Tuesday, November 24, 2009

Incentives matter, but are they enough?

For decades and centuries, countless economists and policy makers have searched for an answer to the proverbial gordian knot that challenges development policy making, "What makes nations rich and poor?". MIT's Daron Acemoglu is the latest to attempt to cut the gordian knot with this answer,

"Fix incentives and you will fix poverty. And if you wish to fix institutions, you have to fix governments."

He cites the successes of the American states along its Mexican border, Singapore, China, Botswana, and so on, relative to the poverty and failure of their respective immediate neighbours to justify this claim. Echoing of the institutionalists, he claims that all of them enjoy law and order, implicit or explicit private property rights, and dependable government services, and their citizens can go about their daily activities and jobs without fear for their life or safety or property rights. He therefore advocates promotion of greater transparency, more openness, and greater democracy, among the poorer nations.

I am not quite convinced whether Prof Acemoglu is not treading the same path of "sweeping explanations" that those he accuses others - Montesquieu (people in hot places are inherently lazy), Max Weber (Protestant ethic), Jeff Sachs (geography and weather), and Jared Diamond (advancement of technology) - of doing.

Enabling citizens to own property and carry out contractual transactions, and live without fear of crime or graft (or atleast unpredictable graft!) is a fundamental pre-requisite for the effective functioning of a modern economy. The recent success of the South East Asian economies and China, with their focus on economic freedom over democratic rights, has highlighted attention on the importance of the certainty inherent in rule of law (however flawed the law be). This disciplines society and administration - creates the enabling environment for individuals and businesses to conduct their business without assuming completely unpredictable and uncertain risks, and assures citizens of living their lives free from fear of crime.

The discipline and certainty provided by the traditional institutional arragements - tribal (as in case of Botswana), cultural (British colonial) and religious (Confucian in case of the Chinese and East Asians) - have played a critical role in their respective successes. This cultural-political milieu, often a legacy of historical evolution, are not easily replicable and often unique to societies. Pakistan is a neighbourhood example of the difficulty of putting in place stable governance structures that help institutionalize the incentives necessary to address poverty. Within India itself, the experience of different states offers a dazzling spectrum of diversity in outcomes in addressing development and poverty.

Further, the soundness and transparency of government institutions that underpin the success of nations - as the recent example of Iraq and the historical litter of long drawn out experiments with democracy from Asia and Africa conveys - is itself not something that can be easily transplanted into polities and societies. In other words, even assuming that fixing institutions will help rid off poverty, how do we fix governments that can align the incentives?

Assembling the right mix of ingredients required to fix institutions is the biggest challenge - one that can rarely be overcome with quick-fixes like transplanting or grafting institutions. It often requires the measured march of history to evolve organically, a process that can at best be expedited. And expediting this should be our effort.

In this context, a new paper by Lisa Chauvet and Paul Collier (full paper here) find that free and fair elections in developing countries improve economic policy by disciplining governments, though infrequent or uncompetitive elections may actually make things worse.

1 comment:

Anonymous said...

ARe Incentive compatibility, institutional transparency, good governance and so on really a recipe for rapid 'catch up' development?
I believe that the only case in which that might occur would be where there is a whole-hearted national commitment to catch up.
Otherwise might not a society choose 'guns over butter'? or environmental or spiritual goals instead?
Indeed, where there is a technology gap, or capital gap, a given society might choose to exercise increased leisure preference financing this by the 'unearned' bonanza from importing that technology or capital.

The Notion that National Politics should concern itself with per capita income is actually quite a new one.
Indeed, Nations like Germany and Japan perhaps only chose to concentrate on Economic growth because Politics was so discredited.
Elections make sense as providing a necessary source of discipline for fiscal policy in the same sense that shareholders at an AGM constrain the management. But State revenue isn't always raised from the people with the votes. Indeed, transfers from the productive sector to an unproductive sector- even if this means killing the golden goose in the long run- are more rather than less likely.

One reason for the focus on incentives rather than old fashioned notions of 'the general will', or 'National spirit' is that Financial Markets have greatly increased in size and prestige. However, The Financial Sector has been shown to be incentive incompatible. "Professional integrity" which as Ken Arrow is necessary to avoid market failure where asymmetry of information exists,has been shown to be something that no Professional body (in the financial sector) can enforce.

In this context, surely it is time to resurrect Political Science as something not reducible to game theory and which actually addresses the question of National Spirit and Resolve in an other than jejune manner?