institutions and economic growth

Written by Afifa Iqbal 12:32 pm

The Nexus Between Institutions and Economic Growth

Institutions, specifically good/inclusive ones and those from Europe and North America, have been synonymous with economic growth. Afifa Iqbal proposes to eliminate the dichotomous view of institutions and instead, pay attention to the dynamics between the concerned state and society, the socio-political realities, and the historical entanglements.
Gul Seema
About the Author(s)
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Ms Afifa Iqbal has a keen interest in identity politics, colonialism and post-colonial development. She is currently working as a Research Assistant at ITU while pursuing her postgraduate studies in Development, Technology and Policy. She is a Gold Medalist in Political Science from the University of Punjab.

Introduction

For centuries, economists have been obsessed with growth and development. Adam Smith’s “Wealth of Nations” can be regarded as the classical theory of growth. The advent of the industrial age and the subsequent development of Western Europe and its institutions accentuated this focus on economic growth.

Simultaneously, many economists tried to explain why certain regions and countries were able to industrialize and develop while other regions and countries lagged behind. In reality, this meant explaining the increasing gap between Western Europe and the rest of the world from the 18th century onwards. Some argued that climate was linked with growth, while others attempted to explain growth through culture.

A third view claimed that wrong policies were the original sin of the underdeveloped regions and countries. However, no view gained as much traction as the essentiality of good/inclusive institutions for economic growth. From development economists to international development agencies, this view was heralded as the panacea for the economic malaises of the underdeveloped/developing countries.

However, it universalized the European and North American institutions as the model institutions and hence failed to take into account the complex historical processes and socio-political configurations of the aforementioned countries. Hence, a new framework is required to understand and kickstart growth in underdeveloped/developing countries. Yuen Yuen Ang’s work on the political economy of China presents such an alternative view.

Are Inclusive Institutions Really a Pre-requisite for Growth?

While the aforementioned views held sway among the economists for a particular time period, they started losing their appeal due to multiple reasons: racist and Eurocentric undertones, static conception of dynamic factors i.e. culture, and weak arguments. In such a situation, institutional economics appeared to have the answers to the growth question that befuddled economists for centuries.

This school of thought argued that good institutions were necessary for growth. As Douglass North stated; “Institutions are a set of rules, compliance procedures and moral and ethical behavioural norms designed to constrain the behaviour of individuals in the interests of maximising the wealth or utility of the principals.”

This particular view of institutions-as-basis-for-growth was critiqued for missing out on the subtle nuances of the lived reality. Economists Pande and Udry argued that the institutions are not necessarily “designed” and in case an attempt is made to do so, the institutions thus created do not always carry out the same agenda as was intended at their creation.

The conception essentially perceives that institutions operate in an ergodic world; a world which changes at a consistent rate, rather than the non-ergodic world; an erratically and inconsistently changing world.  Moreover, “moral and ethical” behaviour is often derived from the informal institutions like religion and caste which in turn determine the standard and sustainability of formal institutions like schools, healthcare, rules governing economic activity, etc.

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In other words, de jure power ends up legitimizing de facto power. For instance, Jim Crow laws ended up legitimizing the racist (de facto) tendencies of American society at that time period. Pande and Udry argue that focus should be placed on de facto institutions (informal) rather than de jure ones. Acemoglu and Robison’s “Why Nations Fail” explores how bad institutions create arrested growth.

Instead of looking at the right policies or the right institutions, they study the wrong policies and bad institutions. Their basic argument is that a country’s growth prospects are directly linked to institutions. The creation of these institutions, in turn, depends on socio-political arrangements which devise certain incentive structures which end up influencing the economic activity.

Since these socio-political arrangements are rooted in history, development is path-dependent. Put differently, bad or extractive institutions exclude the majority of the population from economic and political decision-making and distort the incentive structures in favour of the few. Inclusive institutions are the polar opposite. These institutions protect property rights, rule of law, innovation and adaption.

Since the elites benefit from the distorted incentive structure, they will actively resist the reform efforts. In such a case, political coalitions married to reform and the creation of inclusive institutions should be supported since they offer the best shot at changing the status quo. The recent spin on this essentialist argument about institutions-as-requirement-for-growth comes from the World Bank.

A specific set of institutions is listed as a prerequisite for growth in World Bank’s good governance agenda. Well-defined and well-protected property rights (specifically intellectual property rights), free markets, impartial and meritocratic bureaucracy, rule of law, low corruption, high levels of transparency, and a well-functioning finance sector, constitute the list.

Why ‘Good’ Institutions Are Not Enough to Spearhead Growth?

The gospel of ‘good, inclusive’ institutions as the necessary condition of growth presents institutions as the panacea for all economic malaises of the underdeveloped countries. This overt magical thinking ignores the complicated histories, colonial baggage, and complex socio-political realities of the so-called ‘underdeveloped/developing’ countries.

Russian-born American economic historian, Alexander Gerschenkron in his seminal work titled, “Economic Backwardness in Historical Perspective”, critiques the Eurocentric conception of industrialization. This view conceives of industrialization, and by extension, economic growth and development, as a uniform process independent of time and space. In other words, economic growth follows a pattern and the institutions which made growth possible in Europe will do the same elsewhere.

Gerschenkron critiques this view and argues that the much-heralded institutions of growth in Europe might not produce the same results elsewhere. Moving forward, scholars like Acemoglu often fail to give a consistent definition of ‘good/inclusive’ institutions. The good/inclusive institutions of France might look very different from the good/inclusive institutions of Russia.

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Another important point to note is the inability of such authors to distinguish between good and bad institutions within a single country. For instance, the police in the US have well-documented exclusionary tendencies while the Defence Advanced Research Projects Agency (DARPA) played an important role in turbocharging the innovative tendencies. This implies that bad/exclusionary and good/inclusive institutions can exist simultaneously in a country and economic growth would still happen.

Having stated that, there is no ‘deinstitutionalized’ starting point when it comes to growth. Even the developed countries, initially, have so-called exclusionary/bad institutions at the beginning of their growth story. This entails that those institutions played an important role in initiating the growth processes. Put differently, they ought to have an internal and localized logic that made these institutions work.

Finally, none of these arguments can explain the economic growth of China. None of the institutions listed as a pre-requisite for growth existed in China. Without any clear and well-defined property rights, rule of law, or accountability, China became one of the fastest-growing countries.

Towards a New Approach to Economic Growth and Institutions

The aforementioned critique drives home the fact that institutions, as developed in Europe, are not the blueprint for growth, and the good/bad categorization of institutions should be rendered obsolete. Instead, attention should be paid to the co-evolution of institutions with economic growth and development across the spatio-temporal plane.

Political Scientist, Yuen Yuen Ang, presents a different framework to conceptualize institutions and their link with growth. Ang has done extensive research on the political economy and development of China. In her much-heralded work, “How China Escaped the Poverty Trap”, Ang advances the argument that local institutions should be harnessed to kickstart localized growth processes.

The growth that ensues can be utilized to stimulate the development of new institutions which, in turn, will protect and sustain growth and markets. Since different countries start their growth journey with different institutions, their existing institutions are going to look different at any given time.

For instance, initially, China utilized personal networks of bureaucrats to attract investment in return for a share in profits. This will be termed an extractive bureaucratic apparatus by Acemoglu’s formulation. However, this very arrangement played an important part in China’s growth, ultimately becoming an economic superpower.

Institutions and Growth: The Case of Pakistan

Bad and extractive institutions are often held responsible for Pakistan’s economic troubles. Predatory bureaucracy — a relic of the colonial past — and the military’s incursions into civil affairs are highlighted as the main reasons for the arrested growth story of Pakistan. While there is truth to these arguments, the state-society dynamics, external shock events and geopolitical configurations, and colonial history must also be taken into account.

Asad Sayeed’s argument in “State-Society Conjunctures and Disjunctures: Pakistan’s Manufacturing Performance” can be rearticulated as: the initial phase of growth in a capitalist system depends upon intensive capital accumulation which requires a consensus between state and society with regards to the social and economic implications of this accumulation.

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Ayub Khan was successful in brokering this consensus as the key social groups were either complicit in the government’s designs or benefitted from them. Hence, the Ayubian regime was successful in creating growth-inducing institutions such as Pakistan Industrial Credit and Investment Corporation (PICIC), Industrial Development Bank of Pakistan (IDBP), and Pakistan Industrial Development Corporation (PIDC).

Asad Sayeed calls this the era of conjectural politics. However, in the late sixties, this consensus began to fall apart with the widening regional and class inequalities. This inequality was used by Bhutto and Sheikh Mujeeb-ur-Rehman to mobilize the masses against the Ayubian regime.

This fall of the Ayubian regime coincided with two developments: the resources were just beginning to be diverted to East Pakistan after years of exploitation, and the country’s large-scale manufacturers were at the cusp of making the transition to the manufacturing of intermediate goods after years of state patronage. The state-society disjuncture led to the unravelling of years of state investment and institutional backing.

External shock events and geopolitical configurations have also erected barriers in the path of economic growth. In the Ayubian regime, cold war politics contributed to the increased inflows of foreign aid and assistance. These inflows were used by the state to pacify the key social groups. Afterwards, the 1965 war with India led to the dwindling inflows of foreign aid. This development accentuated the social cleavages thereby derailing the growth process.

Colonial legacy in terms of its impact on constitutional and judicial politics, and social structures also have a significant bearing on the functioning of institutions. Put succinctly, good/inclusive institutions alone will not ascertain growth in Pakistan. If that were the case, the institutions from the Ayubian era would have been successful in doing so.

However, as later developments suggest, this did not turn out to be the case. Any growth strategy adopted by Pakistan has to consider how institutions interact and co-evolve with economic growth over time while being cognizant of state-society dynamics, external factors and historical entanglements.

Conclusion

The case of Pakistan brings to the fore the reality that institutions that can potentially kickstart growth must be localized, and cognizant of the socio-political realities and historical processes of the said country. There are no universally inclusive institutions. Different institutions matter at different stages of economic growth and in order to be instrumental, these institutions must interact and co-evolve with growth processes and socio-political realities over time.


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