the illusory lure of “good governance”

and the hard realities

of growth in poor countries

http://mercury.soas.ac.uk/users/mk17

Mushtaq H. Khan

The Evolution of Governance Policy

The post-war consensus 1945-1970s: Catching up, industrial policy and support for dictatorships: but few countries succeeded

The 1980s: Structural adjustment and the attack on rent seeking: even poorer results, particularly in Africa

The 1990s and beyond: The good governance consensus brings together NGOs, civil society, aid donors and international financial organizations

Key components of ‘good

governance’

Stable property rights / Low expropriation risk

Effective rule of law

Zero or very low corruption

Democratic accountability of government

Effective service delivery capacities

Absence of political violence

Free markets without privileges for any sectors

Aspirations versus Theoretical Models

Many NGOs and developing country citizens support this

agenda because they support the goals of good

governance

But for Bretton Woods institutions and international

donors, these are not just good goals, they are

necessary means for accelerating development

Based on new theoretical models and empirical evidence

that show that achieving good governance is a

precondition for development

The Economic Theory Underpinning GG

The policy support for good governance is based on a

particular reading of New Institutional Economics that

argues

i) Prosperity comes from having efficient markets

ii) Efficient markets require low transaction costs

iii) Good governance reforms lower transaction costs and

are therefore necessary for an efficient market economy

Theoretical linkages in the new consensus

1E conom ic S tagna tion

H igh Transaction C ost M arke ts

C ontes ted /W eak P rope rty R igh ts and W e lfare -R educ ing

In te rven tions

2

R en t-S eeking andC orruption

3

U naccoun tab le G overnm en t

5

4

The New Policy Agenda

E conom ic P rospe rity

M arke t-p rom o ting s tra teg ies

S tab ilize P rope rty R ights th rough

‘R u le o f Law ’ R e form s

A nti-co rrup tion and A n ti-R en t S eek ing

S tra teg ies

D em ocra tiza tion , D ecen tra liza tion and

A ccoun tab ility R e form s

P rom otion o f p ro -poo r serv ice de live ry

The Governance-Growth Debates

The debate on theory and evidence focuses on 3 questions

i) Are these institutions and their proper enforcement desirable goals or are they also necessary preconditions for development?

ii) Even if in theory effective enforcement of these institutions would enhance growth, to what extent are they achievable in the typical developing country?

iii) By focusing on these governance conditions, are we taking our eyes off other more important institutional rules and associated governance capabilities that are both achievable and important for growth?

Cross-Country Evidence

Composite Good Governance Indicators and Per Capita GDP1990/2000

10

100

1000

10000

100000

0 10 20 30 40 50

Average of World Bank Good Governance Indicatorsin 1990 (ranges from 0 to 50)

Lo

gs

of

per

cap

ita

GD

P in

US

$ 20

00

Cross-Country Evidence

Composite Good Governance Indicators and Growth Rates1990-2003

-8

-6

-4

-2

0

2

4

6

8

10

0 10 20 30 40 50Average of World Bank Good Governance indicators

in 1990 (ranges from 0 to 50)

Gro

wth

Ra

te o

f P

er

Ca

pit

a G

DP

19

90

-20

03

Diverging Developing Countries

Cross-Country Evidence

Composite Good Governance Indicators and Growth Rates1990-2003

-8

-6

-4

-2

0

2

4

6

8

10

0 10 20 30 40 50Average of World Bank Good Governance indicators

in 1990 (ranges from 0 to 50)

Gro

wth

Ra

te o

f P

er

Ca

pit

a G

DP

19

90

-20

03

Advanced Countries Diverging Developing Countries

Cross-Country Evidence

Composite Good Governance Indicators and Growth Rates1990-2003

-8

-6

-4

-2

0

2

4

6

8

10

0 10 20 30 40 50Average of World Bank Good Governance Indicators

in 1990 (ranges from 0 to 50)

Gro

wth

Rat

e o

f P

er C

apit

a G

DP

199

0-20

03

Advanced Countries Converging Developing Countries Diverging Developing Countries

Growth-Enhancing Governance versus Good Governance

3. Advanced Capitalist Countries

1. Diverging Developing Countries

Gro

wth

Rat

es

Good Governance Score(Democracy, Corruption,

Stability of Property Rights)

2. Converging Developing Countries

Regression Line

Reforms suggestedby Good Governance

Regression Line

Governance Capabilities that can trigger and sustain growth

Reforms that

sustain growth and

political stability in

successful transformation

societies

Structural Constraints Facing Property Rights in Developing countries

Stabilizing and protecting property rights is costly and assumes that most assets are already productive.

Absence of tacit knowledge about modern production and associated low productivity requires business-government relationships to support ‘learning’

The demand for political redistribution outstrips supply of fiscal resources: political stability requires off-budget resource allocations (patron-client politics)

Stable property rights are absent in ALL developing countries

Achieving stable property rights across the board infeasible in developing countries

Evidence from the transformational states in East Asia and China: Developmental states did not attempt to enforce all property rights equally at early stages of development

Prioritized protection of rights of critical growth sectors/investors and vulnerable groups with appropriate enforcement capabilities

Corrected allocations of assets that could not be corrected by inefficient markets (using land reform, land acquisition, zoning laws, often using informal processes)

Institutions and politics created incentives for primitive accumulators to invest in productive activities

Low grow th deve lopers have ins titu tiona l and po litica l cond itions

that lead to the p ro tec tion o f g row th-reduc ing ren ts

H igh g row th deve lope rs have ins titu tiona l and po litica l capabilities

to c reate grow th -enhanc ing rents and rem ove g row th -reduc ing ren ts

A LL C O U N T R IE S T H E R E F O R E H AV E E X T E N S IV E R E N T S E E K IN G In deve lop ing coun tries the sca le o f the transition and the low leg itim acy o f

ex is ting righ t-ho lde rs m eans illega l rent seek ing (co rruption ) is the no rm

Rents, Rent seeking and Corruption endemic in ALL developing countries

R ents a re increm en ta l incom es c reated by specific ins titu tiona l a rrangem en ts and a re endem ic in A LL m arke t econom ies

R en ts can s igna l e ffic iency and /o r g row th or the reve rse

R ents a re c rea ted and p ro tec ted th rough ren t seeking

The catching up problem

Credibility of withdrawal and effort

If effort is high, investments in learning are viable.

But if the financier lacks the credibility to withdraw effort may be so low that a subsidy is permanently required

Rents and Catching Up

Catching up and the Learning Problem: Effective entrepreneurs and technological capabilities do not exist

Simply offering market opportunities to existing entrepreneurs usually has no effect

Subsidizing infant industries does not work either. Support has to be matched with effective governance capabilities so that entrepreneurs have the opportunity AND the compulsion to learn

The new governance consensus sees no role for assisting catching up. WTO and bilateral trade agreements rule out assistance

Successful countries demonstrate that the development of technological and entrepreneurial capacity happens through temporary rents with matching governance capabilities that ensure that incentives and compulsions for learning are high

Rent seeking/corruption appears as a “malign” process that protects the

inefficient and the socially powerful

Failed Implementation/Permanent Rent Capture

by “Infant” Industries

Rent seeking/corruption appears as “benign” profit-sharing with public

officials (South Korea, China)

Effective Rent-Management/Credible

Exit Strategies

Strategies of rent capture/subsidization in sectors attempting catching up

Successful catching up may co-exist with rent seeking and corruption

Productivity gap preventing moves up the

technology ladder

Democracy is desirable but is based on patron-client politics in LDCs

Democracy in Advanced and Developing Countries

Democracy in advanced countries is characterized by powerful feedbacks between the economy and politics

A broad-based productive (capitalist) sector exists: there are many significant taxpaying productive enterprises

In the system as a whole, economic power and political power are ‘aligned’: if political distribution hurts the viability or limits of tolerance of productive sector, powerful feedbacks begin to correct this

In developing countries, a broad-based productive sector does not exist and the political power of the formal productive sector is low compared to other organizers of political power

Economic and political power are not aligned: Political stability cannot be fully achieved through formal politics (like fiscal redistribution) and informal (patron-client) politics is both normal and necessary

Growth-enhancing governance capabilities

Property Rights Rents and Rent seeking Political Stabilization

for Technology Acquisition

Dynamic Transformation States (possessing governance capabilities for growth)

Slow or Unsustainable Transformations(absence of governance capabilities for growth)

Protection and transfer of rights to unproductive groupsDestruction or loss of rights of productive groups(absence of capabilities to discipline politically powerful)

Fails to maintain systemic stability orresults in damaging property rights or rent outcomes

Protection, creation and transfer of rights to productive groupsDestruction or loss of rights of unproductive groups(ex post flexibility)

Provides sufficient systemic stability andallows productive outcomes in property rights and rents

Business-government relationships allow emerging entrepreneurs to engage in catching-up strategies(effective rent management capabilities)

Political interests and weak institutions protect growth-reducing rents AND fail to protect or manage growth-enhancing rents(state lacks capabilities to prevent rent capture)

Market-led growth strategies are working in some countries but they remain vulnerable

SU S T A I N A BL E C A T C H I N G - U P

ST R A T E G I E S

Strateg ies o f accelerated learn ing and catch ing up effective po litica l capacities o f rent-m anagem ent to ensure rents are tim e-

bound and w ithdrawn from non-perform ers

with Susta inable grow th driven by h igh

rates o f accum ulation sustained productiv ity grow th

and

U N S U ST A I N A BL E C A T C H I N G - U P

ST R A T E G I E S

Strategies of accelerated learn ing and catch ing up effective po litica l

capac ities o f rent-m anagem ent without

G row th in itia lly driven by h igh rates of accum ulation but eventua lly

unsus ta inable

M A R K E T - L E D ST R A T E G I E S

Strategies of in tegrating in to g lobal m arkets using already existing technical com petence

Low grow th in countries w ith low com petitiveness across the board

H igh grow th in countries w ith niches of in ternational com petitiveness but lim ited to a few sectors and typ ica lly

w ith low productiv ity grow th

Research and Policy Agenda

The goals of good governance are desirable in themselves but as a reform agenda for the state it asks limited/wrong questions and gives the wrong answers to these questions

The starting point must be an analysis of how the organization of political power in particular countries has allowed some types of value-enhancing economic transformations but not in others

Incremental Reform has to a) work with existing power structures to identify political and institutional changes that allow better management of property rights in critical areas, more effective political stabilization and more effective technological catching up.

In many cases this will open up national debates and dialogue on b) changing the organization of political power to achieve better developmental prospects. This is a more radical task and can only be undertaken by insiders drawing on an understanding of comparative history and their assessment of domestic political possibilities and their own values