Thursday, November 27, 2014

Good Governance and Economic Performance

BERLIN – The debate about emerging countries’ growth prospects is now in full swing. Pessimists stress the feared reversal of private capital flows, owing to the US Federal Reserve’s tapering of its purchases of long-term assets, as well as the difficulties of so-called second- and third-generation structural reforms and the limits to “catch up” growth outside of manufacturing. Optimists argue that the potential for rapid growth remains immense, owing to better macroeconomic fundamentals and the promise of best-practice technology spreading throughout the emerging world.

So who is right?

Recent events point once again to the importance of good governance and responsive political systems, a familiar topic in studies of long-term economic growth. Countries that appeared successful for a long time, such as Turkey or Thailand, suddenly seem to face obstacles related to governance and the ability to forge domestic political compromises. The resulting divisiveness and dysfunction are surely bigger threats than the Fed’s tapering.

It is the nature of governance that determines whether people deploy their talents and energy in pursuit of innovation, production, and job creation, or in rent seeking and lobbying for political protection. And here the contrast between Egypt and Tunisia may turn out to be an object lesson in what makes the difference between success and failure.

In Egypt, the old regime under Hosni Mubarak, having failed to democratize, collapsed in the face of massive protest. A low-turnout election gave a plurality of the popular vote to the Muslim Brotherhood, which came to power alone and proceeded to ignore good governance and alienate all except its most fervent followers.

The Brotherhood’s approach to governance also explains the mess it made of the economy. Instead of trying to build non-partisan and competent regulatory institutions, all positions were stacked with political followers. Unfortunately, the military intervention last July gave rise to yet another regime that seems unable to build durable institutions that could foster political reconciliation and deliver inclusive growth.

Tunisia may give us an example of the opposite scenario: a real constitutional compromise supported by an overwhelming majority (reflected in a 200-16 vote in the National Constituent Assembly). If that compromise holds, stability will take hold, markets will function, Tunisia will attract investment, and tourism will thrive again.

At the heart of the difference between the two cases is a vision of governance that makes such compromise possible. Such a vision presupposes an assurance that a winner-take-all system will not be established, as well as broad agreement that regulatory institutions should be reasonably non-partisan and staffed with competent professionals.

China’s long-lasting success is sometimes given as a counterexample to the importance of good governance for economic performance. The Chinese example certainly calls into question a strong correlation between multi-party democracy and economic growth.

Democracy is of course something valuable in itself and can be desired independently of its effect on economic growth. But, in the context of economic performance, it is important to emphasize that there is a huge difference between dictatorial regimes, where a single individual monopolizes all power – à la Mubarak or Syrian President Bashar al-Assad – and China, where there has been competition and contestability within a large communist party. And it is the party, operating as a fairly inclusive and meritocratic institution, not an autocratic leader, that has governed in the post-Mao period.

Lack of reasonably independent regulation and competent public administration – or, worse, one-person dictatorships – lead inexorably to economic waste and inefficiency, and eventually to political turmoil. This is true even in cases like Venezuela, where large oil revenues masked the underlying weakness for a while. In the complex global economy of the twenty-first century, sustained good economic performance requires a panoply of well-functioning institutions that do not fall within a single leader’s purview.

For example, successful economies require a reasonably independent central bank, and competent bank supervision that does not get dragged into short term politics. They also need regulatory agencies in sectors such as telecommunications and energy that can pursue policies in accordance with broad goals established by the political process, but with appointees selected according to nonpartisan criteria who then exercise their authority in a way that fosters competition open to all.

When credit decisions, public procurement, construction contracts, and price determination reflect only short-term and purely political goals, good economic performance becomes impossible – even in countries with large natural-resource endowments. In countries with little or no such endowments – where innovation, competitive efficiency, and a focus on production rather than rents is all the more important – the lack of good governance will lead to failure more rapidly.

All of this implies that analyzing the determinants of economic success is a subject not just for economists. Why do some societies achieve the compromises needed to sustain an independent judiciary and a modern regulatory framework – both necessary for an efficient modern economy – while others perpetuate a partisan, winner-take-all approach to governance that weakens public policy and erodes private-sector confidence?

The contrast is starkest in emerging countries, but differences also exist among the advanced economies. Perhaps Germany’s ability to reach sociopolitical compromise – again demonstrated by the formation of a right-left coalition after the 2013 elections – has been more fundamental to its recent economic success than the details of the fiscal and structural policies it has pursued to achieve it.

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    1. CommentedJason Gower

      Of course every developing (and developed) nation has a unique history, culture and institutions but in order to attract foreign investment I think it is fair to say that some level of political and social stability is expected by investors. This more or less implies some level of "good" governance or else these conditions would likely not be present.

      That said, I believe only time will tell if the Chinese brand of Communism is indeed an outlier to be separated from the dictatorial regimes highlighted, as in the end the impact on ordinary citizens is generally the same. Of course it works in times of solid growth and a generally increasing standard of living, this is true in most all cases. However, and especially given the rise of technology/social media/etc., it is near impossible for a nation the size of China to fully control all forms of media and ideas as was possible in the past. How many emerging economies have maintained growth on a trajectory that China has maintained over the past 20+ years with no hiccups? When those hiccups occur I'm not so sure that the scene will be any different than we have seen in the other nations mentioned; only on a much larger scale. From my perspective it seems inevitable. The question is then if the government will reshape itself and Chinese institutions before this happens.

    2. Commentedjames durante

      Compare this view of China with Min Xing Pei's article on extensive and intensive corruption in the Middle Kingdom. China combines the right mix of Confucian conformism and state terror, a docile and super-exploited working class, and a dynamic sense of national destiny to create sustained growth. What I am trying to say is that the author seems to be generalizing on an issue that resists generalization. Economic growth is much more complex than "good governance."

    3. CommentedZsolt Hermann

      Reading this article and following the actions, "solutions" applied in the global crisis all over the world, one has the feeling that we have lost something.
      It seems we have lost our aim, our whole purpose.
      We keep talking about economy, governance and all the variations of those but somehow we forgot for whom all these systems, tools are for.
      What should the economy and the governing structure serve?
      It seems we have lost the "baby" we all want to care for, and we are all arguing about this tool, that tool, this structure and that structure, all of which has become so much more important than the "baby" itself.
      We forgot the human being.
      We live in a human society, full of human beings and the primary objective of all or activities should be the well-being of these human beings.
      And today this human society has become global, interconnected and interdependent, whether we like it or not we have become a single family and we are all mutually responsible for each other.
      Our aim, our focus should be this global human family, their health, sustainable well-being and their sustainable future.
      How the economy and governing structure can safeguard this is secondary. But both the economy and the governance has spun out of control living its own existence, growing in self-importance, while the human being is trampled on the ground.
      And we seemingly do not understand why riots, uprisings and revolutions flare up from place to place and they do not seem to go away.
      I think if we get the primary aim right, if we focus on what is truly important everything else will fall into place.