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Xu Xiaonian:the evolution of institution

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Thank you to the organizers for giving me this opportunity.

 

Frankly speaking, I cannot make a pertinent comment on Professor Claude Menard's speech. He provides a complete framework of new institutional economics that integrates the results of all new institutional economic studies since Coase into this framework and he summarizes the main thoughts of theoretical development and the future research direction. A good comment on this should be highly comprehensive, which is beyond my ability.

 

If there is still any regret, then it should be the evolution of the institution that Professor Claude Menard did not involve into his framework, which is also a great concern for China's policy makers and scholars. Since the time is given to me, I will take this opportunity to talk about my thinking on the evolution of institution.

 

A system is originally defined by North as the rules of the game, but Aoki Masahiko and others attributed the essence of system to “shared belief”, or “consistent expectation”, i.e. system is the game equilibrium under the shared belief. From this point of view, we know that if we cannot form a shared belief, such as the shared belief about the rule of law, then there may be a bad equilibrium, leading to social welfare losses. If a lot of people do not believe in the law or respect the law, people in this society will suffer, especially the honest people, and no one will abide by the law, and then the community have to rely on people to maintain the orders.

 

Due to the existence of “prisoner's dilemma", a bad equilibrium or an inefficient system can exist for a long time. The imperial authority-bureaucrat autocratic and patriarchal society lasted for more than two thousand years in ancient China, which demonstrates the the difficulties for institutional evolution. Evolution is the process of moving from one game equilibrium to another, and the key to the movement is the synchronization of shared belief. Please note that the word "synchronization”; it means that it is not enough to change just some people’s beliefs, but all should change together to help with institutional evolution.

 

It is extremely difficult to change the concept synchronously. The institution with the new concept might be evolved through Pareto improvement; however, some people, especially the elites, are likely to suffer, and they may create a lot of resistance and difficulties to the evolution of the system.

 

Second, there is a verification problem with Pareto improvement of the new shared belief.  Imagine the people in the planned system who never experience the market economy, and how can they believe that the market economy is better than the planned economy? People of my generation have experienced both systems and we are convinced that market allocation of resources enjoys a higher efficiency, but the younger generation only see the market economy and have not suffered from the planned economy. Even some people see returning to the planned system and strengthening government intervention as an effective way to solve real economic problems.

 

The third difficulty of institutional evolution is the first mover disadvantages. The pioneers of reform and the advocates of new ideas will be seen as warriors if they succeed, but will sacrifice if they move too fast. There are more martyrs in the history of reform than warriors, because people always suffer if they do not act according to the old rules. The pioneers are “not gregarious”. Whoever travels the fastest travels alone. And they are often misunderstood and criticized.

 

These difficulties determine that the evolution of the institution must be a slow gradual process. Evolution begins with doubts about existing shared beliefs, which arise from problems and crises. Crises sometimes come from within, but more from the outside world, such as the Sino-British Opium War in 1840, and the US warships breaking into Tokyo Bay, in almost the same period, forcing Japan to open to the world. In the face of the crisis, people have to doubt the old shared beliefs, and begin to find new ideas and new institutional models.

 

The evolution of the institution is complex, difficult and endless. One of the reasons for this is that the superiority of the new beliefs and the new system is difficult to verify, as we just said. In spite of being defeated in the Opium War and the Sino-Japanese War of 1894-1895, and people knew that the system of the Qing Empire could not be maintained, still they did not know what the new system should be, and then they started to try. They tried the republic regime and it turned out not working; Yuan Shikai and Zhang Xun attempted to restore monarchy, and failed, either. It was the same case for the French Revolution. Since 1789, they experienced a number of twists and turns, Napoleon claiming to be the emperor, Bourbon restoration, autocracy of Napoleon III, etc., and it was not until over a century later when they finally established the constitutional democracy.

 

In order to reduce the difficulty of validating new ideas, openness and reference are extremely important. Openness includes active and passive opening. Japan during Meiji Restoration and the five treaty ports in China after the Opium War were passively opened up, and China’s opening up in 1978 was active. Diversified institutional arrangements could be acquired from other countries through opening up, and the cases from these other countries could be used to verify the market economy model, to promote the formation of new shared beliefs and drive the evolution of the institution.

 

Forming new shared beliefs is much easier in a small community than in a large one, as the cost of overcoming the "prisoner's dilemma" in the small community is much lower than that in the large community. Prisoner's dilemma is caused by the difficulty in coordinating expectations; the more people there are, the more difficult it is to coordinate expectations. So in the early days of reform and opening up, we established a special economic zone, which was proved to be successful. That is to create a local microclimate in Shenzhen to form new shared beliefs. Until today, Shenzhen is still the most innovative city in China. The overall institutional design seems to be ideal and perfect, but there is very little success in practice of such design, because the large-scale and unified changes on people’s mindset is not practically feasible.

 

 


◆please indicate the source if authorized: National Economics Foundation

◆photo:National Economics Foundation