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Governance and Growth: Overview of Evidence, Alternative Research and Policy Responses

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Title: Governance and Growth: Overview of Evidence, Alternative Research and Policy Responses


1
Governance and Growth Overview of
Evidence, Alternative Research and Policy
Responses
  • Mushtaq H. Khan,
  • Department of Economics, SOAS
  • Governance for Growth Workshop, Russell Hotel
    July 2-3 2007

2
Governance, good governance and the state
Governance as a reform priority emerged in the
1970s and 1980s when the economic failure of many
undemocratic and corrupt regimes in developing
countries could no longer be ignored Criticisms
from developing country civil society were soon
joined by the development community and
mainstream economists The result was the good
governance agenda improving accountability, the
control of corruption and rent seeking, the
protection and stabilization of property rights,
and improving the rule of law
3
Institutions, rules and governance
Douglass North defined institutions as rules, but
he also pointed out that the existence of a rule
does not mean it can be enforced The debate on
governance is sometimes about the particular
rules that should be enforced, and sometimes
about improving the governance capabilities that
allow the enforcement of these rules The two
issues are closely connected because if a
particular set of rules cannot be enforced, their
appropriateness as a policy priority can be
questioned
4
Sources of support for good governance reforms

Civil society in developing countries often
supports the enforcement of these rules on the
grounds that many are highly desirable goals in
themselves Fiduciary responsibility of donor
agencies has driven concerns about corruption and
the diversion of resources focus on PFM,
anti-corruption strategies and accountability
Our concern is with theory and evidence on the
relationship between better enforcement of good
governance institutions and economic growth
Even if good governance institutions are
desirable, Is the reform agenda implementable to
any significant extent? Are these institutions
and governance capabilities the right priorities
for growth?
5
Background theory Institutional Economics and
Transaction Costs
Douglass North Market transaction costs depend
on how well-protected property rights are, and on
the institutions protecting contracts (the rule
of law) Reducing market transaction costs
reduces market failures and accelerates
investment and growth Efficient market
economies therefore require reforms to improve
the protection of property rights and establish
an effective rule of law
6
Rent-seeking and state intervention
State intervention (like the operation of
markets) is not costless Krueger, Bhagwati,
Posner and others argued there were significant
rent-seeking costs whenever states
intervened The early recommendation was
liberalization if the state did not create rents
there would be no rent seeking Today there is a
recognition that many state services are
critical so the focus is on reducing
rent-seeking costs in critical areas by fighting
corruption and improving accountability
7
New political economy the incentives of
political actors
Politics identified both as a platform for rent
seeking and a competitive constraint on rent
seekers Olsons work on stationary bandits and
democracy Democracy limits rent seeking in
developing countries (but not necessarily
advanced ones!) Models of neo-patrimonialism in
Africa argued that the absence of democracy
allowed big men to use clientelism to sustain
their power at the expense of high levels of
corruption and property right instability
Emerging policy support for democracy and
decentralization as conditions for efficient
markets and low rent seeking
8
The New Policy Agenda
9
The Governance-Growth Debates
  • The debate on theory and evidence focuses on 3
    questions
  • Are these institutions and their proper
    enforcement desirable goals or are they also
    necessary preconditions for development?
  • Even if in theory effective enforcement of these
    institutions would enhance growth, to what extent
    are they achievable in the typical developing
    country?
  • 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?

10
Governance and Growth the Evidence
11
Rule of Law and Growth
12
State Capabilities and Reform Priorities
13
Which governance capabilities to target and
how to measure progress
How to measure governance has taken up a lot of
time, particularly with critiques of the
Kaufmann-Kray indicators and their
responses More important question is are we
focusing on achievable institutions and
governance capabilities required for their
enforcement The broader debate on the evidence
is covered in Hazel Grays literature review
14
Theory reconsidered Transaction Costs
Norths analysis has implications that are often
ignored reducing transaction costs is costly and
all economies (including the US) have high levels
of aggregate expenditure on transaction
sectors When the productive sector is small,
individual capitalists may want stable property
rights but are rationally unwilling to pay high
taxes because they know they will still have to
separately protect their individual rights And
if market transaction costs remain high,
individual capitalists have to devise non-market
arrangements to acquire the assets and resources
they need The focus on property rights stability
across the board is immediately unachievable and
may be ignoring reforms that are likely to
actually make a difference
15
Stable property rights may be unachievable in
developing countries
Evidence from the transformational states of East
Asia and China shows a different set of de facto
institutions property right stability focused on
growth-generating investors and governance
capabilities for enforcing these At the same
time formal and informal institutions for
non-market transfers of assets were common and
were usually growth enhancing Keefer points out
that the same property right stability score
could hide significantly different property right
protection strategies Moore and Schmitz,
Sayeed Close relationships between business and
political power brokers are common in developing
countries, in some cases they result in growth,
in others they result in the collusion Adam Smith
warned of
16
Rents, rent seeking and corruption
Early rent seeking theories also have serious
shortcomings they focus on the rent seeking cost
and not on the types of rents Stiglitz and many
others have shown that a vast range of rents are
essential for the proper functioning of market
economies Many rents are damaging, other rents
are second-best responses to market failures that
would be even worse without the rents Some
recent research has looked at the damaging
incentives created by natural resource rents and
aid (Moore, Keefer) Issues here are whether the
best response is to try and reduce these rents or
improve the institutional and governance
capacities of the recipient to use these rents
effectively (Dijohn, Khan)
17
Rents, rent seeking and corruption
However, a much wider range of rents can evolve
in developing countries and we need to build on
the extensive analysis of rents Rents are
typically created (and protected) through
rent-seeking activities but many rents may have
positive effects for growth in a context of
pervasive market failure (Khan and Jomo) The
compatibility or otherwise of the political and
institutional structure and the requirements of
second-best efficiency for particular rents
define the success of otherwise of the rent
management system In this analysis, what
matters is the compatibility of the institutional
rules for second-best improvements and the
governance capabilities for their enforcement
18
Political stabilization is a very different
process in developing countries
Political stabilization is expensive and in
developing countries requires off-budget resource
allocations (Khan) As a result, honest
politicians find it difficult to get elected,
making the link between democracy,
accountability, anti-corruption and property
right stability weak or non-existent The
structure of patron-client networks (Khan) and
political organizations (Keefer) rather than
democracy and accountability can help to explain
differences in rent creation strategies North,
Wallis, Weingast and Webb are developing a model
of the Limited Access Order violence potential
in developing countries requires the creation of
rents to achieve stability potential governance
implications for developing countries
19
Links identified in new research
20
Policy Agenda
  • Donor concern about the theft of their money
    should not be confused with the challenge of
    governance reforms to accelerate development
  • If key parts of the good governance agenda are
    not easily implementable the agenda can damage
    the identification of other pragmatic
    capacity-building goals
  • The diagnostics of identifying market failures
    that are both important and can be addressed
    given political and institutional initial
    conditions involves judgements we should not
    expect a consensus on these difficult issues (but
    research has identified a range of alternative
    rules and governance capabilities that
    deserve attention)
  • Policy makers should not wait for an academic
    consensus they should also respond to theory,
    facts and their own experiences in developing
    countries

21
Some discussion points
  • The broad agenda of good governance does not
    necessarily have to be abandoned if we recognize
    the (very) long time scales required for its
    effective implementation
  • Identifying the immediate governance priorities
    for growth involves making political judgements
    A viable approach may be to encourage country
    stakeholders to identify the institutions and
    enforcement capacities that are required for the
    success of their growth strategies.
  • Specific donor concerns could support narrow
    governance interests such as PFM and other
    actionable indicators. Some of these reforms
    could contribute to growth provided they are
    complementary with and not a substitute for a
    growth strategy for the country
  • The debate about how to measure should not be
    confused with what to measure. The great
    contribution of WGI has been to keep governance
    at the centre of the policy debate
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