Key Terms and Debates in Governance and Development

Jonathan Di John

Key Definitions

• Institutions—rules of the game that govern human interaction

• Organizations- collective actors in pursuit of specific goals such as profit maximisation

• Governance--the exercise of political authority and the use of institutional resources to manage society's problems and affairs. The set of institutions that regulate the relations between state and citizens.

Property rights

• Property rights—define the rights over valuable assets that generate income flows.

• Jeremy Bentham on the function of property rights• a) preventing conflicts over resources—in the extreme

can take the form of civil war or international wars• b) creates stable expectations and encourages

investment and long-run planning.• c) prevents free-riding: “men who wish to enjoy

without giving themselves the trouble of producing.”

Governance indicators (World Bank)

• voice and accountability• political stability and lack of violence• government effectiveness• regulatory quality• rule of law• control of corruption.

Divergent Paths (North, 1990)

• Spain/L. America—centralized/authoritarian rule→monopolization of markets→arbitrary rule →fiscal instability and state appropriation→insecure property rights→relative economic stagnation

• England/N. America—decentralized, democratic, liberal state→competitive market→stable and predictable fiscal policies→ secure property rights→economic growth.

Post-Washington Consensus: Getting Institutions Right/The Good Governance Paradigm

Quotes from Stiglitz (reflecting on the shift in development thinking)

--“The Washington Consensus held that good economic

performance required liberalized trade, macroeconomic stability and getting prices right. Once the government handled these issues—essentially once the government got out of the way—private markets would produce efficient allocations and growth…But the policies advanced by the Washington consensus are hardly complete and sometimes misguided. Making markets work requires more than just low inflation, it requires sound financial regulation, competition policy, and policies to facilitate the transfer of technology, to name some fundamental issues neglected by the Washington Consensus.”

Growing List of Conditions (Rodrik, 2004)

Corruption and Development

Rents

• Portion of earnings in excess of the minimum amount needed to attract a worker to accept a particular job or a firm to enter a particular industry or activity

• Incomes which are higher than could be earned in the “next-best” use

• Super profits/wages

Rent-seeking: the mainstream approach

• a) competitive market—free entry & exit• b) competitive markets ensures lowest cost

producers• c) rents do not exist in the absence of political

intervention (except in the case of natural monopolies)

• d) the costs of establishing/maintaining property rights is low

Rent-seeking: the mainstream approach

• 1) State-created rents generate rent-seeking

• 2) rent-seeking costs represent the costs of creating, maintaining or changing monopolies and/or other restrictions on the market

Effects of rent-seeking in liberal market models

Rent-seekers(individuals and groups)

Public officials(parties, state)

A

B

Rent-seeking: bribes, lobbying, politicalexpenditures

Rents created: monopolies and damaging transfers

Effects of rent-seeking in liberal market models

• Economic cost of rent-seeking=

• 1) economic cost of resource wastage due to A

• 2) Economic cost of Damaging rents due to B

Costs of Corruption

• Insecure property rights (due to secrecy of the transactions). This makes corruption more of a distortion than taxation.

• Waste of resources

• Misallocation of resources

• Generates legitimacy problems for government

• Increases uncertainty

World Bank Anti-corruption strategies and diagnoses

• Corruption increases when:

• A) Higher “policy distortion index”

• B) Lower opportunity cost of being caught in the act of corruption (low civil servant salaries)

• C) less meritorcratic bureaucracy (leads to short-term time horizons for bureaucrats)

• D) lower predictability of judicial system (lower probability of getting caught and getting penalised)

1. Restrict Centralised Discretionary State Control over Resource Allocation

WHY? a) Rent-seeing, corruption, waste (Influencing)b) Insecure property rights (Abuse)

2. Mechanisms to check the Predatory Statea) Economic Liberalisation (reduces possibility of state-

created rents)b) Democratisation, Decentralisation (introduces

political competition, improves accountability and transparency which should reduce corruption)

The Logic of Governance Reforms

Getting Prices and Institutions Right

GOOD GOVERNANCE

Secure Property Rights

Increase Investment

Increase Growth

REDUCES POVERTY

A RETURN TO THE PRE-REQUISITE VIEW OF DEVELOPMENT

FREE TRADE “Getting Prices Right”

Rent-seeking: an alternative view

• Rent seeking is the expenditure of resources to influence and capture the state in order to acquire or retain the rights associated with rents

• Legal rent-seeking –lobbying, legal contributions to political parties, the time spent on these activities

• Informal rent-seeking –patron-client networks

• Illegal rent-seeking (corruption) an illegal exchange between a public official and an individual or firm, where in exchange for a bribe, a public official provides a benefit not otherwise available to the briber.

• Violent rent-seeking (e.g.- rebellion, civil war)

The Logic of Subsidy in Late Developers

• backward institutional environment/infrastructure —implicit subsidy to producers in more advanced countries (first-mover advantage)

• learning-by-doing (Arrow, 1962) means that producers in LDC’s at disadvantage since earlier developers have more experience

• asset-specific firm investments over time generate rents for firms with experience

\ Late Development (especially Late Industrialization) is inherently RISKY.

Role of the State: Socialize Risk and Induce Risk Taking and Learning

The outcome of the rent-seeking and corruption process can differ depending on the conditions under which rents are allocated.

• Consider two scenarios.

• In Scenario A, rents are allocated to an inefficient crony and subsidies are perpetuated regardless of performance criteria.

• In Scenario B, rents are allocated to political insiders, but are open to competitive bribery, and are subject to performance criteria.

• In case B, it is not only likely that the more efficient crony capitalist will obtain the rent but because the maintenance of subsidies is tied to some performance criteria (such as productivity growth or export targets), there are incentives for the rent recipient to maximize the growth potential of the firm.

Rights, Rents and Rent-seeking

Conventional Production Process

Rent-Seeking Process

Inputs used in production(Land, Capital and Labour)

Final Outputs (goods and services)

Inputs used in Rent-Seeking (Rent-Seeking Cost: inputs used in Lobbying, Political Activity including Bribery and other

Influencing Activities).

Rent Outcomes: Economic Rights are created, maintained, destroyed

or transferred to create specific rents (e.g. licenses allocated,

monopolies and subsidies granted, property rights created.

NET EFFECT

=Net Social

Benefit with Rent Outcome

-Cost of Inputs used

in Rent-Seeking (Rent-Seeking Cost)

Assessing the Evidence• Liberalisation (and especially privatisation) has not reduced corruption

• Higher salaries to bureaucrats not usually associated with declines in corruption

• Decentralisation not generally effective in reducing corruptiona) local politicians often lack resources to sanction

bureaucratsb) local press less effective in magnifting corruption scandals

• Democracy not correlated with lower corruption in LDC’s

Good governance, state capacity and capitalist transformation

Governance Indicators

Rate of Growth

2. Small number of High-growth Developers

Likely historical path of capitalist development

Regression Line 3. Most Industrialized Countries1. Most

Developing Countries

Policy path suggested by the econometric relationship+ve

-ve

Political Economy of Rents and Rent-Seeking

1. Rents = monopoly profits = SUBSIDY2. Rents RISKS3. Rent-Seeking – Influencing Activities to maintain, create and change

rights.4. Rent outcomes – Net benefits associated with the maintenance, change

and creation of rights. 5. IMPORTANT CONDITIONS TO UNDERSTAND THE EFFECTS OF

RENT-SEEKING AND STATE-CREATED RENTS:• Motivations of leaders• Performance Criteria, Disciplinary Power of the State• Selectivity of Rent Development• Security of Growth-enhancing property rights.

Transformation Model of the State in LDC’s

• State does not only provide services and social order

• State active agent in the construction of capitalism in late developers

• Transition to capitalism and primitive accumulation unjust, divisive, corrupt process

• State needs to create rents/patronage to:• a) construct capitalism and subsidize late development• b) maintain political stability

• Corruption likely to accompany this process. Why?1) less legal rent-seeking in place2) construction of capitalism arbitrary3)| Demand for rights/rents much greater than supply4) legitimacy crises add to the perception that corruption is widespread

Reducing the agenda

STRATEGIES• Assess historical record of good enough

governance in now developed countries and developing countries that have achieved good enough governance

• Ask questions about what’s working, the roots of problems, the dynamics of change

• Set priorities strategically

• Aggregate Governance Indicators are Misleading in light of the Differential Capacity Across State Functions within Countries

Nature of Elite Bargains Matter.

• The principal solution through history to the classic Hobbesian problem of endemic violence is the creation of what Nortth et al (2007) call limited access orders (as opposed to the much rarer, open access orders, which characterizes advanced market economies).

• The limited access order creates limits on the access to valuable political and economic functions as a way to generate rents.

• When powerful individuals and groups become privileged insiders and thus possess rents relative to those individuals and groups excluded (and since violence threatens or reduces those rents), the existence of rents makes it in the interest of the ‘privileged insiders’ to cooperate with the coalition in power rather than to fight.

Political Organisations and the Structure of Patronage

• the degree of centralised rule and patronage matters for political stability

• Here, a cursory examination of relatively peaceful polities (Tanzania, Zambia) and those where the state survived even during civil war (Mozambique, Colombia) suggests that:

• the construction of political organisations, particularly political parties, has been central to providing the institutional mechanisms of distributing patronage to regional elites and to important political constituencies in ways that either prevent challenges to authority and/or maintain cohesion of the ruling coalition

National political organisations and the centralisation of patronage

• Enables the executive to have an encompassing interest in the maintenance of political stability

• Limits the extent to which the executive engages in predatory behaviour

• Enables the creation of a loyal and unified military

• Makes the cost of elite exit and rebellion higher

• Allows for the management of adverse economic shocks and crises in ways that does not generate state breakdown