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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.