170). Democracy and free markets are more likely to succeed in contemporary transition when the goal is to change institutional procedural norms, which might be viewed as universally legitimate. Heller argues that capitalist ideology should “keep silent about self-interested economic ends and means and the virtues of Anglo-American society” or run the risk of culture acting as an impediment to transition. In this, Heller draws on both Hayek and Parsons, who believed that to take root, capitalist ideology must appeal to neutral procedural concepts (impersonal norms, pluralism, equality of opportunity, for example) rather than an ideological focus on profit-making or democracy. Heller ends this chapter by presenting a somewhat confusing notion of speeding up the spontaneous order described by Hayek: “In order to obtain spontaneous orders more rapidly … developing societies first need the formal institutions which alone can guarantee the regulated freedom and procedural impersonality that a spontaneous order requires to work its magic” (p. 198). Heller is attempting to add a bit of constructivism to Hayekian spontaneous order — arguing for building institutions that will speed up the processes of spontaneous evolution — with the objective of creating a compromise between the incrementalist and constructivist views of institutional change. Ultimately, Heller sides more with Karl Popper than with Friedrich Hayek, concluding that “Knowledge of capitalism and of its institutions does increase through time, and it could now be time for social scientists to have more confidence in the knowledge that exists” (p. 276).

The sixth chapter discusses the role that crises in developing economies (mostly in Latin America) play in building the institutions of capitalism. While crises are not the best methods for transition, he admits that they do sometimes generate changes that bring a society closer to capitalism. Underlying the discussion in this chapter is Heller?s impatience with incremental institutional reform. He cites work by Grindle and Thomas (1991), who argued that without a crisis, the stakes are too low to generate the desired rapid reform: “the consequences of failing to implement reforms will not be severe, and policymakers lean towards incremental or marginal change” in a non-crisis environment (p. 200). While crisis can motivate change, the ideal path to capitalism for emerging market economies is Weberian in nature with a systematic order of: markets to law, law to bureaucracy and bureaucracy to democracy. Neoliberalism, which Heller defines as proto-capitalist policies that cope with failed state activism by restructuring economies along market lines but without corresponding reforms to the institutional framework of economic regulation, lost the opportunity to build this path.

The seventh chapter deals with how policymakers might go about implementing transition theory in practice. How, Heller asks, might these policymakers translate Weberian theory into workable guidelines for reform? Ideally, Heller would like for all of the reforms to be simultaneously undertaken but he acknowledges that this is not very realistic. Heller describes what he sees as manageable stages of reform that must be sought given the practical difficulties. This chapter starts with a policy priority sequence followed by a sequence that could be followed in crisis-induced transitions and ending with some details on the implementation of reforms in the legal and administrative subsystems.

The final chapter of the book draws on the World Bank’s worldwide governance indicators conducted in 212 countries to argue that transition does not have to occur only very slowly over many generations. While the World Bank report does conclude that “In less than a decade, a substantial number of countries exhibit statistically significant improvements in at least one dimension of governance, while other countries exhibit deterioration in some dimensions,” it is difficult to share Heller’s optimism that transition can proceed as rapidly as he would like based on findings of statistical significance in some countries. Nonetheless, Heller’s closing chapter is a nice wrap-up and highlights many of the book’s strengths.

References:

Buchanan, J. (2000), Moral Science and Moral Order, Indianapolis: Liberty Fund.

Grindle, M. and Thomas, J.W. (1991), Public Choices and Policy Change: The Political Economy of Reform in Developing Countries, Baltimore: Johns Hopkins University Press.

Stiglitz, J. (2000). “Capital Market Liberalization, Economic Growth, and Instability,” World Development, Vol. 28, Issue 6, pp. 1075-86.

Weber, M. (1978), Economy and Society, Berkeley: University of California Press.

Brandon Dupont is Associate Professor of Economics at Western Washington University. His most recent research explores the history of American overseas travel to Europe in the nineteenth and twentieth centuries.

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