Role of institutions in economic development

  • by

Notwithstanding the disillusion with government, it is, however, an indisputable fact that a liberal market oriented economy can yield positive results in a milieu characterised by good governance and effective institutions

No theme in contemporary history of man has aroused such debate and controversy as the subject of development. The subject has been explored and examined from every possible angle and in all its dimensions. There are conferences and seminars galore on the subject and every year thousands of entries are added to the bibliography.

At present, notwithstanding varying approaches to development, there is widespread agreement among economists which is endorsed by international institutions about the supreme importance of strong and effective institutions for ensuring good governance and promoting growth with equity and stability.

Institutions refer to norms, rules of conduct and to well defined and formal organisations that govern the way the society operates e.g. the role of the state in economic life, the administrative system, mechanism of getting into power, laws relating to private property and contracts, agencies for regulating economic and financial system, educational structure, labour market relationships, laws of taxation and inheritance and arrangements for provision of credit.

It has now become crystal clear that many problems of the developing world can be attributed to the rot that has set in the institutional framework of society. Institutional erosion has to be stopped, renovation should be undertaken where possible and innovation where necessary. Without weakening the state system, the political system in many developing countries needs to be renovated so that it reflects and attends to aspirations of the people. It should have built in self correctives so that non-performers do not endure on the basis of worthless slogans and empty promises. At the same time, functionally specific associational groups will have to be developed in different areas of life.

The dominant development paradigm in the quarter century after World War-II assigned a major role to the state in poor lands by assuming the state to have certain characteristics that it turned out not to have. In the name of planning, regulatory systems for allocating resources were created. In exercising such controls, quantitative restrictions rather than price based measures were most often used. A chaotic incentive structure and the unleashing of rapacious rent seeking and resource diversion were the outcomes.

Free market policies in recent years have received powerful support from the International Monetary Fund (IMF) and the World Bank. A large number of countries which are receiving assistance from IMF under its Poverty Reduction and Growth Facility (PRGF), and sector adjustment loans from the World Bank have to abide by the conditionality of pulling back the interventionist state.

Notwithstanding the disillusion with government, it is, however, an indisputable fact that a liberal market oriented economy can yield positive results in a milieu characterised by good governance and effective institutions.

Governance may be taken as connoting how the affairs of the state are administered and regulated. It implies that public authorities play an indispensable and creative role in establishing an environment conducive to growth and in determining an equitable distribution of assets and benefits.

Furthermore, there should be adequate funding for capacity building of institutions that provide social safety nets for the vulnerable and the poor.

An essential feature of good governance is an efficient system of public administration.

The successful carrying out of the tasks of both development and democratisation requires on the part of administrators not only qualities of initiative, leadership and taking of responsibility but also emotional and intellectual integration into what may be called enlightened social values i.e. habits of democratic thought and living and of subordinating sectoral interests to considerations of public good.

An area of special significance for good governance is that of regulatory administration particularly for the financial sector where fraud and unsound management have profoundly destabilising consequences for the economy. Regulatory administration is the main instrument available to the government to enforce compliance with the nationally established standards in various economic and social spheres and with national development objectives.

The regulatory systems have to be designed and constantly watched to ensure that these activities do not become conservative or begin to create bottlenecks in the development process.

Notwithstanding the dominant role of the private sector in Pakistan and a large number of Third World countries, the government’s role in providing some public goods and services and in framing the basic rules of economic activity in terms of safety, protecting the vulnerable segments of society and maintaining a non-distortion policy including macro-economic stability continues to be important.

The World Bank in its 1997 Development Report has indicated that the government can improve development outcomes in the following ways:

(i) By providing macro-economic and micro-economic environment that sets the right incentives for efficient economic activity, (ii) by providing institutional infra-structure – property rights, peace and order and rules that encourage long-term investments, and (iii) by ensuring the provision of basic health, education and physical infrastructure required for economic activity.

The Report has emphasised that the largest source of state inflicted damage is uncertainty. If the state changes the rules often and does not clarify the rules by which the state itself will behave, businesses and individuals will adopt costly strategies to insure against an uncertain future by entering into informal economy for example or sending capital abroad, all of which would impede development.

The 2003 World Development Report has highlighted the importance of institutions such as property rights and rule of law for the efficient operation of markets and the creation of human made assets. The report has emphasised the need for the creation of institutions to ensure an adequate supply of assets that are not spontaneously provided by markets: environmental assets (clean water, clean air, fisheries and forestries) and social assets (mutual trust, ability to network and security of persons and property).

Furthermore, the Report urges the government to create competent institutions for coordination of pick-up signals about problems, and for formulating and executing policies in a transparent and accountable fashion.

There is now general consensus that the governments should move from doing too many things inefficiently to doing essential tasks competently and honestly.


Leave a Reply