Harvard Professor Dani Rodrik has written about how our quest for the best solution often leads us astray and prevents us from finding the most optimal solutions to our problems. He has written a deeply insightful article in which he explores the world of second-best, third-best and other alternative approaches to solving the numerous challenges facing global economies.
We need to start our journey of discovering solutions to complex socio-economic problems by acknowledging that these problems act in multiple dimensions with numerous implications, and each problem often has more than a single solution. In fact, all social issues involving interaction among individual economic agents provide fertile ground for numerous emergent situations, with differing permutations and varying probabilities. The development problems facing extremey diverse settings like that in developing societies require multi-pronged responses, which cannot be straitjacketed into any single consistent and overarching logic.
Most of our development schemes adopt the comprehensive and systemic approach to policy formulation and implementation. In an effort to encapsulate and capture the requirements and demands of all areas and different categories of people, we over-standardize a development scheme into a monolithic set of guidelines and thereby curtail the program's effectiveness. Given the diversity and resultant complexity of problems, it is futile to capture all the possible solutions into a single policy framework.
One of the major challenges faced while formulating policies is the need to put in place adequate checks and balances to limit the role of discretion and thereby reduce the probability of the scheme being subverted or exploited by vested interests. This requirement often becomes an alibi for bringing in multiple layers of bureaucracy, which end up losing sight of the very objectives of the scheme.
In order to avoid getting trapped in this bureaucratic gridlock, we need to aim at getting the outcomes right and not be obsessed with the form of the institutions and processes that gets us there. Therefore, we should focus on cultivating all possible institutions and processes, and not just the "best possible", that provide security of property rights, enforce contracts, stimulate entrepreneurship, foster integration in the world economy, maintain macropeconomic stability, manage risk-taking by financial intermediaries, supply social insurance and safety nets, and enhance voice and accountability. The challenge is to get the incentives right within the institutions and the processes so as to achieve the objectives. But this alignment of incentives should be achieved without significantly disrupting the tenuous local political equilibrium.
In fact, once the incentives get aligned towards achieving the desired outcomes, the means too tend to get aligned along the lines of the broader societal interests. Quite often, the outcomes carry within themselves the seeds for institutional reforms which are directed at moving towards the best practice model. Further, for every reform initiative there is an appropriate pace and sequence, which varies widely across different social and economic contexts, without which the reform risks destabilizing the domestic socio-economic and political balance.
China is the best example of how the non-traditional or the best practice model, need not be the only means towards achieving certain desirable economic outcomes. The spectacular story of Chinese economic growth is an excellent example of how economic growth can be achieved by innovative and practical policy decisions without disspiating scarce resources and valuable efforts in dismantling entrenched power structures. In the absence of any strong legal and institutional framework for enforcing contractual obligations, the role of the guanxi type relational contracting in the Chinese and East Asian way of contracting cannot be under estimated. Foreign firms which quickly grasped this reality were able to take advantage of the tremendous potential offered by these markets. Let me illustrate a few other examples of how alternative approaches to the best practice can help solve development problems.
Multi-lateral agencies and academicians tend to focus more on the institutional and procedural requirements necessary to achieve the desired social and economic goals. They believe that the objectives can be achieved only through institutions that are built on certain universal ideas. Universal ideas like decentralization, deregulation, opening up economies, transparency, stakeholder participation etc need not be seen as sacrosanct and inevitable accompaniments in any institutional reform necessary to achieve development goals. We will explore some examples of such obsession with best practice or standard models, going astray.
The traditional IMF and WB prescriptions view economic open-ness and deregulation as pre-requisites for high economic growth rates. Developing countries are forced into inculcating these ideas into any institutional or policy reform. This arguement misses the critical point that these ideas are only a means towards providing a competitive environment and aligning incentives appropriately. Quite often wholesale and sudden changes, like the "shock therapies" in much of Eastern Europe after the fall of communism, destroys all existing institutions without putting in place any alternative. As the examples of East Asia and China proves, competitive environment, exposure to external market forces, and efficient allocation of resources can be done in more ways than one. All these countries experienced their spectacular growths as closed economies (to both goods and capital), and bureaucratically guided allocation of resources.
Traditional development models stress the need to create strong formal legal institutions, and see informal contract enforcement arrangements as being detrimental to the development agenda. But many academicians refers to the utility of "relational contracting" with all stakeholders, or long-term, personalized relationships built through repeated interactions, in the absence of strong legal enforcement machinery. Such contracting arrangments should be strengthened and developed as a substitute for regular legal systems. In the absence of a strong legal enforcement system, foreign investors in China rely on the "guanxi", or long-term relationships built on trust, which demand immediate payment, screens out unreliablke firms, and re-negotiate when things run into trouble. Dani Rodrik argues in favor of strengthening these relational contracting channels, by iniatiating measures like providing more information about firms, that lowers the information assymetry between them.
Encouraging entreprenuership is one of the most commonly advocated reforms for any developing economy. Lowering entry barriers by reducing licensing and registration requirements is a common prescription for reducing rent seeking and promoting entrepreneurship. But Prof Rodrik argues that "rents may well be a necessary condition for adequate levels of entrepreneurship to emerge in non-traditional economic activities". Most often, free or minimal entry costs, acts as a deterrent to encouraging entrepreneurs. Again the example of many successful East Asian countries, with their heavily regulated business environment and high domestic market prices, provide adequate incentives for entrepreneurs to thrive.
Another example of form taking precedence over susbtance is that of encouraging democracy by forcing down multi-party elections. Many developing countries are socially and ethnically diverse, and in the absence of standard conflict resolution and group bargaining institutions and forums, are often held together by an informal and tenuous consensus or balance of power among the elites or a few groups. A sudden introduction of the elements of multi-party democracy and elections unsettles this unstable equilibrium and brings to the fore the latent differences and long-felt grievances. Civil wars and domestic strife ensues instead of democracy. There are numerous such examples in Africa and East Europe.
Decentralization of authority and decision making powers is a favorite reform theme with multilateral aid agencies. It is argued that decentralization would induce stakeholder participation, improve efficiency of public service delivery, and reduce corrupution. Accordingly funds, functions and functionaries have been decentralized in many countries and many externally assisted and other regular development programs are implemented this way. But there are numerous instances of these powers being delegated to institutions and agencies without the requisite expertise or capacity to administer the delegated powers. The result is increased rent seeking, decreased quality of public services, and wholesale administrative paralysis. Such remedies leave the system worse off than in the first place. While the objectives of decentralization are laudable, the extent to which this reform can be successfully implemented varies widely between and within nations.
Another holy cow with multilateral lending agencies and standard governance theories is transparency. Transparency has emerged as the antidote to cronyism and corruption, and as being vital towards ensuring the effectiveness of governance. This theory fails to acknowledge the reality of the tenuous equilibrium that pervades many societies, where decisions are often made on informal platforms and work flow follows the path of least resistance. Many times, infusion of transparency into such contexts unleashes a cascade of divisive and fissiparous forces that mutates resource draining sub-conflicts that detracts attention form the original objective.
Standardization of procurement and tendering procedures is often a pre-condition for any kind development assistance or soft loans. The objective of having a transparent and fully standardized contracting process is to eliminate rent seeking and ensure quality in the sanctioned works. The standard contracting procedures and documents leaves limited flexibility to accomodate the local needs and requirements. For example, adding or deleting certain components in a work, or changing the specifications of the items to be procured, or adopting slightly informal contracting procedures, are not possible under this arrangement. The rigid procedural requirements overlook the fact that these contracting markets have limited depth and breadth, and often operate through informal mechanisms like sub-contracting and political contracting. Such procedural rigidity contributes significantly towards time over runs and lowering of work quality.
It is observed that local politicians, either directly or indirectly, are most often the major contractors for engineering works and other regular government procurement contracts. Standard models argue that this involvement of political representatives in contracting services and works, breeds corrupt practices and comes in the way of development. It therefore favors eliminating their role in such contracting completely and accordingly puts in place specific controls on this. However, in the real world, these attempt most often end up subverting the whole development agenda and diverting the terms of the debate. The energies get dissipated trying to prevent the involvement of the politician or local vested interest, that the ultimate objective itself remains unachieved.
In many ways, the contracting environment for both engineering works and procurement is very complex and is strongly influenced by local factors (like labor issues, local conflict resolution, tying up of all linkages, rent seeking chains etc) which a local politician is better positioned to combat. Indeed getting the local politician on board is often the best hedge against local uncertainities, including political risks. Instead, we should acknowledge the reality of political representatives involved in contracting, and focus on getting those institutions in place that helps us achieve our objectives. China, with its established arrangement of local party bosses doubling up as entrepreneurs, has achieved precisely the same without unsettling the local political equilibrium.
None of this is to argue that there should not be de-centralization, formal procurement procedures, transparency, legal institutions, deregulation, multi-party elections, and neo-classical growth models. My contention is that all these are ultimately only the means towards certain specific objectives, mainly the effective delivery of governance and public services. Given the compex and often delicately balanced socio-political and economic settings in which these institutions and attributes have to function, it is more appropriate if they are introduced carefully in a phased manner.