Monday, September 14, 2009

The "stationary bandit" as investment promotion agent!

Apart from its stated direct objectives, development also ensures a stream of contract works, material and service procurement, which offers considerable profit opportunities to many people. Though contractors, suppliers and others in the entire production/supply chain are the main beneficiaries, there are others from the political class, bureaucracy, and even media who extract substantial rents from these activities. In fact, a very large and profitable rent-seeking chain, running down to the lowest level of participants, can partake of the spoils from these works and contracts. It is therefore not inaccurate to argue that a continuous process of development generates large enough rental returns for a large network.

Over the last decade, since the process of liberalization gathered steam, there have been a proliferation of private investment activity in different sectors, especially construction and infrastructure, that have had huge economic multiplier effects on the economy. Some states have led the way in the promotion of such investments, whereas others have fallen behind. The differential pace of progress among states have been attributed to investment friendly policies, superior infrastructure provision and linkages, pro-active approach of the respective state governments, and even the legacy of industrial activity in these states. However, closer analysis reveals that the respective political-bureaucratic cultures of the states also play an important role in creating the environment required for encouraging such investors.

I am inclined to argue that in the progressive states, a close nexus between the private investors, contractors and the local political establishment has played a critical role in encouraging investments. In these states, the local political class have been effectively co-opted into the private development efforts, either through direct stakes or having benefited from its rents. A considerable share of the political leaders in these states are themselves contractors or real estate developers. This stakeholder relationship of the political establishment in such private investment projects facilitates their progress and completion. It is also in the interests of political stakeholders that such investments succeed so as to pave the way for benefits from the potential future inflows.

In contrast, in the laggard states, the stakeholder relationship between the political establishment and the investors is tenuous. There are very few politicians with direct stakes or investments in such projects. Also, there is a pervasive culture of suspicion that surrounds such investments. In the cirumstances, with limited or no stake in its success, the political establishment behaves like Mancur Olson's "roving bandit" (to the "stationary bandit" of the former category of states) to collect rents upfront and exit immediately. There are no incentives to ensure even the grounding of private investment projects, leave alone their ultimate success.

Interestingly, the "stationary bandit" type of rent-seeking among the political establishment of the progressive states is also in accordance with the efficiency improving (though not utility optimizing/maximizing) paradigm of neo-classical economics.

Econ 101 teaches us that an action that allocates (or effectively) resources is a Pareto improvement, if it results in a change that makes "at least one individual better off without making any other individual worse of". In other words, a Pareto improvement action expands the total pie without reducing the individual pies of anyone (of course the pies of some people will naturally expand while those of others will not change). Note that Pareto improvements do not address the normative issue of how the incremental (increased size of the pie) allocations get distributed among the new set of winners/gainers. To that extent, equity and distribution issues become marginal to the analysis.

In the aforementioned example, the rents collected by the "stationary bandit" politicians facilitates private investments, generates economic multiplier, and increases market confidence among investors, all of which in turn begets further investments. And all the while, the economic pie keeps expanding and more beneficiaries join the virtuous cycle chain. Further, given their direct stakes in these developments, the political establishment also takes to care to ensure that the rents extracted do not place an unacceptable or unsustainable burden on the investors or developers. To borrow the cliched phrase, they take care "not to kill the goose that lays the golden eggs"!

In contrast, the "roving bandit" not only collects the rents, but in the absence of any stake in the process also ends up demanding and extracting an unsustainably large share from the investors. The result is a landscape littered with still-born private investment projects and economic stagnation. Such banditry puts-off potential investors and erodes the credibility of these states.

This "Pareto improvement generating", "stationary bandit" politician goes against the traditional theories of good governance and corruption-free administration that distinguish much of the conventional wisdom on development. It is also another example of second-best solutions to the complex challenge of economic development that are grounded on socio-political realities.

Without being concerned about the normative issues relating to such rent-seeking, this post only seeks to highlight the importance of such networks in facilitating and sustaining private investments. Nor does it go as far as to claim that such networks are a necessary pre-condition for such developments.

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