The Institutional Foundations of Public Policy

Throughout the last couple of decades, Latin America has been undergoing a process called market-oriented reform in some circles (like the readership of Economía) and neoliberal reform in others.¹ At the height of that movement, several authors, including me, were involved in creating a literature known as the political economy of reform. Ten years ago I wrote a paper with Andrés Velasco, in which we take stock of the previous thinking on those issues.² The word reform had a very specific meaning: as described by Stiglitz, "reforms are now those changes that ‘we' approve of, while changes that we do not condone can be labeled with a term of censure such as ‘backsliding.' "³ That is, the reforms were a set of policies of universal applicability that economists "knew" would benefit the developing countries adopting them. The political economy of reform was basically about finding a way to implement these reforms in political systems stacked with stubborn entrenched special interests that had resisted those policies thus far. Once that magical moment of reform was over, the economists could just sit back, relax, and enjoy watching the countries embark on a healthy development path.

Things have been a lot more complicated than that, and the results of that quest have been rather disappointing. Even though most countries undertook a large number of measures in what was supposedly the right direction, the growth and distributional implications have been far from spectacular, and public opinion in most countries today does not favor the reforms.⁴

Despite the fact that things did not go as well as planned, many actors such as international financial institutions see no reason for major changes in the strategy. They claim that countries should keep pushing for some missing re­forms, while developing a battery of complementary measures related to crisis proofing, institutional (or sometimes second-generation) reforms, and micro­economic policies.⁵

At the analytical level, some authors call for an end to the business of producing universal policy recipes. One of the most clearly articulated arguments in this area is presented in a paper by Lindauer and Pritchett in a previous issue of this journal, with comments by Rodrik, Eckaus, and Velasco.⁶ "Lindauer and Pritchett argue that the first step is to discard the very idea of a big idea. This does not mean that anything goes. Some economic principles ought to be reflected in sound economic policies. As discussant Dani Rodrik points out, however, these principles can underlie a host of different policies, applied through an array of different institutions. For example, allowing interest rates to clear credit markets is an inevitable conclusion of sound economic analysis, whereas choosing the American over the German model for organizing the banking industry is not."⁷

Current recommendations, whether in their more mainstream variety (that is, to keep pushing for an enlarged set of reforms) or in their more eclectic variety (namely, to find out what specific policies and institutions could work under different circumstances), all place a heavy burden of responsibility on the countries' capacity to develop and implement complex public policies. That leads me to the topic of this lecture, which is related to my own re­search agenda: what determines the ability of different polities to undertake the task of producing effective public policies? This question takes on major importance once the analyst moves away from a simplistic universal recipe that, once implemented in a magical moment of reform, leads to everlasting happiness.

Policymaking is a continuous and ongoing process. Aspects of that very process affect the economic and social impact of the policies themselves. This idea is exemplified by one characteristic of policies that has received a lot of attention in modern economic theory: credibility. The effects of policies on the final economic and social outcomes of interest depend on the actions and reactions of economic and social agents, who take into account their expectations about the future of the policies in question before deciding on their responses. As Rodrik explains in reference to trade reform, "it is not trade liberalization per se, but credible...