Thursday, August 6, 2015

The problem with 'best-practice' models

This blog has consistently held that India's implementation deficit is largely a reflection of state capability weaknesses. This weakness is often amplified by the embrace of best practice models. As the cliche goes, "best becomes the enemy of the good" and to rephrase Dani Rodrik, scalable best-practices  are "second-best, at best". Ricardo Hausmann makes a reference to this in his most recent Project Syndicate article.

Consider the example of any regulation which provides the best-practice protections to consumers. In developing countries, many goods and services are offered without the full range of consumer satisfaction standards. They range from product development to safety to functional to servicing requirements. In fact, a significant portion of the value chain of the product or service is typically done in the informal sector. All this naturally lowers the cost of production and producers pass on atleast a share of the savings to consumers in the form of lower prices.

Accordingly, the plastic or steel vessels purchased at your local store, haircut from the 'barber shop', and driving lessons from the neighbourhood 'driving school' are cheap and affordable. Much the same applies to an apartment unit bought from the local developer. Alternatively, for the buyer, the transaction cost associated with the risk of buying a house without clear land title, construction quality assurance, and delivery time commitment is offset by the cheaper price of the housing unit. In an extremely price-sensitive market, such sub-par production, product/service-quality, consumer protection and servicing standards engenders a low-level equilibrium. I have blogged about similar low-level equilibriums in public service delivery here, here, and here

In this context, best practice regulation, which seeks to formalize and standardize processes and quality standards, can have unexpected consequences. One immediate impact is that the cost of production rises as the layers of processes and standards take effect. This in turn prices out a large share of the consumers, leaving a market for that product or service which is unaffordable for the vast majority of consumers.

Another effect is that it amplifies state capability weaknesses. Higher standards in an environment where even the lower standards are not effectively enforced is a recipe for more failures. Worse-still, since producers will struggle to comply with the increased requirements at their prevailing (or even slightly higher) price points, it increases the opportunities for harassment and rent-seeking by inspectors and other public officials concerned with monitoring the rule.

Finally, these best-practice models increase informality. As the cost of compliance increases, firms prefer to go informal so as to continue servicing their existing customers. Perversely enough, the quest for higher standards would end up lowering the informality threshold and increasing the share of the informal sector in the market for that product or service.

Such reform attempts fail because its proponents only ask, "what is the best strategy to improve the quality of a good or service?". Instead, the question should have been, "what is the best strategy to improve the quality of the good or service, conditional on the market constraints and enforcement capability of the public system?". We just can't wish away the real world! 

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