Friday, November 6, 2009

What is wrong with development policy making?

Longish essay (more on the theoretical and abstract front), summarizing impressions on development policy making.

It is commonplace to have development experts and multi-lateral institutions venturing diagnosis of what ails a developing country and ready-to-implement prescriptions for those problems. They despair that corruption and weak governance are holding back these economies from effectively implementing these magic solutions. Is development as simple as these experts would suggest? Is it merely an issue of our not being able to translate a simple policy prescription into tangible action at the field level?

Invest in education and health care to unleash the full potential of your human resources. Reform governance institutions and processes to be transparent, responsive, and participatory. Design policies to align the incentives of the private sector with the larger economic goals. Open the economy, internally and externally, to free movement of capital, labour and technology. Put in place adequate social security and welfare cushions for the disadvantaged and the poor.

The aforementioned recipe, with small variations, is the general one-size-fits-all panacea to any developing country's ills. But as the East Asian and most impressively the Chinese and Indian examples show, these models are chasing the shadows. Decentralization, transparency, good governance, equity were all given lip-service in the Chinese success.

Accordingly, elections are foisted on institutionally deficient polities in the name of democracy, public utilities and services are privatized in the name of efficiency, welfare government role gets rolled back in the name of corruption, and the economy gets deregulated and opened up in the name of globalization and free trade. With the prescriptions implemented one would naturally expect these developing countries to prosper. But recent history of development economics is replete with numerous failed examples of such experimentation. In fact, for many decades now Latin America has been the laboratory for innumerable such experiments with all versions of the liberal free market economy. And the results are for everyone to see!

There are three major traditional explanations for the problems facing developing economies - lack of resources (and so need for massive foreign aid), lack of proper markets (so deregulation and privatization), and weak and corrupt governments (so need for better governance). All three are possible deficiencies in countries, but none of them alone are enough to explain the problems facing these countries. Any explanation requires going beyond this paradigm.

Dani Rodrik explains his approach towards development economics thus, "the right way to approach development policy is to start with the view that we actually don't know where the problems lie, to acknowledge that the key problems may differ from setting to setting, and to adopt an explicitly experimental attitude to policy selection and formulation so that you can learn about the environment in which you operate. In this approach, monitoring and evaluation are key, as you want to pull back from mistakes and improve policies over time. Indeed, you build the monitoring into the policy process itself so that learning becomes part and parcel of it - rather than something you leave to your researchers or economists."

The development contexts in developing countries exhibit spectacular diversity - racial, linguistic, economic, geographic, societal, and religious. A similar set of problems in different countries may manifest as widely varying outcomes. The same set of policy prescriptions may throw up contrary outcomes in countries with the same social contexts. The inter-play of these forces leads to the emergence of patterns of development that goes beyond the scope of any econometric model. These forces interact with each other both at the micro and the macro levels, at the individual and societal level, revealing a whole spectrum of socio-economic outcomes. There exists multiple equilibria for each socio-economic and political context.

All these forces play themselves out in an even more complex and unstable social and political setting, which intimately and immediately influences the final outcomes of this game. Unfortunately, these models give no place for social and political forces and the need to accomodate them in any reform process. It presumed that these forces will be swept away in the remorseless march of the reform process and a new political alignment and equilibrium would develop. In many ways, it is ironical that neo-classical economics is advocating such a transformation, more revolutionary than anything even Marx had advocated, in the political system.

The over-riding concern with institutional weakness, governance deficiencies and corruption has led to an atmosphere of distrust of government and its institutions in developing countries. Standard development models have no place for existing government systems and clamour for wholesale institutional and process transplants. These models see little prospect of any success without such wholesale reforms. It can be said, there is either a best practice/policy/model or there is no hope!

A traditional economist scrutinizes any development policy through a looking glass which focusses on increasing aggregate demand, efficient allocation of resources, least distortionary incentives, and distributive justice. The standard prescriptions include good governance, strong institutions, decentralization, open markets, flexible labor policies, deregulation, privatization etc. There are also specific sets of prescriptions to achieve each of these objectives.

A linear and incremental outlook towards policies and their implementation and movement of societal forces, is not the most ideal way forward. Addressing development challenges in complex settings like in many Asian and African countries often requires a two-track, heterodox approach, straddling contradictory platforms - orthodox and unorthodox, public and private, open and closed, legal and informal. Thus regulation has to co-exist with free markets, legal and extra-legal have to go hand in hand. Phasing and sequencing of reforms vary across societies and economies.

There is no single "optimal reform trajectory", which can be emulated by all nations and societies. What is suitable for one developing country may not be so for another. The same development strategies and reforms may throw up contrasting outcomes in different societies. Finding out what is most appropriate for any country or society is more an exercise in experimentation than any theoretical analysis. Ex post rationalizations are more likely to be successful than ex ante analyses.

As Dani Rodrik says, it is not that economic principles work differently in different places, or need to be tailored to local conditions, but their institutional embodiments vary. He writes,

"Incentives, competition, hard-budget constraints, sound money, fiscal sustainability, property rights are central to the ways in which economists think about policy and its reform. But these principles do not demand specific institutional solutions. Property rights can be implemented through common law, civil law, or, for that matter, Chinese-style socialism. Competition can be maintained by a combination of free entry and laissez-faire, or by a well-functioning regulatory authority. Macroeconomic stability can be achieved under a variety of fiscal institutions." Economic principles should be implemented through formal and informal institutions that have been suitably adaped to meet local demands and requirements.

Quite often the success of NGOs in social and economic development enggineering is presented as proof of the failure of government in addressing development issues. This euphoria invariably overlooks the important fact that such success stories are most often isolated and one-off examples. These examples present interesting challenges of scalability and are excellent examples of the inherent limitations of the very model that achieved the success story.

History is replete with examples of the failed grand development narratives. We can make a better start this time by acknowledging that there can be no grand narrative in development economics in the first place. Only a series of smaller narratives, which emerge through the routine exercise of trial and error, and not as part of a grand policy or design. The challenge is to smoothen this process of trial and error, so as to minimize costs and expedite the process."

Development requires all or some of the aforementioned conventional prescriptions and much more. It is essential to embrace the more unconventional and innovative context-specific approaches, besides exploring, analyzing and drawing from the micro-foundations of development challenges/problems (as is being done by experimenters through RCTs etc). Accordingly, a kaleidoscope of policy alternatives may have to be applied depending on the socio-economic and political contexts.

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