The earthquake that hit the international system at the end of the 1980s is conventionally summarized in one phrase: “the end of the cold war.” In reality, however, it involved at least four distinct elements: the end of the East–West conflict; the breakup of the Soviet Union and its alliance system; the collapse of communism as a global challenge to the West; and the triumph, in ideology if not in practice, of a political and economic model of liberal capitalism. The first three are historical processes that have important implications for the third world. The fourth is more a postulate than a reality, posing as many questions for the future of the third world as it provides answers about the end of the cold war.

The end of the East–West conflict has removed the bipolar contest that fueled most third world conflicts, when it did not generate them, and served as the framework for many North–South financial and military flows. While the end of the cold war has made great power military conflict seem less likely than at anytime in the past century, new strategic issues have emerged, born of the breakup of the USSR, with regard to the regional impact of postcommunist rivalries and to nuclear proliferation. One very important concomitant of the end of communist hegemony has been the breakup of multinational states, ending the understanding in place since 1945 whereby the existing map of the world, unjust and arbitrary as it was, should prevail.

Dramatic international changes are forcing third world countries to adapt their agendas and institutions to become part of a new global political economy. In the case of Latin America, massive shifts in international financial flows, the muting of East–West conflict and renewal of U.S. hegemony, the new primacy of markets, and the return to competitive political systems have been the most significant international changes. Accommodation to these changes is producing multiple tensions and conflicts, and it is not yet clear whether the adjustment will produce competitive economies.

During the post–World War II period, Latin American countries' inward-oriented development strategies – the import-substitution industrialization model – determined their main domestic policies and foreign relations. Now the region is facing new systemic conditions, following a decade of severe economic weakness during the 1980s. Looking back at the “lost decade” and comparing it with the success of the Asian economies, most Latin American leaders have concluded that they have no alternative but to accommodate their domestic policies to the new international context. Their initial success in doing so can be seen in recent economic data: inflation is under control in most countries; financial resource flows and investments have increased, despite the turbulence following Mexico's peso devaluation; and growth is beginning to resume. Nonetheless, Latin America lags behind its East Asian rivals in terms of growth and technological progress.

The end of the cold war and the disappearance of socialism as a major political-economic force opened the way for important changes in the capitalist world. These changes were of at least two types. On the one hand, the cessation of cold war hostilities between the United States and the Soviet Union downgraded the role of military in favor of economic power. This shift, in turn, increased the international standing of Europe and Japan at the expense of the United States, since the former are much stronger economically than militarily. On the other hand, the disappearance of socialism as an economic system focused attention on the differences among models of capitalism. In the 1990s, much more heed is being paid to variations in the ways of doing business in the United States, Europe, and Japan. While neither of these trends is totally new, the changed international panorama since the fall of the Berlin Wall greatly increased their salience.

For theorists and practitioners alike, a major question concerns the characteristics of the post–cold war international political economy. At the macro structural level, debate centers on whether the emerging system will be a multilateral, interdependent one, with close cooperation among capitalist powers, or a regionalized one consisting of trade and investment “blocs” in North America, Europe, and Asia. Our argument is that both of these processes are happening and will continue to do so. This simultaneity, which we call “nonhegemonic interdependence,” results in an unstable situation.

Since the beginning of the 1980s most of the developing world has moved unevenly but undeniably toward liberal, market-oriented economic reforms. The 1960s and 1970s were decades of unprecedented economic nationalism, a growing role for state intervention in the economy, and experimentation with variants of socialism and self-reliance. Comprehensive development planning was widespread, and the prevailing model of development throughout much of Latin America, Asia, and Africa was a variant of a statist, largely inward-oriented import-substitution industrialization. It was also socially redistributive, at least in rhetoric. The 1980s and 1990s, by contrast, have provided a nearly complete reversal in economic policy. Virtually everywhere, developing countries have begun restructuring the nature of their intervention in the domestic economy, liberalizing their domestic trade and investment regimes, privatizing state-owned enterprises, and pursuing a variety of economic reforms.

Behind these policy changes was a new set of ideas. According to some observers, the striking convergence in the pattern of economic (and political) reform efforts reflects a “triumph” of liberalism on a global scale. It is the “end of history,” ushering in a new period of liberal ascendance. This theme has been popularly restated by the U.S. media during the past several years. The extent to which this vision of the new world order is globally shared is subject to serious debate and will be considered in further detail later in this chapter. Nevertheless, there is little doubt that there has been a major change in the language used, the distinctions promulgated, and issues considered important during the past fifteen years.

After nearly three decades of steady economic growth, the six capitalist countries of Southeast Asia today constitute the world's fastest-growing regional economy. The six (Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Brunei) form the Association of Southeast Asian Nations, known as ASEAN. In contrast to their relatively homogeneous Northeast Asian neighbors, the ASEAN countries are characterized by extreme ethnic, cultural, and religious diversity. Their European colonial heritage is equally diverse. Yet unlike other ethnically diverse, European-colonized developing regions such as Africa, the Middle East, and South Asia, the ASEAN countries have maintained ethnic harmony and political peace for decades. Their sustained economic success challenges popular ideologies that, for example, Confucianism is conducive to capitalist economic development while Islam is not, or that colonialism is the primary cause of economic development failure in postcolonial societies. In contrast to ASEAN's success, the four socialist countries of Southeast Asia – Vietnam, Cambodia, Laos, and Burma (Myanmar) – have been counted among the world's poorest and least successful economies, with their 120 million citizens suffering decades of war and civil strife. Tables 8.1 and 8.2 document the economic contrasts between these two groups of countries.

The ASEAN countries' economic success is particularly distinctive for its heavy dependence on the world economy, continuing the region's more than 1,000-year history of widespread participation in maritime-based trade. This is the result of Southeast Asia's distinctive geography, which consists of peninsular and archipelagic territories lying astride the major world sea-trading route between the great empires of China to the north and India to the west.

The 1980s and early 1990s witnessed historic changes in the patterns of economic development that had prevailed since the end of World War II. New winners and losers emerged within what had traditionally been called the “third world.” Thus, as the new century approaches, East Asia's newly industrialized countries (NICs) are on the verge of joining the developed world. At the other extreme, a large part of the African continent has experienced an absolute decline in living standards, and its future prospects appear dim. In between, other countries in Asia, Latin America, and the Middle East are trying – with various degrees of success – to reposition themselves to take advantage of new global dynamics. Finally, a new group of third world nations has appeared as a consequence of the collapse of communism. Eastern Europe and the former Soviet republics are now facing many of the same problems as other developing countries and competing with them for available resources.

There has been a great deal of debate about the reasons for the differential success in achieving economic development. In this book, the authors stress the importance of two sets of variables: international and regional. While not denying the role of domestic economic, political, and cultural factors, we believe that recent analysis has seriously underestimated the relevance of international variables and overlooked the importance of geographic location. Moreover, there has been an interaction between international and regional factors in ways that skew an individual nation's chances of achieving rapid growth with a measure of equity.

INTRODUCTION

In both economics and political science, the study of institutions has achieved a new and increasing prominence over the past twenty years. This emphasis contrasts with economists' previous devotion to the neoclassical paradigm and, to some extent, with behavioralist and pluralist approaches to studying politics. In part this change is due to an interest in problems concerning particular institutional settings: the efficient structuring of the business firm, the nature and practice of economic regulation, the criticism or reform of democratic political institutions, and, more recently, the transition from command economies and totalitarian polities to more capitalistic and democratic forms. But, partly as a result, there has also been an increased appreciation of the need for positive economic and political theory that not only incorporates institutions and their effects, but also gives us tools to analyze institutional formation, maintenance, and change.

It is a measure of the importance of the idea of institutions in social science that the term often goes without an explicit definition in many studies to which it is central, even though writers who do define the term give it a great variety of meanings.

INTRODUCTION

This essay provides perspectives on research on regulation, identifies an agenda of research topics, and discusses approaches to some of those topics. The focus is on a set of presently identified issues on which social science research may be able to make a contribution, irrespective of how amenable the issues are to study with our present set of analytical tools. The essay thus focuses more on research opportunities and less on where progress is most likely to be made. Many of these research opportunities are suggested by regulatory practice and emerging concerns.

One approach to regulatory research focuses on the identification of market failures and on market-like mechanisms for correcting those failures. This perspective is necessarily normative and measures performance in terms of efficiency. Major advances in the theory of regulation have resulted from treating as endogenous the behavior in the regulatory relationship. This includes not only treating the behavior of the firm as endogenous, but also making the choice of a regulatory policy endogenous. The research challenge, however, is broader than that of providing advice about efficient regulatory policies and includes the prediction and explanation of actual regulatory behavior.

A second approach to regulatory research, that of political economy, adopts a positive perspective. In its simplest form, the political economy approach views regulation as demanded and supplied as a function of the interests of those who incur the distributive consequences of policy alternatives. The political economy perspective thus does not require a market failure for regulation to be supplied.

INTRODUCTION

The dramatic political and economic changes underway in Eastern Europe and the former Soviet Union present social scientists with a sobering reality and an unprecedented opportunity. The reality is that our disciplines offer very little theory of relevance to predicting the onset, course, or pace of the changes. The opportunity is a “natural experiment” that permits social scientists to study comparatively an important type of institutional transformation: in an amazingly short period of time the communist parties in a number of countries with different institutional and cultural circumstances peacefully relinquished their dominant political positions to allow democratization and the attempt to create liberal political and economic institutions. While many social scientists have been quick to offer advice about how the transformations should proceed, our purpose here is to consider how social scientists can best learn from this natural experiment.

We make two intertwined arguments about studying the postcommunist institutional transformations, specifically, and major changes in economic institutions more generally. One argument concerns what we believe to be an appropriate substantive focus for study: the evolution of property rights and their credibility. The other argument concerns the weaknesses of the disciplines as they relate to the conduct of that study and the desirability of a political economy approach for overcoming them.

An important empirical regularity motivates our focus on property rights: all our previous political experience suggests that democracy is incompatible with the centralized allocation of economic resources (Lindblom, 1977, chap. 12). A market economy with substantial private property appears to be a necessary, although not sufficient, condition for the persistence of a democratic political system.

The study of political economy typically involves individual researchers following their own instincts about productive ways to expand on the way we think about specific political and economic phenomena. At least as practiced in the United States, institutional impediments frequently stand in the way of appropriate training and research when that research is very different from traditional approaches. Such is particularly true when the new approach falls across the boundaries of existing disciplines.

This volume represents a first step in altering some of these existing institutional impediments. The essays contained here were commissioned for presentation at the Inaugural Conference of the W. Allen Wallis Institute of Political Economy at the University of Rochester. The Wallis Institute was the natural outgrowth of the efforts of the economics and political science departments at the University of Rochester to foster closer intellectual ties than usually exist across these disciplines. The research lines sketched in this book constitute a starting point for the development of new approaches to research and training. This development has been supported and encouraged by the University of Rochester, which has dedicated resources to the development of the Wallis Institute.

The Wallis Institute is named in honor of W. Allen Wallis. He is a former president of the University, but more than that, his career is a personal model of political economy in action. Trained as a statistician, he achieved wide acclaim for innovative statistical approaches – achievements recognized, for example, by his election as President of the American Statistical Association. His career, however, was not narrowly defined by statistics. He ranged from academe to government while maintaining close relations with business and industry.

The Cambridge series on the Political Economy of Institutions and Decisions is built around attempts to answer two central questions: How do institutions evolve in response to individual incentives, strategies, and choices, and how do institutions affect the performance of political and economic systems? The scope of the series is comparative and historical rather than international or specifically American, and the focus is positive rather than normative.

An earlier volume of essays on the state of the field in this series, Perspectives on Positive Political Economy, mainly addressed organizational development. Now, Banks and Hanushek have assembled an exciting collection of papers in which formal theories of political economy are applied to the interaction between institutions and public policy. The chapters cover regulation, privatization, and the construction of credible property rights in economic transformations, as well as the political economy of economic policy in industrial societies (trade policy, macro policy, and budget policy). All of these are significant areas where politics and markets – or political and economic forces – interact. Each of these chapters summarizes a recent research program, integrating a variety of approaches and findings while pointing out the need and direction for future research. Additionally, two chapters address theoretical developments relating to the role of equilibria in institutional choice. Both of these chapters, one on the political economy of law and the other on institutions more generally, focus on problems of cooperation and coordination, and point the way to rigorous microfoundations for institutional analysis.