A Comparative Analysis of Neoclassical Economics and Law and Political Economy: Views on Institutional Foundations as a Means to Economic Development

By Mohamed Camara 

The Law and Political Economy tradition, like the New Institutional Economy, agrees that institutions lead to economic development because markets are regulated by institutions, or, “humanly devised constraints that structure human interactions.”The Law and Political Economy tradition, like the New Institutional Economy, agrees that institutions lead to economic development because markets are regulated by institutions, or, “humanly devised constraints that structure human interactions.” But when these institutions conduce economic growth, these schools of thought separate. Acemoglu, a renowned neoclassical economist at MIT, approaches this debate in a libertarian fashion, arguing for limited government and secured property rights. The LPE tradition finds this inadequate in comprehending the complex nature of property law, the dynamics of public and private conflicts, and coercion. We will make sense of this debate by showing how Acemoglu attributes economic growth to institutions and then compare his perspective to that of the LPE. We will attempt to see how the two schools understand “power” and where they situate power in the market. Acemoglu’s Institutions as a Fundamental Cause of Long-Run Growth, argues that “good economic institutions,” defined as “those that provide security to property rights,”2 are the primary source of economic growth. Economies flourish when property rights are clearly defined and strengthened. In these cases, property owners are likely to invest in their possessions in order to guarantee future profits. Acemoglu also argues that the decentralized nature of democratic power allows for greater distribution of property rights, and hence, development: “Democracy [emerges] where there [is] a strong, politically assertive middle class.”3 This outlook on property has its roots in a 17th and 18th century liberal philosophical tradition spearheaded by John Locke and utilitarian Jeremy Bentham. Locke argued for land ownership on the grounds that, “individuals who took actions to mix their labor with natural resources thereby entitled to be protected in controlling the fruits of their labor.”4 Locke’s understanding of property renders politics and the law secondary in the process of acquiring property; law and politics ought to only define and protect owners’ right to exclude the general society from their property. It is correct that these neoclassics’ suggestions may lead to economic development. Although Acemoglu takes into account economic struggle, i.e. class conflict, his analysis only focuses on the contradictory interests of “de jure” and the “de facto” powers. Nonetheless, due to the mysterious inner workings of the market, people can still reach “partial” and even pareto efficient equilibriums. This example is an attempt to illustrate Acemoglu’s argument: “[a politician] has an incentive to propose a better economic institution and with the extra surplus generated will be able to make himself attractive to voters.”5 The politician enables his constituents’ economic well-being because he wants to be re-elected; the constituents re-elect the politician because they want better economic policies. By looking out for their selfish interests, both the politician and his constituents reach an “efficient outcome;” it is a win-win. Jamee Moudud, an economics professor at Sarah Lawrence College, describes this principle as deceptive, “[an obscuration] of distributive struggles under the banner of ‘economic liberty’”6 To understand Moudud’s criticism, it is crucial that we illustrate the LPE understanding of property as a rudimental fact of economic activity. David Kennedy, legal scholar at Harvard Law School and renowned scholar in the LPE tradition, also argues against the exclusionary property right theory proposed by Acemoglu. Kennedy says, “‘clear’ and ‘strong’ property rights and robust growth or development in today’s industrial society is a more ideological assertion than careful history,”7 stating that property is the relations between people with respect to the politics and the legal framework which constitute property: “What matters is not the ‘strength’ or the ‘clarity’ of property rights, but the relationship between legal entitlements and the distribution and the use of resources in a particular time and place.”8 Because property does not exist in isolation from social relations, people with property have as much of a responsibility to protect those without property with their possessions as non-property owners have a responsibility to respect people’s properties. “Property right law distributes rights and duties among people with respect to things. Every time someone has a ‘strong’ property right, someone else faces a ‘strong’ duty.”9 Duncan Kennedy, one of the founders of the Critical Legal Studies said, “property, contract, and tort…are the ‘rules of the game of economic struggle.’”10 Understanding property right as social relations with respect to things is important because property cannot exist without law, and, if the first axiom is accepted, then the proposal to limit government for the sake of economic development, insofar as the government being responsible for the creation of property law, is counter-intuitive. Analyzing property law according to the argument put forward by LPE scholars, it can be argued that conflict and coercion exist in the private sphere. Considering conflict and coercion both vertically (“de facto” power versus “de jure” power) and horizontally (people versus people), in light of Duncan Kennedy’s remark on “property,” “contract” and “tort” as the rules of the economic struggle, we begin to see that Acemoglu’s libertarian solution to economic development as too simple an answer. Moudud’s criticism of “economic liberty” in Libertarian Doublespeak: Obscuring Distributional Struggles Under the Banner of ‘Economic Liberty, illustrates this point quite well. Moudud takes issue with the passive portrayal of firms in the neoclassical Marginal Productivity Theory in which the labor market is completely apolitical. Workers’ wages are equal to the value of the marginal product of their labor.11 In other words, workers are paid equal to the increase in revenue that their labor adds to the industry’s aggregate revenue. In practice, however, Moudud shows that the MPT is contradictory to how firms operate. For one thing, firms are always competing to set prices. The struggle for leverage over their competitors is precisely the work of firms in a capitalistic economy. Second, firms compete in order to grow; since they want to reduce their marginal cost of production, they invest in more efficient capital or lower labor compensation. The lower the marginal cost of production, the more likely they are to experience economies of scale. Finally, Moudud argues that MPT’s allocation of surplus is not grounded in empirical data on production and labor compensation. By assessing seven of the world’s most industrious countries (Denmark, Finland, Norway, Germany, Sweden, United Kingdom, United States), Moudud shows that law and politics, rather than the “free market,” determine labor compensation. In the listed countries, we find a positive correlation between labor compensation and productivity only in countries where unionization is high12; the weaker the unions in the given countries, the wider the gap between productivity and labor compensation. How do politics and law affect labor compensation with respect to productivity? The answer lies in Duncan Kennedy’s “rules of the game” and the general Law and Political Economists’ vertical and horizontal concept of coercion. According to these views, outcomes of economic bargains in the private sphere are determined by the legal and political entitlements given to parties in conflict. Duncan Kennedy said, “If you can’t strike at all…the size of the strike fund is irrelevant.”13 Laws permit and prohibit. In Duncan Kennedy’s anecdote, for instance, if unionization is prohibited by the law, the law implicitly shifts the coercive power into the hands of employers. On the other hand, if the law permits unionization, as is the case in Norway and Germany, in Moudud’s essay, the coercive power is tilted towards the workers. Legal and political entitlements are also equally important in the question of property law. In the United States, for example, Joseph W. Singer illustrates that the Founding Fathers prevented feudalism by transitioning from fee tail land ownership to fee simple. This change led to ramifications within the state of New Jersey: New Jersey was no longer owned by just Sir George Carteret and John Lord but by hundreds and thousands of homeowners who call it home.14 Because background laws are constantly changing, depending on time and space, the outcomes of economic bargains are unstable equilibriums. Parties’ interests are at odds, and hence, whatever agreements they come to is reached by coercion. Therefore, asserting that the maintenance of “strong” property rights is the formula to attain efficient equilibrium is more ideological than an honest assessment of reality. The institutional foundations for economic development are a concern for all economic schools of thought. Neoclassicists, like Law and Political Economists, agree that institutions are important to economic development. However, where Daron Acemoglu can propose “strong” and “defined” property rights and limited government as a means of growth, the LPE tradition exercises caution. They devote great attention to the social, political, and legal forces in which property is situated. In their view, property consists of rights and duties. This dual nature of property is rooted in laws and politics that govern people’s relations to one another with respect to their possessions. This analytical framework encompasses the complexity of property law, labor relations, and general human interactions in the market. To that end, economic development is promoted by institutions; however, law and politics ultimately determine their outcomes and thus the nature of the economic development. But when these institutions conduce economic growth, these schools of thought separate. Acemoglu, a renowned neoclassical economist at MIT, approaches this debate in a libertarian fashion, arguing for limited government and secured property rights. The LPE tradition finds this inadequate in comprehending the complex nature of property law, the dynamics of public and private conflicts, and coercion. We will make sense of this debate by showing how Acemoglu attributes economic growth to institutions and then compare his perspective to that of the LPE. We will attempt to see how the two schools understand “power” and where they situate power in the market.

Acemoglu’s Institutions as a Fundamental Cause of Long-Run Growth, argues that “good economic institutions,” defined as “those that provide security to property rights,” are the primary source of economic growth. Economies flourish when property rights are clearly defined and strengthened. In these cases, property owners are likely to invest in their possessions in order to guarantee future profits.  

Acemoglu also argues that the decentralized nature of democratic power allows for greater distribution of property rights, and hence, development:

“Democracy [emerges] where there [is] a strong, politically assertive middle class.”

This outlook on property has its roots in a 17th and 18th century liberal philosophical tradition spearheaded by John Locke and utilitarian Jeremy Bentham. Locke argued for land ownership on the grounds that, “individuals who took actions to mix their labor with natural resources thereby entitled to be protected in controlling the fruits of their labor.” Locke’s understanding of property renders politics and the law secondary in the process of acquiring property; law and politics ought to only define and protect owners’ right to exclude the general society from their property. It is correct that these neoclassics’ suggestions may lead to economic development.

Although Acemoglu takes into account economic struggle, i.e. class conflict, his analysis only focuses on the contradictory interests of “de jure” and the “de facto” powers. Nonetheless, due to the mysterious inner workings of the market, people can still reach “partial” and even pareto efficient equilibriums. This example is an attempt to illustrate Acemoglu’s argument: “[a politician] has an incentive to propose a better economic institution and with the extra surplus generated will be able to make himself attractive to voters.” The politician enables his constituents’ economic well-being because he wants to be re-elected; the constituents re-elect the politician because they want better economic policies. By looking out for their selfish interests, both the politician and his constituents reach an “efficient outcome;” it is a win-win.   

Jamee Moudud, an economics professor at Sarah Lawrence College, describes this principle as deceptive, “[an obscuration] of distributive struggles under the banner of ‘economic liberty’” To understand Moudud’s criticism, it is crucial that we illustrate the LPE understanding of property as a rudimental fact of economic activity. David Kennedy, legal scholar at Harvard Law School and renowned scholar in the LPE tradition, also argues against the exclusionary property right theory proposed by Acemoglu. Kennedy says, “‘clear’ and ‘strong’ property rights and robust growth or development in today’s industrial society is a more ideological assertion than careful history,” stating that property is the relations between people with respect to the politics and the legal framework which constitute property: “What matters is not the ‘strength’ or the ‘clarity’ of property rights, but the relationship between legal entitlements and the distribution and the use of resources in a particular time and place.”

Because property does not exist in isolation from social relations, people with property have as much of a responsibility to protect those without property with their possessions as non-property owners have a responsibility to respect people’s properties. “Property right law distributes rights and duties among people with respect to things. Every time someone has a ‘strong’ property right, someone else faces a ‘strong’ duty.” Duncan Kennedy, one of the founders of the Critical Legal Studies said, “property, contract, and tort…are the ‘rules of the game of economic struggle.’” Understanding property right as social relations with respect to things is important because property cannot exist without law, and, if the first axiom is accepted, then the proposal to limit government for the sake of economic development, insofar as the government being responsible for the creation of property law, is counter-intuitive.   

Analyzing property law according to the argument put forward by LPE scholars, it can be argued that conflict and coercion exist in the private sphere. Considering conflict and coercion both vertically (“de facto” power versus “de jure” power) and horizontally (people versus people), in light of Duncan Kennedy’s remark on “property,” “contract” and “tort” as the rules of the economic struggle, we begin to see that Acemoglu’s libertarian solution to economic development as too simple an answer. Moudud’s criticism of “economic liberty” in Libertarian Doublespeak: Obscuring Distributional Struggles Under the Banner of ‘Economic Liberty, illustrates this point quite well. Moudud takes issue with the passive portrayal of firms in the neoclassical Marginal Productivity Theory in which the labor market is completely apolitical. Workers’ wages are equal to the value of the marginal product of their labor. In other words, workers are paid equal to the increase in revenue that their labor adds to the industry’s aggregate revenue.

In practice, however, Moudud shows that the MPT is contradictory to how firms operate. For one thing, firms are always competing to set prices. The struggle for leverage over their competitors is precisely the work of firms in a capitalistic economy. Second, firms compete in order to grow; since they want to reduce their marginal cost of production, they invest in more efficient capital or lower labor compensation. The lower the marginal cost of production, the more likely they are to experience economies of scale.   

Finally, Moudud argues that MPT’s allocation of surplus is not grounded in empirical data on production and labor compensation. By assessing seven of the world’s most industrious countries (Denmark, Finland, Norway, Germany, Sweden, United Kingdom, United States), Moudud shows that law and politics, rather than the “free market,” determine labor compensation. In the listed countries, we find a positive correlation between labor compensation and productivity only in countries where unionization is high; the weaker the unions in the given countries, the wider the gap between productivity and labor compensation.  

How do politics and law affect labor compensation with respect to productivity? The answer lies in Duncan Kennedy’s “rules of the game” and the general Law and Political Economists’ vertical and horizontal concept of coercion. According to these views, outcomes of economic bargains in the private sphere are determined by the legal and political entitlements given to parties in conflict. Duncan Kennedy said, “If you can’t strike at all…the size of the strike fund is irrelevant.” Laws permit and prohibit. In Duncan Kennedy’s anecdote, for instance, if unionization is prohibited by the law, the law implicitly shifts the coercive power into the hands of employers. On the other hand, if the law permits unionization, as is the case in Norway and Germany, in Moudud’s essay, the coercive power is tilted towards the workers.

Legal and political entitlements are also equally important in the question of property law. In the United States, for example, Joseph W. Singer illustrates that the Founding Fathers prevented feudalism by transitioning from fee tail land ownership to fee simple. This change led to ramifications within the state of New Jersey: New Jersey was no longer owned by just Sir George Carteret and John Lord but by hundreds and thousands of homeowners who call it home. Because background laws are constantly changing, depending on time and space, the outcomes of economic bargains are unstable equilibriums. Parties’ interests are at odds, and hence, whatever agreements they come to is reached by coercion. Therefore, asserting that the maintenance of “strong” property rights is the formula to attain efficient equilibrium is more ideological than an honest assessment of reality.

The institutional foundations for economic development are a concern for all economic schools of thought. Neoclassicists, like Law and Political Economists, agree that institutions are important to economic development. However, where Daron Acemoglu can propose “strong” and “defined” property rights and limited government as a means of growth, the LPE tradition exercises caution. They devote great attention to the social, political, and legal forces in which property is situated. In their view, property consists of rights and duties. This dual nature of property is rooted in laws and politics that govern people’s relations to one another with respect to their possessions. This analytical framework encompasses the complexity of property law, labor relations, and general human interactions in the market. To that end, economic development is promoted by institutions; however, law and politics ultimately determine their outcomes and thus the nature of the economic development.

____________________________________________________________________________________

End Notes

1Benham, Alexandra. “ Glossary for New Institutional Economics.” New Institutional Economics: Glossary, 2003, www.coase.org/nieglossary.htm.

2Acemoglu, Daron. “Institutions as Fundamental Cause of Long-Run Growth.” Department of Economics, MIT, 2005: Pg. 395

3Ibid 426

4Singer W., Joseph. “Property.” Harvard Law School: Pg. 250

5Acemoglu, Daron. “Institutions as Fundamental Cause of Long-Run Growth.” Department of Economics, MIT, 2005: Pg. 423

6Moudud, Jamee. “Libertarian Doublespeak: Obscuring Distributional Struggles Under the Banner of ‘economic Liberty.’” Law and Political Economy, 2018.

7Kennedy, David. “Some Caution about Property Rights as a Recipe for Economic Development.” Harvard Law School,  2011: Pg. 3

8  Ibid 5

8Ibid 27

10Kennedy, Duncan. “Stakes of Law, or Hale and Foucault.” Harvard Law School, 1991: Pg. 227

11Moudud

12Moudud, Jamee. “Libertarian Doublespeak: Obscuring Distributional Struggles Under the

Banner of ‘economic Liberty.’” Law and Political Economy, 2018.

13Duncan, Kennedy. “Stakes of Law, or Hale and Foucault.” Harvard Law School, 1991: Pg.331

14Singer W., Joseph. “Property.” Harvard Law School: Pg. 251  

 

 

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