There are several reasons why growth and development have been uneven across countries and over time: high income inequality; state capture by elites and powerful groups; weak state and private institutions related to perennial problems of corruption, rule of law, property rights, and capacity to formulate and implement policies; and “lack of a regional growth pole.” Several of these factors are interrelated. For example, high income inequality could coincide with higher state capture and higher levels of perceived corruption. These bottlenecks to development are detailed below.
SECTION Why Is Development Blocked? Raj Nallari There are several reasons why growth and development have been uneven across countries and over time: high income inequality; state capture by elites and powerful groups; weak state and private institutions related to perennial problems of corruption, rule of law, property rights, and capacity to formulate and implement policies; and “lack of a regional growth pole.” Several of these factors are interrelated For example, high income inequality could coincide with higher state capture and higher levels of perceived corruption These bottlenecks to development are detailed below Regional Growth Pole Helps Spur Development Akamatsu (1962), the Japanese scholar, developed the “Flying Geese Paradigm” to explain technological development in Southeast Asia Embraced also by Kojima (2000), the paradigm views Japan as a leading power—the lead “goose” with the other countries in the region aligned in a “wild geese” pattern, based on their differing stages of growth As the lead nation moves out of labor-intensive production to capital-intensive production, its low-productivity production moves down the hierarchy and the pattern repeats itself This model of comparative advantage described 55 Figure 6.1 Regional Growth Poles Newly industrializing economies Japan Association of Southeast Asian Nations China Vietnam Source: Author’s illustration the economic development of Japan, the second-tier of nations consisting of the new industrializing economies of the Republic of Korea; China; Taiwan, China; Singapore; and Hong Kong SAR, China, followed by the main countries of the Association of Southeast Asian Nations (the Philippines, Indonesia, Thailand, and Malaysia, with China and Vietnam at the rear) (figure 6.1) The paradigm depended on the catalytic role of Japan as the lead nation It is difficult to identify lead nations in other developing regions of the world High-Income Inequality Constrains Economic and Political Development There is now enough evidence that in a country with relatively higher income and wealth inequality, the incumbent government (1) resorts to redistributive policies to maintain political and social stability; and (2) is faced with credit market imperfections as powerful groups corner the credit flows, thus impeding the formation of both physical and human capital among the have-nots For example, Sachs (1989) finds that Latin American and Caribbean countries have higher income equality than other regions, and this is deterring their economic development Persson and Tabellini (1994) find that, indeed, a relatively equal distribution does have a positive impact on economic growth in democratic countries Poor Institutions To trace the variety of institutions prevailing in postcolonial nations, Acemoglu, Johnson, and Robinson (2002) estimate the effect of institutions on economic performance, based on differences in European mortality rates Where Europeans faced high mortality rates, due to an adverse climate or disease environment, institutions tend to be extractive Colonizers were 56 Frontiers in Development Policy unable to settle in these areas and thus concentrated on extracting as much and as many of the resources as possible, without developing institutions to protect property or to limit government expropriation In areas where climate was favorable and the disease environment was manageable, colonizers facing lower mortality rates had incentives to develop institutions that protected property rights and enforced checks and balances on government Europeans settled in large numbers in the United States, Canada, and Australia, where climate was favorable Institutions conducive to growth evolved The fate of much of Africa was very different, however Even after the demise of colonialism, extractive institutions prevailed In a separate article, Acemoglu, Johnson, and Robinson (2002) note the exceptional case of Botswana, where due its unfavorable geographic location, the colonial masters did not tamper with the local tradition of checks and balances This fostered democracy and sustained economic growth According to North and Weingast (1989), British institutions were better in fostering growth because of superior commercial law Consequently, British settler-colonies fared better eventually Latin America was a Spanish and Portuguese colony Similar to their colonial masters, these nations had regulatory monopolies, which prevailed well into current times and impeded growth Despite the same initial advantage during 19th century, each continent was led to a different predicament during the next 100 years or so Formal Rules Are Required for Development During the 11th century, the West was far behind in almost all dimensions, compared with Islamic and Chinese civilizations; but industrialization took place in Great Britain and not elsewhere Greif (1989, 1994) makes a compelling argument that juxtaposes the individualistic nature of the West with the collaborative nature of the East Contracts in the West were mostly bilateral, compared with multilateral contracts in the Muslim world Even though initially efficient, multilateral contracts prevented the formation of formal legal institutions The absence of formal legal institutions forced trade to take place within a certain community This curtailed the growth of exchanges farther afield Bilateral transactions did not enforce communal ties; therefore, the society had greater need to build formal laws and regulations that eventually fostered economic growth Why Is Development Blocked? 57 Perennial Crisis in Governance Destabilizes Development What we learn from the troubles of modern-day corporations? These are the most sophisticated corporations ever formed, yet they are victims of their own governance failures Public sector governance problems are known from time immemorial The first description of state governance problems in the form of bribery, corruption, and other misgovernance is attributed to Patañjali, who lived in India around 53 CE Conversely, corporate governance problems are relatively recent With the industrial revolution came the need for a corporation to organize and manage capital and labor The board of directors, by law, is given full authority in a corporation In the initial days of industrialization, the family-owned corporation had family members on its board However, as the corporations became more complex over time, the board has occupied more a role of overseeing the management team (comprising chief executive and financial officers) This is the problem of principal-agent, where the agent (management team) usurps power from the principal (board of directors and shareholders) The oversight function has been diluted further, owing to the complexity of business transactions and the managers often providing obfuscation In addition, more and more boards are stacked with insiders and friends As a result, we have reached a stage in several big and small corporations where there is a crisis in corporate governance The recent financial crisis is but one manifestation of this corporate crisis, where complexity is deliberately created in the name of financial innovation that, in turn, obfuscates information given to the board of directors, stakeholders, and the public The crisis in corporate governance is compounded by public sector governance where politicians and bureaucrats are influenced by the large corporations State capture is defined by Hellman et al (2000) as the “propensity of firms to shape the underlying rules of the game by ‘purchasing’ decrees, legislation, and influence at the central bank, which is found to be prevalent in a number of transition economies” (p i) This “shaping” may be done not only by the private firms or richer elites (top 20 percent on the income distribution scale), but also by ethnic groups or powerful economic groups in some countries As such, to fully understand the dynamics of state capture, the analysis must be based on winners and losers—not only in terms of income groups, but also in terms of powerful groups and vested interests (including bureaucracy) In almost all the countries, this argument of state capture by a small group of corporations or elites appears to hold because these elites have been colluding with politicians and, with the help of 58 Frontiers in Development Policy bureaucracy, extracting rents rather than investing in productive activities (which Eifert and Gelb 2005 call “low-level political equilibrium”) Private investment and growth are higher in stronger states than in weaker states, and garnering of subsidies by the elites is relatively lower Countries that are “highly captured” may exhibit capture of all or most institutions—such as parliament, political parties, the executives (including ministries and public enterprises), judicial courts, and bureaucrats Firms and groups that cannot compete with favored firms or accommodated groups will go under or have no choice but to resort to “informality” or “unofficialdom” and a “shadow financial system.” By choosing to be in the shadows, these informal enterprises are able to circumvent government regulations relating to property rights, labor laws (such as minimum wages and workers’ safety restrictions), environmental regulations, price controls, and licensing and to avoid taxes and fees To avoid the costs arising from detection and punishment for operating informally (usually illegally), the big corporations and informal enterprises operate through “trust” in the form of transactions, based on reputation, among closed networks of customers and suppliers Political development is blocked by the elites and powerful groups Acemoglu and Johnson (2007) studies a number of countries and finds that the movement from dictatorship or authoritarianism to democracy is blocked by groups that benefit from the status quo In such societies, the reward structure favors the elites Only when there is outside pressure (for example, from donors) or when the vast majority of citizens take to the streets will there be some concessions made to ease restrictions, reduce rent-seeking, and change the reward structure to promote incentives for the many—not just the few There has to be a continuous pressure exerted on closed regimes to provide more equitable services and develop institutions that provide incentives Enlightened leadership and coalition building in civil society (that emphasizes social accountability) can bring forth change agents and place a country on a path of gradual reforms and opening up In Conclusion Growth and development have been uneven over time and across countries Some of the issues considered here—high income inequality, state capture by elites and powerful groups, weak state and private institutions, and the “lack of a regional growth pole”—highlight this disparity in growth and development Why Is Development Blocked? 59 References Acemoglu, D., and S Johnson 2007 “Disease and Development: The Effect of Life Expectancy on Economic Growth.” Journal of Political Economy 115 (6): 925–85 Acemodlu, D., S Johnson, and J A Robinson 2002 “Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution.” Quarterly Journal of Economics 117 (4): 1231–94 Akamatsu, K 1962 “A Historical Pattern of Economic Growth in Developing Countries.” Developing Economies (Suppl 1): 3–25 Eifert, B., and A Gelb 2005 “Coping with Aid Volatility.” Finance and Development 42 (3): 24–27 Greif, A 1989 “Reputation and Coalitions in Medieval Trade: Evidence on the Maghribi Traders.” Journal of Economic History 49 (4): 857–82 ——— 1994 “Cultural Beliefs and the Organization of Society: An Historical and Theoretical Reflection on Collectivist and Individualist Societies.” Journal of Political Economy 102 (5): 912–50 Hellman, J., G Jones, D Kaufmann, and M Schankerman 2000 “Measuring Governance, Corruption, and State Capture: How Firms and Bureaucrats Shape the Business Environment in Transition Economies.” Policy Research Working Paper 2312, World Bank, Washington, DC Kojima, K 2000 “The ‘Flying Geese’ model of Asian Economic Development: Origin, Theoretical Extensions, and Regional Policy Implications.” Journal of Asian Economics 11: 375–401 North, D C., and B R Weingast 1989 “Constitutions and Credible Commitment: The Evolution of the Institutions of Public Choice in 17th Century England.” Journal of Economic History 49 (4): 803–32 Persson, T., and G Tabellini 1994 “Is Inequality Harmful for Growth?” American Economic Review 84: 600–21 Sachs, J 1989 “Social Conflict and Populist Policies in Latin America.” Working Paper 2897, National Bureau for Economic Research, Cambridge, MA 60 Frontiers in Development Policy ... small corporations where there is a crisis in corporate governance The recent financial crisis is but one manifestation of this corporate crisis, where complexity is deliberately created in the... regional growth pole”—highlight this disparity in growth and development Why Is Development Blocked? 59 References Acemoglu, D., and S Johnson 2007 “Disease and Development: The Effect of Life... economic growth Why Is Development Blocked? 57 Perennial Crisis in Governance Destabilizes Development What we learn from the troubles of modern-day corporations? These are the most sophisticated corporations