Monday, November 24, 2014

Conflict Management and Economic Growth

NEW DELHI – One of the most interesting aspects of the prolonged economic crisis in Europe, and of the even longer crisis in Japan, is the absence of serious social conflict – at least thus far. Yes, there have been strikes, marches, and growing anger at political leaders, but protests have been largely peaceful.

While that may change, the credit for social peace must go to institutions such as elections (“throwing the rascals out” is a non-violent way to vent popular anger), responsive democratic legislatures, and effective judiciaries. All of these institutions have successfully mediated political conflict during a time of great adversity in advanced countries.

This suggests that a major reason for underdevelopment may be that such institutions, which allow countries to cope with distress, are missing in poor economies. Economic growth permits conflict between social actors to be papered over. A downturn, however, usually exposes or sharpens latent social tension.

Why do the benefits of growth seem to be easier to share than are the burdens of adversity? This is not a trivial question. Perhaps the answer lies in human psychology. If consumption is shaped by habit, an income loss is very hard to bear and one might fight to avoid it, while fighting for additional gain when one is doing well is less important. Also, because conflict may destroy growth opportunities, it may be seen as costlier when growth is strong. For example, squabbling between workers and management may drive away investors – and thus the chance to start new projects. But if there are no new investment opportunities on the horizon, squabbling is less costly, because the existing plant and machinery are already sunk costs.

Regardless of why conflicts are greater in times of economic adversity, how a society deals with them depends on the scope and quality of its conflict-management institutions. The Oxford University economist Paul Collier has shown that years of weak economic growth typically precede civil war in poor countries. Even after establishing peace, the probability that these countries will relapse into conflict is high.

Not surprisingly, these states typically have weak conflict-management institutions – patchy law enforcement, limited adherence to democratic principles, and few meaningful checks and balances on the government. Similarly, Dani Rodrik of Harvard University has found that the countries that experienced the sharpest declines in growth after 1975 had divided societies and weak conflict-management institutions.

Societies with well-functioning institutions allocate the burden of distress in predictable ways. For example, people who suffer the most adversity can fall back on an explicit social safety net – a minimum level of unemployment insurance, for example. In the United States in recent years, federal and state legislatures prolonged unemployment benefits as joblessness persisted.

Similarly, debtors and creditors can rely on credible bankruptcy proceedings to determine their relative shares. With an explicit institutional mechanism in place to dictate the division of pain, there is no need to take to the streets.

By contrast, when institutions are too weak to offer predictable and acceptable settlements, or to protect existing shares, everyone has an incentive to jockey for a larger slice of the pie. Outcomes will be mediated more by actors’ relative bargaining power than by pre-existing implicit or explicit contracts. Often, bargaining will break down. Everyone is made worse off by strikes, lockouts, and even violent conflict.

Can countries without a reliable and effective legislature or legal system do better to protect against downturns?

One answer may be to use arrangements that depend in a limited way on the legal system for enforcement. For example, labor contracts in many developing countries effectively prohibit employers from firing workers. This is regarded as inefficient because firms cannot adjust quickly to changing business conditions.

Often, such prohibitions are attributed to overly strong unions that hold the economy hostage. But, if slow or corrupt courts mean that a worker who is wrongfully dismissed has no legal recourse, perhaps the prohibition on firing – enforced by mass protests against violations, which are easily and publicly observable – is the only way to protect workers from arbitrary decisions by employers.

Job tenure may also serve as a form of social security, because the government performs miserably on providing a safety net and private insurance markets do not exist. Thus, an inflexible contract can protect workers when the preponderance of bargaining power is with firms.

Such inflexible arrangements are not without cost. In a downturn, too many firms will fail, because they cannot shed labor. Alternatively, knowing that they cannot fire permanent workers, firms may remain tiny in order to remain below the authorities’ radar. Or they may hire informal workers who have no rights, or pay inspectors to look the other way (a related point could be made about workplace safety in Bangladesh’s garment factories).

Thus, the attempt to protect workers with rigid labor laws may have the unintended consequence of generating too few protected jobs. This may be the situation in India, where most workers have few rights, and the few large firms that are established in the formal sector tend to use a lot of labor-saving capital in order to avoid hiring protected workers.

Change is not easy. Protected workers have no reason to give up their benefits. Moreover, removing rigid protections without offering alternative, contingent safety nets and judicial redress is a recipe for conflict. At the same time, some protection is better than none, and if most workers are unprotected, change becomes necessary to avoid even worse conflict.

Sustainable change in developing countries requires reforming not only specific arrangements, such as rigid labor laws, but also more basic institutions, such as the legislature and the judiciary, to make them more responsive to people’s needs. If developed countries’ citizens want to feel slightly better about their economies’ slow growth and high unemployment, they should contemplate how much worse matters could be without the institutions that they have.

The view expressed here are the author’s own.

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    1. CommentedVikas Sarin

      You are correct Raghu, it is the social conflicts that is leading to economic crisis. The external negative politics is affecting the work culture & environment by sprouting black intentions for each other. We are not having a Blue Ocean in this kind of environment and people re fighting for one dollar even. People are stopping the growth of others, creating win-lose situations-rat race. The labor law and legal system cannot work unless there would be standards and proper follow-up and legal govern ance. It will increase the corruptions and hegemony more. The Tower Of Babel cannot be created without standardized governance that is been difficult to execute than plan. Civil wars can increase the unemployment, block the creativity and block the growth & progress transcendentally. The formation of UN has stopped the WW III but the increased terrorism and smuggling cannot be stopped. One solution, stop manufacturing ammunition but how insecure would secure themselves. Basel III can be applied but effectiveness, efficacy and efficiency cannot be predicted.

    2. CommentedTerence Mathew

      Sir dont you also think this has nothing to do with poor economies, for instance lets take the case of India, is India a poor economy,we have all the three mentioned systems,its not functioning effectively The point is i dont think poor or rich economy makes a difference, politicians do.

      What are your thoughts Sir

    3. CommentedRajarshi Samuel Betha

      Hi Dr. Rajan, Insighhtful article but may I ask you a few questions please?

      Isn't a legal system only as effective as the enforcement systems that act decisively on legal judgements?

      Isn't the enforcement system's effectiveness affected by penalties for not adhering to duty (enforcement, i.e like a recursive function), funding and quality of support systems for the enforcement agency (e.g. how the FBI was built over the decades), extent of integrity/corruption in the system (or as a system), etc..

      Doesn't quality of enforcement or voluntary enforcement, (e.g. tax paying behavior in nordic countries vs say India) boil down to what a society or an individual wants from society/the nation - cooperative/good for all, or individualistic/free-for-all/basic-distrust-driven self-seeking behavior?

      While conquerors/occupiers (e.g. colonial settlers in North America) had to cooperate to conquer, the settlers/land-owners (read natives) often fought amongst themselves, and were a victim of their dividedness... Can you say confidently that you don't have a sense of deja-vu when you think of the tribes in African countries, or the Rajputs of pre-colonial India? While there were different means and methods of conflict resolution between these native kings and chieftains, wasn't the key missing ingredient unity, a unity in purpose?

      Conflict management is definitely essential, but digging deeper into the foundation of the psyche of development and growth, wouldn't you agree that a shared expectation of basic trust and cooperation to create development and systems is the key underpinning support towards the actual sustained realization of those goals?

      Now this may seem theoretical and impracticable, and perhaps a verbose reiteration of the basic prisoners' dilemma, but doesn't it atleast highlight that to build deeper roots one has to take a longer term approach to meeting the objectives, work towards building trust, etc., which may not necessarily be optimal in the short term...

      Your thoughts please.


    4. CommentedKarthik M

      I rather think, the burdens of adversity seem to be easier to share than the benefits of growth.
      i too agree with Frank O'Callaghan's comment.
      Though your argument is basically correct, but I think it doesn't provide a satisfactory answer to Frank's question.

    5. Commentedcaptainjohann Samuhanand

      It has nothing to do with prosperity but the location of the Industry and labour and also cultural melieu. In India we had the best paying Maruthi suzuki having the worst labour trouble which ended in violence.It is everything to do with its location in Haryana while the much more exploited labour in southern states had no comparable violence.Even King fisher Airlines and their staff being thrown to the streets and the Owner Vijay Mallayya enjoying his F1 and IPL circus, the labour kept their patience.West Bengal and Kerala which has one of the most protected labour in India are slowly learning their lessons just like China and Vietnam.Even within EU, every country is showing its individuality when adversity affects them.

    6. Commentedsrinivasan gopalan

      More than institutional backing to balance the pains of adjustment when times are tough, Rajan would have been more persuasive if he had adverted to abysmal lack of basic amenities to millions in India. Successive governments and political parties in India were only culpable for the palpable policy apathy they displayed in ameliorating the lot of legions of poor people across the country. It is time Rajan who is in the hot seat dispensing counsel to the mandarins in the Ministry of Finance and to his Harvard-educated Minister, focused on addressing fundamental concerns of illiteracy, ill-health and lack of basic sanitary conditions for millions of Indians so that they look forward to leading a decent living. The failure of growth to provide meaningful livelihood security and assured minimal income to millions in India may perhaps be the travesty of public policy in India down the decades. No amount of sanctimonious homilies such as inclusive growth and faster economic growth as is being pouted and trotted out by the ruling dispensation would help halve the misery of millions, leave alone assuage it!
      G.Srinivasan, Journalist, New Delhi, India

    7. CommentedProcyon Mukherjee

      The European system is more mature to deal with the burdens of adversity and no wonder they have better egalitarian societies that restrain the flaunting of wealth as a measure of prosperity. When the crisis struck in 2008-09, it was the German and Swiss system that immediately responded by sharing the pains of output gap by the “short-time work”, where the lost hours were compensated by the State and Management partially; permanent loss of jobs were minimal. This leads me to think that the way these countries and its institutions behaved in the crisis were in stark contrast to how U.S. corporations and the institutions responded.

      Quality of solutions to the problems of conflicts in the developed part of the world depends on the quality of human bondage that some nations display, in their ability to share and to sacrifice as opposed to selfish appreciation and concurrent abrogation of responsibility. The developing world on the other hand are still evolving their institutions where limits of democracy as a forceful change-driver is more than visible with the waning influence of political will.

    8. CommentedMukesh Adenwala

      It is possible that there are countries have effective legislatures and functional legal system but it is also possible that effective legislatures and legal system become affordable for countries that have had success in developed and who are now rich.

    9. CommentedMukesh Adenwala

      There may not be simplistic explanations, at least I do not have one. Perhaps insights of ethologist could be useful here. There are species where the in-group fighting is more widely prevalent and then there are other species where co-operation between the group members to fight `the other' is more prevalent. Over evolution, the latter group has had more success.

    10. CommentedMukesh Adenwala

      India is yet to find suitable investment model after failure of the avowed Public Sector visualized on the eve of independence.

    11. CommentedMukesh Adenwala

      Higher incomes and better safety nets in developed world must be giving economic freedom to workers there.