ECONOMY

976 questions about a paradox
I’m persuaded that there’s something important about peer effects, yet important
difficulties remain. The simplest version of the peer effect hypothesis—“I want to be
like others”—is too naive. A useful formulation has yet to be found. Moreover, how
important is context? Clearly peer effects are not universal. A parallel set of models
have been studied to deal with the diffusion of innovations: the models frequently
cause an innovation to be adopted if it is being adopted by others without regard to
whether the innovation is good or bad. In a similar fashion, the adoption of a locally
current norm may depend on its interaction with other elements of the individual’s
preferences and opportunities.
[4] Does economics inevitably require a political foundation? Specifically, the economy
depends on property rights system, legal regimes, protection against expropriation,
a stable macroeconomy, and a host of other regulatory policies. All these decisions
have a direct effect on the economy and economic development; and all are endogenous
to the political system. Does this imply that a mature theory of economics and
economic performance requires that economics gain a political foundation?
The premiss in this question is obviously correct. But we should also mention the
legal and social foundations of economics along with the political ones. Each of these
four realms—economic, political, legal, and social—has a different set of institutions
that interact, but they are not the same. Just as economic problems can affect the
political agenda, so too can social problems affect economics and politics. Under
social foundations, I include groups and their effects, including social norms; and
generally, how people behave when they interact.
This issue arises in the study of economic development, where a major question is,
do institutions matter? And, in a collateral version of the question, maybe institutions
matter, but they are endogenous. Describing institutions is not very easy. Commodities
are easier to describe, but are still hard. Institutions are more like services, where
so many difficult questions arise. For example, is a physician-hour the same now as
fifty years ago?
Moreover, the study of institutions faces significant problems of measurement and
empirical testing. For example, we expect the effects of many institutions to have very
long lags. This implies that it is hard to use cross-country data to study institutions.
The latter have yielded a very intensive study of the last thirty years of economic experience,
but data limitations mean we cannot study longer periods in the same way.
The effect of the economy on the political system is equally worth talking about.
For example, I went to the former Soviet Union in 1991. One of the questions we faced
was, should we recommend that they adopt contract law and accounting systems?
I wondered, do we have to recommend that? It seems so straightforward. And yet,
the Soviets did not have either of these things. On the empirical side, the Russians
subsequently did begin to provide these while the Chinese have not. Yet which is
doing better—and why?
Returning to the question: the trouble is, we have a relatively strong theory of
economics, but our theories of politics are weaker, and so adding a theory of politics
to economics under the current circumstances only weakens it. Similarly, in principle