Reading Dani Rodrik’s work is like walking in windy conditions with wind direction not in your favor. The difference is he does it quite well where most stumble.
When most talk about free markets, he suggests the importance of industrial policy, when most talk about flexible exchange rates he suggests importance of undervalued exchange rates, when most talk about virtues of free trade he emphasises that social safety net is equally important, when most favor financial globalization, he is sceptical etc.
This time he talks about second best institutions, when most talk about getting best institutions (also called first best). He has written about the same few times in his blog and this time he writes a short paper on the same.
What does first best mean?
The type of institutional reform promoted by multilateral organizations such as the World Bank, IMF, or the World Trade Organization is heavily biased towards a best-practice model. It presumes it is possible to determine a unique set of appropriate institutional arrangements ex ante and views convergence towards those arrangements as inherently desirable. One of its apparent virtues is that it enables cross-national comparisons and benchmarking: institutional performance can be measured by, say, counting the number of days it takes to register a firm in different countries or settle a commercial dispute in courts.
And what are second best?
I shall argue that dealing with the institutional landscape in developing economies requires a second-best mindset. In such settings, a focus on best-practice institutions not only creates blind spots, leading us to overlook reforms that might achieve the desired ends at lower cost, it can also backfire. I will elaborate on this point using illustrations from four areas: contract enforcement, entrepreneurship, trade openness, and macroeconomic stability.
Read on to understand his perspective in the four areas. The paper is bound to create controversy as most of his work does. I would be looking forward to application of his ideas.