<div>As recently as 1990 policymakers and academics believed widely that all that was needed for dramatic increases in prosperity in transitional economies was to roll back the state. The arguments in this book present an articulate antidote to that assertion: While the state must withdraw from many activities involving direct production and exchange, it must provide good laws and enforce them for economies to prosper. In one chapter, Robert Summers brilliantly exposes the complexity of this requirement, listing eighteen minimum conditions for the creation of the rule of law. Other chapters describe the benefits of good commercial law on economic growth, the political foundations of American commercial law, how poor governance led to the Asian financial crisis, the institutional requirements for environmental markets, and constitutional structures that lead to efficient government. <br></div><div>The contributors, renowned experts in their fields on the complex institutional requirements for prosperity, offer arguments from economic theory, economic history, legal theory, and political science. The chapters are simultaneously of high scholarly quality and intensely applicable. Indeed many of the ideas here are being used to design reform projects in developing countries. <br></div><div><i>Market-Augmenting Government</i> will appeal to legal theorists, economists, and political scientists, and in particular to institutional economists. Its writing is friendly to the general reader, with only a few of the chapters requiring specialized knowledge. The book will also figure importantly in policy circles as governance moves center stage in the practice of reform and development. <br></div><div>Omar Azfar is Research Associate, IRIS Center, University of Maryland, College Park. Charles A. Cadwell is Director and Principle Investigator, IRIS Center, University of Maryland, College Park. <br></div>

Market-Augmenting Government

The Institutional Foundations for ProsperityBy Omar Azfar

University of Michigan Press

Copyright © 2003 Omar Azfar
All right reserved.
ISBN: 9780472068173
Market-Augmenting Government: How, Why, and When States Support Markets

Omar Azfar and Charles A. Cadwell

Market-augmenting government is the answer Mancur Olson developed in response to the question of what type of government is needed for economic growth. The idea that markets are the best mechanism for facilitating economic growth now dominates prescriptions for economic development, but the circumstances in which markets develop are not fully understood. Despite our ability to share information nearly instantaneously between rich and poor places, in some countries markets develop while in others they do not. Where markets are undeveloped, people remain mired in poverty and attendant human ills. Why is it that in some places markets operate to permit millions to be better off while in others markets remain primitive and people poor? And what activities of the state are required for markets to function well?

Mancur Olson (193298) was, of course, a major figure in the evolution of thinking on these questions. When he coined the phrase market-augmenting government in 1997, it reBected a lifetime of scholarship and observation. Olsons famous books, so familiar to graduate students and others, address some fundamental aspects of the design of good government, describing why it is difficult to organize groups, why groups may organize in ways that are inimical to economic growth, and why different types of regimes have different incentives to promote or inhibit markets. Market-augmenting government is an attempt to distill ideas that are bound up in Olsons Power and Prosperity (2000), the last chapter of which is entitled The Kind of Markets Needed for Prosperity. In Power and Prosperity, Olson concludes that prosperity can be achieved in societies with rights-respecting governments that provide for both secure property and contract enforcement while avoiding predation of various sorts (most harmfully that benefiting narrow lobbies). In his last months, Olson was testing his new phrase, market-augmenting government, on a variety of interlocutors, seeking to determine whether it achieved the right balance between simplicity and capturing a complex problem. Had he survived to see Power and Prosperity to publication, the title for its final chapter might well have been Market-Augmenting Government. The study of how governments (the primary focus of political science) augment markets (the primary focus of economics) falls squarely into interdisciplinary political economy. It is fitting that this book is appearing in the Economics, Cognition, and Society series of the University of Michigan Press. From the inception of this series of 1990 until his untimely death, Mancur Olson served on its advisory board. In that capacity, he urged consideration of books that integrate economics with political science and sociology. Market-Augmenting Government is just such a book.

Market-augmenting government was not, for Olson, a lightly considered articulation of an ideological middle between advocates of state or market. Instead, in developing this phrase, Olson turns on its head the question of how to get government out of the way of markets. Olson here suggests a key challenge for government: how to augment the markets that exist everywhere, supporting the complex transactions characteristic of successful economies. His formulation serves several useful purposes. It focuses us, first, on how it is that markets actually work and on the details of the particular institutions that contribute to that functioning. Second, he leads us beyond the question of which institutions constitute a market-augmenting government to the question of how such institutions emerge.

Sadly, Olsons sudden death in 1998 at the age of sixty-five truncated his work on this last question. In this book, nine scholars supplement the rich body of work that constitutes Olsons own output on the question. In this introductory essay we have two tasks: to provide a framework for these individual contributions, and to place them into a context that recognizes our collective debt to the scholarship of Mancur Olson. To accomplish this task we will pose three questions. What is it that governments do to augment markets? Why do governments augment markets? And how could we design government to better augment markets? Most contributions here concern themselves with all three questions to some degree, but we have organized the essay in an order that builds logically from the what is it? to the how do we get more of it?

I. The Questions to Be Answered

Let us begin by stating the issue in economic terms. Recall the two fundamental theorems of welfare economics: market allocations produce Pareto-efficient allocations, and any Pareto-efficient allocation can be produced by means of exchange (following an appropriate distribution of initial wealth). These are strong theoretical results, and taken together with the observed inefficiencies of state-led production and exchange they suggest a powerful rationale for expanding the dominion of markets (at least for private goods without externalities) and, correspondingly, constraining the role of the state. It is less well understood, however, that these theorems in fact provide a rationale for the role of the state. It is, after all, the voluntariness and regularity of exchange that leads to the efficiency of markets.

However, the rules that assure voluntariness and regularity are not found in nature. As Hernando de Soto points out, Westerners take this mechanism so completely for granted that they have lost all awareness of its existence....It is an implicit legal structure hidden deep within their property systems (2000, 8). Participants in any system of trade or exchange will engage in collective action to develop and enforce rules of all kinds. Market-augmenting governments are those that expand the dominion of markets by providing rules that facilitate voluntary and reliable trade.

In recent years, at the Center for Institutional Reform and the Informal Sector (IRIS) and elsewhere, economists have begun to remedy this neglect of the fundamental role of the state in augmenting markets. In this book, we further advance this research agenda. While both economic history and the comparative performance of modern states have been used to shed light on the importance of good government for economic performance, many questions remain. Among them are several that are addressed by the authors collected here.

1. What particular legal institutions actually augment markets? What about them produces this outcome?

2. How do dictatorships and democracies differ in augmenting markets? What forms of democracy best augment markets?

3. What explains historical cases of political and economic policy reforms that increased market augmentation?

4. How do the particular institutions within a democracy (such as a free press) augment particular markets (such as financial markets) and thereby (for example) prevent financial crises?

5. What forms of governance can augment markets at a supranational level, where force cannot easily be used to police economic activity?

6. Can government facilitate the development of markets to address externalities such as environmental impacts? While the gaps in our knowledge are vastly greater than...