Why Is Development Blocked?

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.

Why Is Development Blocked?

Raj Nallari

SECTION 6

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

inequal-ity 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

Par-adigm” 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 diff ering stages of growth As the lead

nation moves out of labor-intensive production to capital-intensive

pro-duction, its low-productivity production moves down the hierarchy and

the pattern repeats itself This model of comparative advantage described

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 Philip-pines, Indonesia, Thailand, and Malaysia, with China and Vietnam at the rear) (fi gure 6.1) The paradigm depended on the catalytic role of Japan as the lead nation It is diffi cult 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

fl ows, thus impeding the formation of both physical and human capital among the have-nots For example, Sachs (1989) fi nds that Latin American and Caribbean countries have higher income equality than other regions, and this is deterring their economic development Persson and Tabellini (1994) fi nd 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, Ace-moglu, Johnson, and Robinson (2002) estimate the eff ect of institutions on economic performance, based on diff erences 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

Figure 6.1 Regional Growth Poles

Source: Author’s illustration.

Japan

Newly industrializing economies

Association of Southeast Asian Nations

China Vietnam

unable to settle in these areas and thus concentrated on extracting as

much and as many of the resources as possible, without developing

insti-tutions 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 diff erent, however Even after

the demise of colonialis m, 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 diff erent 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

dimen-sions, compared with Islamic and Chinese civilizations; but

industrial-ization 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 effi cient, multilateral contracts

pre-vented 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 afi eld Bilateral

transac-tions did not enforce communal ties; therefore, the society had greater

need to build formal laws and regulations that eventually fostered

eco-nomic growth

Perennial Crisis in Governance Destabilizes Development

What do 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 fi rst 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, cor-porate governance problems are relatively recent With the industrial rev-olution 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 corpo-ration In the initial days of industrialization, the family-owned corpora-tion had family members on its board However, as the corporacorpora-tions became more complex over time, the board has occupied more a role of overseeing the management team (comprising chief executive and fi nan-cial offi cers) 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 provid-ing obfuscation In addition, more and more boards are stacked with insid-ers 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

fi nancial crisis is but one manifestation of this corporate crisis, where complexity is deliberately created in the name of fi nancial innovation that,

in turn, obfuscates information given to the board of directors, stakehold-ers, and the public

The crisis in corporate governance is compounded by public sector gov-ernance where politicians and bureaucrats are infl uenced by the large cor-porations State capture is defi ned by Hellman et al (2000) as the “propensity

of fi rms to shape the underlying rules of the game by ‘purchasing’ decrees, legislation, and infl uence 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 fi rms or richer elites (top 20 percent on the income dis-tribution 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

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 fi rms or accommodated

groups will go under or have no choice but to resort to “informality” or

“unoffi cialdom” and a “shadow fi nancial 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

cus-tomers and suppliers

Political development is blocked by the elites and powerful groups

Acemoglu and Johnson (2007) studies a number of countries and fi nds

that the movement from dictatorship or authoritarianism to democracy

is blocked by groups that benefi t from the status quo In such societies,

the reward structure favors the elites Only when there is outside

pres-sure (for example, from donors) or when the vast majority of citizens

take to the streets will there be some concessions made to ease

restric-tions, 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

account-ability) 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

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