Friday, July 4, 2008

Fixing institutions, not policies

Over the past decade or so, development economics has moved from faith in "getting policies right" (Washington Consensus) to getting the "rules of the game right". Institutional context for the policies, and not the policies themselves, became the focus of attention.

Good governance, or political accountability and the quality of bureaucracy as well as the rule of law, has become the touchstone for evaluating reforms, both political and economic, in developing countries. Governance has become closely tied with developing and nurturing institutions and strict enforcement of rule of law. Aid by multi-lateral and even major donor countries are increasingly being tied to rule of law conditionalities and for strengthening such institutions.

Daniel Kaufmann and Aart Kray of the World Bank even came up with the "300% dividend", which claimed that in the long run, a country's income per head rises by roughly 300% if it improves its governance by one standard deviation. They find that while every rich country with the arguable exceptions of Italy and Greece scores well on rule-of-law measures, most poor countries do not.

Harvard economist Dani Rodrik, the leading proponent of the "institutionalist" school of development economics, argues that the quality of institutions have the biggest influence on incomes across developing world. In contrast, both trade and geography have limited role in influencing incomes and economic growth.

While the broader definition of rule of law involves protecting civil and political rights of individuals, its more relevant meaning refers to "property rights and the efficient administration of justice", which provides stability to the political and economic systems. Economists see stable, predictable laws as encouraging investment and growth. Such institutional reforms include strengthening judicial institutions, contract enforcement processes, and law enforcement machinery.

Many development economists even see rule of law as a desirable end in itself. Dani Rodrik has dwelt on the intrinsic importance of the rule of law, transparency, voice, accountability, or effective government, and even claims that "good governance is development itself". He feels that good governance should focus on strengthening those "institutional arrangements that can best relax the constraints on growth".

While this chain of deduction appears plausible, the evidence so far may not be enough to conclusively establish which way the causation link runs, from rule of law to economic growth or vice-versa. Most often, economic growth by itself can be a strong stimulus for development of rule of law institutions.

Brookings' Global Economy and Development COnference has a set of six working papers that debate what works and what doesn't in fighting poverty and addressing the development challenge. (From Marginal Revolution)

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