------ EH.NET BOOK REVIEW ------
Title: 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 façade
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’s (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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Geographic Location: General, International, or Comparative
Subject: Economic Development, Growth, and Aggregate Productivity, History of
Economic Thought; Methodology, Markets and Institutions
Time: 20th Century: Pre WWII, 20th Century: WWII and post-WWII